The requirements of transparency warrant a complete disclosure at the commencement of this newsletter. The facts contained hereinbelow relate to my election as a Non-Executive Non-Independent Director (NENID) for a second term on the Board of a listed entity. However, this newsletter is not about me, but about the role and functioning of Proxy Advisory Firms (PAFs), and their influence and impact on the corporate world.

I was elected as an NENID, with the support of 83.1% of the shareholding voting in favour of my reappointment. This was inspite of negative recommendations by 3 PAFs which strenuously argued that my candidature should not be supported.

Since issues are what need to be focused on, it is appropriate to get to grips with all the objections raised, the responses of the company, and the provisions of law and regulations.

One PAF, while not commenting on my fitness to be appointed as an NENID, chose to reclassify as a Non-Independent Director (NID) an Independent Director (ID), who had been re-elected only a year before, on the ground that the firm that she belonged to received payment for services rendered to the company. This PAF, which is US based, decided on the basis of its own guidelines that “where the payment for services during a year exceeds USD 10,000, the Director concerned will be classified as an NID”. Using this methodology, which is inconsistent the SEBI LODR Regulations and the provisions of law, the PAF decided to categorise a woman ID as an NID. Since she was, and is, the only woman Director on the Board, such reclassification by the PAF resulted in the Board not having, in the opinion of the PAF, any woman ID. Based on this questionable premise, the PAF concerned concluded that the composition of the Board was not in accordance with the regulations, and decided to vote against a second term for an NENID, on the ground that he was a member of the Nomination and Remuneration Committee (NRC). In the opinion of the PAF, he was the senior most member of the NRC. How they arrived at this conclusion is itself questionable. The larger question is whether a person categorised as an ID, consistent with the definitions of law and regulations, can be casually re-categorised by a PAF as an NID. Can the internal guidelines, for what they are the worth, of the PAF, override statutory and regulatory prescriptions? This is not a case of additional prescriptions, but overturning the definition contained in law and regulations. If this is allowed to pass unquestioned, the regulations and laws will lose their meaning and relevance. As for the limit of USD 10,000, it might have been determined based on facts and circumstances obtaining in the USA. There can be no case whatsoever for extrapolating such internal guidelines relating to another jurisdiction, and attempting to torpedo in the process, the re-election prospects of an NENID.

The second PAF recommended against the reappointment of the NENID concerned on the ground that “he failed to discharge his duties in a fair and impartial manner”. In arriving at this conclusion, the PAF relied on the order passed by SEBI in the Settlement proceedings relating to the company in 2022. The PAF conveniently failed to notice that a Settlement Order is based on the premise that the company neither admits nor denies any alleged wrongdoing which has been referred to in the notice issued to the company. If there is no admission of any wrongdoing by the company, and if such non-admission is a basic feature of the Settlement Order, and in fact, the entire Settlement system, it would seem inappropriate to refer to the allegations contained in the notice, and to presume that those allegations had been established. What is also relevant is the fact that this matter was raised by the same PAF in 2022, and notwithstanding a clarification provided at that point in time, the PAF had decided to recommend against supporting the resolution proposing the appointment for the first time of the person concerned as an NENID. Considering that he has been an NENID for the previous 3 years, it is passing strange that a conclusion which had no basis even in 2022, would be reiterated in 2025 in the context of reappointment. It is fanciful for the PAF to conclude that the person concerned failed to discharge his duties in a fair and impartial manner. Such a conclusion questions the basis on which the Settlement Scheme has been implemented. Since it is improper to comment on the Settlement Order, no such attempt is being made.

The third PAF recommended against the appointment of the NENID on the ground that no cooling off period of 1 year was served during his transition from ID to NENID. The term of the person concerned as ID ended in 2022. Regulations do not provide for a cooling off period in the case of persons who are moving from the independent category to the non-independent category. This is unlike the provision of a cooling off period for persons moving from non-independent category to the independent category. The provision of regulations is very clear on this account. If at all there was any merit in the contention of the PAF, it should have been raised in 2022 when the person concerned moved from being independent to being non-independent. Even at that time, there would have been no merit in asking for a cooling off period since the regulations did not contemplate any such requirement. It is strange that after the person concerned had served a 3 year term as NENID, the question of cooling off is being raised, when what is being sought by the company is a second term as an NENID, namely in the same category in which the person served during the 3 preceding years. The PAF has gone on to suggest that not serving a cooling off period may raise questions over the independence of the person during his tenure as an ID. This question has no relevance considering the person has served as an NENID for the preceding 3 years. Even earlier, if there was any such concern, SEBI would have addressed it through appropriate provisions in regulations. In support of the PAF, it must be stated that the firm reiterated “that the proposal is compliant with law” and added that the concern is based on the PAF’s governance policy stance. This again raises the question whether a PAF’s “governance policy stance” should override the provisions of law and regulations. The firm has also fairly stated that the shareholders may take note of the company’s response and the PAF’s comments thereon, and take an informed decision.

There are several other matters in respect of which the PAFs tend to second-guess the Regulators. For example, SEBI prescribes that a person can be a Director on the Board of a maximum of 7 listed entities. It has been noticed in the past that where a person is a Director on 5 such entities, the PAF(s) recommends against the appointment of such a person, thereby second-guessing the Regulator on the number of directorships a person can have in listed entities.

The focus hitherto in this newsletter has been on the stand taken by PAFs and their not being consistent with the provisions of law and regulations. What is equally disturbing is the fact that some corporates tend to go strictly by the advice of PAFs, and do not apply their minds to the resolutions in question. The standard explanation seems to be that they do not have enough time to go into the merits of the resolutions, and therefore go entirely by the recommendations that they have received from the PAFs. This is as clear a case of outsourcing judgement and decision-making, as can exist in the corporate world or elsewhere. At one level, it is also a failure of the corporates to discharge their responsibilities towards their stakeholders by taking informed decisions, rather than by rubberstamping on recommendations which might not be tenable. It is time for the Regulators to step in and assert the primacy of regulations, especially, when they are sought to be undermined by recommendations made on the basis of internal policy guidelines of individual PAFs.

PAFs in India are said to be regulated under the provisions of SEBI (Research Analyst) Regulations, 2014 (RA Regulations). Those regulations might need to be revisited to address the excesses PAFs sometimes resort to. Also, if such regulation does not extend to PAFs based outside India, it needs to be examined whether recommendations put out by their India-based offices should be brought under these regulations.

In November, 2018, SEBI had setup a Working Group “with respect to issues of Proxy Advisors”. The 6 member Working Group included a representative of one of the PAFs (normally SEBI Committees comprise more than 30 members, with 2 representatives of the PAFs. It is informally understood that the 2 members, by their inputs, significantly influence the content of some of the recommendations that SEBI Committees/ Groups make). The question of a possible conflict of interest in regard to the composition of the Working Group arises when one notices that in a long report, addressing several aspects of the functioning of the PAFs, there was recusal by the PAF member of the Working Group only in regard to one issue, namely, that of “protecting Proxy Advisors from adverse legal action for holding honest opinions which are disliked by companies or individuals”. Clearly the question of conflict of interest did not arise when the Working Group addressed several other aspects relating to the functioning of the PAFs.

Consideration of space prevent a detailed analysis of the Working Group’s report. The entire approach seems to have been to endorse whatever practices and processes were in place at that time, and to lean in favour of the PAFs. Some sentences from the report are reproduced below

1. There should be Chinese walls between PAFs and their consultancy firms.
2. Requiring a Proxy Advisor to disclose the reasons for recommendations may be burdensome. The detailed rationale is usually the primary breadwinner for the Proxy Advisors, and mandating it to be made public would destroy the business model of most of the Proxy Advisors.
3. Disclosing all avenues of income generation would be over-regulation, but a material revenue (say 10% plus) stream should be disclosed publicly.
4. It should be noted that by design the recommendations of Proxy Advisors are generally aligned with the views of the shareholders who pay for such analysis, and on whose behalf they undertake their analysis.

There are a few other observations which require to be gone into. The RA Regulations provide that 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 (emphasis supplied). The Working Group’s report further says that “the Working Group believes that clients conduct extensive due diligence when they review and select their Proxy Advisor(s) and this will ensure that the Proxy Advisor has staff with sufficient skillsets”.

The Working Group has recommended “that except for factual errors, Proxy Advisors should not be mandated to carry views which they don’t subscribe to, and the company has enough resources to publicise a differing view point”. This does not adequately address the question of the damage likely to be done when the reports of the PAFs are with the investors, and there is no way for the corporate to ensure that its views are also available to all the investors before “voting decisions” are taken.

The Working Group has further stated that the Regulator must protect the freedom of Proxy Advisors to express their opinion. “This is important for the future of corporate governance in the country, as corporates with deep pockets may use shareholder money to silence criticism. At the same time, the Regulator must not become a mechanical defender of Proxy Advisors”.

There are instances in which PAFs have made diametrically opposite recommendations in regard to some resolutions. Needless to state, this causes confusion for investors and leads to the question whether there is an ultimate truth in such recommendations, or whether it is a case of “your truth, my truth, and the truth”.

The views expressed hereinabove might be jarring to the ears of the cheerleaders of PAFs. Suffice it to say, that in an important matter such as this, the attempt should be to carve out a legitimate role for PAFs, respecting the primacy of law and regulations, and ensuring that PAFs become a source of information, rather than a disproportionately persuasive influence, rendering voting decisions by corporates as manifestation of non-application of mind.