This article analyses the law governing the operation of proxy advisors in India, and advocates for the strengthening of regulation to ensure that proxy advisors adhere to the highest standards and are held accountable for their recommendations.

Proxy advisory services are becoming increasingly prevalent in India with institutional investors relying on their recommendations when exercising their voting rights in listed companies. As a result, proxy advisors’ recommendations are beginning to influence the actions of listed companies. Illustratively, the Avantha Group had modified a restructuring plan for Crompton Greaves after investors and proxy advisors opposed the shareholding structure contemplated by the original plan. Recently, IiAS, a proxy advisory firm, approached SEBI to intervene in the proposed issuance to stock options to Paytm’s founder and CEO, Vijay Shekhar Sharma.

Proxy advisors’ reports can be useful tools for investors as their recommendations and findings are based on research on the proposals presented by listed companies to their shareholders. Shareholders may, therefore, make informed decisions without undertaking research themselves. In addition, proxy advisors generally hold companies to higher corporate governance standards than those mandated by law, and, in theory, encourage greater transparency.

Although proxy advisory services are gaining popularity globally, they are largely unregulated. The Securities and Exchange Board of India (SEBI) has adopted a light-touch approach to regulating proxy advisors in India. However, the absence of stringent standards and a detailed framework has led to several concerns amongst listed companies and their majority shareholders.

The Regulatory Framework

In India, proxy advisors are regulated by SEBI through the SEBI (Research Analysts) Regulations, 2014 (SEBI Regulations) and certain SEBI circulars.

Registration

Indian proxy advisors – i.e. persons who provide advice to institutional investors or shareholders of listed companies in relation to their exercise of their rights in the company including recommendations on public offers or voting recommendations on agenda items – must register with SEBI.

Foreign proxy advisors that intend to provide proxy advisory services in respect of Indian listed companies, or Indian companies that are to be listed, do not need to register with SEBI. Instead, they must enter into an agreement with a SEBI-registered proxy advisor in India when providing such services. As a result, foreign proxy advisors may operate in India with relative impunity, and are not required to demonstrate minimum qualifications and, or, India-specific expertise.

Qualifications and Eligibility

SEBI-registered proxy advisors do not need to have any specialist qualifications, and may operate on the basis of a bachelors’ degree in any discipline. Where the proxy advisor is an entity, the individuals employed by it to provide proxy advisory services must satisfy this minimum qualification requirement.

The SEBI Regulations do not require that Indian proxy advisors have any expertise in business, commerce, economics, finance, accountancy, law, etc. As a result, proxy advisors may make recommendations on matters that they are not technically qualified to opine on.

Conversely, SEBI requires that investment advisors have: (i) specialised educational qualifications; and (ii) a track record of activities relating to advice in financial products or securities or fund or asset or portfolio management.

The services provided by investment advisors and proxy advisors are not dissimilar – investment advisors analyse companies prior to investment in, or exit, from a company, while proxy advisors analyse companies during the tenure of a person’s investment in a company. In both cases, this may amount to strategic advice on investments. Given the strategic nature of advice provided by investment advisors and proxy advisors, proxy advisors should, at minimum, be required to have the same qualifications as investment advisors.

Proxy advisors should also be subject to the same capital adequacy or net worth requirements as investment advisors. However, the capital adequacy or net worth requirements for proxy advisors are significantly lower than those prescribed for investment advisors.

Reports

When issuing reports, proxy advisors are required to take steps to ensure that the facts mentioned are based on reliable information. The recommendation policies that they follow when issuing their reports must be publicly disclosed.

At present, there are no restrictions as to the matters in respect of which proxy advisors may make recommendations (e.g. M&A transactions, internal restructuring, disputes, etc.). Although the Working Group on Issues of Proxy Advisors constituted by SEBI (Working Group) had considered (i) this issue; and (ii) and stakeholder representations that proxy advisors do not have the requisite expertise to opine on opine on such matters; in its 2019 report (Working Group Report), the Working Group ultimately concluded that “…there is no reason to restrict the areas of analysis for a proxy advisor based on the evidence available…”.

The quality of proxy advisors’ analysis is necessarily dependent on their expertise. For instance, if a proxy advisor is making recommendations against the adoption of annual financial statements, they should, ideally, have expert knowledge regarding accounts and accountancy, the industry of which the listed company is a part, and macroeconomics. However, it is often unclear whether the proxy advisor does have the necessary expertise, particularly as the SEBI Regulations do not require the publication of the qualifications of the individuals engaged in the preparation of the report.

While proxy advisors must provide the rationale for their recommendations, and publish their voting guidelines, the merit of, and, or, rationale for, their recommendations are not often clear. In the past, proxy advisors have recommended voting against the adoption of annual accounts seemingly on account of minor violations such as the failure to publish the standalone accounts of a subsidiary on the listed company’s website.

In 2021, IiAS came under scrutiny from some quarters pursuant to their recommendation against the appointment of Rama Kirloskar as joint managing director of Kirloskar Brothers Limited citing her lack of track record. However, when it was highlighted that they had been in favour of the appointment of individuals with similar track records in the case of other companies, IiAS sought to distinguish their recommendation against Ms. Kirloskar’s appointment by pointing out that she was neither a founder, nor a first-generation entrepreneur without explaining how these factors would render her unqualified to hold the position to which she was being appointed.

Correction or Modification

Companies often disagree with proxy advisors’ recommendations in respect of their voting agenda and, or, share issuances. As a result, SEBI, through Procedural Guidelines for Proxy Advisors issued on 3 August 2020 (Procedural Guidelines), has mandated that proxy advisors:

a. Share their reports with their clients and the company simultaneously;

b. Should define the timelines within which the company must comment on the recommendations; and

c. Circulate the comments or clarifications received from the company as addenda to the report along with the proxy advisors’ revised recommendations and, or, comments, if any.

Proxy advisors are required to alert their clients of any factual errors in, or material revisions to, their reports within 24 hours of receiving information.

The issuance of corrections through addenda is not ideal as clients and, or, other shareholders may not access the addenda, and the report with the erroneous recommendations or facts would continue to be the primary document to which they refer.

Conflicts of Interest

Proxy advisors often provide other services such as corporate governance advisory and environmental, social and governance (ESG) advisory services, and are not restricted from providing such services to companies in respect of whom they issue proxy advisory reports. The Procedural Guidelines instead mandate that proxy advisors:

a. Disclose conflicts of interest (existing or potential), and the safeguards implemented to mitigate these in every document in which they provide advice; and

b. Establish procedures to disclose, manage and, or, mitigate potential conflicts of interest from their other business activities.

However, conflicts of interest are usually disclosed only in proxy advisors’ reports and not on their websites where the recommendations (without rationale) are often disclosed.

In any event, the fact that a proxy advisor may issue recommendations in respect of a company with whom they have a monetary relationship is a cause for concern.

Grievance Redressal

Previously, listed companies could only seek redressal against proxy advisors through litigation. On 4 August 2020, SEBI issued a circular permitting listed companies to approach SEBI with grievances against proxy advisors. On receiving a grievance, SEBI will examine whether the proxy advisor has breached the SEBI Regulations and, or, the SEBI-mandated code of conduct for registered proxy advisors. The circular does not mandate: (i) a timeframe for processing of grievances; or (ii) the publication of SEBI’s decisions in the matter. Thus far, SEBI has not published any information as to grievances raised and, or, addressed in connection with proxy advisors.

Gaps in Regulation

Proxy advisors appear to pride themselves on recommending that companies adopt higher corporate governance standards than those mandated at law. However, too often, there is little evidence to support that these standards have a demonstrable positive impact on the management of companies.

While complete reports are usually behind a paywall, most proxy advisors make their recommendations on voting agenda (without the rationale) available to the public at no cost. Public shareholders who have access to the recommendations without the rationale, or details of the proxy advisor’s conflicts of interest, may vote in accordance with the recommendations without evaluating whether the proxy advisor’s rationale: (i) adequately supports their recommendations; or (ii) may be influenced by their relationship with the listed company. The relatively high cost of procuring the full report from a proxy advisor may prove to be prohibitive and most public shareholders are, therefore, unlikely to be able to understand the context in which the relevant proxy advisor has made their recommendations.

Concluding Comments

Given the role that proxy advisors play and the impact that they may have on the decisions of listed companies, the regulatory framework for proxy advisors should be strengthened to ensure their

independence and the underlying premise of their recommendations. Ideally, the SEBI Regulations should be amended to better protect the shareholders who rely on proxy advisors, and the listed companies that may be impacted by their reports.

To the extent that foreign proxy advisors are permitted to operate in India, they must be required to register with SEBI. Further, all proxy advisors – Indian or foreign – should be: (i) required to hold higher qualifications – ideally in the fields of finance, accountancy, business management, commerce, economics, financial services, markets or law; and (ii) proscribed from opining on matters that require specialised training unless they can demonstrate that the individuals making such recommendations have the requisite qualifications to do so. The qualifications of the individuals involved in preparing the report should be disclosed in the report.

Proxy advisors should be proscribed from issuing reports in respect of companies to whom they provide other services and, or, their group companies. In addition, where proxy advisors publish their recommendations (or summaries of their recommendations) on their websites, these should be accompanied by details of their conflicts of interest, if any.

Corrections to reports – whether pursuant to new facts or clarifications from companies – should be disseminated through a revised report from which the erroneous information has been removed rather than through an addendum. Proxy advisors should also be required to publicly disclose: (i) every instance in which they issued corrections to their recommendations; and (ii) the track record of their recommendations showing the number of occasions on which resolutions were passed or defeated in consonance with their recommendations. This is similar to merchant bankers being required to disclose their track record vis-à-vis pricing of IPOs in offer documents.

To the extent that proxy advisors make their recommendations available to the public, they should be required to publish a summary of the rationale at no cost to ensure that investors have access to all relevant information.

SEBI should also institute a comprehensive grievance redressal mechanism which: (i) prescribes timelines for disposal of grievances; (ii) provides for the publication of SEBI’s decisions and rationale when disposing of grievances; and (iii) requires proxy advisors to publish details of grievances.

Strengthening the SEBI Regulations in this manner would improve investor confidence in proxy advisors, may encourage investors to place greater reliance on their recommendations, and would also strengthen the capital markets and securities law ecosystem.