SEBI’s new rules for investment advisers: A step in the right direction?

The Securities and Exchange Board of India (SEBI) is entrusted with the duty to promote and develop investor protection within the securities market of India. Due to the growth of Indian asset management and financial advisory businesses, there was a need for transparency in the conduct of dealing with market participants.

In the light of the same, SEBI had enacted the SEBI (Investment Advisers) Regulations in 2013 (2013 Regulations). However, over time, the need for an amendment arose due to the rampant increase in investor complaints against the investment advisers regarding the charging of exorbitant fees, false promises on minimum returns, non-adherence to the risk profile of clients, etc.

Keeping this in mind, SEBI recently rolled out the SEBI(Investment Advisers)(Amendment)Regulations, 2020 (amendment). This was done after the consultation papers floated by SEBI in 2016, 2017, 2018 and 2020 to promote effective regulation of investment advisers. With this background, this article aims to analyze the implications of the amendment on the investors and the investment advisers at large.

Segregation of Services

Prior to the amendment, individuals and partnerships firms could not engage in advisory and distribution simultaneously, but corporate bodies were allowed to carry out both these services, through a separate division solely dedicated to advisory services.

This lead to a conflict of interests and breach of fiduciary duty owed to the clients. Instead of advising on the prime interests of the clients, corporates engaged in self-fulfilling interests to receive high commissions. In a bid to curtail such practices, the amendment provides for segregation of advisory and distribution services.

Unlike before, individual investment advisers cannot advise and distribute investment products at the same time. They can either be registered with SEBI as an investment adviser or provide distribution services. Further, the amendment has also barred family members of the individual advisers such as children, spouse, and parents from offering distribution services to clients who are receiving advisory services from the advisers and vice versa.

Moreover, the segregation mandate has been extended to non-individual advisers as well, since they are required to segregate investment and advisory services for clients at a group level. It is evident from the amendment that the segregation of services is applicable even to the group entities of the non-individual advisers.

Therefore, a joint venture, associate company, holding company or subsidiary company of the parent entity is allowed to render only one kind of service to clients. Further, an arm's length relationship needs to be maintained between advisory and distribution-related activities of non-individual advisers.

The segregation mandated by SEBI can keep a check on practices of many distributors who tend to sell products solely with the motive of reaping high incentives through means of commission instead of basing it on the merit of the product itself. This greatly hinders the fiduciary relationship owed to the clients. Also, there are wealth managers who charge a distribution commission and other fees on certain products. Such practices will be curbed due to the segregation of advisory and distribution services to an individual client that will be beneficial for investors.

Although SEBI's initial proposal was to create separate legal entities to provide advisory and distribution services, it was probably shelved owing to the compliance costs involved. However, SEBI’s mandate to set up a separate division for advisory and distribution services to maintain an arm’s length relationship between the two will serve the purpose of the initial proposal in a cost-efficient manner.

Mandatory Corporatization

It is now mandatory for individual advisers to corporatize once they exceed the threshold of 150 clients. Moreover, non-individual advisers need to meet the net worth requirements of Rs.50 lakhs while individual advisers need to meet the net worth requirements of Rs.5 lakhs within a period of three years after the amendment comes into force.

It is necessary to point out that mandatory corporatization for the cap of just 150 clients is too less. This poses a daunting task for individual investment advisers who may not possess adequate capital to corporatize their business, especially because their present income may not be too high. Further, such a change will incur extra costs that might drive out individual investors from the business altogether.

A lot of individual registered investment advisers might have crossed the said threshold already and it might be challenging for them to bring in the funds of Rs.50 lakhs in order to corporatize their business. Such a mandate put forth by SEBI is neither beneficial for the investors nor the investment advisors.

Furthermore, it is unfair to presume that individual advisers cannot handle 150 clients. It is important to realize that individual investment advisers can recruit Persons Associated with Investment Advice under the said regulations. On this account, they can efficiently handle customers more than the prescribed threshold without the need to corporatize.

The authors also suggest that it is more rational to decide the threshold for corporatization based on the turnover of the advisers rather than the number of clients. Therefore, SEBI should reconsider its stance on this front.

Greater Transparency

It is now mandatory for investment advisers to enter into written agreements with their clients. This can help in solidifying the relationship between the adviser and the client and gives rise to relevant expectations. Further, they are also required to maintain records to ensure transparency regarding their advisory services.

In a bid to further the cause of transparency and accountability, corporate advisors are also required to provide an objective analysis of the recommendations and advice provided by them. The particulars of the analysis are dependent on the requirements of the client. These include reasons for advising a certain product, how such advice fulfills the expectations of the client, the risk attached to such transaction, etc.

Change in Eligibility Criteria

The Regulations have laid down certain eligibility criteria in order to register with SEBI as an adviser, which are as follows

1. A professional qualification or post-graduate degree or diploma in finance, accountancy, business management, commerce, economics, capital markets, banking, insurance or actuarial science; or

2. A graduate in any discipline with experience of at least five years in activities relating to advice in financial products/securities/fund/asset/portfolio management.

As per the amendment, along with fulfilling such criteria, the adviser is also required to possess a certificate on financial planning or fund or asset or portfolio management or investment advisory services from either National Institute of Securities Markets (“NISM”) or any other organization whose certification is accredited by NISM.

Along with the certificate, the adviser must also have five years of experience to qualify for registration.

The requirement pertaining to work experience needed to qualify as an investment adviser not only enhances the duty of care and responsibility owed to the client but also increases the expectation with respect to the quality of advice provided to the clients.

Fee Structure

The 2013 Regulations did not prescribe a maximum limit for the fees that can be collected by an adviser and allowed the adviser to charge any amount as long as it was ‘fair and reasonable’. The presence of such vague guidelines attracted numerous complaints by clients who were charged exorbitantly for advisory services.

Thus, SEBI has addressed this concern in the amendment by notifying certain fee structures namely- (a) the assets under advice (AuA) model or (b) the fixed fee model. The AuA models allow advisers to charge a maximum of 2.5% per asset under advice per annum. The fixed fee model disallows advisers to charge above Rs.75,000 per annum. Although this can facilitate a uniform fee structure amongst all investment advisers, the intervention of SEBI in deciding the fee structure of advisers can be said to be arbitrary in nature.

Specifying a cap, i.e. Rs.75,000 on the fees that can be charged by the investors restricts the fee-charging ability of an adviser. Such a cap disregards complex transactions and large transactions that require nuance and careful deliberation by investment advisers. Also, the tailor-made advice for such transactions requires compensation equal to the effort employed into it. Hence, it would be ideal if the parties involved determine the fees rather than using the pre-determined fee structure of SEBI.

Conclusion

The amendment is a welcome change that inculcates a pragmatic approach to promote investor protection. Further, it has put in place a robust regulatory framework that upholds the rectitude of the conduct of investment advisers. Although great reliance has been placed on the interests of the investors, certain regulations that might have a detrimental effect on the advisers need to be revisited and suitable changes must be made accordingly.

The authors are students of the School of Law at Christ (Deemed to be University)