April 22, 2016

Of Advisors, Distributors and Protestors

Last week, I had a conversation with a certain financial advisor who has, thus far, not registered under SEBI’s Investment Adviser Regulations.  About three years ago, shortly after those regulations were released, I remember asking him if he planned to register.  His response then was similar to that of many other advisors: he felt no need to do so, and that being a “distributor,” there was no legal obligation for him to do so.  When I spoke to him last week, I asked him if he was considering a change in his stance, particularly in light of SEBI’s decision to disclose distributor commissions in the investors’ account statements.  His response: “The only change is that I have become more of a protestor than a distributor.”

That struck me as a very profound statement, even if he did not intend it that way.  While he was making it in the context of SEBI’s recent directive, I could see it as a telling comment on the warped trajectory that SEBI’s engagement with the fund distribution community has taken since the release of the Investment Adviser Regulations. 

Most people in the industry believe that the regulations make a distinction between “advisors” and “distributors”. At the risk of sounding like a dissenting idiot, I think that is a disputable inference.  The regulations state that an advisor is someone “who for consideration, is engaged in the business of providing investment advice”.  In turn, investment advice is defined as relating to “investing in, purchasing, selling or otherwise dealing in securities or investment products, and advice on investment portfolio containing securities or investment products, whether written, oral or through any other means of communication for the benefit of the client and shall include financial planning”.  Based on that, I reason that all self-styled “distributors” are actually “advisors”. 

The regulations then go on to say that some advisors are not required to register themselves.  In other words, the regulations make a distinction not between “advisors” and “distributors”, but between “advisors who need to register”, and “advisors who need not register”.  Yes, a number of us, me included, use the term “distributor” to refer to those who are registered with AMFI.  But that term is by no means exclusive of the term “advisor”.

So what explains the prevailing view?

As far as I can make out, this is because of a line in the regulations that is widely and frequently quoted out of context: “…no person shall act as an investment adviser or hold itself out as an investment adviser unless he has obtained a certificate of registration from the Board under these regulations”.  Here’s the problem: can this line really be applicable to those who are exempt from registering?

Regardless, at least one senior SEBI official has publicly questioned the right of those who called themselves “advisors” to do so without having registered under the regulations.  Worse, SEBI issued a press release (which I challenged in this post) that “cautioned” the general public to “deal with only SEBI registered investment advisers.”  Fact is, these regulations allow for the amicable co-existence of advisors who are required to register and advisors who are not required to register.  So why should there be the need for caution? Why, indeed, should SEBI and its officials be going to such lengths?

By some accounts, it would seem that officials at SEBI haven’t taken kindly to the fact that in the three years since the regulations came into force, less than 300 individuals/ entities have chosen to register.  I don’t want to speculate on that but their actions certainly make me wonder.  I also wonder if SEBI’s latest directive to disclose distributor commission amounts in the investors’ account statements has any merit or whether it is a step that is as questionable as those mentioned above.  Right off, it does come across as being morally problematic.  Among other things, an investor could end up concluding that the amount disclosed is the money the distributor made off him/her.  In a way that is correct, but more accurately, it is the fund house that is making money off the investor, a part of which is paid to the distributor.  Why only that information should be disclosed, remains a mystery.  Then, there is the question of its utility.  Would such transparency actually enable an investor to make a better, more informed decision?  I doubt it.  On the other hand, with the passage of time and the power of compounding, this information could bias an investor against the distributor.

To be clear, I am not siding with the fund distribution community.  I subscribe to the view that far too many distributors are ill-equipped to offer good advice, and that a large number of them don’t always act in the best interest of their clients.  Just as anyone else in the industry with a sense of fair play, I am appalled and puzzled by the incentives being doled out by fund houses in general to the distribution community at large.  And I support the need for SEBI to take action.  My disconnect is with the heavy-handed manner in which SEBI has chosen to approach this issue. 

SEBI already has enough rules in place which if properly enforced, can rationalize the payments made by fund houses to distributors.  And ever since it shifted the responsibility for conducting the certification exam for distributors from AMFI to NISM, it has much more of a say in the matter of competency standards for distributors.  SEBI also has the the power to book errant distributors on the grounds of mis-selling, among others.  I think it is time that SEBI realized that its actions are hurting the competent, principled advisors whose only fault seems to be that they have rightfully opted not to register under the regulations.

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