CONCEPT PAPER ON REGULATION
OF INVESTMENT ADVISORS
1. Background
1.1 Section 11 (2)(b) of SEBI Act empowers
SEBI to register and regulate working of Investment Advisors and such other intermediaries who may be
associated with securities market in any other manner.
1.2 As decided by SEBI Board in
its meeting dated March 22, 2007,
SEBI had posted a consultative paper on the “Regulation of Investment Advisors”
on its website inviting public comments. Based on public comments received on
the consultative paper as also the USAID (Fire Project), a memorandum was placed before the SEBI Board proposing
a regulatory approach for Investment Advisors. It was proposed that the Regulations
shall be implemented through an SRO. As Investment Advisors offer products
across asset classes, it was
felt that the respective regulators may take a view and formulate similar norms
and code of conduct.
Accordingly a reference was made to the HLCC on Financial and Capital Markets.
1.3 HLCCFM in its meeting held
on December 22, 2008 set
up the D. Swarup Committee to re‐examine the issue. The committee
submitted its report to government in December 2009 which was discussed in the
HLCCFM meeting in March 2010. Subsequently, regulatory issues relating to
Wealth Management and / Private Banking undertaken by banks were discussed by
the FSDC Sub‐Committee
in its meeting on March 4, 2011.
1.4 In
this background, SEBI has developed a framework for regulation of investment advisors through the SRO route.
2. Tackling Conflict of Interest
in Distribution of Financial
Products
2.1 It is axiomatic that any
industry, in order to achieve scale and high productivity, must be free of
internal contradictions and conflicts of interest. Financial sector is no
exception. The financial product distribution space is particularly fraught
with these conflicts between the manufacturers of financial products like
banks, mutual funds, and insurance companies, etc. and the distributors which
sell these products who call themselves by various names like agents, financial advisors, financial
planners, etc.
2.2 It
is necessary to resolve or at least mitigate these conflicts, especially in the
case of financial products because of their two peculiar characteristics.
Firstly, the products are intangible and conceptually more difficult to
understand. Secondly, the pay‐offs 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.
2.3 Two
major conflicts of interest in the financial product distribution space are the
following:
a. Dual role played by
distributors as an agent of investors as well as of the manufacturers. This is
due to the fact that with respect to many financial products, agents receive
their payments from two sources: commissions from the manufacturers (either directly
or through deductions from the investment amount of investors), and advisory
fees or other charges received from the investors. This immediately raises the
question: whose interests do they represent: the manufacturers’ or the
investors’? This question has also been raised in the Devendra Swaroop
Committee report on ‘Minimum Common Standards for Financial Advisors and
Financial Education’. This prevalence of divided loyalties may not be in the
best interest of all the stakeholders concerned. It often results in a
situation where the distributors are loyal to only themselves. They would
happily churn investors’ portfolio and also squeeze more commission from the
manufacturer.
b. A situation might arise where
distributors are likely to be partial to, and would sell more products of the
manufacturer who is the best paymaster; and ultimately, other manufacturers
would scramble to do the same, thus leading to a race to the bottom. Thus,
there is an inherent conflict in the activities of an agent/distributor
distributing similar products of various manufacturers.
2.4 There could be many possible
solutions to these issues ‐ the most obvious and the easiest being enhanced
disclosures. However, in a country like India
where levels of literacy are low and financial literacy even lower, disclosures
have a limited effect.
2.5 The Financial Services
Authority, UK,
had outlined plans to ban commission payments for product providers and enforce
financial advisors to agree on fee payments with clients upfront. It 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 pre‐scripted
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
i.e. 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 as per para 2.3(a) 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.
2.6 SEBI, with effect from August 01, 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.
2.7 In
this paper, we are attempting to deal with only the first type of conflict of
interest. The possible model for tackling this conflict of interests may be the
following:
a. The person who interfaces with
the customer should declare upfront whether he is a financial advisor or an
agent of the manufacturer.
b. 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.
c. This will resolve the first conflict of
interest as in para 2.3 (a).
3. Structure of Proposed Regulations
3.1 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 mis‐selling,
violation of code of conduct, conflict of interest etc. The SRO set up for the
regulation of Investment Advisors shall 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.
3.2 The SRO formed to regulate
investment advisors will be registered under the SEBI (Self Regulatory
Organization) Regulations, 2004. SRO will have sufficient resources to perform
its functions. Its duties would include registering and setting minimum professional
standards, including certification of investment advisors, laying down rules
and regulations and enforcing those; informing and educating the investing
public; setting up and administering a disputes resolution forum for investors
and registered entities etc. Persons desirous of registration as Investment
Advisors shall obtain registration with the SRO established for the purpose.
The SRO will be entitled to charge a fee for granting registration and an
annual fee.
3.3 Complaints / disputes
arising out of investment advisory services will be taken up by the SRO with
the respective regulatory authority, while the complaints regarding the
financial products and their manufacturers will be handled by the respective
regulators.
3.4 Investment
Advisors tend to call themselves by varied names viz. wealth managers, private
bankers etc. This causes much confusion as to their role and responsibility.
Hence 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.
4. Definitions
4.1 Investment
Advisor
Investment advisor for the purpose of the
regulations shall be any person or entity that provides investment advice
directly or indirectly for a consideration, which may be received directly from
the investor or who holds himself out as an investment advisor.
4.2 Investment
Advice
Investment advice shall be 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. It shall
include:
(a) Financial advice; or
(b) Financial planning service or
(c) Actions which would influence an investment
decision and are incidental to making an investment/investment decision.
5. Coverage
5.1 Individuals
The following set of individuals would need to
get registered under the regulations to be able to provide Investment Advisory
Services:‐
a. Independent Investment
Advisor– Independent Investment Advisors are professionals who offer
independent advice on financial matters to their clients and recommend suitable
financial products or products that are traded and settled like financial
products.
b. Representatives of investment advisors or intermediaries who on behalf of the investment advisor or intermediary provide investment advice to investors: Representative would mean a person, in the direct employment of, or acting for, an investment advisor, who performs on behalf of the investment advisor any investment advisory service, whether or not he is remunerated, and whether his remuneration, if any, is by way of salary, wages, commission or otherwise, and includes any officer of an investment advisor who performs for the investment advisor any investment advisory service whether or not he is remunerated, and whether his remuneration, if any, is by way of salary, wages, commission or otherwise;
5.2 Non‐individuals
The following set of non‐individuals (corporate
entities) would need to get registered under the regulations to be able to
provide Investment Advisory Service:
a. Banks providing investment advisory/ wealth management services: In India
Banks are allowed to perform only Investment Advisory Services. Those banks
which provide similar services would be required to get registration under
these regulations.
b. Any entity, other than an individual person ‐ representing investment advisor, who
on behalf of the investment advisor provides investment advice to investors :
Representative would mean a person, acting for, an investment advisor, who
performs on behalf of the investment advisor any investment advisory service,
whether or not it is remunerated, and whether its remuneration, if any, is by
way of, commission or otherwise, and includes any officer of such an entity who
performs for the investment advisor any investment advisory service whether or
not he is remunerated, and whether his remuneration, if any, is by way of
salary, wages, commission or otherwise;
6. Persons Exempt from the regulations
6.1 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.
6.2 The
following shall be exempt from registration under these regulations:
a. An advocate and solicitor or law firm, whose
offer of financial advice is solely incidental to his legal practice.
b. 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.
c. Any person who publishes magazine/newspaper,
where —
I. the newspaper is
distributed generally to the public in India;
II. the advice given, or analysis or report
issued, is promulgated only through that newspaper;
III. 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
IV. 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.
d. Any person who owns, operates or provides an
information service through an electronic, or a broadcasting or
telecommunications medium, where —
I. the service is
generally available to the public in India;
II. the advice given, or analysis or report
issued is promulgated only through that service;
III. 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
IV. 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.
e. 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.
f. Any person offering exclusively insurance
broking services under regulation of Insurance Development and Regulatory
Authority.
7. Registration Requirements
7.1 The
Individuals who wish to get registered under these regulations would need to
satisfy the following criteria:
a. Individuals should acquire a
Professional Qualification from a recognized institute for e.g. Chartered
Accountancy form ICAI, MBA in Finance or similar qualification from a
recognized university or should have at least 10 years of relevant experience;
and
b. Certification from NISM or
such other organization approved by SEBI for this purpose
c. The individuals should conform to the Fit and
Proper Criteria s laid down in Schedule II of SEBI (Intermediaries)
Regulations, 2008.
7.2 Entities
who wish to get registered under these regulations would 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 organization 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.
8. Obligations of an Investment Advisor
8.1 Fiduciary 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.
8.2
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.
8.3 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.
8.4 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.
8.5 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.
8.6 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 shall 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.
9. Execution Services
Investment advisors shall 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.
10. Outsourcing
Other than sourcing of research reports, no other
part of investment advisory activity can be outsourced.
11. 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
12. Entities registered as 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.
13. Public Comments
Public Comments are invited on the Concept Paper
on Regulation of Investment Advisors. All comments may be forwarded by e‐mail
to Shri Manish Tekriwal, Manager, Investment Management Department, Division of
Funds ‐
1 at manisht@sebi.gov.in latest by 1730 hours on October 31, 2011.
