BY ABHIRAJ DAS, FOURTH YEAR STUDENT AT GNLU, GANDHINAGAR
In the past few years, there have been some striking recommendations and red-flags being given by “proxy advisors” regarding corporate-governance of some of the leading incorporates of India. A few instances can be red-flagging the 35-years-long tenure of RIL’s auditors, or recommendation in the Tata-Mistry skirmishes. Very recently, in Crompton-Greeves Power, a huge value depreciation for minority shareholders owing to the issues of corporate governance & conflict of interest of independent director was highlighted.
What are Proxy advisory firms?
Proxy advisory firms are independent analyst offering analysis and voting recommendations to the institutional shareholders and investors. Securities and Exchange Board of India (SEBI) defines proxy advisors as “a person who provides advice in relation to the rights of the shareholders and investors including recommendations on public offer or voting on agenda items.” The term “proxy-advisory” originates from the concept of “proxy voting” where shareholders authorizes other person to vote on his/her behalf, and offer services related to proxy-voting by aggregating-and-standardizing information.
It is a gospel truth that shareholders do not pay much attention to the voting in the AGMs or EGMs. In large public listed companies, public shareholders have relatively small stakes and there remains a collective-action problem and “shareholder-apathy” which lead them to vote as per the vox populi, and institutional investors like mutual funds, banks, DFIs, insurance companies, etc. cannot possibly make an well informed decisions in such voting owing to the huge-number of stocks they handle. Proxy advisory firms (PAF) undertake heavy-data researches and analyse the major agendas which are subjected to voting, providing detailed reports on voting to strengthen the corporate governance within the company.
The recommendations by these independent and expert firms have tendencies of de-stabilising (or re-stabilising) management and raise corporate governance standard as these advisories may be related to voting against re-appointment of independent directors, auditor’s appointment, M&A and corporate structuring where there seem possibilities that public shareholding might erode, and thus, have become important corporate intermediaries. While proxy advisories in India are still at nascent stage, the American ISS deal with around 44,000 meetings in 115 markets yearly to execute more than 10.2 million ballots representing 4.2 trillion shares. A recent study has shown that around 83% of ‘vote against’ recommendations include mainly “reappointment of non-executive directors” and “remuneration of statutory auditors”.
Issues concerning the PAF
In addition to the potentially huge impacts these firms have, there are several downsides as well. Sometimes, simultaneously these firms also offer voting advices to the shareholders of the same companies to whom they provide corporate governance recommendations which leads to conflict of interest. There are conflicts also when the key managerial persons of proxy firms hold important positions in the subject companies. Another major concern is that these advisory firms are not subjected to fiduciary duty to show that their recommendations are in the best interest of shareholders and the corporations. Independent study has shown that ratings used by these firms do not accurately foretell subject’s performance. Further, there have been diametrically opposite opinions on the same issue. Concerns are also there that they sometimes provide distorted recommendations to further their own interests. Another issue is that even when any error is highlighted they have not always been rectified.
Recent Regulatory Developments in the US
The Concept-Release of 2010 by the US Securities and Exchange Commission had raised concerns inter alia regarding the influence proxy advisors had over their clients “without appropriate oversight” or “an actual economic stake in the issuer”. Amendments have been adopted by SEC allows investors utilising proxy voting advice to receive “more transparent, accurate, and complete information on which to make their voting decisions.”
In July 2020, Exchange Act Rule 14a-1(l) has been amended to include if a person (includes entity) offers proxy advises, it shall constitute as “solicitation” under s. 14a and that such persons shall be generally required to file and furnish information regarding definitive proxy statements. Further, paragraph ‘A’ is inserted to Rule 14a-1(I)(1)(iii) clarifying that the terms “solicit” and “solicitation” include any proxy voting advice.
Addressing the issue of conflict-of-interest, amendment has been made to Rule 14a-2(b) which now obligates that proxy-voting recommendations includes the conflicts-of-interest disclosure specified in new Rule 14a2(b)(9)(i). Further facilitating informed decision-making by the clients of such advisors, a new Rule 14a-2(b)(9)(ii) has been adopted which requires that “proxy voting advice business” adopt and publicly disclose written policies and procedures. This new term provides flexibility to cover future business models which may engage in type of advice the rules aims to address, and does not merely base upon the businesses which presently provide such services. It has also been provisioned that the registrants i.e. the subject companies shall also be provided with the report of the voting-recommendations under Rule 14a-2(b)(9)(ii)(B). Para ‘E’ has been inserted to Rule 14a-9 to define the scope of ‘misleading’ which means “the failure to disclose material information regarding proxy-voting-advice, such as the business’s methodology, sources of information, or conflicts-of-interest.” Adoptions of these amendments addresses the different concerns with the proxy firms.
Recent Regulatory Developments in India
SEBI brought SEBI (Research Analyst) Regulations, 2014 within a few years of the advent of the industry in India. The Regulation requires such entities to register with SEBI and lays down internal policy, and also imposes a fiduciary duty to offer detailed disclosures if required. Further, firms must proffer unbiased advice based on reliable information. Under regulation 23, they are also required to disclose the reasoning to the public. An eight-point Code-of-Conduct for firms and their employees has been adduced which broadly covers honesty & good faith, diligence, conflict of interest, insider-trading or front-running, confidentiality, professional standards, compliance, and responsibility of senior management. Recently, SEBI has introduced Procedural Guidelines for Proxy Advisors and Grievance Resolution between listed entities and proxy advisors. These circulars are the result of SEBI Working Group which recommended improvements through disclosures of conflict-of-interests, voluntary best practises, setting up code-of-conduct which are to be followed by proxy advisors on “comply or explain” basis. One of the remarkable procedures required is that the firms must also share the recommendation to the subject company as well and to include company’s response thereto as addendum. This will allow subjects to clarify on any aspect which it considers have not been completely regarded while extending the proxy recommendations.
It is very much evident that the circulars issued by SEBI are similar to the US SEC issued Rule Amendment for Proxy Voting Advice 2020 in various terms such as affording subject companies a copy of the recommendation, client access to company response, conflict of interest disclosure norms, etc. However, given the fact that Indian industry for proxy advisors is still at nascent stage, and the US market is relatively aged, it was prudent only on the part of the regulator to consider the US model. The advisory firms are required to disclose the recommendations on their website and are mandated to devise policies for voting advices including the situations when voting-recommendations are not to be offered. These policies are required to be reviewed at least once a year.
It is pertinent to note that there is no specific mention about foreign proxy-advisory-firms in either of the circulars, thus it will be interesting to observe how the code-of-conduct, as was recommended by the Working Group, are applied to them. Another interesting aspect is that compulsory disclosures of revenue models, key income-sources, clientele have not been provisioned. Since there is a possibility of conflict-of-interest in situations where the firms may retaliate against the incorporates who didn’t avail their services by way of aggressive advices to their clients, though proxy advisors are required to disclose and mitigate any “potential” conflicts, the disclosures of the clientele could have offered reassurance against such recommendations. However, in case of any grievance the listed entities are at liberty to approach SEBI which shall investigate the matter considering non-compliance with regulation 24(2), which provides for Code-of-Conduct, r/w regulation 23(1) of SEBI (Research Analyst) Regulations, 2014 or the procedural guidelines circular recently issued. If any contravention is established, it can lead to inter alia suspension/cancellation of the registration under SEBI (Intermediaries) Regulations, 2008.
Shareholder’s votes have the potential of wide consequences on corporate decisions and governance of a company which in turn affects the market and economy ultimately. Therefore, there lies a fiduciary responsibility upon the institutional investors, who represent large number of shareholders, to vote in the best interest, and attributes a huge relevance to the recommendations made by the proxy-voting advisors. The extensive impact such recommendations may have and the possible conflict-of-interest which may arise are the major reasons for regulating these proxy-advisors.
Having higher standards of transparency and oversight will certainly enhance the quality and credibility of this intermediary. These various aspects would require that investors take the ultimate decision based on the proxy advices and the company’s responses thereto, which would lead to more-informed exercise of voting rights and at the same time ensure that proxy advisors do not ‘control’ the voting. This sector needs nurturing at the hands of regulators & this could prove to be a major step. But time will only tell how these rules perform.