SEBI Considers Regulating Independent Research

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The Securities and Exchange Board of India (Sebi) is considering extending regulations to cover independent research analysts according to a report by MSN India.

Indian research analysts attached with brokerage firms, fund houses, investment banks and other market intermediaries are currently governed by Sebi regulations, but there are no comprehensive rules that could also cover third-party or independent analysts. In a board meeting late last year, Sebi had discussed the need to have a comprehensive set of regulations for research analysts.

The scrutiny was apparently triggered by short ideas research.  Sebi is concerned that ‘bear cartels’ have used the negative issues raised in short ideas reports to beat down share prices.  Reports from one particular overseas research firm (unnamed) has raised concerns about a few Indian groups in the recent months.

Some commentators have suggested that the ‘overseas firm’ causing regulatory anxiety is Toronto-based Veritas Investment Research.  Veritas provides earnings quality, forensic accounting and fundamental valuation analysis on a limited number of firms, including Indian companies.  Veritas put out a report on Reliance Industries and Reliance Commuications in July 2011,  Kingfisher Airlines in September 2011, and DLF earlier this month.

A Sebi official said the regulator supports good research, however, research on its own cannot generate sufficient revenue to sustain its existence, therefore, it has to rely on other parts of the organization. This could lead to conflicts of interest.

Among the measures being discussed by Sebi, analysts could be asked to make disclosures regarding incentive structure, shareholding pattern, market dealings, and various direct and indirect business interests.  Current Sebi regulation already requires ‘Chinese Walls’ to avoid any conflict of interest arising out of reports published by equity research units.  The new rules could also prescribe mechanisms to ensure that the research analysts’ trading activities or financial interests do not prejudice their reports.

Veritas is a very reputable firm which has been producing independent research since 2000. It is staffed with forensic accountants, and most of its 13 analysts are Chartered Public Accountants, Chartered Accountants and/or Chartered Business Valuators.   We would be very surprised if the firm was participating in ‘bear cartels’.  It is not a Muddy Waters, which explicitly front runs its own research.

It is unclear what jurisdiction Sebi would have over Veritas, which is based in Toronto with no offices in India to our knowledge.  Nevertheless, it is unfortunate if Sebi is taking steps to try to discourage forensic analysis.  There is a shortage of sell ideas in equity research, and, although company management does not like critical equity research, it is healthy for markets.

 

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