​​​Performance Validation Agency: SEBI’s Fresh Step Towards Investor Protection

[By Srishti Multani & Aryan Birewar]

The authors are students of Symbiosis Law School, Pune.



The Securities and Exchange Board of India (‘SEBI’) on 31st August 2023, issued a Consultation Paper to propose a Performance Validation Agency (‘PVA’). The objective of such an institution is to validate performance claims of SEBI-registered intermediaries. Such validation will enable the entities to catapult their customer-base in the securities market. There was a pressing need for transparency and authenticity in the claims made to attract investors. In this article, the authors examine the rationale behind a PVA, stress-points of the consultation paper, and critically analyze the benefits and challenges posed by the establishment of a PVA. Furthermore, they suggest certain solutions to address the forthcoming said challenges.  

Need & Rationale  

The urging requirement of credibility in the securities market pushed the regulator to produce this proposal. All the SEBI-registered intermediaries seek to increase their customer-base, which requires them to build investor trust. Such validation by the PVA will allow the intermediaries to attract investor clients in the market by highlighting their performance claims. An independent body like the PVA will facilitate the trust-building process between market intermediaries and investor entities.  

Presently, SEBI has imposed differential restrictions on the market intermediaries in making performance claims to expand their service-base to more investor clients.  

  1. Claims of Asset Management Companies (‘AMC’) and Portfolio Managers are self-verified. There is absence of any independent body to validate their claims.  
  2. Claims of Investment Advisers (‘IA’) and Research Analysts (‘RA’) cannot be made in reference to their past performance. As per the existing SEBI Advertising Code, any ‘buy/sell/hold’ recommendation by these intermediaries cannot be made in reference to past performance and by usage of any superlative terms. For example, ‘best’, ‘top’, ‘leading’, etc.  
  3. Claims of Stockbrokers pertaining to past or future returns ensuing from algorithmic trading is not permissible.  

The regulator recognized the need for intermediaries like IA’s, RA’s, Stockbrokers, etc. to showcase their performance claims to increase their clients. The same must be predated with an independent and impartial performance claim validation agency to ensure accuracy and correctness of claims floated in the securities market.  

The functioning of such an agency will preclude eventualities of false, misleading, and inflated performance claims floated to attract investors. It will ensure that all participating intermediaries resort to fair and correct practices to expand their services to the investor clients. It is important to recognize that relying on verification from just one brokerage company can be misleading for investors, as it does not offer a comprehensive view of trading performance across all accounts. This makes the existence of a PVA all the more important.  

Proposal by SEBI 

The following proposals encapsulate the major highlights in SEBI’s Consultation Paper: 

Criteria for Grant of Recognition  
  1. SEBI has mandated the PVA’s to be subsidiary entities of Market Infrastructure Institutions (‘MII’s). The rationale provided by them is that MII’s are the sole components of the securities market, which deal with a largeamount of investor data daily. As per the Bimal Jalan Panel (2010), they defined MII’s to be inclusive of Stock Exchanges, Depositories, Clearing Corporations, etc.  
  2. PVA’s are thus mandated to be wholly-owner or jointly-owner subsidiary entities of MII’s.  
  3. PVA’s will be recognized by SEBI only, when their parent MII fulfill the eligibility criteria prescribed by SEBI.  
Obligations of a PVA 

The paper prescribes the task of claim validation to be based on the parameters of risk, return, volatility, or any other parameter deemed suitable by SEBI. It is PVA’ duty to ensure that all information shared to them by the investors or intermediaries is kept confidential. Since, the major function is validation of investor data, SEBI permits PVA to partner with credit rating agencies for the purpose of validation, who aid in evaluating credit worthiness of debt securities and their issuers. Notably, the PVA can charge a reasonable fee for the validation of performance claims.  

Categories of Claims validated by PVA.  
  1. Actual Profit – The PVA validates the actual profit minted by the investor basis the advice rendered by the SEBI-registered intermediary.  
  2. Algorithm – The recommendation rendered by PVA is derived from a certain algorithm. PVA undertakes performance evaluation of such algorithms over a prospective reasonable test period.  
  3. Stock/Portfolio – In order to evaluate recommendation of a stock/portfolio, the PVA must furnishthe recommendation on the day of recommendation and period of holding by the SEBI-registered intermediary.  
Display of Recommendations  
  1. Exclusive Access– The validation of such recommendations is required to be published on their websites with access exclusively with clients. 
  2. Public Recommendations – Once the intermediaries publish the recommendations they can be accessed on the websites of the intermediaries and PVA both. 
  3. Specific Recommendation – When the intermediaries seek validation of a specific portfolio recommendation, then it shall be published on the websites of the intermediary and PVA in the format prescribed by the industry practice. 

The unique attribute in these proposals is the “No Cherry-Picking” principle. As per this principle, the PVA cannot arbitrarily select clients, results, or events to their favor. Any validation of a performance claim must be done for all clients to prevent biases in the results. Furthermore, all such claims must be verified from third-party independent sources excluding the entity making the claim. 

Analysis of the Proposals  

The principal reason for this proposal was the pressing need for transparency and investor reliance. By virtue of being an independent verification body, it benefits both the investor and registered intermediaries – eliminating inflated performance claims and permitting marketing of successful investment advice, respectively.  

For the investors, they place reliance on the stock and portfolio recommendations furnished by the SEBI-registered intermediaries to reap good returns. It becomes vital that an independent, third-party evaluator validates these recommendations. Especially, in cases of claims made by Asset Management Companies and Portfolio Managers, they are self-verified sans being subject to any external system of checks. 

For the SEBI-registered intermediaries, they pressed the regulator for such an initiative as they want to increase their service-base to maximum investors. By virtue of their claims being validated, it increases their credibility in the securities market to be able to hook more investor entities in their client-base by gaining trust in the eyes of the investors. Indeed, there have been piecemeal efforts on the regulator’s end to cure the menace of false, misleading, and inflated performance claims. On 5th April 2023, SEBI released a Circular (Advertisement Code) prohibiting use of certain superlatives by IA’s and RA’s to attract investors based on untrue claims and promises of sterling returns.  

The benefits available to both players in this market equation is coupled with a fair share of challenges.  

Firstly, the compliance cost could cause discomfort to the smaller investors and intermediaries. Apart from the fees, the operational cost to gather the investor data for the PVA to process it is on the higher end. Those with humble financial and operational resources at their disposal will struggle to get their performance claims validated, thereby being placed on an unfair playing field in terms of the credibility aspect from the investor’s eyes 

Secondly, the privacy consideration of the investor entities. The proposal requires the intermediaries to furnish portfolio recommendations and actual profit of the investors to the PVA. The Consultation Paper fails to provision any remedies for any operational risks like data breach, leaks, etc. of such sensitive investor data. An elaborate manual/handbook for handling sensitive investor data must be made available to all the participating intermediaries. 

This, in turn, consolidates SEBI’s take on mandating PVA’ to be subsidiaries of MII’s. Vide a SEBI Circular (Guidelines for MII Cyber Security and Cyber Resilience) dated 29th August 2023, SEBI in Annexure – A ordered the MII’s to implement certain practices like – encrypted data backups, continuity drills, vulnerability testing, Multi-Factor Authentication, etc. All these aim to identify lacunae in existing security controls and consolidate effectiveness against varied forms of ransomware attacks. Hence, implementation of these practices down the funnel, i.e., PVA’s will address the budding issue of investor data privacy and security.  

Concluding Remarks  

In conclusion, the establishment of the PVA by SEBI is a notable measure aimed at improving transparency and reliability in India’s financial markets. The objective of this project is to furnish investors with authenticated performance statistics, thereby promoting a more knowledgeable investment culture. Although there are legitimate concerns, such as the possible difficulties faced by smaller participants and the issue of data privacy, these can be effectively dealt with by implementing customized legislation and implementing strong security measures. SEBI can implement standardized validation procedures, redirecting attention from self-proclaimed assertions to reliable and verifiable performance facts. Investors will derive advantages from trustworthy information, while reputable intermediaries will acquire recognition. Collaboration, innovation in validation methodologies, and the implementation of data protection procedures are crucial.In the end, this endeavor necessitates collaborative endeavors from all parties involved to establish confidence in the financial ecosystem, hence advantageous to investors and the market. 


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