Proxy adviser "brain fade" is a threat to independent research

Anyone who values high-quality independent research on financial issues has reason to be concerned with Treasurer Josh Frydenberg’s proposals to knee-cap proxy advisers. His new rules will create a nanny state which restricts the publication of critical analysis unless ASX companies have received a copy a week beforehand and authorised its release.

What would this mean for individual investors? Ultimately, a dearth of independent research and oversight of the equities and other listed vehicles in which they park their money. 

It’s a terrible signal to other Australian Financial Services Licensees who are in the business of challenging listed company management and boards.

Proxy advisers are pesky analysts who produce voting recommendations for institutional investors on resolutions at company meetings. Lots of AGMs take place in a short space of time, so we add value by identifying the issues and working out if the proposals are in our clients’ economic interests. This typically involves analysing director elections, votes on executive pay issues and capital items like selective buybacks or placement approvals.

While our output is a little quirky, under the law we are regulated precisely the same as the sell-side. We have an AFSL that authorises us to provide general financial product advice on securities to wholesale clients. We rely on financial analysis to guide our research so every report we produce is no different under the law to any broker note.

Like traditional sell-side researchers, we are subject to an overriding duty to produce research in a manner that is “honest, efficient and fair”. ASIC provides extensive guidance on what this means in practice. Regulatory Guide 79 Improving the Quality of Investment Research (RG 79) is the bible – it sets out how we deal with resourcing, competence, research quality, methodology and transparency; and avoiding, controlling and disclosing conflicts of interest.

RG 79 is very clear about analyst interactions with issuers. It prevents researchers from privately sharing research and recommendations with a company before publication to clients. Nothing stopping an analyst from checking facts, but they have to be careful. Having reports vetted by company management has long been a bridge too far. It compromises independence and is an invitation to front running and selective disclosure. Breach that and ASIC will ping you.

So, what’s all the fuss about? 

Under the proposals canvassed in Treasury’s unironically titled paper, Greater Transparency of Proxy Advice, key principles in RG 79 are tipped on their head. Proxy advisers would be required to selectively release their research to companies - a week ahead of publication to their clients. We would be prevented from speaking about our research publicly and couldn’t release it at all until the end of the expiry period unless we carried pointers to the company’s rejoinder. This regulatory brainfart mandates selective release and would prevent us from speaking to our clients, about our work!

The AFSL regime is principles-based and serves the analyst community and their clients well. It doesn’t impose any restrictions on how a researcher goes about it. If you want to make a negative stock recommendation based on public documents without interacting with the company, you are free to do so. Think the accounting is dodgy and worth a short? Bomb away – provided you don’t transgress the standards, you are free to advise your clients as you see fit. No requirement to blow a kiss to a CFO who might be offended.

The proxy adviser proposals are not just a downwards punch on a fringe group - they are a regulatory face-plant with much wider implications for all researchers. If entrenched boards and stock promoting management succeed this time in using the Treasurer’s office to stifle dissent, it won’t be long before they are emboldened to pass similar laws for the pre-approval of downside research that is popularised by hedge fund sales desks. It’s not crazy to imagine existing broker reports that canvass AGM issues will be caught in the crossfire.

This direction is an embarrassment for Australia’s reputation as a financial centre. Sophisticated investors should be free to contract with whomever they like for research and advice without State intervention. Further, it is preposterous that the Treasurer is suggesting that proxy advisers be required to disgorge our valuable intellectual property, to a third party (a listed entity) we have no contract with, for no consideration, in advance of publication to our clients - solely for the purpose of allowing company management to pre-emptively censor and stifle dissenting opinion.

Why would anyone bother to risk their capital establishing an independent research house, if it is at risk of sovereign intervention in this manner?

ASIC conducted a thorough investigation into all proxy advisers in 2017 & 2018 and found no cause for concern. There were no complaints by the users of the research. If there are problems with individual advisers, it is well accepted that ASIC can impose tailored licence conditions on their operations. Undeterred, conflicted business groups such as the Australian Institute of Company Directors and their paid hangers-on have continued their evidence-free campaign for industry-wide intervention despite not yet citing a single instance of harm.

Directors and CEOs have arrived at the Treasurer’s door demanding regulatory solace for the collective narcissistic injury that has resulted from challenge to their authority. If Josh Frydenberg placates them by upturning key principles in the financial services landscape that have served investors, analysts and markets so well, other researchers are now on notice that the demands for regulatory reform won’t stop at proxy advice.

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