Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Investor rules: A brave step forward

The regulations should be seen as an opportunity by advisors to be seen as respected professionals.

The Securities and Exchange Board of India (Sebi) had recently enacted the investment advisers regulations after many years of foot-dragging. The main reason for the delay was a concern that the regulator may bite off more than it can chew. After all, investment advisors and distributors number in lakhs and the task of regulating so many was ambitious. The views which have appeared in the media over the past two weeks range from the “regulations exempt almost everyone" to “widely framed regulations…almost amounting to an overkill". The reality is probably in between. This piece critically looks at four developments brought about by the regulations.

Scope of regulations

The regulations broadly cover anyone who gives investment advice for a fee to the residents of India. Whom the regulations exclude from registration and regulation is interesting.

It exempts people not providing advice in the area of securities. So an insurance advisor need not register. This is sensible, given turf wars between financial regulators in the past. Hopefully, the regulations would set the benchmark for other financial regulators to catch up, too.

It also excludes those who provide investment advice incidental to their main business. Chartered accountants and lawyers are predictably exempt. This is also appropriate, though I am not sure how a lawyer can give investment advice incidentally.

Another exemption extends to stock brokers, portfolio managers and merchant bankers, who are already registered with Sebi. But these entities are only exempt from registration provisions and not substantive provisions of the regulations. This is logical as once a person is registered with Sebi, she already falls under Sebi’s domain for such things as conduct and inspection. Making substantive parts apply on such entities would ensure that they do not indulge in misconduct while avoiding duplication of registration.

Where Sebi gets into interesting territory is when it exempts distributors registered with the Association of Mutual Funds in India (Amfi) providing investment advice incidental to their primary activity. So it appears that such distributors can provide investment advice, that they need not register with Sebi and the substantive provisions of conduct do not apply to them. This broad exemption seems contrary to the aim of the regulations, which is that distributors are sellers of the creators of financial products (known in industry jargon as manufacturers) and thus have an incentive to market the product that provides the juiciest commissions.

Sebi rightly exempted distributors of mutual funds (MFs) because the task is too big for its limited bandwidth. However, the exemption is too broad since it exempts them from the substantive conduct provision of the regulations. Clearly, MF distributors should be subject to the same fairness requirements and code of conduct as is applicable to investment advisors and stock brokers.

Segregation between advisory fee and commissions

The regulations seek to segregate the advisory hat from the commission based hat of the advisor/distributor. While as discussed earlier, the distributors have been given a long rope and are exempt from regulation, other provisions of the regulations try to build a wall around conflict-free advice and conflicted distribution. There is a requirement of segregating commission based activities from the advisory ones, no commission for products advised on and an arms’ length distance between adviser activities and activities such as distribution and brokerage.

These are sensible, though the way the conflicting provisions on distribution pan out needs to be seen. It is not clear how a sole proprietor, as most advisors-cum-distributors are today, would segregate their small offices. Many distributors-cum-advisors are currently under the mistaken belief that they must give up one hat. This is not correct, but Sebi needs to clarify this.

Qualifications and certifications

There are basic qualifications and certifications required for those people out on the field giving advice. This has been made applicable to all those who give advice in a corporate set-up. This is a positive development and certification from the Financial Planning Standards Board India (FPSB) and other certified authorities will be required before advice is given. A requirement for capital adequacy, though the number required is low, is out of place. It is not clear why an investment advisor needs capital. We need smart advisors not rich ones.

Substantive provisions

The substantive provisions provide for acting in a fiduciary capacity, full and honest disclosure of all relevant facts, disclosure of all conflicts, providing suitable advice based on the risk profile of the client, restriction on self trades where advice on those has been given and record keeping. These are eminently right and provide a well-regulated framework.

While there are some chinks in the armour, I think Sebi has made a brave attempt. While it needs to plug some loopholes and work towards creating a self-regulatory body that takes part of the burden off Sebi’s shoulders, this regulation will provide a well-regulated industry, trust in the advisors and thus in the markets by investors and create high standards for other regulators to match up. This should also be seen as an opportunity by advisors to be seen as respected professionals rather than as agents selling products.

Sandeep Parekh is founder of Finsec Law Advisors.

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