By Gaurav Pingle, Practising Company Secretary ( gp@csgauravpingle.com )
Introduction
Regulation 22A was introduced to the SEBI (Investment Advisers) Regulations, 2013 (‘SEBI (IA) Regulations’) by an amendment introduced in 2020. The said regulation relates to ‘Implementation of advice or execution’. This article is an analysis of the provisions relating to the newly introduced Regulation – Implementation of advice or execution by Investment Advisers (IAs) along with an analysis of several interpretative letters under SEBI (Informal Guidance) Scheme, 2003.
SEBI’s rationale for such amendments
SEBI had floated a Consultation Paper to review the regulatory framework for IAs on January 15, 2020. SEBI noted under the erstwhile IA Regulations, individual IAs were not allowed to sell any product and/or to provide execution services. Only corporate entities registered as IAs can offer execution or distribution services, subject to the condition that investment advisory services are offered through separate identifiable division or department. SEBI had noted that IAs are helping clients in the implementation of the advice given to the client by charging some consideration as implementation (execution) fees. SEBI had also noted that clients consider IAs to be their trusted adviser and hence expect services as a ‘one-stop shop’. To enable IAs in helping clients in the implementation of the advice, SEBI proposed some amendments:
(i) Implementation services in the securities market may be allowed to IAs. However, IAs shall ensure that while providing such services to the advisory clients, no consideration is received directly or indirectly at IAs group/family level.
(ii) IA shall provide implementation services to its advisory clients only through direct schemes/direct code in the securities market.
(iii) SEBI also proposed that IAs shall not be entitled to charge any implementation fees from the client. Group/family of IA also cannot charge any implementation fees from the client, etc.
Extant provisions
Based on the above proposal, SEBI amended the IA Regulations and provided for implementation of advice or execution. Almost all recommendations have been incorporated in the SEBI (IA) Regulations. SEBI now provided that IA may provide implementation services to the advisory clients in the securities market. However, IAs shall ensure that no consideration including any commission or referral fees, whether embedded or indirect or otherwise, by whatever name called is received; directly or indirectly, at IA’s group or family level for the said service, as the case maybe. IA shall provide implementation services to its advisory clients only through direct schemes/products in the securities market. The IA or group or family of IA shall not charge any implementation fees from the client. The client shall not be under any obligation to avail implementation services offered by IA.
Implementation Issues
The amendments have directly affected the working and operations of IAs. In the recent time, IAs have restructured their business model in order to align itself with the revised SEBI (IA) Regulations. SEBI seems to be very clear that IAs should only advise, consult and suggest appropriate plans and that IAs can provide implementation services with no further charges. Also, now the discretion is with the investor whether or not implementation services are to be availed from the said IA. Prima facie, the rules are very clear, making a specific distinction with functions and professional fees between ‘consulting’ and ‘implementing’ activities.
Analysis of SEBI’s Interpretative Letters
In this regard, SEBI has issued several interpretative letters under the SEBI (Informal Guidance) Scheme, 2003. The same have been summarized here.
- HDFC Securities Limited: In this case, the issue was – can a trading member receive broking income from advisory clients for execution services. SEBI noted that the client had signed
–up with the same entity for both broking services and investment advisory services. After referring to Regulation 22A of SEBI (IA) Regulations, SEBI stated that IA may provide implementation services to the advisory clients in the securities market, however, the client shall not be under any obligation to avail implementation services. SEBI also noted that IA/group of IA shall not charge any implementation fees from the advisory client. SEBI concluded by stating that trading members or its group entity cannot receive any broking income from advisory clients with providing execution services, whenever such execution is emanating from advice offered by a trading member as IA. The case precisely falls under Regulation 22A of the SEBI (IA) Regulations.
- Paytm Money Limited (PML): Total 3 issues were raised by PML and accordingly SEBI replied to the same. (i) PML doesn’t charge any advisory or execution fees, however, it intends to avail reimbursement of services related out of pocket expenses such as – KYC, technology hosting, platform maintenance, etc. SEBI clarified that PML cannot avail any reimbursement of any amount for the services given to clients, from AMC whose direct plans are being sold by them to clients. (ii) Another issue was – Can PML seek electronic consent of the clients on certain points share the same with the clients on registered e-mail addresses for their records and reference. On this point, SEBI emphasised the importance of entering into an investment advisory agreement with its clients and stated that merely seeking an electronic consent and sharing with clients may not be considered as sufficient compliance with SEBI (IA) Regulations and Circulars. (iii) In the SEBI (IA) Regulation, SEBI has defined ‘principal officer’ as Managing Director or designated director or managing partner or executive chairman of the board or equivalent management body who is responsible for the overall function of the business and operations of a non-individual investment adviser. PML questioned whether the department head in charge of advisory business who is a member of the management advisory committee appointed by the board of directors be a principal officer as such a person would be responsible for the overall functions of the advisory business. SEBI clarified that such person (i.e. department head in-charge of advisory business) cannot be a ‘Principal Officer’ of the IA, unless he is also Managing Director or designated director or managing partner or executive chairman of the board or equivalent management body of IA.
- Jade Capital Market Private Limited: In this case, the issue was – can IA continue to collect performance-based fees wherever the same is due in terms of the agreement executed with the client, even if such fee is due on the date after March 31, 2021. SEBI referred to the revised Regulations and Circulars, and observed that IAs are not permitted to collect any fee other than the fee as prescribed in Circular (‘Asset under Advice Mode’ or ‘Fixed Fee Mode’). SEBI also clarified that IAs shall mandatorily be required to executed IA agreement with their clients (including existing clients) by April 1, 2021. SEBI ultimately meant that IAs cannot continue to collect performance-based fees in terms of the agreement executed with the client (even if such fee is due on the date after March 31, 2021). This question was a combination of performance-based fees and execution of IA agreement.
Observations & Conclusion
The objective of SEBI (IA) Regulations, inter alia, was to lay down the framework for advisers who acts in a fiduciary capacity towards their clients and to address the conflict of interest arising due to the dual role played by the entity as adviser and distributor of financial products. The amendments introduced by SEBI attempt to address these concerns. Taking this into consideration, SEBI rightly observed that a trading member cannot receive broking income from advisory clients for execution services and also that IAs cannot continue to collect performance-based fees. However, in my view, SEBI ought to have permitted PML to at least avail reimbursement of services related out of pocket expenses such as – KYC, technology hosting, platform maintenance, etc. Such reimbursement would have not created any conflict of interest with regard to the role of IA.
Regulation 22 of SEBI (IA) Regulation has changed the business model for quite a few IAs. In addition to this, the IAs are required to ensure the balance of qualification, experience and net worth requirement introduced and amended by SEBI. Probably for experienced IAs, such regulations would not been challenging, however, new entrants are facing a lot of challenges to enter or sustain in this highly regulated industry. Also, mutual fund distributors are not affected in anyways by the SEBI (IA) Regulations and amendments.