An increasing number of HNIs are openly bargaining with fund distributors to get a share of trail commission

The confusion over accounting of trail commissions continues to rattle the mutual fund industry. On the one hand, there was a clear need to stop the practice of tying investors to a specific distributor in perpetuity or to ask them to get a no-objection certificate in order for them to shift to another distributor.

In late December, the Securities and Exchange Board of India (SEBI) directed the Association of Mutual Funds in India (AMFI) to implement its own earlier decision that said that funds should pay trail commission to new distributors when the client has moved away from one distributor to another.

Moneylife Digital has reported earlier (see here) on the confusion arising over implementation of this rule without examining all the issues and consequences. It has led to a raging battle to transfer assets under management (AUMs) by hook or by crook. Distributors tell Moneylife Digital that investors are being asked to sign a scrap of paper where the fine print permits the transfer of their AUM to a new distributor; these sources say that banks have been especially active in obtaining such a transfer under the guise of consolidating investors' accounts.

With independent financial advisors (IFAs) reluctant to service small investors after SEBI scrapped the entry load, it has been a happy hunting ground for banks to get the business of such customers. Naturally, IFAs are outraged. They are especially angry at mutual fund companies that are in a hurry to accept and act on these requests to transfer AUMs. The game has shifted from serving the investor to running after trail commissions.

Moneylife had earlier reported that the chase for trail commission business is gaining traction among the largest banks and financial advisory firms like HDFC, NJ IndiaInvest and Prudent Corporate Advisory Services who are actively encouraging their team to snatch AUMs.

"Now I am getting threatening calls from high net-worth individuals (HNIs) saying that now that you are getting paid (trail commission), how much (of the commission) are you ready to part with me, or I will transfer the AUM. I have no option but to agree, otherwise he (the HNI) will move to some other broker," says an IFA.

But many agree that who deserves the trail commission is the moot question. When an investor who has bought a scheme from distributor A and transfers it to B, the general understanding is that B will begin to earn the trail commission. And hence the rush to get investors to sign a transfer form. But B has done nothing to earn that investment, so some IFAs themselves admit that it seems unfair that B has to be paid. On the other hand, A cannot continue to earn the trail when the investor has moved away. So should trail commissions be abolished when an investor shifts to another distributor? Some agree, even though it would deal yet another blow to the IFA industry. The solution is obviously to find another way to compensate advisors.

What is worse, the only beneficiary in all of SEBI's actions seems to have been banks and bank distributors. Was this the end goal that SEBI had in mind when it scrapped entry loads? And shouldn't the regulator have examined the issue of trail commissions fully over the past couple of years, when investors had been complaining about not being able to switch IFAs?
Top SEBI officials have taken the position that the industry will learn to swim and find a solution. But as things stand, mutual funds are only sinking with large sums of money flying out of the industry. That result defeats the government's stated objective of encouraging retail investors to participate in the capital market through mutual funds. Isn't SEBI completely out of sync with this objective?