CONCEPT PAPERONREGULATIONOF INVESTMENTADVISORS
1. Background
1.1 Section 11 (2)(b) of SEBI Act empowers SEBI to register and regulate working of
Investment Advisors and such other intermediaries who may be associated with securitiesmarketin any othermanner.
1.2 As decided by SEBI Board in its meeting dated March 22, 2007, SEBI had posted a consultative paper on the “Regulation of Investment Advisors” on its website inviting public comments. Based on public commentsreceived on the consultative paper as also the USAID (Fire Project), a memorandum was placed before the SEBI Board proposing a regulatory approach forInvestment Advisors. It was proposed that the Regulationsshall be implemented through an SRO. As Investment Advisors offer products across asset classes, it wasfelt that the respective regulators may take a view and formulate similar norms and code of conduct. Accordingly a reference was made to the HLCC on Financial and Capital Markets.
1.3 HLCCFM in its meeting held on December 22, 2008 set up the D. Swarup Committee to re‐examine the issue. The committee submitted its report to government in December
2009 which was discussed in the HLCCFM meeting in March 2010. Subsequently, regulatory issuesrelating to Wealth Management and / Private Banking undertaken by banks were discussed by the FSDC Sub‐Committee in itsmeeting on March 4, 2011.
1.4 In this background, SEBI has developed a framework for regulation of investment advisorsthrough the SROroute.
2. Tackling Conflict ofInterestinDistribution of Financial Products
2.1 Itis axiomatic that any industry, in orderto achieve scale and high productivity, must be free of internal contradictions and conflicts of interest. Financialsector is no exception.
The financial product distribution space is particularly fraught with these conflicts between the manufacturers of financial products like banks, mutual funds, and insurance companies, etc. and the distributors which sell these products who call themselves by various nameslike agents,financial advisors,financial planners, etc.
2.2 It is necessary to resolve or at least mitigate these conflicts, especially in the case of financial products because of their two peculiar characteristics. Firstly, the products arePage 2 of 11 intangible and conceptually more difficult to understand. Secondly, the pay‐offs are in a distant future and can be camouflaged by several factors externalto the product. Itisin this context that the distributors occupy a key role; all the more so considering the low levels offinancial literacy and awarenessin India.
2.3 Two major conflicts of interest in the financial product distribution space are the following: a. Dual role played by distributors as an agent of investors as well as of the manufacturers. This is due to the fact that with respect to many financial products, agents receive their payments from two sources: commissions from the manufacturers (either directly or through deductions from the investment amount of investors), and advisory fees or other charges received from the investors. This immediately raises the question: whose interests do they represent: the manufacturers’ orthe investors’? This question has also been raised in the Devendra
Swaroop Committee report on ‘Minimum Common Standardsfor Financial Advisors and Financial Education’. This prevalence of divided loyalties may not be in the best interest of all the stakeholders concerned. It often results in a situation where the distributors are loyal to only themselves. They would happily churn investors’ portfolio and also squeezemore commission fromthemanufacturer.
b. A situation might arise where distributors are likely to be partial to, and would sell more products ofthemanufacturer who isthe best paymaster; and ultimately, other manufacturers would scramble to do the same,thusleading to a race to the bottom.
Thus,there is an inherent conflictin the activities of an agent/distributor distributing similar products of variousmanufacturers.
2.4 There could be many possible solutions to these issues ‐ the most obvious and the easiest being enhanced disclosures. However, in a country like India where levels of literacy are low and financial literacy even lower, disclosures have a limited effect.
2.5 The Financial Services Authority, UK, had outlined plans to ban commission payments for product providers and enforce financial advisors to agree on fee payments with clients upfront. It defined two categories ofservice: independent and restricted, on the basis of which advisors would charge the fee. Examples of restricted advice may be where advisors offer advice only about the products of a particular manufacturer; or about the products from a defined list of manufacturers. Independent advice would include unrestricted advice based on a comprehensive and fair analysis of the relevantPage 3 of 11 market. However, there is a kind of restricted advice called ‘basic advice’. With Basic
Advice, the consumer is asked some pre‐scripted questions about their income,savings and other circumstancesto identify the consumer’sfinancial priorities and suitability for a stakeholder product, but a full assessment of their needs is not conducted nor is advice offered on whether a non‐stakeholder product may be more suitable. ‘Basic advice’ is excluded from the new rules i.e. in case of basic advice, commissions can be paid and the new advisor charging rules are not applicable to the same. Also, non‐ advised or execution only sales would be remunerated only by commission and would not fall within the ambit of the advisor charging rules. Thus, in the FSA model, the first conflict of interest as per para 2.3(a)seemsto have been addressed by ensuring thatthe distributor/advisor owes allegiance to only one paymaster at a time‐either the manufacturer orthe investor.
2.6 SEBI, with effect from August 01, 2009, had banned entry loads in mutual fund investments and had mandated that the upfront commission should be paid directly by the investors to the distributors based on factors like assessment of the service of the distributor. However,the distributor continued to earn trail commissionsfrom the Asset
Management Company at the same time. Thus, the first conflict of interest was only partiallymitigated in thismodel.
2.7 In this paper, we are attempting to deal with only the first type of conflict of interest.
The possiblemodelfortackling this conflict ofinterestsmay be the following:
a. The person who interfaces with the customershould declare upfront whether he is a financial advisor or an agent ofthemanufacturer.
b. If he is an advisor, he would be subject to the Investment Advisors Regulations; and would require a much higher level of qualifications. He would act as an advisor to the investor on all financial products. He would receive all payments from the investor and there would be no limits set on these payments. On the other hand, there will be agents who will be associated with themanufacturer and would receive their remuneration from them. However, they will be prevented from styling themselves asfinancial advisors and will have to callthemselves as agents only.
c. This willresolve the first conflict ofinterest asin para 2.3 (a).
3. Structure of Proposed Regulations
3.1 The proposed regulatory framework intends to regulate the activity of providing investment advisory services in various forms by a wide range of entities includingPage 4 of 11 independent financial advisors, banks, distributors, fund managers etc. The investment advice may be provided for investments in various financial products including but not limited to securities, insurance products, pension funds, etc. While the activity of giving investment advice will be regulated under the proposed framework through an SRO, issues relating to financial products other than securities shall come under the jurisdiction of the respective sectoral regulatorssuch as action for mis‐selling, violation of code of conduct, conflict of interest etc. The SRO set up for the regulation of
Investment Advisors shall follow the rules/regulations laid down by respective regulatorsfor productsfalling in theirjurisdiction, including but notlimited to suitability and appropriateness ofthe products.
3.2 The SRO formed to regulate investment advisors will be registered under the SEBI (Self
Regulatory Organization) Regulations, 2004. SRO will have sufficient resources to perform its functions. Its duties would include registering and setting minimum professionalstandards, including certification of investment advisors, laying down rules and regulations and enforcing those; informing and educating the investing public; setting up and administering a disputes resolution forum for investors and registered entities etc. Persons desirous of registration as Investment Advisors shall obtain registration with the SROestablished forthe purpose. The SRO will be entitled to charge a fee for granting registration and an annualfee.
3.3 Complaints/ disputes arising out of investment advisory services will be taken up by the
SRO with the respective regulatory authority, while the complaints regarding the financial products and theirmanufacturers will be handled by the respective regulators.
3.4 Investment Advisors tend to call themselves by varied names viz. wealth managers, private bankers etc. This causes much confusion as to their role and responsibility.
Hence the regulations will provide that no person can carry on the activity of offering investment advice unless he is registered as an Investment Advisor under the regulations. On the other hand any person who has obtained the certificate of registration as an Investment Advisor must necessarily use the word “investment advisor” in his name.Page 5 of 11
4. Definitions
4.1 Investment Advisor
Investment advisor for the purpose of the regulationsshall be any person or entity that provides investment advice directly or indirectly for a consideration, which may be received directly fromthe investor or who holds himself out as an investment advisor.
4.2 Investment Advice
Investment advice shall be an advice written, oral or through any other means of communication given regarding investment of funds in financial products or products that are traded and settled like financial products purportedly for the benefit of the investor. Itshall include:
(a) Financial advice; or
(b) Financial planning service or
(c) Actions which would influence an investment decision and are incidental to making an investment/investment decision.
5. Coverage
5.1 Individuals
The following set of individuals would need to getregistered underthe regulationsto be able to provide Investment Advisory Services:‐
a. Independent Investment Advisor– Independent Investment Advisors are professionals who offer independent advice on financial mattersto their clients and recommend suitable financial products or products that are traded and settled like financial products.
b. Representatives of investment advisors or intermediaries who on behalf of the investment advisor or intermediary provide investment advice to investors:
Representative would mean a person, in the direct employment of, or acting for, an investment advisor, who performs on behalf of the investment advisor any investment advisory service, whether or not he is remunerated, and whether his remuneration, if any, is by way of salary, wages, commission or otherwise, andPage 6 of 11 includes any officer of an investment advisor who performs for the investment advisor any investment advisory service whether or not he is remunerated, and whether his remuneration, if any, is by way of salary, wages, commission or otherwise; 5.2 Non‐individuals
The following set of non‐individuals (corporate entities) would need to get registered underthe regulationsto be able to provide Investment Advisory Service:
a. Banks providing investment advisory/ wealth management services: In India Banks are allowed to perform only Investment Advisory Services. Those banks which provide similar services would be required to get registration under these regulations. b. Any entity, other than an individual person ‐ representing investment advisor, who on behalf of the investment advisor provides investment advice to investors :
Representative would mean a person, acting for, an investment advisor, who performs on behalf of the investment advisor any investment advisory service, whether or notitisremunerated, and whetheritsremuneration, if any, is by way of, commission or otherwise, and includes any officer of such an entity who performs for the investment advisor any investment advisory service whether or not he is remunerated, and whether his remuneration, if any, is by way of salary, wages, commission or otherwise;
6. Persons Exemptfrom the regulations
6.1 A person shall be deemed not to be engaged in the business of providing investment advice, if the advice is solely incidental to some other business or profession and the advice is given only to clients of the person in the course of such other business or profession and the advice does notspecify particularsecurities and islimited to general commentsmade in good faith in regard to trendsin the securitiesmarket,the economic situation ofthe country.
6.2 The following shall be exemptfromregistration underthese regulations:
a. An advocate and solicitor or law firm, whose offer of financial advice is solely incidentalto hislegal practice.Page 7 of 11
b. Chartered accountants who are registered under the Institute of Chartered
Accountants of India providing of any investment advice is solely incidental to the accounting practice.
c. Any person who publishesmagazine/newspaper, where —
I.the newspaperis distributed generally to the public in India;
II. the advice given, or analysis or report issued, is promulgated only through that newspaper; III. that person receives no commission or other consideration, apart from any fee received fromsubscription to or purchase ofthe newspaper,for giving the advice, or forissuing or promulgating the analysis orreport; and
IV. the advice is given, or the analysis or report is issued or promulgated, solely as incidentalto the conduct ofthat person’s business as a newspaper proprietor.
d. Any person who owns, operates or provides an information service through an electronic, or a broadcasting ortelecommunicationsmedium, where —
I.the service is generally available to the public in India;
II. the advice given, or analysis or report issued is promulgated only through that service; III. that person receives no commission or other consideration, apart from any fee received from subscription to the service, for giving the advice, or for issuing or promulgating the analysis orreport; and
IV. the advice is given, or the analysis or report is issued or promulgated, solely as incidentalto that person’s ownership, operation or provision ofthatservice.
e. Any stock broker or sub‐broker as registered under SEBI( Stock Broker and Sub‐
Broker) Regulations, 1992, who provides any investment advice as per Regulation 7 read with Schedule II of SEBI(Stock Broker and Sub‐broker) Regulation, 1992 and not charging any consideration forsuch advice.Page 8 of 11
f. Any person offering exclusively insurance broking services under regulation of
InsuranceDevelopment and Regulatory Authority.
7. Registration Requirements
7.1 The Individuals who wish to getregistered underthese regulations would need to satisfy the following criteria:
a. Individualsshould acquire a ProfessionalQualification froma recognized institute for
e.g. Chartered Accountancy form ICAI, MBA in Finance orsimilar qualification from a recognized university orshould have atleast 10 years ofrelevant experience; and
b. Certification from NISM or such other organization approved by SEBI for this purpose c. The individualsshould conform to the Fit and Proper Criteria slaid down in Schedule
II of SEBI(Intermediaries) Regulations, 2008.
7.2 Entities who wish to get registered under these regulations would need to satisfy the following criteria:
a. Capital Adequacy Requirement: Entities would need to maintain a minimum net worth which would be separate fromthe net worth required for other activities.
b. Key personnel: Entities should have at least 2 key personnel having the relevant experience exclusively for such activity. Such key personnel should also acquire the certification from NISM or such other organization as approved by SEBI for this purpose and haveminimumqualification as prescribed.
c. The entity should conform to the Fit and Proper Criteria laid down in Schedule II of
SEBI(Intermediaries) Regulations, 2008.
d. The applicant must have adequate infrastructure to enable it to discharge its functions as an Investment Advisor.
8. Obligations of an InvestmentAdvisor
8.1 Fiduciary Responsibility to Investors
All information received and provided by the investment advisor would be in fiduciary capacity. The investment advisor will be responsible to maintain confidentiality of thePage 9 of 11 investment advice provided to the client and information provided by the client. Advice should be given by the advisorin the bestinterest ofthe investor.
8.2 Suitability and Risk Profiling
The Investment Advisors ortheirrepresentatives would be required to do adequate risk profiling ofthe client before any investmentservice is provided to them. Based upon the risk profiling performed by the investment advisor or their representative suitable investment advice should be provided. The records ofsuch risk profiling and investment advice should bemaintained by the Investment Advisor.
8.3 Advertising and Marketing Material
Investment Advisors should not use any advertisement that contains any untrue statement of material fact or that is otherwise misleading. They should not use or refer to testimonials(which include any statement of a client’s experience or endorsement).
Refer to past, specific recommendations made by the advisor that were profitable, unless the advertisement sets out a list of all recommendations made by the advisor within the preceding period of not lessthan one year and complies with otherspecified conditions. 8.4 Conflict ofInterest
No financial incentives/ consideration would be received from any person other than investorsseeking advice. In case of advice regarding investmentin entitiesrelated to the investment advisor, adequate disclosures shall be made to investor regarding the relationship. 8.5 Maintaining Records
Records in support of every investment recommendation /transaction made which indicates the data, facts and opinion leading to that investment decision would be maintained by the Investment Advisor. Records should be retained for at least 5 years.
Systematic record of all advises provided would be keptincluding audio recording of any oral advice given.Page 10 of 11
8.6 Fees and Charges
The Investment Advisor would clearly indicate to its clientsthe fees and chargesthat are required to be paid by them. An investment advisor shall disclose to a prospective clients all material information about itself, its businesses, its disciplinary history, the terms and conditions on which it offers advisory services, its affiliations with other intermediaries and such other information as is necessary him to take an informed decision whetherto avail ofitsservices.
9. Execution Services
Investment advisorsshall not acceptfunds/securitiesfrominvestors, exceptthe fee for investment advice. If Non‐individual investment advisors (corporate entities) offer assistance in execution services such as broking, custody services, DP services, accounting etc., they must make appropriate disclosures, clarify that the investor is under no obligation to use theirservices and maintain armslength relationship through creation of Chinese walls. The choice of opting for execution services offered by investment advisor should be left to the investors. Fees and charges paid to service providersshould be paid directly to themand notthrough investment advisors.
10. Outsourcing
Other than sourcing of research reports, no other part of investment advisory activity can be outsourced.
11. Liability
The investment advisors shall not be liable for civil or criminal liability in respect of advice given unlessthe advice is negligent or mala‐fide in nature. Any dispute between the investment advisor and his client would be resolved through grievance redressal mechanismor arbitration created by SEBI
12. Entitiesregistered as Portfolio Managers
Portfolio Managers who provide only investment advice would need to be registered only as investment advisors after their present registration expires. Portfolio Manager
Regulations would be amended in view of the proposed AIF Regulations as well as the
Investment Advisor Regulations.Page 11 of 11
13. Public Comments
Public Comments are invited on the Concept Paper on Regulation of Investment
Advisors. All comments may be forwarded by e‐mail to Shri Manish Tekriwal, Manager,
Investment Management Department, Division of Funds ‐ 1 at manisht@sebi.gov.in latest by 1730 hours onOctober 31, 2011.