Is SEBI trying to harm investors’ interests & destroy fee-only advisory?

In a backward step, SEBI has proposed several harmful changes to regulations governing investment advisors in a consultation paper. We discuss why these affect investors' and can kill fee-only advisory. You can write to SEBI and help stop these suggestions from becoming a rule.

Published: January 21, 2020 at 2:09 pm

Last Updated on January 22, 2020 at 12:05 pm

On Jan 15th 2020, SEBI released a “Consultation Paper on Review of Regulatory Framework for Investment Advisers (IA)”, where changes that can directly harm investors’ interests have been proposed. This set of proposals if implemented can also destroy conflict-free fee-only advisory and completely dilute the purpose of IA. We explain why and how you can provide feedback (format given below) to SEBI before Jan 30th 2020. This is the consultation paper.

While the paper is well-intentioned with an objective to “strengthen the regulatory framework for Investment Advisers (IA) as well as empower the IA to effectively discharge their responsibilities towards the investors who are the clients of IA“, SEBI has diluted the very intention and spirit of the regulation concerning registered investment advisors (IA). If these become rules, we will see IAs offering regular plans that first serve their interest.

1 Back to square one! investment advice = product pushing!

Initially, IA regulations proposed to ensure complete segregation of product selling (commission-based distribution) and investment advice. Then it allowed a way for non-individual (company setup) to offer both with an “arms-length distance”. Now it wants to offer a “level-playing field” to individual investment advisors!

That is, individual SEBI registered investment advisors (RIAs) can be a commission-based product pusher and investment advisor! SEBI, however, wants “client level segregation” (applicable to both individual and non-individual RIAs).

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This means if a client is offered a mutual fund regular plan, they cannot be offered investment advice. This is bizarre at best. They want a registered investment advisor to offer mutual funds without advice! How can a product be suggested to a client without evaluating the associated need?

SEBI assumes such segregation will avoid conflict of interest. In fact, it will just do the opposite. Mutual fund distributors (including several Twitter experts actively followed by young earners looking for scraps of “Gyan”) claim they are being paid by AMCs and not by clients. Many investors believe they do not pay anything from their pocket for regular plans.

Imagine this (if the proposals come through). An RIA tells a client, “you can opt for our free mutual fund service or pay a fee for our financial plan and invest in direct plans. If you choose our free mutual fund service we will take care of the implementation, but you have to invest in direct plans on your own”.

In a country where the word “fee” is frowned upon (because it is missing the letter “r”!), most clients would choose to buy regular mutual funds. This proposed client level segregation will destroy investor interests and fee-only financial advisory in one stroke.

Also, notice that client-level segregation was not so far implemented for non-individuals! They could and they have been happily offering regular plans and charging fees. Ideally, no investment advisor should distribute any product. At least client level segregation for individual advisors, should not be implemented.

This proposal will completely dilute the advisor regulations beyond recognition and it will be a case of “Caramba! Back to square one!” (from Tintin and the broken Ear)

2 Will new and young RIAs be forced to quit?

Any individual registered as investment advisers whose number of clients exceed 150 or whose asset under advice exceed forty crore rupees shall compulsorily re-register itself as a non- individual investment adviser within 6 (six) months of the trigger event.
Non-individual Investment advisers shall have a net worth not less than fifty lakh rupees (within three years)
In what can only be described as a bizarre move SEBI wants individual RIAs with 150 clients or 40 Crores plus assets under advice to become non-individual RIAs with 50 lakh set side as a net worth of the entity!
Just a handful of NRI clients or clients with heavy real estate is enough to cross the 40 crore barrier. Or low-cost financial planning service delivered to 150 clients would mean the advisor will have have a net worth of 50 lakh set aside for this!. Many fee-only advisors do not have this and it is unfair of SEBI to suddenly ask an individual advisor to register as a firm. This may force many new and young RIAs with a passion for conflict-free advice to quit.
Even if they comply, the cost of compliance and associated expenses imply the cost to the client will increase.

3 Lack of respect for privacy

SEBI wants RIAs to record telephone calls and video conferences held with clients and hold it for five years. There is no mention of consent from clients! This is yet another instance of how clueless SEBI officials are about how difficult and expensive it is to maintain such records. Then there is the aspect of privacy and security concerns.  Again, records cannot be maintained without increasing fees. Just the email trail alone is sufficient in case of disputes as there is a written contract.

What you can do to prevent SEBI from implementing these changes

SEBI has sought feedback from the general public on or before Jan 30th 2020. Please write to [email protected]

in the following format (the proposal number refer to the text in the consultation paper.

Format to be used for sending feedback to SEBI (with sample response, you can copy and paste this format in your email and replace the text underlined)

Email subject: Feedback on Consultation Paper on Review of Regulatory Framework for Investment Advisers (IA)

Name of entity/person/intermediary/organization:__________
1 Proposal: Further, any individual registered as investment advisers whose number of clients exceed 150 or whose asset under advice exceed forty crore rupees shall compulsorily re-register itself as non-individual investment adviser within 6 (six) months of the trigger event. Non-individual Investment advisers shall have a net worth not less than fifty lakh rupees.
Comments/Suggestions:  Should be removed or imposed only for RIAs engaged in stock advisory as primary service.
Rationale: This is impractical and unreasonable. Will force many RIAs to go out of business. RIAs who operate as pure financial planners should be distinguished from RIAs with stocks advisory
2 Proposal:
3.1.5. Further, for Investment Advisers who are individuals, to have a level playing field, it is proposed that individuals may also be allowed to provide both IA services and distribution services provided client level segregation is adhered to. To enable IAs to distribute, they may obtain appropriate distribution registration. To address the issue of conflict of interest, a client can either be an advisory client where no distributor consideration is received at the family level or distribution services client where no advisory fee can be collected from the client at the family level, where “family” shall include individual, spouse, dependent children and dependent parents.
Comments/Suggestions:  Should not be implemented
Rationale: Individual investment advisors should be barred from distributing any insurance or mutual fund product directly or indirectly to clients. This is the only way to avoid conflict of interest.
3 Proposal:
3.6.3. The record of interactions with the client could be, inter alia, in the form of: a. Physical record written & signed by the client, b. Telephone recording, c. Email from registered email id, d. Record of SMS messages, e. Any other legally verifiable record.
Comments/Suggestions:  Only email records and written correspondence can be preserved. Telephone or video conversations or SMSes or other forms of electronic communication should not be recorded.
Rationale: This is disrespect and breach of my privacy. Even if I gave informed consent for the same, maintaining these records is an unnecessary headache and additional expense which I will have to bear.
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