A leg-up from Sebi

The Securities and Exchange Board of India (Sebi) has unveiled a consultation paper to revise the regulatory framework governing investment advisors (IAs) and research analysts (RAs). Among the suggested ideas are relaxing entry criteria, such as minimum qualifications, certifications, and net worth requirements; allowing part-time IAs, RAs, and independent compliance officers; and, relaxing the definition of “principal officer”. Will these and other changes proposed by the new framework achieve Sebi’s objectives? Over the past few years, the Indian stock markets have attracted millions of new investors. But, as the consultation paper points out, “the number of IAs/RAs today is not commensurate with the large investor base ... This is leading to the proliferation of unregistered entities acting as IAs and RAs”. Sebi wants the service of IAs and RAs to be available to more investors for whom “a much larger number of IAs/RAs is required”. Will the proposed changes achieve this laudable objective?
 

The menace of illegal advisories
 

In an ideal world, investors’ primary source of information should have been the traditional business media and, better still, Sebi-registered IAs and RAs. But like moths to the fire, millions of investors are attracted to social media for investing wisdom. This is the domain of self-styled investment gurus, trainers, and influencers. Collectively, they are a formidable force. While Sebi has attempted to crack down on many of them it takes a lot of hard, painstaking work to investigate and establish facts, give them time to reply, make a case, issue a show-cause notice, and then pass an order.
 

There are two major issues with using legal action to control illegal advisories. One, the penalty is usually too meagre to act as a deterrent. An advisor who did not perform the “Know Your Customer” process as required under the Prevention of Money Laundering Act, did not do risk profiling, had no records to show for suitability of advice and investment rationale, and did not have an audit done, among the many violations his firm was guilty off, got away with a fine of only Rs 6 lakh. The second issue with Sebi’s battle against illegal advisors is that many of them have become smarter. They couch their service as training courses after advertising high returns they have notched up. It turns out these trainers are hopeless traders/investors, as their leaked income-tax returns show. They can be accused of misrepresentation and cheating, but it is up to investors to file such cases. Sebi can act only when they impart buy/sell advice of Sebi-regulated products such as stocks, mutual funds, and bonds, not for false claims of their investing or training prowess. The net result: The tribe of influencers will keep growing until, of course, a bear market starts when many investors would leave the market in droves.
 

Can the new relaxed norms proposed by the consultation paper wean investors away from the overwhelming tide of influencers, and encourage them to approach RAs, as Sebi hopes? The suggested changes make it easier to register as an advisor or analyst, but the entire gamut of onerous record-keeping, disclosure, and audit requirements has been left untouched. It has also added more paperwork, now that regulating IAs/RAs has been delegated to a third party, BSE-owned BSE Administration & Supervision Ltd (BSEASL).
 

The current rules require advisors to perform an objective risk-profiling of clients. That should include financial details, including goals, preferences, borrowing, current investments, savings, expenses, personal taxation and so on. IAs have to record the suitability of products recommended and also the rationale of every piece of advice provided, and must have a documented process for selecting investments based on the client’s objectives and financial situation. Advisors cannot accept fees through the credit card and have to sign lengthy and intricate investor agreements (26 clauses), which can be overwhelming for clients and resource-intensive for IAs. IAs also have to maintain records written and signed by them, telephone recordings, emails, SMS messages, and any other legally verifiable record for five years.
 

Just three months ago, Sebi announced every six months advisors would have to declare to BSEASL dozens of minute operational details over eight pages such as their shareholding pattern, beneficial owners with more than 10 per cent capital, the number of clients, advertisement details, distributor commission, details of social media handles, details of bank account/s for receiving advisory fees, details of contact persons, principal officers, advisors providing advice, details of the managing director and other directors, etc. While Sebi has a justification for all this, such record-keeping, disclosure, and tightened audit norms will keep the advisor population stunted. I am not suggesting that these norms be relaxed. But the fact is investment advice is a small business segment if done in the right way. Like insurance, there is no natural pull — investors are not seeking it. This is why there are hardly a few hundred investment advisors even as the investing population has exploded to over 90 million. The issue at hand is not just strict entry criteria being relaxed. The ratio of the effort of following the Sebi rules and the reward that the business brings is simply not attractive enough.
 

The silver lining is Sebi’s effort to redefine the RA’s work. Currently, it is a confusing piece of regulation, designed principally to cover analysts in investment banks and brokerages, while imposing onerous and meaningless requirements for independent analysts. While suggesting new regulations and paperwork for analysts, the paper clarifies their roles, allowing them to offer “model portfolios”, which, under the current rules, is considered investment advice. Given that almost all investment advice is stock-related, there will be a sharp rise in RA registrations and platforms that were illegally offering model portfolios will become legit, while investment advisories will remain a struggling profession, governed by an elaborate but irrelevant pile of rules.

The writer is editor of www.moneylife.in and a  trustee of the Moneylife Foundation; @Moneylifers