In the continuous bull market, a large number of new retail investors set foot in the stock market for the first time, becoming the target of smart operators, hoping to obtain rich returns. The hype ranges from brokers demonstrating sky-high returns from algorithmic trading strategies, to derivatives trader-turned-educators sharing fake profit and loss screenshots to lure people into their courses. The Securities and Exchange Board of India (SEBI)’s proposal to set up an independent Performance Verification Authority (PVA) to verify performance statements is a good attempt to increase the credibility of such statements so that investors can learn from the chaff Sift out the wheat.
SEBI proposes PVA to verify returns displayed by registered entities and charge a fee. It is proposed to establish the institution as a subsidiary or affiliate of the stock exchange. The establishment of an independent PVA is certainly a positive for regulated players engaged in portfolio management services, mutual funds, research analyst and investment advisory services, and broker-dealers offering proprietary trading strategies. So far, the real claims of law-abiding players in these fields have been overwhelmed by the high-profile claims of dubious operators. Now, legitimate players can make their claims stand out by earning the PVA’s stamp of accuracy. Earlier this year, SEBI banned all registered research analysts and advisory services from sharing any performance data in their client communications in an effort to deter mis-selling. That’s a blow to businesses because track records of returns are a key factor for investors in choosing advisers. The creation of the PVA will allow research analysts and investment advisors to resume the use of performance data.
But if SEBI expects the PVA to stop claims that regulated entities inflate performance, or defraud investors by unregulated entities, those goals are unlikely to be achieved. In the market, fund managers always have a way to manipulate performance data. They can use convenient start and end dates for return calculations, extrapolate past returns into the future, present short-term results as lasting, or attribute fluke returns to skill or “proprietary” processes. SEBI has handed over the responsibility to PVA to ensure that entities do not cherry-pick data. But since the PVA will be compensated by market participants seeking validation, it is moot whether it would reject assignments based on carping for data.
The creation of PVAs may also have limited impact on unregulated entities marketing outlandish claims privately to investors over the phone or on social media. In this case, investors can request PVA verification and refuse service to players who refuse to provide verification. SEBI can increase investors’ awareness of the PVA mechanism. But it cannot solve the problem of retail investors succumbing to greed.