Shareholder Activism and Corporate Democracy in India and U.S.A. (Role of Proxy Advisors)

-ZUBA PARVEZ BUBERE, LL.M., BUSINESS AND CORPORATE LAW, SYMBIOSYS LAW SCHOOL, PUNE

INTRODUCTION

In an era of growing Shareholder Activism and Corporate Democracy, the landscape has clearly changed dramatically and indeed, positively. In the present scenario, one of the primary objectives of activist shareholders is to pressurize firms to consistently aim for better performance in terms of Corporate Governance and thereby enhancing Corporate Democracy. The reasons could be both financial as well as non-financial. Shareholders have come up with effective modes to impact the governance regime of corporate firms and its Board of Directors. The highest measure of Corporate Democracy can be understood as to mean neither the extent of freedom nor the extent of equality, rather the level of participation. Consequently, contributory roles played by Proxy Advisors can be viewed as important aspects being consistently regulated and monitored. An in-depth explanation of these areas, issues respecting the same and responses to these concerns are dealt with in detail.

Proxy Advisors, their Role and Impact on Corporate Democracy

Institutional investors investing in companies of different countries are obliged to comply with the respective legal systems, complexities and requirements. The role of proxy advisors remains to assist such investors to form an informed decision by extending valuable research in relation to the corporate governance of respective countries. They provide recommendations on the rationale of a proposed resolution, facilitating companies to vote “for” or “against the motion. Therefore, the role of proxy advisors can have a significant impact on a company’s voting results.

Proxy advisors have a considerable impact on the corporate democracy mechanism of a company. The reason for the same can be stated to be the growth of institutional shareholdings and passing of regulatory reforms for the purpose of enhancing shareholder voting. It is perhaps, extremely critical that advices and recommendations forwarded by proxy advisors and proxy advisory firms be just, fair and independent. In all cases, they must be free of potential conflict of interests. On one hand, where it can be said that reports by proxy advisors could be relied upon, on the other hand, it cannot be negated that the recommendations and reports as provided by proxy advisors may not turn out to be as per the expectations of the promoter of the issuer company. In a nutshell, any kind of prediction on the voting of this particular group of shareholders is a challenging task for the reason that the said group makes a constant attempt to increase their participation in an informed manner.

Issues in Relation to the Working of Proxy Advisors

The nature of working of such proxy advisors or proxy advisory firms can lead to the generation of conflict of interests in numerous ways. The following are some of the significant issues to be taken into account:

Dual Service

Proxy advisors provide dual service, both consultancy services to issuers and proxy research and advice to investors. The risk associated with this function is that they could provide inappropriate proxy advice to investors on how to read statements by issuers and this may be totally dependent on the extent of influence of issuers on the proxy advisors.

Relationship of Proxy Advisor with Issuer

Secondly, if the proxy advisor is, in any manner, related to the issuer i.e. through commercial or personal relationships with the issuer or the issuer’s major shareholders, this may result in rendering a biased advice to the investors, thereby creating a conflict of interest.

Potential or material interest of Proxy Advisor in the issuer

Any potential or material interest of the proxy advisor in the issuer can lead to conflicts since there is an existence of a possibility that recommendations made by proxy advisors would be affected by such potential/material interests.

Relative influence of Proxy Advisor client

An influence of a particular investor client on the proxy advisor while advising any other investor client can severely affect the independent nature of advice rendered.

Mandate by the Securities and Exchange Board of India (SEBI)

In India, there exist certain regulations as drafted by The Securities and Exchange Board of India (SEBI) that are to be mandatorily complied with by proxy advisors. The objective of such guidelines is to protect the interests of investors from any defective/faulty research report, thereby avoiding conflict of interests. Apart from observing compliance to the said regulations, proxy advisors have to fulfill additional disclosure responsibilities as follows:

Compulsory registration with SEBI.
Maintenance of adequate capital.
Employees of proxy advisors must possess minimum qualification in any discipline.
Maintenance of a record of voting recommendations and furnishing the same to the Board on request.
Disclosure of research details along with effectiveness of the same in ensuring accuracy of data.
Disclosure of policies and procedures adopted for the purpose of interacting with issuers, informing issuers of the recommendations and review of the same.
Addressing issues relating to conflict of interests, etc.

Mandate by the Securities and Exhange Commission (The United States)

Bearing in mind the issues as stated above, it was in the year 2014 that The Securities And Exchange Commission issued specific guidelines regarding proxy advisors in the form of a Staff Legal Bulletin10. Under the guidelines, there are certain responsibilities that are to be fulfilled by investors who opt for the services of proxy advisors and such guidelines are to be followed by the proxy advisors. These comprises of some points on due diligence such as follows:

Capacity and competency to efficiently address proxy issues.
Adoption of robust policies and procedures.
Disclosure of potential conflict of interests.
Disclosure of significant relationships or material interests including those associated with provision of consultancy services to companies.

CONCLUSION

A careful understanding of the concepts and their significance leads to the opinion that the trend in the growth of Corporate Governance highlights a positive sign ensuring greater accountability and transparency in the working of the Board through enhanced shareholder participation. There is indeed a growing general awareness amongst the masses regarding the position of shareholders and the rights and powers concerning their position. The massive contribution made by Proxy Advisory Firms (PAFs) towards Shareholder Activism is quite apparent too. Recent developments in the area throws a light on improved corporate governance standards, improvement in shareholders’ rights viz. right to receive information, right to appoint and remove directors, etc., ease of exercising these rights, creation of new shareholder remedies, and so on. Besides, the establishment of grievance redressal mechanisms, class action suits, etc has have added to the bonus.

At the same time, it is also become important for the companies to look at the prevalence of red flags, if any. This may include inability of the management to resolve concerns of shareholders or disregarding their concerns, substantial increase in the shareholding by certain shareholders, lack of communication with shareholders, poor financial and market performance in comparison to competitors, etc. In such a scenario, to minimize the risks of being targeted by activist shareholders the company must take measures such as striking a balance between legislative compliance-corporate strategy-policy making, regular assessment of the performance of the company and its directors, inviting shareholder comments on numerous aspects, formulating a long-term strategy and analyzing its benefits, etc.

In the light of current trends and developments, companies are required to observe fair and transparent corporate governance practices along with ensuring a high level of shareholder participation. Instances of the same include: safeguards in relation to related party transactions and consolidated quarterly results. Adopting such an attitude will ensure enhanced shareholder credibility. Several regulators, too, promote such practices. Entities are therefore required to function as per the pace of recent developments in corporate governance.

LIST OF REFERNCES:
Sakate Khaitan, Aditi Chandak and Sangeeta Jhunjhunwala, Shareholder Activism in India, Thomson Reuters, https://uk.practicallaw.thomsonreuters.com/w-013-9526?transitionType=Default&contextData=(sc.Default)&firstPage=true
Shareholder meetings and practices in leading economies, Ingovern, http://www.ingovern.com/2015/03/shareholder-meetings-and-practices-in-leading-economies/
Noor Hayati Abdul Samad, A legal perspective of shareholders’ meeting in the globalised and interconnected business environment, ScienceDirect (January 27, 2015), https://www.sciencedirect.com/science/article/pii/S187704281500467X
Aditi Jhunjhunwala and Suman Poddar, Dance of Corporate Democracy: The rise of Proxy Advisors, Vinod Kothari and Company (March 15, 2016), http://vinodkothari.com/wp-content/uploads/2017/03/Dance_of_Corporate_democracy-_rise_of_proxy_advisors-1.pdf
Bernard S. Black, Shareholder Activism and Corporate Governance in the United States, Researchgate (January 2002), https://www.researchgate.net/publication/315468713_Shareholder_Activism_and_Corporate_Governance_in_the_United_States

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