Sebi mulls new rules to curb ‘conflict of interest’ in market

Sebi mulls new rules to curb ‘conflict of interest’ in market

New Delhi: Sebi is considering a new set of norms to check ‘conflict of interests´ in the stock market, as it looks to rein in any nexus amongst the corporates, research analysts, investment advisors, and various market entities.

The new rules would also look at discouraging misaligned employee incentives - a practice prevalent among the capital market entities for rewarding their staff purely on the basis of business generated by them and irrespective of the interest of customers or investors being safeguarded.

IOSCO, a global cooperative of market regulatory agencies from across the world, including India, has called for effective steps by the regulators against conflict of interest and misalignment of incentives in securities market.

The new rules, to be called “Guidelines For Dealing With Conflicts of Interest in Securities Market", would apply to all the entities present in the Indian capital market, directly or indirectly, as also their employees.

These would include all participants in Indian securities market, associated persons, investment vehicles, collective pools of capital, institutional investors and stock exchanges.

An official said that ‘conflict of interests´ has emerged as a major area of concern for regulators across the world, including in India, and the new rules would look at removing the loopholes that allow irregularities like insider trading, front-running and misaligned employee incentives.

The aim is to check those actions of the market entities, as also of their employees, where interest of investors could be compromised to promote the business interests, he said.

Currently, Sebi has prescribed codes of conduct for market intermediaries to deal with the conflicts of interests in the market, while there are also regulations with penal provisions for insider trading and unfair practices.

But, there are no guidelines to identify and deal with conflict of interests by associated market entities such as research analysts, investment advisors and employees of market intermediaries etc, which are are not registered and regulated by Sebi at present.

Sebi is of the view that the absence of a general and comprehensive principle to deal with conflict of interests poses regulatory gaps in oversight and mitigation of possible conflicts of interest that may arise in the activities of these associated entities.

The new norms would also focus on active involvement of senior management of market participants, adoption of clear and concise policies, adequate disclosures, information barriers and effective corporate governance procedures.

At the employee level, the focus would be on remuneration to commensurate with the job functions, maintaining record of activities and specific prohibitions, among others.

As per IOSCO, the most common conflict of interests include use of non-public insider information obtained in the course of business, front-running, cherry picking (of stocks), unfair treatment among investors and unfair practices in analysis report preparation and distribution.

While framing the new rules, Sebi would also draw from the report of a Working Group on Conflicts of Interest in the Indian Financial Sector by RBI.

As per the report, the major sources of ‘conflict of interests´ in Indian financial sector include closely-held structure of Indian corporates, cross-holding among the companies, a dominant role of promoters in governing the companies and “tunnelling" or diversion of funds between different firms within the business groups.

Sebi has previously said that conflicts of interest also arise where market participants, who are supposed to act in the interests of customers or investors, use their authority or information to instead advance their own interest.

Such motives could be achieved through bad financial advise, inappropriate margin lending, misleading disclosure and reporting, front running and front loading, among others.

“Conflicts of interest also arise in the case of stock exchanges in their dual role as self regulatory organization (SRO) and commercial business entities," Sebi said in a recent memorandum submitted to its board.

“... Business interest of an exchange may prompt an exchange to turn a blind eye to a broker churning their clients’ accounts as higher volumes means greater income for the exchange," Sebi said.

While Sebi has been promoting the SRO (Self Regulatory Organisation) model for various market segments, it has found the self-regulation as such as a “glaring source of conflict of interest".