March 16, 2015

Interpreting SEBI’s Adviser Regulations

In the excitement surrounding the recent Budget and the possibility of a cap on distributor remuneration, one news item didn’t quite get the attention it deserved.  On 25 February, SEBI released a set of FAQs which were intended to “address the queries of various market participants on the applicability and interpretation” of its 2013 Adviser Regulations.  I am not sure why it took them over two years to issue these, and that, too, after two hundred and forty odd advisors (that’s how I spell it) had registered under the regulations.  But I am glad that they did.  In this post, I offer my thoughts and my understanding on some of the implications for mutual fund distributors.  Let me hasten to clarify that I am not a legal expert and that I am offering this for the greater common good of mutual fund distributors.  It would be wise to consider taking a formal legal opinion before you decide a course of action.

Let me first step back a bit.  When the regulations had originally come out, I had mixed feelings about these.  On one hand, I found these praiseworthy because for the first time in India, there was a legally enforceable definition of the terms, ‘Investment Advice,’ and ‘Investment Adviser,’ and a restriction on the use of the term ‘Investment Adviser’ by only those persons or entities who/that met a specific set of conditions. On the other hand, I was stunned by the rigorous requirements that these regulations imposed upon any advisor who/that registered with SEBI. If I were a mutual fund distributor, those requirements would have made me want to find out a way to avoid registering with SEBI. 

On the surface of things, it seemed that single-product advisors such as mutual fund distributors did not necessarily have to register.  However, the conditions of their exemption were wide open to interpretation.  An advisor would have needed to get a legal opinion on how to conduct their business without the fear of violating the regulations.  Well, after two years of suspense, the FAQs have cleared the air over a number of ambiguities.  While there are still some issues that could do with a bit of clarification, in my reading, enough has been done for most advisors to confidently move on.  With that background, let me now address the question that I have been most asked: is it necessary for a mutual fund distributor to register with SEBI?

In my understanding, a mutual fund distributor who/that merely facilitates the execution of transactions is not deemed to be an investment adviser as per the regulations.  Thus, such a distributor will not be covered by these regulations, and will not be needed to register.  This would hold good irrespective of whether such a distributor is facilitating execution in mutual fund schemes and/or in any other investment product. At the same time, it also appears that such a distributor cannot claim to be an investment adviser.

If a mutual fund distributor offers advice only on mutual fund schemes, it appears that while such a distributor will be deemed to be an investment adviser and can claim to be an investment adviser, he/she would not be required to register with SEBI.  If such a distributor is also a registered insurance agent/broker and/or a registered pension advisor, and offers advice within the scope of those roles, then, too, he/she would not be required to register with SEBI.  There is a bit of ambiguity, though.  Exemption is granted only provided the distributor offers “basic advice.”  It is not clearly laid out as to what this may mean, particularly as regards to whether this includes financial planning or not.

As defined by the regulations, financial planning includes “analysis of clients’ current financial situation, identification of their financial goals, and developing and recommending financial strategies to realise such goals.”   Further, offering financial planning is regarded as offering investment advice.  The ambiguity as to its inclusion in the term, “basic advice,” stems from a reference to it in the FAQs which reads thus (emphasis is mine):

“A person acting in multiple capacities such as insurance agent, pension advisor, mutual fund distributor, etc. and expand (sic) his scope of activities to include investment advice on other financial products or engaged in the financial planning of the clients, then he may be registered and regulated under IA Regulations for advising on such other financial products or financial planning of the clients.”

The reason for that emphasis is to highlight the choice of the phrase, “may be,” as opposed to something on the lines of “required to be,” which has been used elsewhere in the FAQs.

Personally, I take the view that financial planning, to the extent that it leads to a recommendation of mutual fund schemes, would form a part of the “basic advice,” that SEBI alludes to.  For one, in its dos and don’ts to investors, as regards to investing in mutual funds, SEBI has this to say:  “Don’t rush into making investments that do not match your risk taking appetite and investment goals.”  For another, in its Code of Conduct for intermediaries of mutual funds, it says: “A focus on financial planning and advisory services ensures correct selling and also reduces the trend towards investors asking for passback of commission.”  And, then, in the 2012 amendment to its regulations on the prohibition of fraudulent and unfair trade practices, it defines mis-selling of units of a mutual fund scheme to include, “not taking reasonable care to ensure suitability of the scheme to the buyer.”

Of course, there is nothing quite like taking a legal opinion to be sure one is on safe ground.  Which brings me to the role of AMFI in all of this. 

When the regulations originally came out, AMFI should have pro-actively helped mutual fund distributors by getting them a formal legal opinion.  After all, it was an issue that affected the entire industry.  Yet, for over two years, it let the distributors be under the cloud of ambiguity, and fend for themselves.  To set the record straight, a few industry leaders, as also many distributors, did say that they expected things to be resolved the way they have now been.  It is a moot question, though, whether that was on account of a premonition, or an ostrich-like thinking, or something else.  

The FAQs can be accessed here.

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