SEBI proposes self-regulation for investment advisors

The Securities and Exchange Board of India (SEBI) has proposed a self-regulatory framework for investment advisors who offer products across asset classes. The market regulator today issued a concept paper on regulations for investment advisory seeking public comments. 
 
Since the production and sale of financial products involves a conflict of interest, SEBI said, it is necessary to resolve or at least mitigate these conflicts, especially in the case of financial products because of their two peculiar characteristics. First, the products are intangible and conceptually more difficult to understand. Second, the payoffs are in a distant future and can be camouflaged by several factors external to the product.

It is in this context that the distributors occupy a key role, all the more so considering the low levels of financial literacy and awareness in India, SEBI said.

SEBI said the conflict of interest arises mainly because of the dual role played by distributors as an agent of investors as well as of the manufacturers as they receive their payments from two sources - commissions from the manufacturers and advisory fees or other charges received from the investors.

"This raise the question as to whose interests do they represent, the manufacturers' or the investors?"  It often results in a situation where the distributors are loyal to themselves, SEB noted.

The proposed regulatory framework intends to regulate the activity of investment advisory services in various forms by a wide range of entities, including independent financial advisors, banks, distributors, fund managers etc. 

The investment advice may be provided for investments in various financial products, including but not limited to securities, insurance products, pension funds, etc.

While the activity of giving investment advice will be regulated under the proposed framework through an SRO, issues relating to financial products other than securities will come under the jurisdiction of the respective sectoral regulators such as action for mis-selling, violation for code of conduct, conflict of interest etc.

Advisor Vs Agent

SEBI cited plans outlined by the Financial Services Authority, UK to ban commission payments for product providers and enforce financial advisors to agree on fee payments with clients upfront. It has defined two categories of service: independent and restricted, on the basis of which advisors would charge the fee. Examples of restricted advice may be where advisors offer advice only about the products of a particular manufacturer; or about the products from a defined list of manufacturers.

Independent advice would include unrestricted advice based on a comprehensive and fair analysis of the relevant market. However, there is a kind of restricted advice called basic advice. With basic advice, the consumer is asked some prescript questions about their income, savings and other circumstances to identify the consumer's financial priorities and suitability for a stakeholder product, but a full assessment of their needs is not conducted nor is advice offered on whether a non-stakeholder product may be more suitable.

Basic advice is excluded from the new rules, ie, in case of basic advice, commissions can be paid and the new advisor charging rules are not applicable to the same. Also, non-advised or execution only sales would be remunerated only by commission and would not fall within the ambit of the advisor charging rules.

Thus, in the FSA model, the first conflict of interest seems to have been addressed by ensuring that the distributor/advisor owes allegiance to only one paymaster at a time either the manufacturer or the investor.

SEBI, with effect from 1 August 2009, had banned entry loads in mutual fund investments and had mandated that the upfront commission should be paid directly by the investors to the distributors based on factors like assessment of the service of the distributor. However, the distributor continued to earn trail commissions from the asset management company at the same time. Thus, the first conflict of interest was only partially mitigated in this model.

The possible model for tackling this conflict of interests may be the following:

•  The person who interfaces with the customer should declare upfront whether he is a financial advisor or an agent of the manufacturer.
  
• If he is an advisor, he would be subject to the Investment Advisors Regulations; and would require a much higher level of qualifications. He would act as an advisor to the investor on all financial products. He would receive all payments from the investor and there would be no limits set on these payments. On the other hand, there will be agents who will be associated with the manufacturer and would receive their remuneration from them. However, they will be prevented from styling themselves as financial advisors and will have to call themselves as agents only.

SRO model

The proposed regulatory framework intends to regulate the activity of providing investment advisory services in various forms by a wide range of entities, including independent financial advisors, banks, distributors, fund managers etc. The investment advice may be provided for investments in various financial products, including but not limited to securities, insurance products, pension funds, etc

While the activity of giving investment advice will be regulated under the proposed framework through an SRO, issues relating to financial products other than securities shall come under the jurisdiction of the respective sectoral regulators such as action for misselling, violation of code of conduct, conflict of interest etc.

The SRO set up for the regulation of investment advisors should follow the rules/regulations laid down by respective regulators for products falling in their jurisdiction, including but not limited to suitability and appropriateness of the products.

The regulations will provide that no person can carry on the activity of offering investment advice unless he is registered as an investment advisor under the regulations. On the other hand any person who has obtained the certificate of registration as an investment advisor must necessarily use the word investment advisor in his name.

Definition of investment advisor

SEBI has defined investment advice as an advice written, oral or through any other means of communication given regarding investment of funds in financial products or products that are traded and settled like financial products purportedly for the benefit of the investor.

Banks providing investment advisory/ wealth management services would be required to get registration under the
regulations.

A person shall be deemed not to be engaged in the business  of providing investment advice, if the advice is solely incidental to some other business or profession and the advice is given only to clients of the person in the course of such other business or profession and the advice does not specify particular securities and is limited to general comments made in good faith in regard to trends in the securities market, the economic situation of the country.

• An advocate and solicitor or law firm, whose offer of financial advice is solely incidental to his legal practice;
  
• Chartered accountants who are registered under the Institute of Chartered Accountants of India providing of any investment advice is solely incidental to the accounting practice;
  
• Any person who publishes magazine/newspaper, where: the newspaper is distributed generally to the public in India, the advice given, or analysis or report issued, is promulgated only through that newspaper, that person receives no commission or other consideration, apart from any fee received from subscription to or purchase of the newspaper, for giving the advice, or for issuing or promulgating the analysis or report; and
  
• The advice is given, or the analysis or report is issued or promulgated, solely as incidental to the conduct of that person's business as a newspaper proprietor.
  
• Any person who owns, operates or provides an information service through an electronic, or a broadcasting or telecommunications medium, where:

The service is generally available to the public in India;

The advice given, or analysis or report issued is promulgated only through that service;

That person receives no commission or other consideration, apart from any fee received from subscription to the service, for giving the advice, or for issuing or promulgating the analysis or report; and

The advice is given, or the analysis or report is issued or promulgated, solely as incidental to that person's ownership, operation or provision of that service.

• Any stock broker or sub-broker as registered under SEBI (Stock Broker and Sub-broker) Regulations, 1992, who provides any investment advice as per Regulation 7 read with Schedule II of SEBI (Stock Broker and Sub-broker) Regulation, 1992 and not charging any consideration for such advice.
  
• Any person offering exclusively insurance broking services under regulation of Insurance Development and Regulatory Authority.

Individuals who wish to get registered under these regulations would need to satisfy the following criteria:

• Acquire a professional qualification from a recognised institute like. Chartered Accountancy form ICAI, MBA in Finance or similar qualification from a recognised university or should have at least 10 years of relevant experience; and
  
• Certification from NISM or such other organisation approved by SEBI for this purpose
  
• The individuals should conform to the Fit and Proper Criteria laid down in Schedule II of SEBI (Intermediaries) Regulations, 2008. They need to satisfy the following criteria:

a) Capital adequacy requirement: Entities would need to maintain a minimum net worth which would be separate from the net worth required for other activities.

b) Key personnel: Entities should have at least 2 key personnel having the relevant experience exclusively for such activity. Such key personnel should also acquire the
certification from NISM or such other organisation as approved by SEBI for this purpose and have minimum qualification as prescribed.

c) The entity should conform to the Fit and Proper Criteria laid down in Schedule II of SEBI (Intermediaries) Regulations, 2008.

d) The applicant must have adequate infrastructure to enable it to discharge its functions as an investment advisor.

Responsibility to investors

All information received and provided by the investment advisor would be in fiduciary capacity. The investment advisor will be responsible to maintain confidentiality of the investment advice provided to the client and information provided by the client. Advice should be given by the advisor in the best interest of the investor.

Suitability and risk profiling

The investment advisors or their representatives would be required to do adequate risk profiling of the client before any investment service is provided to them. Based upon the
risk profiling performed by the investment advisor or their representative suitable investment advice should be provided. The records of such risk profiling and investment
advice should be maintained by the investment advisor.

Advertising and marketing material

Investment advisors should not use any advertisement that contains any untrue statement of material fact or that is otherwise misleading. They should not use or refer to testimonials (which include any statement of a client's experience or endorsement).

Refer to past, specific recommendations made by the advisor that were profitable, unless the advertisement sets out a list of all recommendations made by the advisor within the preceding period of not less than one year and complies with other specified conditions.

Conflict of interest

No financial incentives/ consideration would be received from any person other than investors seeking advice. In case of advice regarding investment in entities related to the
investment advisor, adequate disclosures shall be made to investor regarding the relationship.

Maintaining records

Records in support of every investment recommendation /transaction made which indicates the data, facts and opinion leading to that investment decision would be maintained by the investment advisor. Records should be retained for at least 5 years.

Systematic record of all advises provided would be kept including audio recording of any oral advice given.

Fees and charges

The investment advisor would clearly indicate to its clients the fees and charges that are required to be paid by them. An investment advisor should disclose to a prospective
clients all material information about itself, its businesses, its disciplinary history, the terms and conditions on which it offers advisory services, its affiliations with other intermediaries and such other information as is necessary him to take an informed decision whether to avail of its services.

Execution services

Investment advisors should not accept funds / securities from investors, except the fee for investment advice. If non-individual investment advisors (corporate entities) offer
assistance in execution services such as broking, custody services, DP services, accounting etc, they must make appropriate disclosures, clarify that the investor is under no obligation to use their services and maintain arms length relationship through creation of Chinese walls. The choice of opting for execution services offered by investment advisor should be left to the investors. Fees and charges paid to service providers should be paid directly to them and not through investment advisors.

Outsourcing

Other than sourcing of research reports, no other part of investment advisory activity can be outsourced.

Liability

The investment advisors shall not be liable for civil or criminal liability in respect of advice given unless the advice is negligent or mala fide in nature. Any dispute between
the investment advisor and his client would be resolved through grievance redressal mechanism or arbitration created by SEBI.

Portfolio managers

Portfolio managers who provide only investment advice would need to be registered only as investment advisors after their present registration expires. Portfolio Manager
Regulations would be amended in view of the proposed AIF Regulations as well as the Investment Advisor Regulations.

SEBI has sought public comments on the concept paper on regulation of investments advisors latest by 1730 hours on 31 October 2011.