Regulation of proxy advisers in India: is it a threat to shareholder activism?

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Kritika Agarwal
Majmudar & Partners, India
kagarwal@majmudarindia.com

Introduction

In August 2018, domestic and international proxy advisers recommended that shareholders vote against the reappointment of three directors to the board of a leading Indian private sector bank. As the directors in question included the founder of the bank and other industry stalwarts, the voting recommendation drew significant flak. Two out of the three directors backed out of the voting process while the founder director was reappointed with a very small margin. Following this incident, several industry experts called for greater regulation of proxy advisers, who in this case were, primarily, international companies not in a position to understand the Indian business model of promoter-run businesses and susceptible to formulating voting recommendations on the basis of standard policies applicable to United States-listed companies.

In India, domestic proxy advisers have been subject to the Securities and Exchange Board of India’s (SEBI) regulations since 2014. However, based on the foregoing incident, in November 2018, the SEBI constituted a committee to review the 2014 regulations applicable to proxy advisers and to recommend changes. The committee issued its report to the SEBI in May 2019, and on 3 August 2020, the SEBI released revised compliance guidelines for proxy advisers, which will take effect on 1 January 2021.

Existing regime

Under the existing regime, domestic proxy advisers are treated on par with research analysts and are, therefore, required to:

• register with the SEBI;

• meet the specified qualifications, eligibility criteria and capital adequacy norms;

• adopt internal policies and procedures for the identification, prevention and resolution of conflict of interest;

• comply with the prescribed code of conduct; and

• publish policies and research methodologies for voting recommendations.

New procedural guidelines for proxy advisers

The new guidelines, some of which appear to be clarificatory in nature, require proxy advisers to:

• formulate and disclose voting recommendation policies and review such policies on an annual basis;

• include, in the voting recommendation policies, instances in which the company will not provide a voting recommendation;

• disclose research methodologies and processes followed while assessing voting recommendations;

• alert clients of any factual errors or material revisions to the voting recommendation within 24 hours of the receipt of information;

• develop a communication process for clients and listed companies as well as a sharing policy;

• share voting recommendations with clients and the listed company at the same time;

• revise the voting recommendation or provide an addendum to the voting recommendation upon receipt of a different view from the listed company than that stated in the voting recommendation report, as considered appropriate;

• disclose to clients if the voting recommendation entails a higher standard than that required by law, and the reasons for such a recommendation;

• disclose conflict of interest on every specific document while giving voting recommendations, and address possible areas of potential conflict and safeguards put in place to mitigate possible conflicts of interest; and

• establish clear procedures to disclose, manage and mitigate any potential conflicts of interest resulting from other business activities.

Grievance redressal mechanism for listed companies

In addition, the SEBI has established a grievance mechanism pursuant to which a listed company can approach the SEBI with any complaints against proxy advisers. Upon receipt of the complaint, the SEBI will examine if the proxy adviser has been in breach of the applicable guidelines and take necessary action. The grievance mechanism will also take effect from 1 January 2021.

Is the SEBI overregulating proxy advisers?

While discussing the implications of the new guidelines, it is important to highlight that India currently has only three domestic proxy advisory companies. They are: (1) Stakeholders Empowerment Services; (2) InGovern; and (3) Institutional Investor Advisory Services. The SEBI has remained silent on regulating foreign proxy companies like Institutional Shareholder Services and Glass Lewis, who actively advise on Indian listed companies, especially those who have American Depository Receipts (ADRs) listed on US stock exchanges.

Interestingly, the new SEBI guidelines appear to borrow heavily from the US Securities Exchange Commission’s (SEC) listed amendments extending oversight on proxy advisers, which were issued in July 2020. The SEC has introduced requirements to ensure that the subject company is provided with a copy of the voting recommendation report at the same time as the proxy adviser’s clients, and it has also adopted policies for the sharing of voting recommendations, research methodologies, and disclosure and mitigation of conflict of interest.

However, two major points of difference are as follows: (1) the SEBI has expressly required proxy advisers to incorporate an addendum or revise voting recommendations upon receipt of a different view from the subject company. In doing so, the SEBI has ensured that the shareholders are informed of the response or view of the subject company through the proxy adviser and has put the onus of this on the proxy adviser. On the other hand, the SEC has chosen to be more reasonable on this aspect and limited the requirement for proxy advisers to include a weblink listing the response received from the subject company; (2) the SEBI has made it mandatory for proxy advisers to justify if their voting recommendation is based on a higher standard as opposed to the legal requirement. It is a well-known fact that proxy advisers’ voting recommendations often seek to impose higher standards as compared to requirements under law with a view to improve the corporate governance standards of companies.

Most of the other requirements imposed under the SEBI’s guidelines appear to be clarificatory in nature, as they currently exist in one form or the other in the SEBI’s regulations which govern research analysts.

Overall, the SEBI has also acknowledged the important role played by proxy advisers in encouraging shareholder activism and improving corporate governance standards in listed companies. However, with the new guidelines, the SEBI is seeking to ensure that shareholders receive information from both – the proxy adviser as well as the listed company – and are able to make an informed voting decision. The SEBI has adopted a light hand in regulating proxy advisers and has, mostly, left it to the discretion of the proxy adviser to adopt adequate policies, procedures and safeguards to mitigate incorrect voting recommendations and conflicts of interest. By providing a mechanism for Indian listed companies to approach the SEBI for any grievances with proxy advisers, the SEBI has also ensured that proxy advisers are careful in providing voting recommendations. That said, it is hoped that the SEBI will only take action if a proxy adviser has defaulted in complying with the regulations or its internal policies, and does not unduly question the voting recommendation, which is merely an opinion of the proxy adviser.

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