By Jayant M. Thakur
Chartered Accountant
SEBI has issued on 7th October 2016 a consultation paper
proposing some amendments to regulations relating to investment advisors and
investment advice generally. Some of the proposed changes affect Chartered
Accountants, Company Secretaries, lawyers and other professionals directly. The
changes generally would make the regulations relating to investment advisors
much stricter. They will also make the categorisations between various types of
advisers sharper, so much so that they may end up being mutually exclusive.
Curiously, this paper has
invited widespread criticism on the grounds that SEBI perhaps did not expect.
Clearly, there were certain valid concerns SEBI has had to address through the
proposals. However, partly due to over-reach and partly due to
ill-drafted/ill-conceived proposals, there has been a strong opposition.
However, considering that amendments are inevitable, it is necessary to
consider the background and also the proposals as they presently stand.
Background of the provisions
SEBI had in 2013 notified regulations
relating to investment advisers (the SEBI (Investment Advisers) Regulations
2013 or “the Regulations”). These Regulations created a fresh category of
persons who assist investors in making investments. The others include
portfolio managers, mutual fund distributors, stock brokers, etc. This
category was created for a specific objective and to resolve certain conflicts
of interest that arose when the adviser was also the seller/distributor of
products.
An investor who approaches an
intermediary faces a concern about the objectivity of the intermediary. On one
hand, the investor expects that the intermediary will give him impartial advice
on which product he should invest in, taking into account his needs and
circumstances. On the other hand, the intermediary usually is paid by the
organisation (i.e., mutual fund, etc.) whose product he distributes. In
any case, he has his further own self interest to serve which may motivate him
to push those products that give him the highest of commissions/remuneration.
The result can not only be costly for the investor in terms of his effectively
paying high cost for making investments, but he may also end up holding
investments that are not suited to him. Mis-selling of units is such a serious
issue that it has actually been made a category of fraudulent practice under
the PFUTP Regulations. Generally, code of conduct relating to intermediaries
too lay stress on their taking into account interests of their clients above self-interest.
However, obviously, this is not
enough. So long as there is conflict of interest, temptations will remain and
no regulations can resolve it merely by mandating against it or banning it. The
Investment Advisers Regulations created a neat solution. It created a category
of intermediaries – Investment Advisers – who would focus on giving advice and
not distributing products. Thus, they will render skilled advice to clients
taking into account their needs and circumstances and thus suggest a portfolio
or investment products that serve their needs. More importantly, their fees
will be directly paid by such clients. The Investment Advisers thus have
motivation as well as interest in focussing only the interests of clients. They
are generally not permitted to accept remuneration/commission from entities
whose products they may recommend.
The Regulations go further and
mandate a higher level of professionalism in such Investment Advisers. They are
required to carry out proper client analysis and document it. Acting as
Investment Advisers would require prior registration. A certain level of
qualifications and also certification is also mandated for such persons.
However, while Investment
Advisers generally were required to obtain registration, exemption from
registration was given to certain persons. For example, persons who give
investment advice as part as incidental to their other activities are not
required to register. A good example is of Chartered Accountants who may give
such advice as part of their practice of rendering tax and related advice to
their clients. Similarly, distributors of products may also give such advice. Such persons are not required to be registered.
This may now undergo a
significant change as per the proposals made in the Consultation Paper.
No exemption to Chartered
Accountants and others who render investment advice incidentally
Chartered Accountants, Company
Secretaries, lawyers, stock brokers, etc. who give investment advice
incidental to their primary activity of professional practice will now require
registration as Investment Advisers. The result will be that such persons will
now have to focus on their core activity and cannot, even if asked, render
investment advice to their clients.
It is not as if such persons
are not qualified or otherwise unregulated. Further, it is also not as if they
have conflict of interest. Yet, this requirement is proposed.
It is possible that some such
persons may obtain the required registration to enable them to continue giving
such advice to their clients. However, it is more likely that the
categorisation of persons will become more distinct and separate with each group
focussing on their own activities.
Mutual Fund distributors to be
debarred from giving investment advice
As explained earlier,
intermediaries such as mutual fund distributors face the very conflict of
interest that is the focus of the Investment Advisers Regulations. They are
paid by the mutual fund/AMC whose products they sell though the investor may
expect that they are given impartial advice suited to their circumstances. Such
distributors under the Regulations were not required to be registered as Investment
Advisers, if they gave advice that is incidental to the selling of such
products. The Consultation Paper now proposes to wholly prohibit them from
giving such advice even incidental to selling.
Categorisation between Research
Analysts and Investment Advisers
Research Analysts and
Investment Advisers provide similar functions in relation to giving of
investment advice. However, the nature of their functions and approach is
significantly different and thus requirements relating to their registration
and functioning are covered under separate Regulations. A proposal now makes
this categorisation even sharper.
The Consultation Paper observes
that investment advice is often given in electronic and broadcasting media. A
certain level of exemption is presently provided under the Investment Advisers
Regulations to such advice that is widely available to public. It is now
proposed to divide such advice being given. Simply stated, generic advice in
such media to public at large can be given by research analysts while client
specific advice can be given by Investment Advisers.
Another recommendation further
clarifies this divide. Research Analysts would be required to send their
recommendations to all classes of its clients at the same time. The reason is that
their recommendations are generic and product related and not client specific.
Thereafter or independently, the role of the Investment Adviser would arise
where the investor would take the help of such Adviser to decide whether such
recommendation is suitable for his needs and circumstances.
Investment tips via social
media and the like
This proposal has seen very
strong criticism. While the criticism is justified, the evil that is sought to
be addressed also needs to be considered.
It is too often found – as
evidenced by several orders of SEBI – that there are persons who use the
internet and social media for giving tips in dubious scrips whose price and
trading are manipulated to trap unsuspecting investors. Tips are given by SMS,
whatsapp, social media, etc. Often, these scrips are what are known as
“penny stocks” who rarely have any intrinsic value but are quoted at low
prices. The price of the shares are manipulated and huge volume is also seen in
stock exchange which tempts investors into investing. The investing public may
be influenced by the low price and hence, there is expectation that loss too
can be low. The shares, after some time, see their price and volumes both
crashing with investors then left holding the valueless shares. In some cases,
SEBI has identified persons who carry out such manipulative/fraudulent
activities and debar/punish them. At other times, it may be difficult even to
identify who they are.
The Consultation Paper now
seeks to wholly debar giving of such tips unless such persons who give tips are
themselves registered as Investment Advisers and thus subjected to the
regulatory requirements. Moreover, giving of such tips in violation of such
requirements will be treated as a fraudulent act inviting stringent punishment.
This proposal has invited very
strong criticism. The objection obviously is not against action against such
dubious/fraudulent tippers. It is the blanket and overreaching ban against all
type of tips on internet and social media irrespective of who is giving such
types, of what type and in what manner. To give a most basic example, a person
may recommend in passing to his friend a particular share in a conversation
over WhatsApp. This may not be well researched and even accurate. Yet, such a thing is so common. Such a tip may attract severe punishment.
It is common to find
whatsapp/facebook groups where investment advice is freely taken/given amongst
like minded persons. There are countless blogs that discuss investments and it
is likely that some sort of recommendation may be given on such blogs. Critics
have given example of comments of persons like Warren Buffet and the like who
discuss their investments publicly.
It is felt that SEBI has not
thought through this issue well and their recommendation may restrain free
discussion of stocks and investments generally. It is even stated that such
restriction amounts to severe and unjustified restraint on freedom of speech.
One will have to see how SEBI
deals with this criticism and what modified form of regulation it comes out
with.
Ban on schemes, competition,
games, etc. relating to stock market
SEBI has observed that many
persons organise competition, games, etc. relating to stock market which
may involve predicting the price of shares on stock markets. The paper makes it
clear that SEBI does not approve or endorse such schemes and thus the public
may engage in such schemes at their own risk. However, SEBI goes a step beyond
such hands-off/caveat emptor approach and notes that the public may end up
suffering losses. Hence, the paper recommends a total ban on such schemes, etc.
Client Agreement by Investment
Advisers
Client agreements have always
been a concern in respect of intermediaries in securities markets. There may be
non-uniformity or even sheer non-existence of such agreements. Or the terms may
be one-sided or opaque. Certain minimum level of protection of clients may not
be provided. Hence, SEBI often provides for certain standard form of such
agreements with certain minimum requirements that cannot be deviated from. For
Investment Advisers, the paper recommends a “Rights and Obligation” document.
The paper recommends a certain minimum provisions in such document including
various disclosures by the Investment Adviser. The result would be that, while
avoiding over-formalisation, a certain level of protection as well as
disclosure would be available to the client.
Other recommendations
The Paper generally seeks to
make several other amendments. The Regulations particularly relating to Investment
Advisers will thus see substantial amendments.
Conclusion
Intermediaries are considered
to be the gatekeepers to securities markets who deal with investors directly.
It is then inevitable that such intermediaries will face considerable
regulation and supervision. It is also expected that SEBI would ensure that,
through registration, it creates a requirement whereby only qualified persons
who comply with certain basic requirements as well as ethics are only permitted
to operate. Further, conflicts of interests are also avoided. This has resulted
in not only multiple categories of such intermediaries but increasingly complex
regulatory requirements. Whatever shape the final requirements may come in
following the consultation paper, they will only increase such requirements
which eventually will also increase costs of compliance. The multiple
categories will ensure that there is sharp specialisation and many
intermediaries and even professionals like Chartered Accountants will have to
give up certain activities they may otherwise be engaging in. The investors
will have advantage of such specialisation but will then have to go to multiple
intermediaries to fulfill their simple desires of investing in capital market
products. _
