Our recommendations on Sebi’s consultation paper on amending the Investment Adviser Regulations

“It’s a very simple principle: You want to give financial advice, you’ve got to put your client’s interests first. You can’t have a conflict of interest.”

- US President Barack Obama, 2015

Background

Read together, SEBI’s three consultation papers (issued Oct 2016, Jun 2017 and Jan 2018) on Amendments to the SEBI (Investment Advisers) Regulations (2013) clearly indicate the regulator’s goal — to ensure that advisors, by whatever name called, put the best interests of their clients first.

SEBI has recognised the inherent conflict of interest that exists between “advising” and “selling” of investment products by the same entity/person. Its latest paper leaves no room for advisors to conceal any potential conflict of interest. A financial professional seeking to give advice on investing in financial products would have to pick between one of two business models starting April 2019:

• operate as an advisor, and commit to fiduciary duties of putting the best interests of the client first, on a transparent fee model (‘client pays’); or
• choose to be a distributor, and continue to earn a lifetime of commissions from mutual fund companies (‘manufacturer/ mutual fund company pays’)

In the June 2017 paper, SEBI proposed that Mutual Fund Distributors (MFDs) can only explain/describe the features of mutual fund schemes of which they are distributors, and distribute the said schemes while ensuring their suitability to the investor. The Jan 2018 paper, however, allows distributors to determine appropriateness by identifying the product category that is best suited for the client as well as by explaining product features.

Who should give advice?

The wide definition of the term appropriateness in the SEBI paper would mean that a distributor can continue to perform nearly all the activities of an advisor — identifying the customer’s objectives, resources, investment time horizon, risk profile and preferences; and explaining the product features. All this while avoiding all the regulation, supervision and higher level of fiduciary accountability that advisors are required to hold themselves to.

Assuming the distributor narrows to five products that suit the client, the only activity that he will now not be allowed to do is recommend a specific product. But even recommending a fund could be easily done under the guise of ‘explaining product features’; an activity permitted to distributors under the proposed regulations.

We believe that any determination of appropriateness or suitability should only be performed by an advisor, who is required under the terms of his SEBI registration to operate as a fiduciary. After all, the fiduciary standard means that advisors, by whatever name called, are legally obligated to put their client’s best interests first rather than simply finding “suitable” or “appropriate” investments.

Our Suggestions

• Any suitability assessment should be the exclusive domain of Registered Investment Advisers, who are required by law to operate as fiduciaries, and are subject to a higher, ethical customer-first standard.
• To address legitimate concerns on pricing smaller investors out of the financial advice market, Sebi could permit Distributors to give basic investment advice to ‘retail investors’; defined as those investing, say less than Rs 2 lakh per year, across all mutual funds.

Sebi’s 1992 charter spells out its primary goal, which is “to protect the interests of investors in securities”, and not the business models and interests of brokers, distributors or bankers. Unless Sebi resists the lobbying by vested interests and limits the activities of a distributor to merely highlighting product features (as in its earlier papers), its efforts to segregate distribution from advice will come to naught. All we will see is those who have registered as RIAs as a regulatory fig leaf to cover their distribution activities will drop all pretence, surrender their RIA licence and continue as Distributors.

Put the Client First! was originally published in Blog | Clearfunds on Medium, where people are continuing the conversation by highlighting and responding to this story.