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.
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