An independent distributor highlighted to us the conflicts of interest that could arise with the new SRO
The Securities and Exchange Board of India (SEBI) will soon appoint a self regulatory organisation (SRO) for mutual fund distributors. The market regulator will select one of three applicants for the job—Institute of Mutual Fund Intermediaries (IMFI), Organisation of Financial Distributors (OFD) and Financial Planning Standards Board (FPSB) India. IMFI has been set up by the Association of Mutual Funds in India (AMFI). The OFD was set up by Financial Intermediaries Association of India (FIAI), a grouping of 15 large distributors and FPSB is a financial planners’ industry body. Is there a conflict of interest between the promoters of these applicants and small distributors?
Chilukuri KRL Rao, a mutual fund distributor based in Hyderabad, says, “One thing that is common in all these applicants is, either they have a negligible representation for small distributors or independent financial analysts, or IFAs (who mainly serve small investors), or no representation at all.”
As Moneylife has pointed out in the past, in the top 15 cities IFAs contribute around one-fourth of the total fund inflows. From beyond 15 cities, IFAs’ contribute the highest share amounting to 55% of the total fund inflows. (Read: Mutual fund regulations: Who contributes the most to equity inflows is overlooked)
AMFI has been known to support big fund houses and large distributors. Last year, AMFI scrapped the plan to ban upfront commission. According to Rao, FIAI is a trade body of the biggest distributors in India who predominantly support upfront commissions and are known to be prone to churning, while FPSB India is in the business promoting certified financial planning (CFP) course. Though, improving knowledge will be a desirable objective for any financial professional, doing it forcibly may prove to be counter-productive, Rao fears.
“The lack of transparency in payment of commissions is the root cause of all the ills associated with the industry including upfront commissions,” says Rao. He is of the opinion that the semi-regulatory powers a fund house body gets through SRO may be leveraged to further the practice of upfront commissions to increase their profitability at the expense of small distributors or IFAs.
Upfront commission paid out by mutual fund houses to distributors has always been a bone of contention. Last year, industry body Association of Mutual Funds in India (AMFI) scrapped the plan to ban upfront commission. Trail commissions, though lower than the one-time upfront commission, support the business model of small distributors and IFAs as they establish long-term relationships with their clients. Big unscrupulous distributors, on the other hand, look to earn higher in the form of upfront commissions through excessive churning of their clients’ portfolio. This practice in not only damaging for the client but affects the industry as a whole. (Read: Why don’t funds promote trail commissions instead of upfront commissions?)
Would the new SRO make transparent the payout of upfront commissions or would it ban the payment of upfront commissions completely? AMFI promoted IMFI may not prove to be effective as AMFI itself has failed in the past to get the market regulator to ban upfront commissions. As pointed out by Rao, AMFI Code of Ethics (ACE) for Asset Management Companies says, ”Members and their key personnel, in the conduct of their business shall observe high standards of integrity and fairness in all dealings with investors, issuers, market intermediaries, other members and regulatory and other government authorities.” But, to this day, no fund house publishes on its website the basis of payment of commission or incentives to an intermediary. Thus, AMFI has proved to be ineffective in the past. OFD would most likely support the interest of large distributors, while FPSB would look to promote its CFP certification to distributors.
Edelweiss Broking is offering gift vouchers to invest in ELSS. This amounts to offering passbacks, a practice barred by SEBI.
Edelweiss Broking Ltd is offering its clients a waiver of transaction charges for investing in equity linked savings schemes (ELSSs) through its online platform and along with this, if the lumpsum order value is above Rs40,000, the clients would receive a Flipkart gift voucher worth Rs500. “This special offer is valid for all ELSS transactions carried out upto the 31st of Dec, 2013,” mentions a promotional mailer sent out to its clients. The mailer goes on to mention the benefits of investing in ELSS offers with its top four ELSS recommendations. The ‘Code of Conduct for Intermediaries of Mutual Funds’ laid down by the Securities and Exchange Board of India (SEBI circulars: MFD/CIR/06/210/2002 dated June 26, 2002 and SEBI / IMD / CIR No. 8 / 174648 / 2009 dated August 27, 2009) clearly states that “Intermediaries will not rebate commission back to investors and avoid attracting clients through temptation of rebate/gifts etc.”
“This is an innovative idea of Edelweiss to offer a “pass back”, according an independent financial advisor Chilukuri KRL Rao. Mr Rao from Hyderabad has drawn our attention to the ground-level practices that hurt investors and smaller distributors. He says, “The lack of transparency in payment of commissions is the root cause of all the ills associated with the industry including upfront commissions.”
We had earlier reported on how fund houses were paying upfront commissions for ELSS (Equity Linked Saving Schemes) and other schemes to garner assets. (Read: Upfront commission being granted for ELSS schemes and MIPs become attractive for distributors due to upfront commissions) Upfront commission as high as 3% were being paid for ELSSs and as much as 1%-1.5% was being paid in the case of MIPs (Monthly Income Plans).
“High upfront commissions lead to the practice of excessive churning by unscrupulous mutual fund distributors in order to earn themselves a higher commission. This practice of fund houses offering a higher upfront commission and lower trail commission is detrimental to many honest distributors who promote investing in mutual funds for the long-term,” says Rao.
The regulator once again fails to take strict action. We have seen this in the case of portfolio management schemes as well, where many PMS companies, including the big ones, are not complying with SEBI’s directives on disclosure of performance data. Portfolio management services (PMS) companies are to “ensure that the clients have access to updated information about the portfolio manager, portfolio managers shall place the latest disclosure document on their website, wherever possible.” But still a large number of asset managers are not following these instructions. (Read: PMS firms misinterpret SEBI rule and avoid disclosure and Investors kept in the dark and hard-sold poor PMS schemes, due to bad disclosure practices)