Synopsis of SEBI (Research Analysts) Regulations, 2014 – Part 1

CA Rajesh Pabari

The following few pages are summary of SEBI (Research Analysts) Regulations, 2014. Part 1 mainly includes important provisions from the introduction part and basic understanding of the regulations and related aspects.

Introduction: It’s not at all a surprise if the Regulator is asking a person to register with them if he is influencing investment decisions of the investor community. This regulation has not come out of the blue. There would have been a history of cases where analysts would have fooled investors resulting into their losses in the past.

The regulator wants to know whether the persons influencing the market are capable and competent enough to appear in front of the public and guide them where to invest and where not, which shares to buy and which ones to sell off.

In nutshell, the regulation requires that no person can act as a Research Analyst or Research Entity before obtaining a certificate from SEBI.

Existing Research Analysts: Entities or Analysts currently acting as such are allowed to operate as such till 29^th May, 2015 (six months from the commencement of the SRAR, 2014) if they make an application for registration before 29^th May, 2015 till the disposal of the application.

As per my calculation, the Regulations will come into force from 29^th November, 2014 in India. (On 90^th day from publication in Gazette)

Before moving further, it will be beneficial to go through the definition of Research Analysts.

Definition of “Research Analyst” is very much wide and amongst other things includes those entities and persons making recommendations in public media. The first line of the definition says “….a person who is primarily responsible for…”

What about newspapers? In my opinion newspapers will not be included and will not need to register because they are not primarily responsible for preparation or publication of the research report. But it will include newspapers, websites, and those who send SMSes for price targets and buy sell recommendations if they are doing on their own and not at the instance of some third party. Third party has to be registered with SEBI in such cases.

Exceptions:I don’t understand the logic of creating so many exceptions; however SEBI may come up with explanation for creating so many exceptions.

1. Investment Adviser(May be because they are already registered with SEBI for giving investment advices)

2. Credit Rating Agency(I don’t see any logic in creating this exception because role of Credit Rating Agency is far different from Research Analyst. So, I wondered when I saw this as exception. Apart from that, even employees and directors making public appearances are covered in exceptions. What is the need of excluding them? Are credit rating analysts and research analysts having the same standing, roles and responsibilities? Is this exception just for the kinds of report that Credit Rating Agencies in their normal course of business distribute or is it blanket exception to do anything that a Research Analysts does? We will wait for the clarifications to come)

3. Asset Management Company or Fund Managers

Q. What about person located outside India and in the business of issuing research reports?

Ans. They shall enter into an agreement with a research analyst or research entity registered under this regulations. Obviously, for providing the services of a research analyst or research entity.In such cases, responsibilities of the Indian party entering into agreement increases multifold. Analyzing the analysis provided by the foreign party itself becomes an internal task.

Q. What are the eligibility criteria for enrolling as a Research Analyst?

Ans.An individual registered as research analyst, individuals employed as research analyst and partners of a research analyst, if any, engaged in preparation and/or publication of research report or research analysis shall have the following minimum qualifications, at all time.

• Specified professional qualification as mentioned in regulation 7 (allowed even if a graduate in any discipline with an experience of at least fiveyears in activities relating to financial products or markets or securities or fund or asset or portfolio management) and
• NISM Certification for research analyst at all times
  • Research Analyst or research entity already engaged in issuance of research report and seeking registration under these regulations to comply with this requirement within two years of commencement of this regulation

(I feel it’s too long time, but maybe SEBI felt its ok to provide TWO Years for obtaining the NISM certification, I am surprised why it should take two years for analysts to obtain NISM certification while at the same time it is a pre-requirement for the fresher analyst to enter the field of giving research papers and advices. Are the existing research analysts so much incompetent to clear it within even 4 to 6 months??? A big surprise for the investor community to accept the period of two years.)

Capital Adequacy Requirements:

Existing research analysts shall comply with the Capital Adequacy requirement within one year from the date of Commencement of Regulations.

Period of Validity of Certificate: Five years from the date of Issue

Renewal of Certificate: Apply three months before expiry of the Certificate.

Regulatory body for Research Analysts: Board may recognize any body or body corporate for the purpose of regulating Research Analysts. Board may specify that no person shall act as research analyst unless he is a member of a recognized body or body corporate.

MANAGEMENT OF CONFLICTS OF INTEREST AND DISCLOSUREREQUIREMENTS

Take an example of a conflict of interest. Suppose I am a Research Analyst giving recommendation for buying Securities of Company X and also holding shares of Company X (which may be a B group company not having much liquidity or market standing). I am providing services to 100 clients (let’s say many of them are HNIs), in such case if I recommend them buying the shares of Company X, what would be my responsibilities? What disclosures I should make before recommending a buy on the stock? What are the conflicts of interest?

As per the regulations, the research analysts and research entities are supposed to follow the below mentioned regulations specified in this regard.

• They need to have a written internal policies and control procedures governing the dealing and trading by any research analysts for
  1. Addressing actual or potential conflict of interest arising from dealings or trading of securities of Company X
  2. Promoting objective and reliable research that reflects the unbiased view of research analyst; and
  3. Preventing the use of research report or research analysis to manipulate the securities market.
• Research analyst or research entity shall have in place appropriate mechanisms to ensure independence of its research activities from its other business activities.(Tough time for brokers and it’s tough for SEBI to prove in such cases whether there is any independence of research activities from its other business. It’s highly improbable in case of broking industry where the broker earns brokerage based on buying behavior of client based on recommendations of their in-house research analysts. Only time will tell)
• Limitations on trading by research analysts
  1. Trading by Research Analysts: Personal trading activities of the individuals employed as research analyst by research entity shall be monitored, recorded and wherever necessary, shall be subject to a formal approval process.
  2. Restriction period for Trading: Independent research analysts, individuals employed as research analyst by research entity or their associates shall not deal or trade insecurities that the research analyst recommends (or follows)within thirty days before and five days after the publication of a research report.
  3. Not to deal in contrary to Recommendations: Independent research analysts, individuals employed as research analysts by research entity or their associates shall not deal or trade directly or indirectly in securities that he reviews in a manner contrary to his given recommendation.
  4. Restriction on purchase or receiving securities of company planning for IPO(same business type the analyst follows or recommends): Independent research analysts,individuals employed as research analysts by research entity or their associates hall not purchase or receive securities of the issuer before the issuer’s initial public offering,if the issuer is principally engaged in the same types of business as companies that the research analyst follows or recommends.
  5. Restriction no. 2,3 and 4 will also apply to a research entity unless it has segregated its research activities from all other activities and maintained an arms-length relationship between such activities. (This will add up to auditor’s duty, this may be a serious concern at top level. If SEBI does not establish a mechanism to ensure that this does not happen, the same things will happen which may have been happening for long time.  I hope SEBI and auditor community will take this seriously.)
  6. Notwithstanding anything contained in (2) to (4),such restrictions to trade or deal in securities may not apply in case of significant news or event concerning the subject company or based upon an unanticipated significant change in the personal financial circumstances of the research analyst,subject to prior written approval as per the terms specified in the approved internal policies and procedures.
• Restriction on Compensation of Research Analysts
  1. Remuneration to research analysts cannot be based on any specific merchant banking or investment banking or brokerage service transactions.(For ex. It will be against the regulations If a broker has defined a commission plan for research analysts such that if his research report results in generation of more than average brokerage from dealing in a particular security covered by the research report, the research analyst will get a particular % of the difference in brokerage)
  2. Compensation being paid to Research Analysts of an entity shall be documented and approved annually by Board of Directors/Committee appointed by Board of Directors of the research entity and the remuneration should not be linked by entity’s merchant banking or investment banking or brokerage services divisions.
  3. The Board/Committee appointed shall not take into consideration analyst’s contribution to research entity’s investment banking or merchant banking or brokerage services business.
  4. An individual employed as research analyst by research entity shall not be subject to the supervision or control of any employee of the merchant banking or investment banking or brokerage services divisions of that research entity.(To maintain independence of the research analyst)
  5. Restriction on Merchant Bankers/Investment Banker for publication of report/analysis on Subject Company (priced by Merchant Banker): MB/IB shall not publish or distribute research report or research analysis or make public appearance regarding a subject company where they acted as manager/co-manager. The period of restriction is as follows

6. Exception to the above restriction: I don’t think there was any requirement to make this exception but since SEBI has provided the same I need to mention it.

Research analyst or research entity may publish or distribute research report or research analysis or  make public appearance within such forty day and ten day periods, subject to prior written approval of legal or compliance personnel as specified in the internal policies and procedures.

Two things to note:

1. There has to be prior approval from legal or compliance personnel (ideally head of the department or director level responsible person, since it is a serious issue and may lead to reputational damage in case of non-compliance)
2. The procedure of publication or public appearance in such case should be documented in internal policies and procedures. The publication or public appearance should be in exceptional cases and not as a routine activity which will be cleared from department and you should get away with.

To be continued in part 2 of the Analysis.

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