Mutual Funds
SRO for mutual funds may favour large distributors

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.
 

Also read:

Investment Advisor Regulation III: SROs have never worked in the past; will it work now?

Self regulation may be injurious to AMFI

SEBI pulls out 17-year-old idea: AMFI should regulate itself

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Edelweiss attracting investors by offering passbacks. Is SEBI watching?

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)

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COMMENTS

mAYANK

3 years ago

The Industry is digging its own grave.In the RGESS schemes the Industry gave a huge upfront commission of around 6-8% and this was within knowledge of AMFI. Industry was aggressively pushing RGESS because it was Mr. Chidambram's baby.

Saraswati

3 years ago

Wow...i don't understand the regulations. But it's good to get something while you save!!!

Manmadha

3 years ago

Boooooo....

REPLY

Debashis Basu

In Reply to Manmadha 3 years ago

Very intelligent comment ;)

Krishna

3 years ago

Chilukuri...KRL....Rao....who? Do his comments and quotes matter? Edelweiss is a wonderful company and has wonderful website. With this offer I would invest it through them than investing through icicidirect! They are not recommending any fund. If I invest in ELSS, I am happy investing through them.....Moneylife - pls get your analysis right!!!

REPLY

INDLA SREEDHAR REDDY

In Reply to Krishna 3 years ago

Hi Krishna, first understand one thing. Mr. Chilukuri KRL Rao brought one unethical promotion by Edelweiss into limelight.we have to applause him for that. When SEBI issued clear instructions not to give/payback any inecntives/gifts to customers in returns to the investments. How Edelweiss is offering flipkart voucher.Even if it is Edelweiss or some other big brand company also, everybody has to follow SEBI's rules and regulations. I request Money life to take this matter with SEBI.

Raghu

In Reply to Krishna 3 years ago

Dear Mr Krishna , Please do appreciate that some one comes out in the open only with details.The analysis part ,why only money life , even SEBI will do and actions will follow.Money life had published this article , only after the initial scrutiny.Even I have great respect for Edelweis, probably , in this case they might have done it by oversight( even then they are guilty, there is no doubt). But this is un ethical practice.Just see the other coment , one investor wants to buy this for an a small ice cream!The gift is taking over the financial objective!Financial decissions should not be entered because of temptations. One should understand the product first. Unfortunately , when there is a free bee , there are so many who get duck out.

Vikas Gupta

In Reply to Krishna 3 years ago

Mr Krishna! His comments matter a lot for the system. If somebody dares to bring the illegal activity of such a giant to the general public, one should applaud for him.

Letter from the Editor
Indian investors are often taken for a ride by unscrupulous middle-men, brokers, insurance agents and even their own friends. Few fight back, as Dilip Modi did. He fought and won an arbitration case against Destimoney Securities. We document his case in his own words to show you what it takes to win such cases. But the real benefit of Mr Modi’s story is that it tells you the precautions to take to ensure that you don’t land up in a soup like he—and many others—did. He is retired and had the time and tenacity to pursue his case. We are not sure how many others can do the same. We also analysed arbitration statistics and found that winning arbitration cases is heavily stacked against investors. In our Cover Story, we offer tips and advice on what one must keep in mind and what one needs to be careful about.
 
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