Proxy Advisors

What this chapter covers

This chapter carries 2 per cent of the III-A examination.

Learning Objective: After studying this chapter, you should know about Definition and Role of Proxy Advisors · Conflict of Interest and Disclosure Requirement for Proxy Advisers

23.1 Introduction

Regulation 2 (p) of Research Analyst Regulations, 2014 defines Proxy Advisers as "Proxy Adviser" means any person who provides advice, through any means, to institutional investors or shareholders of a company, in relation to exercise of their rights in the company including recommendations on public offer or voting recommendation on agenda items.

Which is the first review question — the answer is Proxy Advisors.

Three elements of the definition are worth marking. The advice may be through any means; the audience is institutional investors or shareholders of a company; and the subject is exercise of their rights in the company, expressly including recommendations on public offer or voting recommendation on agenda items.

Note where the definition lives — in the Research Analyst Regulations, 2014, not in a separate set of regulations of its own. That single fact governs most of this chapter.

What these firms actually do. Proxy advisory firms are independent research outfits that evaluate the pros and cons of corporate matters such as mergers, acquisitions, top appointments and CEO pay, which shareholders are expected to vote on in AGMs, EGMs or court-convened meetings.

Four kinds of corporate event are named — mergers, acquisitions, top appointments and CEO pay — which is the fourth review question: all of these.

These firms engage in heavy-duty analysis of the major actions that are put to vote and produce detailed reports advising shareholders on how they should swing to safeguard their interests. Proxy advisory firms charge fees to institutional investors and provide regular, independent voting recommendations on the companies that the latter own.

And their weight has grown: internationally, proxy advisers have become quite persuasive and large institutional investors have become reliant on their research.

Why they matter more in India now. Since the implementation of the Companies Act 2013 (the 'Act') and enhanced corporate governance standards under the Securities and Exchange Board of India (SEBI) (Listing Obligations and Disclosure Requirements) Regulations 2015, the role of proxy advisers has become more prominent. Their recommendations have been responsible for shaping increased disclosures, transparency and compliance with the best corporate governance practices by many listed companies in India.

23.2 Impact on corporate governance

Proxy Advisers assists in creating a positive impact on corporate governance and compliance culture. Six benefits are listed.

• i) Benefits to Institutional Investor. Institutional investor's managers have a fiduciary responsibility to vote in a manner that is in the best interests of their beneficiaries. It is an important and monumental task that happens during a very compressed timeframe, as shareholder meetings happen based on the calendar set by corporate law. Thus, proxy advisors help investors vote intelligently, especially when there is a time crunch to read and analyse a lot of data.

The compressed timeframe is the point. Meeting seasons cluster, and a fund holding hundreds of companies must vote on all of them within weeks.

• ii) Benefits to global investors. It is not always easy for global investors to have a complete understanding of all local market practices, across what may be highly diversified global investment portfolios. Proxy advisors prepare research reports that help global investors receive informed analyses and recommendations, taking into account local as well as global good practice principles.

• iii) Efficiencies of scale and non-duplication of effort. Instead of thousands of institutional investors doing the same primary research, there are efficiencies of scale if a handful of proxy advisors conduct the same and pass on the benefit of costs and specialisation to the investors. As proxy advisors review hundreds of companies across sectors, they are also able to provide a bird's eye view and deeper dive into the companies being researched.

• iv) Benefits to small investors. Many investors do not have the necessary resources or time to follow and closely analyse all shareholder meeting announcements and have access to all published materials on shareholder meetings, often published in local languages and/or at short notice. Proxy advisors serve as 'information gatherers' for them, providing full access to all relevant company meeting materials and disclosed information, as well as voting recommendations.

And a practice worth noting: many proxy advisors do not share detailed rationale which is reserved for their paid institutional investors while providing free recommendations to all investors without charge.

The recommendation is free; the reasoning is paid for.

• v) Better public disclosure by companies. Broadly, proxy advisors keep clients up to date with corporate governance developments, offering specialist insights. Proxy advisors have increased shareholder activism and pushed companies to adopt a high level of disclosures. It has led to higher rates of compliance with corporate governance codes and standards. They also encourage companies to improve the transfer of relevant information, increase issuer and market awareness of local and global best practices and contribute to improvements in corporate governance in specific and governance in general.

• vi) Easier translation and understanding of legal language. Proxy advisors collect and translate key materials, translating legal and accounting jargon into plain English and provide a consistent structure of relevant information across all companies in all markets. This allows shareholders to have a better understanding of the companies in which they invest, resulting in a positive impact on the relationship the company has with its shareholders.

And the change in behaviour this has produced: earlier companies considered obtaining shareholder's approval a mere procedural formality, however, they are now wary of the fact that entities are scrutinising their resolutions, particularly with the interest of minority shareholders in mind. Companies now take additional care in drafting their resolutions. Consequent to the reports of proxy advisors, the companies had to withdraw/amend resolutions put forth to the shareholders for approvals due to concerns raised by proxy advisors.

Resolutions withdrawn or amended — the practical measure of the influence.

The registered firms

Currently, Proxy Advisors registered with SEBI are as follows:

• i) Institutional Investor Advisory Services India Ltd (IiAS).

• ii) Stakeholder Empowerment Services (SES).

• iii) Institutional Shareholder Services India Pvt Ltd (ISSIPL).

• iv) Ingovern Research Services Pvt Ltd (IRSP).

Four firms — a small industry, which is precisely why point (iii) speaks of efficiencies of scale if a handful of proxy advisors do the work.

23.3 Internal controls and disclosures

SEBI regulates the activity of proxy advisers in India under SEBI Research Analyst Regulations, 2014. Under these Regulations, such entities are required to register with SEBI and comply with the provisions pertaining to formation of internal policies and procedures, disclosures in reports etc., code of conduct, maintaining a record of voting recommendations.

How the borrowing works: all provisions of Chapters II, III, IV, V and VI shall mutatis mutandis apply to proxy advisers. These are:

Chapter II Registration of Research Analyst

Chapter III Management of conflicts of interest and disclosure requirements

Chapter IV Inspection

Chapter V Procedure for action in case of default

Chapter VI Miscellaneous.

So the whole research analyst machinery applies — registration with SEBI, written internal policies, the limitations on trading and on publication, the disclosure requirements, the records preserved for a minimum period of five years, the annual audit, the compliance officer, and inspection and default procedures.

Qualification. The employees of proxy advisors engaged in providing proxy advisory services shall be required to have a minimum qualification of being a graduate in any discipline: Provided further that certification requirements for employees of proxy advisors engaged in providing proxy advisory services shall be as specified by SEBI.

A graduate in any discipline — a lower bar than the research analyst's own qualification requirements, because the work is governance analysis rather than securities valuation.

Two additional disclosures. The proxy adviser shall additionally disclose the following:

i. the extent of research involved in a particular recommendation and the extent and/or effectiveness of its controls and procedures in ensuring the accuracy of issuer data;

ii. policies and procedures for interacting with issuers, informing issuers about the recommendation and review of recommendations.

The first is unusual and important. A client is told the extent of research involved in a particular recommendation — whether this was a deep review or a policy-driven call — and how good the firm's controls are at ensuring the accuracy of issuer data.

Records. Proxy adviser shall maintain the record of his voting recommendations and furnish the same to the Board on request.

And a residual power: in case of any inconsistency or difficulty in respect of applicability of provisions of these regulations to proxy advisers, SEBI may issue such clarifications or exemptions as may be deemed appropriate.

Code of conduct: proxy advisor shall abide by Code of conduct prescribed under Third Schedule of SEBI Research Regulations, 2014.

23.4 Procedural guidelines

There are broad three key areas of conflict for Proxy advisors:

• 1) shareholding in the proxy advisor by a listed company or a group which has listed companies.

• 2) consulting assignments provided to companies who may, in turn, be scrutinised in the next shareholding meeting.

• 3) any other source of revenue or relationship (for instance inter-locking board positions) which poses a real or apparent conflict of interest.

Note the phrase "real or apparent." For an adviser whose product is an opinion on governance, the appearance of a conflict damages the product almost as much as the fact of one.

Regulation 24(2) read with 23(1) of SEBI (Research Analyst) Regulations, 2014 mandates proxy advisors to abide by the Code of Conduct specified therein, and SEBI circular of August 3, 2020, August 27, 2020 and December 31, 2020 prescribes compliance of following procedural guidelines.

a. Proxy Advisors shall formulate the voting recommendation policies and disclose the updated voting recommendation policies to its clients. Proxy Advisors shall ensure that the policies should be reviewed at least once annually. The voting recommendation policies shall also disclose the circumstances when not providing a voting recommendation.

Reviewed at least once annually, and the policy must say when the firm will not recommend at all.

b. Proxy Advisors shall disclose the methodologies and processes followed in the development of their research and corresponding recommendations to its clients.

c. Proxy Advisors shall alert clients within 24 hours of receipt of information, about any factual errors or material revisions to the report. Further, any such material revisions to their reports shall be communicated to the clients within 72 hours of receipt of the information, while ensuring that adequate time is available for clients to make an informed decision.

Two clocks — 24 hours to alert, 72 hours to communicate the revision — with the overriding requirement that adequate time is available for clients to make an informed decision. A correction that arrives after the vote is worthless.

d. Proxy Advisors shall have a stated process to communicate with its clients and the company.

e. Proxy Advisors shall share their reports with their clients and the company at the same time. This sharing policy should be disclosed by proxy advisors on their websites. Timeline to receive comments from the company may be defined by proxy advisors and all comments/clarifications received from the company, within the timeline, shall be included as an addendum to the report. If the company has a different viewpoint on the recommendations stated in the report of the proxy advisors, then proxy advisors, after taking into account the said viewpoint, may either revise the recommendation in the addendum report or issue an addendum to the report with its remarks, as considered appropriate.

Simultaneous sharing is the heart of the 2020 reform. The company sees the report when the clients do, may comment within a defined timeline, and its comments shall be included as an addendum to the report. The adviser then either revises or explains — but is not obliged to change its view.

f. Proxy Advisors shall clearly disclose in their recommendations the legal requirement vis-a-vis the higher standard they are suggesting, if any, and the rationale behind the recommendation of higher standards.

A crucial honesty rule. Proxy advisers often ask for more than the law demands. Where they do, they must say what the law actually requires, what they are asking for instead, and why.

g. Proxy Advisors shall disclose conflicts of interest on every specific document where they are giving their advice. Further, the disclosures should especially address possible areas of potential conflict and the safeguards that have been put in place to mitigate possible conflicts of interest.

On every specific document — not once on a website. Which is why the third review question, phrased as "Proxy Advisors shall not disclose conflict of interest on every specific document", is False.

h. Proxy Advisors shall establish clear procedures to disclose, manage and/or mitigate any potential conflicts of interest resulting from other business activities, including consulting services, if any, undertaken by them and disclose the same to clients.

Consulting services are named expressly — the second of the three conflict areas.

23.5 Grievance redressal between listed entities and proxy advisers

Regulation 4(2)(a) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 ('LODR') applies here. It casts certain obligations on listed entities to protect and facilitate the exercise of the rights of shareholders, including:

• a) right to participate in, and to be sufficiently informed of, decisions concerning fundamental corporate changes.

• b) opportunity to participate effectively and vote in general shareholder meetings.

• c) effective shareholder participation in key corporate governance decisions, such as the nomination and election of members of the board of directors.

• d) exercise of ownership rights by all shareholders, including institutional investors.

And the proxy adviser's place in that scheme: proxy advisors, over the past few years, have played a key role in enabling shareholders to effectively participate in corporate governance decisions and thus, furthering the achievement of the above objectives.

But disagreement is inevitable. Due to the inherent nature of the work, it is probable that proxy advisors and listed entities may have different views on any agenda item of the listed entity leading to grievances.

The route. In order to facilitate resolution of such grievances of listed entities against SEBI registered proxy advisors, the listed entities may approach SEBI. SEBI will examine the matter for non-compliance by proxy advisors with the provisions of the Code of Conduct under regulation 24 (2) read with regulation 23(1) of the SEBI (Research Analyst) Regulations, 2014 and the procedural guidelines for proxy advisors issued by SEBI.

To SEBI — the second review question.

And note carefully what SEBI examines. Not whether the recommendation was right, but whether there was non-compliance by proxy advisors with the provisions of the Code of Conduct... and the procedural guidelines. A company that dislikes the conclusion has no remedy; a company that was not given the report at the same time as clients, or whose comments were not carried as an addendum, does.

The chapter's review questions confirm four things:

• A person advising institutional investors on the exercise of their rights, including public offers and voting recommendations, is a proxy advisor.
• A listed entity with a grievance may approach SEBI.
• It is False that proxy advisers need not disclose conflicts on every specific document.
• Mergers and acquisitions, senior management appointments and CEO compensation are all of these evaluated by proxy advisers.