Contributed by Rajlakshmi Chakravarti

Introduction

SEBI recently released a consultation paper on August 31, 2023, proposing to set up Performance Validation Agency (PVA), that would be an independent body. The PVA’s primary function would be to provide validity and credibility to performance claims made by SEBI-registered intermediaries (such as investment advisers, stockbrokers etc..) and other entities. SEBI has further proposed either making the PVA a subsidiary of a Market Infrastructure Institution (MII) or. providing joint support to the PVA through multiple MIIs. As with any new proposal, it is important to examine the PVA’s impact on stakeholders. This paper will thus analyze the introduction of PVA, and attempt to conclude whether this comes as a relief or a concern, for companies and the stakeholders?

Analysis: PVA: A Relief?

In the consultation paper, SEBI states, “Intermediaries/other entities need to showcase their performance to attract more clients and grow and continue to do business. However, in the rush for more clients some of these entities may indulge in making inflated claims of their performance or recommendations to investors, thereby misleading the investors.” This has been used by SEBI to highlight and justify the need for PVAs.

Presently, there exists no such uniform and standardized mechanism which verifies performance claims of intermediaries/entities. The lack of such a system, creates an opportunity for self-verification, which can be misused. The SEBI circular from 2023 regarding the “Advertisement Code for Investment Advisers (IA) and Research Analysts (RA)” restricts investment advisers and research analysts from making misuse of the opportunity to self-verify yet many continue to do so. For example, in 2023, Money Market Manthan Financial Services did misuse such an opportunity. But without a credible verification body, who is there to check such misuse? Further, while aiming for higher investment returns, investors search for an authority to rely on,. The answer to their problems is thus, “PVA”. By verifying performance claims, PVA can prevent such misuse and build investor confidence simultaneously. Also, intermediaries/entities, such as investment advisers, research analysts, stockbrokers etc., have been demanding the opportunity to showcase their past performances. This opportunity is currently not available to them but by allowing them to avail it instead, PVA can help them expand their business.

The consultation paper further lays down a list of claims that can be validated by PVA-

• The claims of actual profits made by clients of intermediaries and entities, inclusive of each client. Thus, SEBI here has made it clear that there would be no selective picking of clients.
• The performance claims and the performance algorithm of intermediaries and entities, which would be tested during a “prospective reasonable test period” and would be displayed on PVA’s website.
• The performance of recommended stock/portfolio. The intermediaries/entities would need to disclose their recommendation, along with its details, to SEBI and it must be the same as provided to their client.
• Other performance claims, not specifically included in the above-mentioned points but must continue to follow the principle of not being selective when it comes to clients/favorable events/strategies or other results. These claims should also be of such nature that can be put through independent verification from other sources than only through the intermediary/entity itself. Again, SEBI here has clearly removed the opportunity for intermediaries/entities to self-verify their performance claims.

The consultation paper also lays down the role and responsibilities of PVA, like validating performance claims but on basis of particular parameters such as risk, returns, volatility etc. and upholding the privacy of the information that it receives.

But what is noticeable here is that the PVA extends the same scrutiny to itself, as it does to the intermediaries/entities. The restriction on “cherry-picking” clients limits the discretionary powers of PVA in selecting the claims of clients that it would be willing to investigate and validate. This enhances PVA’s credibility. Moreover, the aforementioned parameters (risk, returns, volatility etc.) which would be used for validation strengthens PVA’s credibility. The consultation paper also emphasizes the transparency that PVA provides. Client-specific PVA-validated performance claims would be displayed on intermediaries’/entities’ websites, accessible only to involved clients. For claims not client-specific, a same-day public disclosure would be made on the intermediaries’/entities’ websites and the PVA’s website. Thus, SEBI distinguishes between disclosure requirements, according to whether the performance claims are client-specific or not. This further indicates SEBI’s reasonable approach towards the extent of the transparency so provided.

PVA stands to significantly impact shareholders. Increased investor confidence could lead investors to paying a premium for those company’s shares whose performance claims have been validated by PVA, working to increase the share value. Furthermore, the transparency and credibility brought about by PVA would bring in more investors, thus increasing shares’ liquidity in the market. Not only that, PVA would also impact companies significantly. Firstly, it would lead to improved corporate governance as the threat of performance scrutiny under PVA will push companies towards better internal structure and management. Secondly, as mentioned earlier, PVA builds investor confidence. This would consequently improve companies’ profits.

Analysis: PVA: A Concern?

We have discussed the many reliefs provided by PVA. However, it is uncertain whether the discussion so far has provided the whole picture or whether is there also a downside to a PVA. The consultation paper specifically mentions a “reasonable fee” to be charged by PVA for its service. This may pose a problem to small-scale intermediaries/entities due to their financial limitations. They may also face difficulties in complying with SEBI’s rules regarding PVA as they may lack the resources to meet specific requirements, such as proper websites to display PVA-validated performance claims etc.. Another such factor can be the cost of audits conducted by PVA. This could potentially lead to a reduction in companies’ profits and thus, also lead to a reduction in shareholder returns. Consequently, both companies and shareholders could be negatively impacted. Another point to consider is that the validation process of PVA itself can take significant time which would restrict investors from making their investment decisions based on the latest information or condition of the intermediary/entity. Furthermore, due to the stricter standards imposed on intermediaries/entities through PVA, investors may be reluctant to invest in such intermediaries/entities. The PVA would also handle confidential data, such as performance claims of the intermediary/entity and customer data. This further leads us to data privacy concerns. Will the PVA be efficient in maintaining the privacy of such data? The intermediaries and entities may be reluctant to disclose their data due to this very concern. Similarly, the clients would be reluctant to invest as their data (or in other words, customer data) could also face the risk of public exposure. Such reluctance can further lead to market uncertainty. Additionally, if the validation agency reveals issues with a company’s performance claims, then the shareholders can also be affected negatively as such revelation could lead to the decline of the company’s stock price. Furthermore, companies may attempt to circumvent PVA’s scrutiny, for their benefit. This may create an uneven playing field for PVA by reducing its effectiveness in the eyes of investors and reducing investor confidence in the system designed to help them.

Furthermore, if PVA is put into place, it would have the recognition of SEBI. This may lead to blind faith placed on PVA by the clients/investors. But is this significant amount of dependence safe? It can create opportunities to misuse such faith and dependence. Also, as aforementioned, SEBI proposes making PVA a subsidiary of MII. But will PVA be impartial in its verification decisions? Is a single body of mechanism sufficient and efficient to handle all performance claims of all the intermediaries/entities? Or would it lead to lengthy delays and thus, create a similar situation to the current Indian Judiciary, with too many pending cases?

CONCLUSION

The step towards PVA is a step towards a uniform and standardized mechanism that would aid in building a better relationship between clients and the SEBI-registered intermediaries/entities. However, this would require effort. While there are concerns about the impact of PVA on companies and the stakeholders, there are also advantages to PVA, as this paper shows. Thus, we come back to the main question as laid down in the beginning of this paper- will PVA be a relief or a concern for companies and the stakeholders? It is put forth that if strict regulations are provided to: prevent misuse of PVA power, breaches data privacy, and “cherry-picking” claims, then, a smooth, cost-effective, and efficient mechanism can be sought under the PVA. Here, companies would be unable to find loopholes for their own benefit, as sufficient validation agencies would be set up and the limited resources of small-scale intermediaries would be considered. In such a scenario, PVA can be more of a relief rather than a concern for the investors/clients, the intermediaries/entities, and the financial world.