Proposed amendments to Investment Advisers, Regulations: Establishing Investor-Adviser’s Fiduciary relationship

On January 21, 2013, the SEBI (“Investment Advisors”) Regulations, 2013 (“IA Regulations”) were notified by SEBI. The object of these Regulations was to lay down the framework for independent financial advisers and to address the conflict of interest arising due to the dual role played by distributors of financial products. The following objectives were to be achieved by SEBI while making these regulations:

1.To act in a fiduciary capacity towards its clients and shall disclose all conflicts of interests as and when they arise.

2. To not receive any consideration from any person other than the client being advised.

3. To maintain an arms-length relationship between its activities as an investment adviser and other activities.

4. To disclose to its client, any consideration received or receivable by it for any distribution or execution services in respect of the products or securities for which the investment advice is provided to the client.

5. To disclose to the client any actual or potential conflicts of interest arising from any connection to or association with any issuer of products/ securities.

Following are the views on the Proposed Amendments issued on 07 October, 2016 by SEBI with respect to IA Regulations:

Re-look on the Exemption provided from registration (Regulation 4):

1. To Mutual Fund Distributors.
2. To certain persons engaged in providing Investment Advice.

An investment adviser is defined as an entity engaged in the business of providing investment advice for a consideration. Insurance agents, mutual fund distributors, advocates, chartered accountants, stock brokers, fund managers, people giving general comments in good faith on trends in the financial market, members of a self-regulatory organization and those offering investment advice are exempted from the registration process.

As per the existing regulation, the Mutual Fund Distributor (“MFD”) is entitled to distribute & execute the products and advise the investors. Such distributors are receiving commission from the Fund houses (Asset Management Companies) as well as fees from the Investors which leads to conflict of Interest resulting into non achievement of the desired objectives behind formulating such regulations.

According to the new proposals, mutual fund distributors will no longer be allowed to provide incidental or basic investment advice on any MF schemes they sell, unless they register separately with SEBI as an investment adviser as well. They will be given three years to become advisers and until then, they will have to refer to themselves as “mutual fund distributors” only and not as “wealth/financial advisers”. Distributors who want to continue as distributors, have to name themselves as mutual fund distributors only and cannot provide any advisory service other than the specifications of the product they are selling. If a distributor becomes a pure adviser instead, he shall be allowed to receive trail commission for the products already distributed subject to disclosures to the clients. However, he can undertake fresh business only under a fee-based advisory model.

Thus looking at the above proposals, it can be stated that they are beneficial from the Investors point of view in protecting his interests. Going point by point, it may be observed that:

• The compulsory registration of an adviser acts like a filtration process thus ensuring that only qualified / certified professionals are undertaking the job.
• A time period of three years is given to comply with the requirements of the proposal however no specific procedure for the same has been given. A little bit of vagueness appears in specifying the time period.
• The use of a name like ‘independent financial adviser’ or ‘wealth adviser’ should be used by only registered advisers as many people get confused and get lured by such fancy names.
• One of the proposals also gives the right to a distributor to remain a distributor however without providing any advice which if taken into account will ensure better execution of service as well as the MFD would not have any vested interest in the same.
• Further, the proposals do not debar a distributor who has been registered as an adviser to receive the trail commission thus ensuring that no investment management company shall take advantage of the proposal made. 

Thus in generality, when an Investor approaches the Mutual Fund distributor for the purpose of seeking advice as to where to invest, he tends to be more biased towards the policies that he currently sells and by which he earns a greater commission thus acting in vested interest, whereas, when an Investor seeks advice from a different subsidiary or from an independent adviser dealing only with the task of providing advice as to which policy is better for the investor with respect to the needs of each and every Investor, it provides a greater array of policies thus benefitting the Investor by widening his scope.

Further other persons who provide investment advice like insurance agent or people providing advice on pension products are to be registered under their respective Acts (IRDA and PFRDA) and would not have to register under the IA Regulations. This proposal again helps in avoiding any conflict by not allowing one adviser to be regulated by two laws on the same subject.

Investment advisory services through a separate subsidiary:

As per Regulation 22 of IA Regulations, banks, NBFCs and body corporates providing investment advices shall segregate this service from other services they provide. The earlier position with respect to the same was that if an entity wanted to provide advisory services then it had to form a separate department for the same. As per the proposed amendment, SEBI has gone a step ahead and it has suggested that not only a separate department but a separate subsidiary shall be formed, if an entity wants to provide advisory services in addition to its primary activity. The time prescribed to comply with the same is 3 years.

Though the above proposal aims at ensuring that the entity and its subsidiary are at arms-length distance from each other but by putting a clause for a separate subsidiary altogether the time period falls short. Huge companies who have the funds can easily form the required subsidiary, but the small time players are at a loss in this case. It will require a huge investment on their part and thus in a way deter them to take up the advisory services business. Though this proposal ensures no biasness but to a certain extent also ignores the small time distributors.

Certain Clarifications Proposed by SEBI:

Along with the proposed amendments, certain clarifications were also proposed as a part of the consultation paper with respect to the IA Regulations in order to clarify the intent behind making of these regulations and to achieve its objectives. They are as follows: 

1. With respect to investment products and Advice in electronic/broadcasting media

The definition of the term investment advice included the term ‘investment products’ which was nowhere defined under the IA Regulations. Thus people could interpret it in a number of ways leading to ambiguity. A clarification to that respect has been proposed by SEBI thus defining the term ‘investment products’ as follows-

“Investment products shall include all financial instruments that are regulated by any financial sector regulator in India. However, advice exclusively on products in non-securities market which are regulated by sectoral regulators shall be outside the scope of the IA regulations\". 

This removes ambiguity and gives the correct interpretation of the term to avoid multiple interpretations clearly stating that any advices given on the subject matter exclusively on the products in the non – securities market are considered to be outside the scope of IA Regulations, hence reducing the burden of SEBI.

Further, the IA regulations do not apply to any advice given through newspapers, magazines, any electronic or broadcasting or telecommunications medium, which is available in the public domain. Thus another clarification in this respect is that SEBI has not exclusively exempted these publishing from SEBIs purview and it will be regulated by the provisions pertaining to recommendations in public media as specified in Regulation 21 of SEBI (Research Analyst) Regulations, 2014, thus ensuring that the same are being regulated.

However, it is proposed by SEBI that advising clients after getting them subscribed/registered on any public media platform shall be considered to be an investment advisory service and thus be regulated by the IA Regulations.

2. Difference in the activities of investment adviser and research analyst

The proposals clearly state that there is a difference between an investment adviser and a research analyst. It states that the reports published by a research analyst shall be available to all clients at the same time and not only to selected clients. Further, investors can take help of these research reports to take investment advice. However, if an investor personally approaches and pays fees to a research analyst then they shall act in fiduciary capacity and act in best interest of the clients.

The benefits of distinguishing a research analyst from an investment adviser is that, many people are getting themselves registered as research analyst instead of investment adviser in order to avoid various compliance requirements specified in IA Regulations such as suitability of the recommendation, risk profiling, etc. Thus, clarity on this distinction is very important.

3. Receipt of consideration

For a person to be called as an investment adviser it is very important that the advisory services to the client are provided in exchange for a consideration.Clarity on the term consideration has been proposed to cover all forms of remuneration or compensation including the receipt of any economic benefit, whether in the form of an advisory fee, some other fee relating to the total services rendered, commission received or receivable by an investment adviser or any of its associates or subsidiaries either directly or indirectly in respect of the underlying products or securities for which advice is being provided.

This clarity was necessary as the term consideration was being misinterpreted. Persons providing investment advisory services without consideration from the clients were taking undue advantage presuming themselves not falling under the purview of the IA Regulations. Thus it was important to clarify the fact that consideration is not a narrow term to be taken advantage of.

4. On the compliance audit requirement

Regulation 19 (3) of IA Regulations states that, an investment adviser shall conduct yearly audit in respect of compliance with these regulations from a member of Institute of Chartered Accountants of India or Institute of Company Secretaries of India. 

In order to bring the adverse observation or comments of the audit to the notice of SEBI, a proposal has been made that the compliance relating to audit must be completed within 3 months after the end of the financial year. This ensures that the adviser does not get enough time to manipulate his accounts and forge his audit report. Therefore, it helps in providing a clear insight of the company.

5. On mode of acceptance of fee

It was observed that many investment advisers receive advisory fee in the form of cash deposit. Thus this money is many a times unaccounted for giving rise to black money.

It is therefore proposed that an investment adviser shall accept fees strictly by account payee crossed cheque / demand draft or by way of direct credit into the bank account through NEFT/ RTGS/IMPS or any other mode allowed by RBI. 

Restrictions in respect of:

1. Providing trading tips using various electronic modes

2. Offering or organising schemes/competitions/games related to security market

3. Providing free trial trading tips

It is often seen that many Investment Advisors who are not registered as per the IA Regulations provide trading tips through various electronic modes and social networking media such as SMS, whatsapp, e-mails, internet, twitter, etc. as a result of which many people get lured and influenced by such tips which results in poor investment decisions subsequently having a negative impact on the stock market.

Hence, the proposal that such advisors can only give advice once they are registered with SEBI as registered Investment Advisers. Further it was proposed to add a clause under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 {PFUTP Regulations}, to restrict such activities by making necessary amendments to PFTUP Regulations to ensure that remedy is available to every investor against any unfair trade practice on the part of Unregistered Investment Adviser.

Similar to the above restriction and clause under PFTUP Regulations, there is one more restriction proposed in respect of Offering or organising schemes/competitions/games related to security market. This restriction serves the same purpose as above and thus has relevance.

The third issue faced is the free tips provided to lure prospective investors. This again is harmful as people with no experience also come into the picture and provide tips as per their convenience. There is no remedy also against such people. Even if an adviser has experience but without having knowledge of the investors risk profile or doing an analysis of the investor needs, the advice will not be in the best interest of the investor. Hence, it is proposed to prohibit such free trial trading tips.

It is next to impossible for SEBI to go to the bottom of the issue because of encryption and the sheer enormity of it. It may end up being like the Censor Board which keeps hacking `vulgar scenes’ from being screened when they are in plenty via smartphones. Of course, SEBI may also have to master hacking in which case it instead of enforcing law may end up breaking it.

Thus though this proposal has been made but there are no guidelines for the execution of the same and that will be an issue to deal with once this proposal comes into effect.

Requirement of providing ‘rights and obligations’ document to the clients:

It is often seen that the Investment Adviser give advice to the Investors orally which does not bind or obligate them with any kind of obligations or duties towards their clients. Therefore it is has been proposed  that an investment adviser shall, at least two days prior to on boarding the clients, provide ‘Rights and Obligations’ document to the clients stating the inter relationship and terms and conditions of investment advisory services offered, which shall be binding on investment adviser and its clients.

The document should contain certain obligations of the investment adviser, certain risk factors that are to be stated along with the methods of Dispute Resolution as well as the process of the Termination of the Relationship.

Thus to ensure that the rights of the investors are not infringed and are protected and there exists a fiduciary relationship between the Investor and the Advisor, this document is of utmost importance so that the rights and duties of both the parties are secured without any dispute.

Advertisement Code and Display of Details on Websites:

People these days publish fraudulent and irrelevant information in the advertisements such as solicit investment or promising unrealistic returns in the security markets which leads to wrongful manipulation of the investors decisions. Sometimes, the advertisements are complex or filled with technical terms to hide or confuse the potential investors in making them believe something that is not there in reality by playing with words.

Thus, the proposed amendment in this respect is that there should be a certain advertisement code to be followed, which is again beneficial for the investors as many of them don’t even understand a particular language. Thus classifying certain advertisements as unethical helps in ensuring a fair projection of the service. Another proposal of maintaining a copy of advertisement for a period of 5 years, which helps in keeping a check on any past advertisement as well. This code is also important as it provides a disclaimer to the Investor not to rely upon these advertisements as they are just to encourage the investors to invest.

Moreover, in today’s modern era many people are rely upon the internet services and it is one of the major sources for the Investors to look upon for deciding their Investment decisions. Many IA use this technology to their advantage by making websites for the same. However, they do not disclose all the details on that website such as their registered address, contact no, validity of registration, etc. Such details are very important for an Investor if he wants to ascertain the genuineness of the Adviser and thus this code proposes to ensure transparency between both the parties.

Applicability in respect of:

Risk profiling and suitability requirement of non-individual investors

The current provisions of IA Regulations do not differentiate between retail individual investors and non-individual investors such as corporate, institutional etc. However, risk profiling is considered to be one of the most important element for an investor while making investment decisions. Risk profiling varies from investors to investors. In case of Individual Investors, the risk faced is easily calculable whereas in case of Non Individual Investors the risk calculation is complex due to complex structured products and investment in derivatives etc. 

Thus risk profiling is mandatory in case of individual investors in all cases. However in the case of corporate entities, the skills of the adviser would not be enough to profile the risk and further certain factors for risk profiling may not apply to corporate entities hence only wherein risk profiling is of utmost importance, it is proposed to be made mandatory whereas in other cases the adviser is not supposed to carry out the same.

Online investment advisory services and use of automated tools

Many a times, investment advisers use robo advisers which use a lot of algorithm formulae and calculations and give the results based on the information we put in. Under IA Regulations, there is no express prohibition for use of automated advice tools by SEBI registered investment advisers. The risk profiling of the investor is mandatory and all investments on which investment advice is provided shall be appropriate to the risk profile of the client. IA regulations have also specified that where tools are used for risk profiling, it should be ensured that the tools are fit for the purpose and any limitations are identified and mitigated. The records pertaining to risk profiling and risk assessment of the client and suitability assessment of the advice being provided shall have to be maintained by the investment adviser for a period of five years.

Thus it is proposed that anyone who uses this automated tool must ensure its proper condition, must ensure that its fit to use, must disclose to the client how the tool works and shall also be responsible for any advice given by the tool. So basically, herein the automated tool enters into a fiduciary relation with the client and does the work of an investment adviser and to ensure that there is some accountability of the same, the investment adviser who uses this tool or the hirer of such an automated tool will be held responsible for the same to protect the interests of the client.

Recognition of Chartered Financial Analyst

Regulation 7(1) of the IA Regulations gives the qualifications, eligibility criteria for a person to give investment advice. The qualifications included a post-graduation degree or a graduation degree with 5 years of experience in activities relating to advice in financial products.

Along with these qualifications, a certification on financial planning or fund or asset or portfolio management or investment advisory services is required:

(a) From NISM; or

(b) From any other organization or institution including Financial Planning Standards Board India or any recognized stock exchange in India provided that such certification is accredited by NISM. 

It is proposed that the degree of CFA shall be considered to be as a proper qualification for any interested individual who wants to practice as an investment adviser even without the certification from NISM.

This proposal is beneficial as it widens the scope of investment advisers and includes some intellectual beings who have passed the CFA exam thus ensuring appropriate advice to the investors.

Conclusion

It is of utmost importance to interpret a regulation and understand the intention of the law makers before making any amendments. The above amendments proposed by SEBI try to establish a fiduciary relationship between the Investors and the Investment Advisers as they create certain obligations on the part of the Investment Advisers which make them more responsible towards the rights of the Investors.

With these amendments, SEBI tries to clarify certain important elements of the Regulations such as the important concept of “Investment product”, difference between the Individual Investors and Non Individual Investors with respect to the essential factor of Risk Profiling.

It also tries to provide a clear insight with respect to the importance of the registration of the Investment Advisers and how publishing of certain information through electronic and social media might lead to manipulation of the Investors decisions resulting in huge variations in the security market.

Thus in a nutshell, it can be said that these amendments proposed by SEBI are though slightly vague when it comes to certain issues such as time limit of 3 years and online publications, etc. but they are indeed for the betterment of the Investors as well as the Investment Advisers. It also reduces the amount of pressure on SEBI by providing proper justifications and clarifications. Hence, these should be definitely taken into consideration by the Regulators in order to reduce further complications, avoid conflict of interest, provide transparency and facilitate smooth and process driven functioning of the Financial Markets bringing stability. Though in short run, Speculators and Punters may have to change the course a bit, however, they are not expected to change the inherent trait of gambling on the market perceptions.