SEBI’s draft regulation for investment advisors: Molehill out of a mountain?
Narendra Kondajji 08 October 2012

SEBI has just come out with draft regulations for investment advisors. Unfortunately, the proposed regulations will be of little consequence. It will mean little to investors and mis-selling may continue as before and with appropriate disclosures! An analysis of the proposed rules…

Investment advisor regulations have been discussed on and off for the past five years. In 2007, the Securities and Exchange Board of India (SEBI) published a consultative paper on “Regulation of Investment Advisors”. In 2008, the Swarup Committee re-examined the issue and submitted its report in 2009. The report was revolutionary in its thinking prescribing all financial products have to become “no load”. Opposition to this report was vociferous. After much heat and dust, including dharnas and morchas by a section of soon-going-to-be-affected persons, the report was buried deeply and quietly. In September 2011, SEBI published another concept paper on the regulation of investment advisors, which led to much debate. And now, in September 2012 the draft regulation on investment advisors in India has come out. How significant are these draft rules? Will it change the way people buy and sell financial products? Will conflict-of-interest be reduced?


SEBI’s concept paper had explained passionately the causes of conflict-of-interest, lamenting lack of financial literacy “in a country like India” and uselessness of disclosures when investors are financially illiterate. The concept paper proposed to set the things right by portraying work qualifications such as Chartered Accountants and Master in Business Administration-Finance as free from conflict-of-interest. SEBI highlighted the low level of financial literacy in India and the consequences thereof. It also mentioned about inherent conflict-of-interest in the prevailing agent-cum-advisor model of business practice. The concept paper advocated very strongly, the setting up of a Self-Regulatory Organisation (SRO) to regulate investment advisors. This writer participated in the debate actively and sent detailed comments to SEBI. The draft regulations appear to be a skeleton of what the concept paper set out to achieve. Here are some facts that come out:


SEBI has avoided turf war by restricting the licensing requirements of securities products, excluding insurance, real estate, commodities and pension products.  If you look at any upper middle-class household, a chunk of savings is compulsory through employment (provident fund and superannuation fund). Next, big commitment is towards house purchase/construction and this area is not going to be covered through this regulation. What finally gets covered is a very small part of the savings—investing in riskier assets.  So, on a weighted average basis, the effect of this regulation on a typical upper middle-class household is minimal.


The regulation appears to be enabling and not disabling.  No one is going to be affected negatively and they may continue to do what they are doing. However, this negates the very object of the regulation—that of removal of conflict-of-interest involved in financial advisory and product sales—as the focus is very narrow and limited to the act of giving advice. 


Most of the clearly identifiable conflicted practices are left untouched.  So this regulation is not applicable to a host of financial service providers such as stockbrokers, mutual fund advisors, pension advisors, insurance agents or brokers. It is also excludes advice givers who are advising in good faith, free of cost.


In a complete turnaround, this regulation now tries to remove the conflict-of-interest through a mere disclosure. Look at the following wording: An Investment Advisor shall try to avoid conflicts of interest, and when they cannot be avoided, should ensure that appropriate disclosures are made to the clients and that the clients are fairly treated.


In another major effort at watering down, an investment advisor may have the cake and eat it too. Just read this provision—“An investment advisor shall disclose all consideration and rewards that it will receive if the client chooses the recommended security or investment.”


Financial planners, fund managers who are employees of mutual funds and asset management companies (AMCs) and alternative investment funds (AIF) are covered under the regulation. Entities other than an individual have to set up “Separately Identifiable Department or Division”.  It is not a “Chinese Wall” but only an internal department or division.


Qualification of advisors now also includes post-graduate degrees or diplomas in most of the related areas such as finance, accounting and so on. Certification requirement is expanded to include “CERTIFIED FINANCIAL PLANNER” awarded by Financial Planning Standards Board India. A two-year time is also given to obtain these certifications including the one offered by NISM.


Capital adequacy for body corporate is set at Rs25 lakh and Rs5 lakh for individuals. Young professionals may feel the entry barrier is high. It would be advisable if the capital adequacy is waived off for individuals.


Registration fee is a steep Rs10,000 for individuals and Rs100,000 for body corporate for a period of five years. This will hurt many two-person dejure body corporates created by husband-wife, father-son, friends and relatives, which then work as de facto individual-run organisations.


Till such time an SRO is set up, SEBI will handle the licensing process.  Does it have the bandwidth for this?


Who will be afraid of this regulation? None, because this regulation does not stop any of the existing practices, with perhaps financial planners being the only exception.


There is a saying in my mother tongue which when loosely translated means that “one caught a small rat after digging a big hill”.  I have the same sense about this draft regulation. The list of excluded services is much longer than the included ones. If these provisions are gazetted as they are, the regulation would remove none of the existing conflicts-of-interest. Body corporates would be glad that they can now have one more vertical to attract investors—a mere “separate department” and ‘disclosure’ is sufficient to run the racket.


Not being a super-regulator, SEBI has restricted the applicability of this regulation only to a small sub-set of existing players and clearly precluded any future turf-wars.  At the end, all are happy continuing to do what they are doing at present. From intention of the concept paper to the draft regulations, a lot of regulatory zeal has evaporated.


Those who are practicing as fee-only financial planners/advisors would be moderately elated to realise that they now have a regulatory framework to lean on.  But they will be frustrated after knowing the costs involved in complying with the regulation in toto.  They will not have any ‘exclusive’ tag as other so-called conflicted entities can also be investment advisors.


In other words, entities with conflicts-of-interest would be very happy to know that life can continue as usual and in fact may get even better with an additional label to sport—“Investment Advisor”. After discarding the disclosure route in the concept paper, the regulation now requires mere disclosures to comply with.


What Is Good In This Regulation?

Young graduates and post graduates whose hands are not yet bloody with legacy products and practices can think of setting up a free-of-conflict profession (from the regulatory point of view).  However, this enthusiasm may yet be dampened with socialist era provision such as “Investment Advisors may charge fee subject to the ceiling specified by the Board, if any”. Even the existing conflicted service providers/intermediaries can think of redeeming themselves by complying with the provisions in letter and spirit.


How Can an Investor Benefit?

My experience says that there are as many mis-buyers as there are victims of mis-selling.  Pass-backs even when banned are demanded and received gleefully. There are investors who are well-versed about minutest options in their pads, pods and tablets but not their investments.  The gap between general literacy and financial literacy is too wide for one advisor’s lifetime to bridge. Investor Protection Fund, instead of diminishing in size, is increasing.  The existing IPF corpus is good enough to start at least half a dozen good universities in India.


Given the economics of becoming an investment advisor, what category of investors would benefit from this regulation is a question that will be answered by the behaviour of the investors. An investor who is willing pay separately for advice is the intended beneficiary of this regulation.  How many such investors are there is anyone’s guess. I am not cynical though because there are small yet growing numbers of people who are willing to entrust their financial future to someone such as a “CERTIFIED FINANCIAL PLANNER. They do trust but also test.  They would be pleased with this regulation for sure.


Am I Happy To Become An Investment Advisor?

Answer is yes and no.  As a “CERTIFIED FINANCIAL PLANNER, I comply with fiduciary responsibilities at much higher levels.  But now to do it, I have to incur more cost and this is a negative. On the positive side, I have regulatory backing and can be regulatory-proud, if I can present as such to my clients. One thing, however, I am much pleased to notice is Annexure E—Comments. I am seeing for the first time that the regulator has listed down comments/feedback received in a summary format. Though it not on par with the efforts of countries such as UK and Australia, it is a good beginning. Also, Indian investors or a small set of them can be proud of the fact that they are now either on par or ahead of many developed countries when engaging an investment advisor.

9 years ago
There are ways of removing conflict of interest:

1) A feedback form duly filled by the client to be verified and appraised by an independent third party, to ascertain whether the adviser has acted in the best interest of the client. (any breach of trust / abuse to attract harsh penalties)

2) Periodic performance appraisals / audits to determine the adviser’s competence. Advisers to be made responsible for generating reasonable and acceptable returns over 3 yrs or 5 yrs time period.

When investment advisers act in client’s interest and strive to achieve acceptable results, there shall be no room for conflict.

But, it seems difficult to do simple things
Sumeet R Nayak
9 years ago
Unfortunately the Indian investor is still not ready to pay a fee for independent/unbiased financial advise. They would rather take advise from their friends and family than pay for it.
Pankaj Kulkarni
9 years ago
The networth requirement is definately too much, probably SEBI wants advisors to restrict themselves to urban investors.
Secondly risk tolerance has been made compulsory, however no universally acceptable test exist. It should best be kept to advisors and clients to mutually decide.
9 years ago
This is one more example of SEBI, though Empowered, chooses to act decisively . From past experience, we know , SEBI is a white elephant. SCORES system created and much advertised, is a classic example. It has not resolved Investors complaints in any big way. It is yet another shield for unscrupulous for Merchant bankers , who are regularly protected by SEBI. Even RTI querries have not yielded any fruitful results. It is better to ignore such white wash actions
Replied to sachchidanand comment 9 years ago
I have the misfortune to have experienced total apathy from SEBI to book unscrupulous Merchant Bankers. SEBI has stonewalled all efforts to cleanse their own stable . I filed over 120 complaints on SCORES giving specific complaints against Merchant Bankers but could not elicit any plausible & proper response.
suneel kumar gupta
9 years ago
I see moneylife is very serious about investers interest & expects effective draft for regulating advisers, but we live in a country, where," safety of luggage lies with passenger' philosophy is being used by Govt/ authorities for best option is investor literacy. This aspect should be addressed more.

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