Authored by: Anushka Ukrani


Overview

An Investment Adviser (“IA”) providing investment advice is governed by the Securities and Exchange Board of India (“SEBI”) (Investment Advisers) Regulations, 2013 (“IA Regulation”). According to the IA regulations, in order to act as an IA, the applicant must mandatorily register with the Securities and Exchange Board of India under the IA Regulations.

Under Regulation 2(m) of IA regulations, an IA has been defined as a person involved in the business of rendering ‘investment advice’ to clients or other persons or groups of persons, for consideration, and also includes any person who holds himself out as an investment adviser. Investment advice has been defined under Regulation 2(l) as an advice relating to investing in, purchasing, selling or otherwise dealing in securities or investment products, and advice on investment portfolio containing securities or investment products, for the benefit of the client and includes financial planning. It can be made orally or in writing or through any other means of communication. However, any general advise given through a widely available public platform such as newspapers, magazines or any other means of broadcasting or telecommunication, is excluded from the ambit of ‘investment advice’.

The IA Regulations, were notified with the object of laying down a framework for investment advisers and to address the conflict of interest arising due to the dual role that was being played by them as an adviser as well as distributor of financial products. IA Regulations impose certain requirements to be fulfilled by IAs, for instance, qualification and experience criteria, risk profiling of clients, disclosure requirements, maintenance of records, etc. Over the years, SEBI had been receiving numerous complaints against IAs. These complaints were mostly against charging unreasonably high fees, non-adherence to risk profile of client and non-disclosure of complete charges. In order to address these issues, on 3rd July 2020 (effective from 30th September, 2020). The amendments are intended to strengthen the regulatory framework for investment advisers. In this article we will discuss the key aspects of this amendment and its pros and cons.

Key aspects of the amendment

Enhanced minimum Net worth requirements: Net worth has been defined by the explanation to regulation 8 (1) as the aggregate value of paid-up share capital plus free reserves not including the reserves created out of revaluation, reduced by the aggregate value of accumulated losses, deferred expenditure not written off, including miscellaneous expenses not written off, and capital adequacy requirement for other services offered by the advisers. The amendment has increased the minimum net worth requirement for individuals as well as non-individuals.

IA Category Prior to Amendment Post amendment
Individuals 0.1 million or 1 lakh 0.5 million or 5 lakhs
Non-individuals (companies/LLPs) 2.5 million or 25 lakhs 5 million or 50 lakhs

It is necessary for all existing IAs to comply with the enhanced requirements within 3 years.

Enhanced qualification requirements: Regulation 7 earlier required the IAs and their representatives to fulfil ‘any one’ of the following two requirements:

  • Professional qualification/PG Degree/Diploma in the relevant area.
  • Graduation in any subject along with 5 year work experience in the field relating to advice in financial product/securities/asset/fund/portfolio management.

With the amendment both these requirements need to be met cumulatively and not alternatively. However, existing individual IAs have been exempted from complying with the enhanced qualification and experience requirement in the newly added proviso to regulation 7(1). National Institute of Securities Market (“NISM”) certification continues to be an essential requirement; however, obtaining certification through continued professional education programs (“CPE”) has been disallowed.

SEBI has introduced the concept of Principal Officer in the 2020 Amendment Act. All non-individual investment advisers need to designate a person who is responsible for the overall function of the business and operations as Principal officer. The principal officer can be managing director or designated director or managing partner or executive chairman of the board or head of Investment Advisers department. They have to comply with the qualification requirements as provided in the Amendment Act.

The term representatives, who are essentially all client facing persons, has been replaced by Persons Associated with Investment Advisors (“PAIA”) who are also required to meet the enhanced requirements. PAIA cover a wider ambit of persons than representatives and include all client-facing personnel irrespective of their nature of association (i.e. through an employment contract or other means) with the IAs. Also, under regulation 13(e), those individual IAs who have more than 150 clients need to get themselves registered with SEBI as non-individuals IAs.

Segregation of advisory and distribution activities: Prior to the amendment an IA could provide both investment advice as well as distribution services to his clients subject to certain regulations. However, this created a conflict of interest. To address this issue the amendment provides for segregation of advisory and distribution activities at client level. Now an individual can either register as an IA or provide distribution services as a distributor.

  • For individual IAs: Now under the amended Regulation 22(1) an individual IA is not allowed to provide any distribution services to his clients. Also, under Regulation 22(2), his family members (spouse/children/parents) are also not allowed to provide distribution services to clients advised by him. So now if an IA is providing advisory services to a particular client, then husband/wife of the IA cannot render distribution services to the same client. Similarly, if a particular client is receiving distribution services from a family member, then the IA is barred from rendering advisory services to that client.
  • For non-individual IAs: Under Regulation 22(3), a non-individual IA shall maintain client level segregation at group level. They cannot offer advice and distribution services to the same client within the group and have to maintain separation of advisory and distribution activities by ensuring that these services are provided through a separately identifiable department or division.

Lack of clarity on performance fee: The IA must ensure that the fee charged to the client is reasonable and fair. Although IA Regulations do not explicitly prohibit charging of a performance fee, in an interpretive letter issued by SEBI to Market Magnify Investment Adviser and Private Research Limited pursuant to its informal guidance application, SEBI has stated that linking advisory fee to the profit and loss generated by the client assuming that the client has acted upon advice is not envisaged under the IA Regulation. Similar view was taken by SEBI in another interpretive letter issued pursuant to an informal guidance application filed by Capstocks Securities (India) Private Limited. Further the press release which introduced the amendment has also indicated that further information on mode of charging of fee, periodicity shall be separately specified through a circular.

Implementation of advice or execution services: The amendment inserted Regulation 22A which permits the IAs to provide implementation services to their clients through direct schemes/products in the securities market. However, they cannot charge any consideration whether direct or indirect for the same and neither can their family members/group.

Mandatory agreements between client and investment advisors: The amendment has made it mandatory for IAs to enter into an agreement with clients under Regulation 19(1)(d) for ensuring “greater transparency in advisory activities.”

Hits and Misses

These amendments have been made in light of the changes that have occurred in the securities market like new products are being offered, the complaints from investors on lack of clarity on fee or high fee being charged and issues of conflict of interest. The purpose is mainly to address the various issues related to conflict of interest and excessive fee faced by clients. These issues have been adequately addressed in the amendments by way of segregation of advisory and distribution activities. The provision requiring agreements between clients and IAs is another welcome addition which can be seen as an attempt to provide sanctity to the commercial and legal terms governing the relationship of IAs with their clients. Also allowing IAs to render implementation services but without charging any fee or commission goes a long way in prohibiting IAs from charging their clients twice, first by way of advisory fee and then as commissions for implementation/execution. This is a welcome step as most clients require implementation services and end up being charged indirectly for it.

However, the amendment also raises certain questions. As the amendments have enhanced the net worth requirements and eligibility qualifications for investment advisers, they will have to ensure that they as well as their personnel meet the revised criterion which includes NISM certification. Also, obtaining fresh certification through CPE Program has been explicitly prohibited. It is a huge ask and could negatively affect the growth of advisory practice in the long run. The amendment requires an individual with 150 clients to register as a non-individual. But it needs to be seen that an IA with 150 clients may not be able to meet the net worth requirement of 50 lakhs. It will force them to remain under the 150 clients mark out of choice in order to avoid corporatization.

Although certain issues could have been addressed better, the amendment is surely a step in the right direction to strengthen the regulatory regime surrounding investment advisory services.


The author is a law graduate from the Campus Law Centre,  University of Delhi.


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