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Photo: iStock
Photo: iStock

Sebi to firms: Can’t advise, distribute to same client

Sebi consultation paper proposes client segregation, new rules for financial advisers

To address the issue of mis-selling and overcharging from investors in the capital market, the Securities and Exchange Board of India (Sebi) has proposed client segregation for entities providing both advisory and distribution services. This means, a company with both advisory and distribution arms will be able to offer either financial advice or product purchase to its clients. Sebi has also proposed capping investment advisory fees to 2.5% of the assets under advice (AuA) or a flat fee of 75,000 per year.

The proposals were part of a consultation paper on Sebi-registered financial advisers (RIAs) that the regulator unveiled on 15 January. The paper noted that there have been numerous complaints about investment advisers promising assured returns, charging exorbitant fees and mis-selling products.

Client segregation

Sebi has proposed an answer to the vexed question of separating the distribution and advisory businesses. Under the existing rules, individual advisers cannot offer both distribution and advisory services, but corporate entities can offer both through separate departments. Sebi’s consultation paper adopts a new approach that will be applicable to both individual advisers and corporate entities. Neither can offer both distribution and advisory services to the same client. To prevent companies from circumventing the rule through group entities, the entire corporate group within the ambit of the Companies Act, 2013 will be considered as one entity. So a bank providing distribution services and its wealth management subsidiary providing advice will be considered as one entity.

“Intermediaries were taking some assets under distribution and some under advisory for the same client. These proposals will put an end to this unethical practice, which was an indirect form of giving a kickback to the client. Giving kickbacks from commissions is illegal," said Feroze Azeez, deputy CEO, Anand Rathi Pvt. Wealth Management.

Existing clients who pay both distribution commissions and advisory fees will get the right to choose between the two service models. “The customer segregation rule can force providers to ask clients to redeem funds and move to direct plans, triggering tax and exit load. Alternatively, it can force providers to abandon their RIA services and keep clients in regular plans due to the cost of wholesale switching," said Amol Joshi, founder, PlanRupee Investment Services. What Joshi means is that companies may ask clients to switch to direct plans if they want to become financial advisers or advisers may give up the advisory licence and become distributors. The paper considers a family as a single client unit. Family includes individual, spouse, dependent children and dependent parents. “Different members of the same family will have different requirements. A person in their 40s and 50s may not understand direct plans and need a distributor. His millennial daughter might prefer an RIA. Why force families to choose?" he asked.

Sandeep Jethwani, managing partner and head of advisory, IIFL Investment Managers, interprets it differently. “Legacy (existing) assets where the investment adviser is being compensated under a previous distribution engagement will be excluded from AuA for the purpose of charging a fee. This will ensure no forced redemption of the old assets," he said. While Joshi worries that the rules would give a binary choice to entities with distribution and advisory arms, Jethwani says, both models can co-exist in case of legacy assets under management.

Other proposals

Under current rules, individuals registered as financial advisors are not allowed to provide execution services. Corporate financial advisors can do so provided execution and advice are segregated. Sebi has proposed that RIAs be allowed to do so, but without charging customers. This bar on payment includes direct and indirect payments such as commissions. RIA will mandatorily have to sign an investment advisory agreement with Sebi-prescribed terms.

The regulator has also proposed a cap on the fees charged by investment advisers at 2.5% of AuA. This includes all securities and products for which an adviser has rendered advice. If the client opts for a fixed fee model, the annual fee will be capped at 75,000 per family. “The cap of 2.5% is liberal and even exceeds the maximum 2.25% that can be charged by mutual funds. On the other hand, 75,000 is low for large clients. The paper is impractical and I don’t see it being implemented in its current form," said Joshi. “The fee cap of 75,000 per year is low and can be problematic (for advisers) when there is a lot of work to be done, the matter of advice is complex and the client has a lot of assets," said Suresh Sadagopan, founder, Ladder7 Financial Advisories.

Finally, Sebi has suggested a hike in the net-worth requirement from 1 lakh to 10 lakh for individuals to register as financial advisers. For non-individual financial advisers, the net worth has been increased from 25 lakh to 50 lakh. The investment adviser and principal officer must also have post-graduate qualifications in finance, economics or related subjects. They must also have at least five years of experience.

Existing entities need to meet the net-worth and qualification criteria within three years; otherwise they may see their registration being cancelled. Also, advisers must maintain records for five years and get themselves re-certified on the expiry of their existing certifications.

Omissions

Some experts pointed out omissions in the consultation paper. “The paper makes no mention of strictly regulating the nomenclature being used by intermediaries. Creative names are used by sellers to mislead clients into believing that they are advisers. Different participants should be made to use a term that truly describes what they are doing," said Sadagopan. He added that the regulation governing financial advisers is far stricter than those governing distributors of mutual funds and other financial products. Mutual fund distributors can give advice to clients if it is incidental to their business. “Incidental advice is a sticky area and many have been providing advisory services under the shelter of incidental advice. This ambiguity pertaining to incidental advice should have been dealt with to curb misuse of the incidental advice provision and also suggest what kind of work can be done under the ambit of incidental advice," he added.

“The paper lays down a threshold of 40 crore after which the intermediary must be a corporate. The 40 crore consists of AuA of all the clients together and it is far too low. Converting ourselves into companies or limited liability partnerships means a huge jump in the net worth requirement from 1 lakh to 50 lakh invested into the company. This also involves a payment of 1 lakh per year to Sebi and a few lakhs towards compliance costs. We currently charge low fixed fees even for clients with large assets. This will become unviable. Small RIAs will be driven out of business," said Avinash Luthria, a Bengaluru-based Sebi-registered financial adviser. Azeez pointed out a major lacuna in the proposed rules. “They are not explicitly applicable across investment products.

Nowadays, providers charge low advisory fees on mutual funds but hefty commissions on products like portfolio management services (PMS), alternative investment funds (AIFs), unlisted stocks and insurance policies," he added. All these products are regulated by Sebi but insurance products are regulated by the Insurance Regulatory and Development Authority of India (Irdai). In other words, selling products such as insurance can become far more lucrative for intermediaries than Sebi-regulated products and lead to mis-selling.

The proposals are a welcome step and will further improve customers’ experience. On the flip side, they leave crucial questions unaddressed like who can use the term adviser and widen the regulatory gap between lightly regulated distributors and heavily regulated advisers. They might also take a toll on existing clients.

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