Investor rules: A brave step forward

I have a piece on the newly minted regulations of SEBI on investment advisors in the Mint. In fact this is my first piece in the paper in 6 years since my friend Raju Narisetti started the paper as editor (stand corrected - my second piece). In brief, I believe SEBI has made a brave attempt to tackle the issue of investment advice and given the problems of segregation of distribution from advice which is attempted and also the attempt to cross over (or rather being careful not to cross over) to investment advice falling within the domain of other financial regulators, it's a step forward. Below is the full piece (linked here).

SEBI has recently enacted the SEBI (Investment Advisers) Regulations. This was passed after many years of foot dragging. The main reason for the delay was a concern that the regulator may bite more than it could chew. After all investment advisors and distributors number in lakhs, and the task of regulating so many was ambitious. The views which have appeared in the media over the past two weeks range from the ‘regulations exempt almost everyone’ to ‘widely framed regulations…almost amounting to an overkill’. The reality is probably in between. This piece critically looks at four developments brought about by the regulations.

First is the scope of the regulations. It broadly covers anyone who gives investment advice for a fee to residents of India. Who it excludes from registration and regulation is interesting. It exempts people not providing advice in the area of securities. So an insurance advisor need not register. This is sensible, given turf wars between financial regulators in the past. Hopefully, the regulations would set the benchmark for other financial regulators to catch up to. It also excludes those who provide investment advice incidental to their main business. Chartered accountants and lawyers are predictably exempt. This is also appropriate, though I’m not sure how a lawyer can give investment advice incidentally. Another exemption extends to stock brokers, portfolio managers and merchant bankers who are already registered with SEBI, but these entities are only exempt from the registration provisions, not the substantive provisions of the regulations. This is logical, once a person is registered with SEBI she already falls under the domain of SEBI for such things as conduct and inspection. Making substantive parts apply would ensure that they do not misconduct themselves while avoiding duplication of registration. Where SEBI gets into interesting territory is where it exempts AMFI registered distributors providing investment advice incidental to their primary activity. So it appears that distributors can provide investment advice, that they need not register with SEBI and the substantive provisions of conduct do not apply to them. This broad exemption seems contrary to the aim of the regulations which is that distributors are sellers of the creators of financial products (known in industry jargon as manufacturers) and thus have an incentive to market the product which provides the juiciest commissions. SEBI rightly exempted distributors of mutual funds because the task is too big for its limited bandwidth. However, the exemption is too broad since it exempts them from the substantive conduct provision of the regulations. Clearly, distributors of mutual funds should be subject to the same fairness requirements and code of conduct as is applicable to investment advisors and stock brokers.

Second, the regulations seek to segregate the advisory hat from the commission based hat of the advisor/distributor. While as discussed in the previous para, the distributors have been given a long rope and are exempt from regulation, other provisions of the regulations try to build a wall around conflict free advice and conflicted distribution. There is a requirement of segregating commission based activities from the advisory ones, no commission for products advised on and an arms length distance between adviser activities and other activities like distribution and brokerage. These are sensible, though the way the conflicting provisions on distribution pan out needs to be seen. In particular, it is not clear how a sole proprietor, as most advisor cum distributors are today, would segregate their small offices. Many distributors cum advisors are currently under the mistaken belief that they must give up one hat, this is not correct, but SEBI needs to clarify this more clearly.

Third, there are basic qualifications and certifications required for those people out on the field giving advice. This has been made applicable to all people who give advice in a corporate set up. This is a positive development and certification from FPSB and other certified authorities will be required before advice is given. A requirement for capital adequacy, though the number required is low, is out of place. It is not clear why an investment advisor needs capital. We need smart advisors not rich ones.

Fourth, the substantive provisions provide for acting in a fiduciary capacity, full and honest disclosure of all relevant facts, disclosure of all conflicts, providing suitable advice based on the risk profile of the client, restriction on self trades where advice on those has been given and record keeping. These are eminently right and provide a well regulated framework.

While there are some chinks in the armour, I think SEBI has made a brave attempt at the rather ambitious task ahead of it. While it needs to plug some loopholes and work towards creating a self regulatory body which will take part of the burden off SEBI’s shoulders, this regulation will provide a well regulated industry, trust in the advisors and thus in the markets by investors and create high standards for other regulators to match. This should also be seen as an opportunity by advisors to be seen as respected professionals rather than agents selling products.