Home >Money >Personal Finance >Sebi should lay down rules to offer adequate protection to all investors

In his book Liar’s Poker, Michael Lewis describes his early career as a trader at Salomon Brothers. A proprietary trader at the bank fooled Lewis into selling loss-making bonds to his client, leading to a loss for the client and a loss of face for the novice trader. Lewis quickly caught on, and over the next few months learnt important lessons, often at the expense of his clients.

Despite the passage of time, Liar’s Poker remains an essential book for anyone trying to understand misaligned incentives and a cut-throat work culture where profits and commissions are prized over client interest. I was reminded of Lewis’ funny yet insightful observations because of two recent developments.

On 12 April, Sebi gave an adjudication order against Yes Bank and its officers. As part of this order, Yes Bank was fined 25 crore, and three officers working for the private wealth management division of the bank were individually fined smaller amounts of 50 lakh and 1 crore. The order was passed for violating Prohibition of Fraudulent and Unfair Trade Practices regulations.

In a separate development, Sebi invited comments on new proposals to define so-called ‘accredited investors’. If accepted, the proposals would allow firms to sell financial products to certain investors without the usual checks and balances that are applicable when offering financial products to small investors. This is a common practice in most developed markets.

According to Sebi’s discussion paper, accredited investors “are sophisticated enough to not require extensive regulatory protection, and therefore issuers of securities and providers of financial/securities market products/services are offered a regulation-light regime…" Sebi goes on to list several benefits to the Indian securities market that can be gained from the flexibility offered by an accredited investor regime.

Market participants have generally welcomed the move. However, Sebi’s paper is not clear on how it will decide whether certain products can be offered only to accredited investors.

To comment on the accredited investor framework, we first need to know what can be exempted. The US Securities Exchange Commission (SEC) has a framework for exempted securities that can be offered to accredited investors. According to the SEC, its exempt offering framework “will promote capital formation and expand investment opportunities while preserving or enhancing important investor protections".

Instead of an exempt offering framework of the type that exists in the US, Sebi’s framework provides two possibilities: a) of lower ticket size or b) of flexibility in regulatory requirements.

The proposal seems to be a tacit admission that Sebi’s minimum ticket size requirements are preventing the industry from finding enough customers. However, it is hard to understand the logic of offering a lower ticket size to sophisticated investors and a higher ticket size for unsophisticated investors. Perhaps, it would be more logical to remove the ticket size restrictions and limit the distribution of alternative investment funds (AIFs) and portfolio management services to accredited investors.

The second approach, to relax regulatory requirements for accredited investors, is more in keeping with what we find in other jurisdictions. Here, Sebi has proposed that new regulations can be created for products that can be offered only to accredited investors. This places the responsibility of determining what can be offered to accredited investors on the department within Sebi which regulates that particular product.

To be successful, Sebi’s framework has to recognize the fiduciary responsibility that investment advisers and asset managers have towards their clients, irrespective of their net worth and sophistication. The framework should also lay down some basic principles that Sebi would use to determine regulatory relaxations that can and cannot be offered. It would also be useful to articulate fiduciary requirements to which asset managers and wealth managers would be subjected, including disclosures and a governance framework that reduces the risk of mis-selling.

Companies offering financial products have a fiduciary responsibility towards their customers. Industry professionals are required to exercise reasonable care and independent professional judgment while performing investment analysis, giving investment recommendations and taking investment actions. It is in Sebi’s own interest to clearly lay down the rules of the game to provide the appropriate level of protection to all investors.

Vidhu Shekhar is country head, India, CFA Institute.

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