Either Advise Or Sell, Investment Advisers Can’t Do Both, SEBI Says

From Oct. 1, individual investment advisers can either distribute investment products or advise on them, but can’t do both. The Securities and Exchange Board of India has amended the Investment Advisers Regulations, setting a tone for a reform that may change business dynamics for these entities.

Any person who advises clients on purchase, sale, investment or portfolio management in securities for a consideration is an ‘investment adviser’ under the SEBI regulations. A person is restricted from providing such services unless she obtains a certificate of registration from the regulator.

The amendment also aims to strengthen the existing regulatory framework by making it mandatory for a non-individual investment advisor to introduce client level segregation between advisory and distribution activities. It also introduces a revised net worth criteria for individuals and corporate persons.

Here are the key changes introduced by SEBI....

Segregation Of Services

Advisers at present aren’t required to segregate advisory and distribution services. As fees vary based on the nature of products, an investment adviser is likely to recommend a product which gives her the maximum incentive on distribution. This goes against the best interest of clients and gives rise to a conflict of interest—a situation which SEBI now intends to address.

Individual investment advisers can no longer advise and distribute investment products simultaneously. They will have to chose between one of them and seek a registration with SEBI for that.

The amendment also restricts the advisor’s family—spouse, children and parents—from providing distribution services to a client receiving advisory services.

The segregation isn’t limited to individuals alone. Non-individual advisers, including companies and limited liability partnerships, must segregate clients at a group level for investment and advisory services. As per the framework prescribed by SEBI:

• The same client cannot be offered both kind of services through a non-individual adviser’s group entities. Thus a holding, subsidiary, joint venture or associate company of an advisor can only provide one type of service to such client.
• Non-individual advisers must maintain an arm’s-length relationship between their advisory and distribution functions by rendering services through a separate department or division.

Financial advisers welcomed this move.

Many distributors may sell products based on their incentive rather than merit of the product, Aveek Mitra, CEO and founder of Aveskat Financial Advisory, said. This way, the limitation put by SEBI to allow either distribution or advisory services to a single client may avoid such situations and will be beneficial for investors, he said.

It will result in client level segregation and address the issues around conflict of interest, Suresh Sadagopan, founder of Ladder 7 Financial Advisories, said.

Rukshad Davar, partner at Majmudar & Partners, pointed out that SEBI had initially proposed to mandate the creation of separate legal entities for offering advisory and distribution services.

However, it appears to have acknowledged the compliance costs involved and has limited the requirement to creating a separate division/department which maintains an arm’s-length relationship, he said.

Corporatisation

To further standardise the investment advisory business and improve its quality, SEBI has introduced mandatory corporatisation for individual advisors after they cross a threshold of 150 clients. Further, non-individual advisers must have a net worth of Rs 50 lakh within three years from the amendment.

Sadagopan pointed out that the limit of 150 clients for corporatisation is far too low. He said many individual investment advisers may not have the wherewithal to corporatise their business, considering their current income.

Mitra agreed that the threshold of 150 is too small a number. “Let’s say, an investment advisor earns an annual fee of Rs 10,000 per client. As per the new requirement, the advisor would be forced to convert from a proprietary firm to a company or LLP even though he’s making only Rs 15 lakh,” he said. Considering high cost of research, travel, database etc, it would be non-remunerative and won’t serve either the investor or the adviser, Mitra said.