07 November 2016

CII's 7th Financial Markets Summit

The flagship financial/capital market seminar of Confederation of Indian Industry (CII) will take place on 10th November 2016.  The summit promises to be interesting as we have seen a change of guard at RBI and soon will see one at SEBI - giving a sort of tabula rasa for a new policy framework. I will be speaking on "Framing conducive policy and regulations for effective and efficient financial markets". Please do register for the same, details are as below:


03 November 2016

Did Sebi just score a self-goal on stock advice and free speech?

I have a piece in today’s ET “Did Sebi just score a self-goal on stock advice and free speech?” where I argue that the consultation paper of SEBI lacks internal logic, and would hurt investors rather than protect them. The restrictions on free speech would make Warren Buffet (if he chose to come to India, or commented on Indian stocks) a criminal. Please find below the full piece:

SEBI has come out with a consultation paper to modify the existing regulations of investment advisors, distributors and research analysts. The proposed amendments should be abandoned, commas and full stops included. As proposed, they would hurt investors, mandate un-suitable products to investors, fight the law of economics (unsuccessfully), outlaw honest conduct as fraud and place unconstitutional restrictions on your and my freedom of speech.

The current regulatory landscape is as follows. We have 80,000 odd distributors of mutual funds. These are agents of mutual funds and receive a commission from the funds. This is a conflicted model as it incentivises distributors to sell the products juiciest for themselves, not the most appropriate for the investor. This has been tackled by SEBI in a three-pronged approach. Limit commissions aggressively, strict disclosure norms of what is shared with the distributor and imposition of fiduciary standards on the distributors. Then there are advisors who advise clients for a fee and are not permitted a commission, though their distribution arm may charge such commission on a disclosed basis. Distributors of mutual funds are today exempt from registering as an investment advisor so long as they give incidental advice, which in fact they are obligated to give based on a 2011 circular of SEBI. Specifically, they are obliged to study the financial situation, investment experience, and investment objectives of the investor before recommending a product.

Now SEBI seeks to take away the advisory exemption to distributors. This seemingly innocuous move will have catastrophic consequences. While we have over 500 registered advisors, by my estimate, those who are advisors without any affiliated distribution function would run in single digits. It is not economically viable to be pure a play advisor. Dangerously, such a regulatory fatwa would force distributors, not to register as advisors, but rather to stop their advisory role. People assume this will hurt distributors. In fact, distributors will be happy to give up the advisory role which imposes a cost and a fiduciary obligation on them and little revenue. The sole loser of this move will be the investor. Distributors will not only obtain the ability to sell products without a basic check on the risk profile and risk appetite of the client, but the law will force the distributor to sell unsuitable products to investors, for without proper advice there can never be a proper sale. This is an avoidable regulatory self-goal.

The second proposal of the SEBI paper is to disallow a division of the investment advisor to provide distribution and execution or orders. Instead, it mandates the separate arm to be set up as a separate subsidiary. For this it relies on RBI mandating banks to set up separate subsidiaries to provide advice and not directly by the bank. The reason RBI has mandated the subsidiary model is not to help investors, but to protect the banks from investors claiming that they have been defrauded or sold unsuitable products by the bank. This too would be investor unfriendly.

The third proposal is the most innocuous sounding, but the most dangerous. It seeks to curb providing securities specific recommendations through SMS, email, blog, chats, social media etc. unless that person is a registered investment advisor. Not only that, it proposes to categorise such communications by itself as fraudulent. The charge of fraud requires proving intent to defraud, material mis-statement, causation and actual harm. All four seem not required to prove fraud if you share an honest opinion about a listed company on WhatsApp. In addition, it would make Warren Buffet (if he were based in India) a criminal as he shares his views on a large number of companies. The following statement from his annual letter to shareholders could land him in jail for up to 10 years “Precision Castparts Corp. (“PCC”), a business that we purchased a month ago for more than $32 billion of cash. PCC fits perfectly into the Berkshire model and will substantially increase our normalized per-share earning power.” However, a graduate who wishes to register with SEBI is fine commenting on all and sundry companies. The proposal will chill whistle blowing, chill factual and analytical communication about listed companies in general, and impose a constitutionally impermissible restriction on freedom of speech.

Finally, the paper discusses the Research Analyst Regulations of SEBI. Any person who provides research reports giving buy/sell/hold recommendations, or provides an opinion on listed companies is obligated to register with SEBI. The paper seeks to impose suitability obligations on the analyst ensuring “that the research service offered to the investor is based on overall financial situation and investment objectives of the client.” A research report is typically shared en masse often with thousands of people. Imposing a suitability requirement would be unworkable and is the task of the client’s investment advisors.


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SEBI is clearly the most open regulator in terms of listening to comments and it is hoped that they will abandon this entire project, perhaps retaining only the full stops.

30 September 2016

Corporate Governance in India

Delighted to announce the publication of book 'Corporate Governance in India' of which I authored one chapter - on Related Party Transactions.

Link to OUP site.



01 September 2016

Class action suits - Potent, yet problematic?

I have a short piece on class actions under the new Companies Act and its dysfunctionality linked here and copied below:

After the Satyam fraud, India, as a country, realized that shareholders, of Indian companies, who have faced fraud, could not be made whole. In contrast, the international shareholders could obtain US $125 million by filing a class action suit at a US court. The Irani Committee proposed the inclusion of class action law suits in the then proposed Companies Act.

Section 245 of the Companies Act provides a right to members and depositors to bring an action against the company, its directors, auditors, experts, or consultants, for any fraudulent act or omission committed or likely to be committed by them. This has so far remained a dead letter since we have not yet seen a single class action law suit since 2014. This is primarily because of what economists call the tragedy of the commons. An investor must fight alone bearing the costs of, and delays in, litigation, but the benefits are enjoyed by all investors. In addition, the provision is clumsily drafted, complete with a glaring typo, provides barely any benefit, puts an onus of collecting a sufficient number of investors or depositors, and even has a provision for imposing costs in some cases.

For class actions to be effective, the right place to introduce a beneficial provision is in the Civil Procedure Code and the provisions should have clear benefits, deal with the tragedy of commons, reduce the burden on the litigating investor/depositor and finally, for this to really succeed, there will need to be an introduction of contingent fees payable to lawyers.

23 August 2016

Sebi’s move to curb distributors may hurt MF investors - ET

I have a piece in today's Economic Times analysing SEBI's circular seeking to impose particular disclosure norms which are intended to dis-intermediate distributors. While disclosures and expense caps both have existed, the new development will hurt investors rather than help them. Please read the full piece below to see why or click here for the original piece on ET's website:

"A person with surplus money is likely to invest it in four broad classes of assets and investments: Real estate, gold, fixed deposits and other investments.
The last decade has been brutal to nearly all investors. Gold hasn’t performed well except in spurts, real estate has been disappointing.
Ulips and other toxic products which were hard-sold with up to 45% commission would take a decade just to reach the par value. Fixed deposits provided an optical illusion, with high inflation, they mainly yielded negative real returns.
The only real investment which has consistently delivered, over any 3-year or longer period after all expenses, has been equity mutual funds.

An investor is free to invest directly in the stock market, or free to pay a fee to a mutual fund for managing his money. Similarly, an investor is free to directly invest in a mutual fund or invest through a distributor.
Market regulator Sebi provides a cap on the total fees chargeable by mutual funds to the investor. This has prevented creation and sale of toxic mutual funds.
Sebi’s circular effective October mandates disclosure of absolute amounts, instead of percentage, of commissions paid by funds to distributors. It also obligates the disclosure of the expense ratio of the fund where a distributor is involved and where it is a direct sale. These appear at flush blush to improve transparency, but will push investors away from mutual fund investments.
Firstly, the disclosure of commission in absolute number for investments is likely to overstate the commission in later years.
For a distributor, investment advice, fulfilling suitability, KYC norms, cost of travelling and selling to the investor and other costs are incurred in the first year and the benefits are usually paid by way of trail commissions over many years.
Sebi has encouraged this underpayment initially with emphasis on the ‘trail’ as being useful for the cause of longterm investment. Clearly, the investor will be unhappy seeing a commission paid in year 5 when little service is provided.
Secondly, showing the expense of a direct plan versus showing the expense of a distributed plan every six months will goad the investor into believing the two products are identical and he is wasting money on the distributed plan. A distributor is no longer merely an agent of the fund as Sebi has imposed specific KYC and suitability norms on the distributor.
Thus pushing an investor away from the distributor is likely to push the investor away from the most suitable products. The average small retail investor in the absence of proper advice may buy over-risky products because they seem to produce better returns or buy under-risky product resulting in low income.
Of course, a sophisticated investor does not need a distributor, but the number of sophisticated retail investors is quite limited. Sebi has already made sufficient disclosures mandatory showing the different expense ratios between direct and distributed plans.
Thirdly, many costs are attached with creating a mutual fund product including asset management fees, trustee fees, registrar and transfer agent fees, legal and audit fees, advertisement and Sebi fees. It is unclear why only one of them is deemed important from a disclosure perspective, except to push a dis-intermediated model.

Finally, the real danger of a dis-intermediated model is this. Only 11% of equity funds are sold directly, the balance nearly 90% is sold through distributors. These distributors travel through smaller cities, or spread the message through bank branches and are spreading the word of the relatively safe, high-return investment with a small and capped expense ratio.
If these distributors are dis-intermediated, what will happen will be not sale of lower cost mutual funds as Sebi is aiming. But rather investors will move away to other push products like Ulips, which are toxic, fixed deposits, which post inflation reduce wealth, or non-productive assets like land and gold.
If India wants to build its equity markets, build its infrastructure, build a productive industry which requires capital, it must seek full disclosure and cap on fees as Sebi has rightly done till now, but it should not physically seek to dis-intermediate distributors. That will hurt most the investors, the regulator seeks to protect."

01 August 2016

Courts might hold guaranteed return of capital clause invalid - Business Standard

I have a piece in today's Business Standard on the Tata-Docomo dispute. Here is the link and below is the full piece:

The Tata Docomo deal poses one of the most interesting conundrums from a legal perspective. This piece is based on the broad contours of the arguments in public domain. And as a lawyer, I may disclaim my views on seeing the definitive agreement between the two. Broadly the issue is that Tata and Docomo entered into an agreement where Docomo invested in Tata’s telecom business. The agreement was signed with a clause guaranteeing at least 50% return of (rather than on) capital in case the company did not do well. While ordinarily, contracts are enforceable, this one had two legal issues.

The first was that for a foreign investor, RBI permits investment in Indian companies through equity or debt route. The debt route is quite restrictive and the equity rather liberal. The foreign exchange Act, FEMA, and RBI’s position on FEMA is that if you make an equity investment, you cannot get a guaranteed return on or of capital. In fact, if you so choose, the equity investment must come as debt and relevant regulations with respect to lending by a foreign entity would kick in. Tata and Docomo did not term it a debt issuance and therefore the investment was valid, but the condition guaranteeing return of capital was not.

The second issue is an old circular under the Securities Contracts (Regulations) Act which prohibits puts and calls in contracts in public companies. The rigour of the circular is now diluted, but it was a broader prohibition then.

While the Supreme Court has in case after case reduced the possibility of court intervention where an arbitral tribunal has passed an order, this may well be a case where courts may hold the clause in the agreement as being invalid. The twist in the tale is that Tata seems to support the payment while RBI is opposing the same. Ultimately, the case will likely take many twists and turns before finally getting decided in the Supreme Court. 

02 June 2016

Reforms at SEBI - my interview for cover story of Dalal Street Investment Journal

I was interviewed by the Dalal Street Investment Journal on the performance of SEBI till now and the future of the regulatory framework of the securities markets.

Below is the full interview: