SEBI circular on mutual fund due-diligence given the go-by

SEBI’s circular on due diligence to be done by large distributors is yet to be taken seriously. Some banks are not even aware of it!

Six months after the Securities and Exchange Board of India (SEBI) got a new chairman, the market watchdog issued a new circular that aims to regulate the distributors by putting in place a due-diligence process to be conducted by the asset management companies (AMCs). The objective is noble—to protect the interest of investors. The circular has stated that the due diligence process shall be initially applicable for large distributors. But are the distributors following these rules?

As per the SEBI circular, mutual funds are supposed to ensure that customer relationship and transactions shall be categorised either as ‘advisory’ or ‘execution only’. For the advisory function, the distributor will sell “only that product categorisation that is identified as best suited for investors within a defined upper ceiling of risk appetite. No exception shall be made.” For the ‘execution-only’ relationship, if “the distributor has information to believe that the transaction is not appropriate for the customer, a written communication be made to the investor regarding the unsuitability of the product. The communication shall have to be duly acknowledged and accepted by (the) investor.”

SEBI has also specified that “customer confirmation to the effect that the transaction is ‘execution only’ notwithstanding the advice of inappropriateness from that distributor be obtained prior to the execution of the transaction.” SEBI has also specified that the compliance and risk management functions of the distributor shall include a variety of elements such as review of products and the periodicity of such review; factors to be included in determining the risk appetite of the customer; review of transactions; exceptions identification; escalation & resolution process by internal audit; recruitment, training, certification and performance review of all personnel engaged in this business, etc.

All this is a lot of work, but the key question with any regulation in India is simple: What if the rules are not followed? Indeed, some aspects of the SEBI circular are impractical and have nothing to do with returns, which is the only thing that can serve customer interest. After all, if a distributor can recommend a lousy fund and still can easily prove that he has worked in the ‘best interest’ of the customer given the available information, this regulation is of no meaning.

In any case, we wondered whether these rules are being followed and in what form? We asked a savvy investment advisor based in Chennai for his feedback from the ground. His response: “I checked with some active advisors. They are not even aware of the August circular of SEBI. So there is no question of whether it is being followed. I spoke yesterday to a few bank relationship managers and investment advisors; they are not even aware of SEBI’s August circular.”

In contrast, here is the ground reality of how advice is manufactured by some large distributors, as found out by another smart distributor. “One investment advisor at a foreign bank told me that they charge 2.5% as fee for mutual fund investments. They have a ‘white’ and ‘black’ list. Even in the white list, different funds have different weights, based on which revenue credit would be given to the relationship manager. The weight is given based on the revenue tie-up the bank has with AMCs. The white or black or weight has nothing to do with an investor or his risk profile.” A big target of mis-selling is small businessmen with bank loans. One distributor reported to us: “Some of my SME clients who use the overdraft facility at State Bank of India (SBI) are forced to invest in dud products of SBI MF & SBI Life.” Is there any chance that SEBI would be even aware of any of these incidents and how?
In July, HDFC Bank ran its ‘Power of 3’ campaign: Promoting three funds of HDFC Mutual Fund. The relationship managers were asked to focus only on this product and sell maximum SIPs (Systematic Investment Plans). According to an independent distributor: “I hear that around 90,000 SIPs were sold by HDFC Bank on that month alone. Being a HDFC Bank customer, I happened to visit their branch for some work and I can see RMs (Relationship Managers) aggressively selling the ‘Power of 3’ to everyone including me. The RM told me that they have been told that July performance is critical for their annual appraisal and variable pay. The icing on the cake is that HDFC MF up-fronted the entire 3-year commission (upfront + trail) in one month itself and the entire revenue credit was given to RMs. What more an RM can ask for?” Now, in this case, the customer may not lose because HDFC has some very good funds. But imagine the ‘Power of 3’ campaign by LIC Nomura or JM Mutual Fund!

These episodes also show what the power equation today is. AMCs are really at the mercy of large distributors and SEBI’s move to regulate the latter through AMCs only means looking at the problem of mis-selling from the opposite end! Unless SEBI regulates large distributors directly, the 22nd August circular will have far less meaning than what is intended.

1 decade ago
dear friends,it looks that SEBI and his present boss is keenly bent on ethnic cleansing of the already rare specie called MF advisor and it looks soon that Mf advisory as IFAs will soon be found in EXTINCT category-the reasons are as follows-
SEBI is targetting only distributors and that too which are small by new and new circulars,but SEBI never asked AMCs or fund managers for any kind of compliance,
SEBI for all losses to investors will hold advisors as responsible for losses and in future may come out with FATWA that advisors will have to pay all losses to investors if their advice gives negative result-but SEBI has never set any compliance of performance based to fund managers or AMC bosses,
The attitude of SEBI has always been pro AMC because it removed entry load but did not touch the issue of expense ratio or AMC charges which are to the tune of 2.5 % to investors and thats the reason many AMCs have made profits to the range of 250 crores though investors in those AMCs are at huge loss,
can SEBI touch this issue?
It looks now that in near future advisor community will be in EXTINCT category and then only AMCs and investors will interact directly-in that case has SEBI planned for any new FATWA?
will SEBI ask same kind of recorded documents which it is asking advisors to keep?
what about present situation for investors who invest directly in AMC offices at the advice of AMC sales staff?has it given any guidelines for this?
I think Mr SInha is proving his foolishness by creating norms without checking practcability of these FATWAs-his approach looks totally biased and against advisor community and PRO AMC-
may be what is cooked inside AC offices is not known to INVESTORS on whose name every kind of stuff is supplied.,
1 decade ago
SEBI has given power to control Mutual Fund Industry does not mean that SEBI has to know what every investor is discussing with Advisers/distributors point to point whether investor has agreed to invest in Lumpsum or in sip for fixed up a particular date for future investment.Whether discussion is amicable or words exchanged meant a forceful insistence etc.How SEBI will keep and maintain a record of hundred of thousands of investors and refer if any complain comes.All these beyond any practicable implementation.
1 decade ago
More regulations/ ciculars are like antibiotics , kill good and bad bacteria both, then one is forced to take remedial measures to manage the side effects more than the desease .. Antibiotics should be taken with care and when necessary , continuous /non stop experimentation /intake of variety of antibiotics is very harmful - can do more harm than the desease that maybe just a viral and there may be no need for any anti biotic medicine.

Even if we compare with advice of veterans in Mutual fund industry they advise that there is no need to constantly review ones MF portfolio as markets are dynamic and performance is linked to markets where no has any control and surely no one can predict the movement. everyday monitering does not help.
Vikas Gupta
1 decade ago
SEBI Circulars are meant for IFAs or small distributors, National Distributors or Banks have nothing to do with these circulars. SEBI is asking for Due Diligence. Please tell me can anybody ask HDFC Bank that Do all his July investors of 90,000 SIPs Purely fit only 3 schemes of HDFC Mutual fund out of a whole no. of schemes available?
Can anybody ask Axis Bank why most of his investors are suitable for NFOs of Axis Mutual Fund only?
Can anybody ask PNB why most of his Investors were suitable for UTI MF Schemes in Aug & Sept'11? Was there any logic other than Foreign Trips for Bank Staff?
Now there rises a question When all these National Distributors or Banks have their self interest in selling particular schemes of a particular Fund House or Life Insurance Companies instead of Objectives & risk profile of their investors, Where are our Govt. Watchdogs who pretend to be Investor savy. SEBI shows that it is acting in the interest of Investors but can anybody quote a case where SEBI had acted against any National Distributor/AMC/Registrar/NSE Brokers till date while it is receiving n no. of Complaints through its Official Website SCORES?
1 decade ago
even at today the valuation of the sip investment in these fund of power of 3 is negative.

the banker told me the same, these are the best fund,however in the previous month before the power of 3 the force me to buy a fidelity Child care plan,when I have already retired and put all my SIP in equity fund of HDFC mutual fund,

I make the SIp ceased by giving a written request that too in CAMS office, they denied me ,that it cannot be stopped nor withdraw.
Replied to GANESH comment 1 decade ago
1)The current valuations being below your purchase price is due to the market realities but good funds finally deliver.

2) We must learn to say "No" if somebody tries to sell a product we do not need.Certainly for a retired person,child care plans are meaningless but you had the option to say "No".

3) "SIP's in MFs can be stopped anytime and CAMS or any other entity cannot deny the same.
Vikas Gupta
Replied to Sundaram comment 1 decade ago
I totally agree with Sundaram that we must learn to say "No" if somebody tries to sell a product if he/she is not a Professional of that product.Has anybody gone to a Orthopaedician for treating his dental problem? If no, why one should take the advice of a Banker for Mutual Funds or Insurance Products? They are Professionals for completing their targets & least bother about their Customers who trust them because of their Banking Relationship. Everybody should understand that they have to visit Different Professionals for their different needs.
Moneylife Digital Team
Replied to Vikas Gupta comment 1 decade ago
To say no, you need to know
For this, read the most unbiased and pro-investor publication. You know which one. ;-)
Replied to Moneylife Digital Team comment 1 decade ago
I like the humility!!!! :-) :-)
Dr Vaibhav G Dhoka
1 decade ago
As said there is no dearth of regulations here,but there is definitely we are very poor at ENFORCEMENT.More the regulations more are the chances of corruption.Therefore instead of spending energy on new regulation we should see proper enforcement of prevailing regulation.And in every new regulation SEBI should study cost effectiveness of such regulation to MF industry as whole.It should not be failure as seen in Self declaration by Ad visors.
Vikas Gupta
Replied to Dr Vaibhav G Dhoka comment 1 decade ago
I agree with Dr. Vaibhav that we are lacking at ENFORCEMENT. Can anybody tell how the regulations can be enforced particularly in the Financial Matters?
Ramesh Bhat
Replied to Vikas Gupta comment 1 decade ago
It will be very difficult for SEBI to regulate all distributors across the country hence now they had taken up about 1000 crores AUM distributors are regulated.

SRO is the only solution where the regulations can be enforced among distributors especially the Banks and NDs
Replied to Ramesh Bhat comment 1 decade ago
SRO is an utopian idea, which has never worked in India. Creating an SRO of national distributors who will work in investor interest is like asking a bunch of tigers to turn vegetarian. What about their quarterly targets set by the management?
1 decade ago
There is a clause which says one investor should not hold more than 25% of the entire Aum of a mf scheme/fund. There should also be another clause which should prevent a distributor from doing not more than a certain % if their overall MF business (that too for a MF promoted by the same group). This will prevent mis-selling and also a concentrated portfolio for the investor.
Vikas Gupta
Replied to Srini comment 1 decade ago
I totally agree with Srini that there should also be another clause which should prevent a distributor from doing not more than a certain % if their overall MF business (that too for a MF promoted by the same group).
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