On whose side are you – Product Manufacturer or Product Buyer ?

There has been a lot of heartburn about the RIA regulations ever since they were brought out over 3 years ago. At the heart of the debate is the angst caused by SEBI’s approach of “Fees OR Commissions”. Many feel that this is a move by SEBI to disintermediate the Mutual Fund Distribution and that this move will favor fund houses and large players in the distribution business.

Whether or not that was SEBI’s intention, I feel that the impact will be quite to the contrary. That apart, it would be helpful to understand the need for defining AND imposing a Fiduciary Standard in the securities market.

A Fiduciary is a person who is entrusted with property or power for the benefit of another. A fiduciary standard for financial advisors means that they are accountable for delivering advice which is solely in the best interest of the client. Not doing so would be a breach of contract.

Irrespective of SEBI’s intentions or the probable impact of the new rules on the market, understanding the meaning and purpose of the Fiduciary Standard will help each of us to take a better call on what the future is going to look like and what to do today so that we become one of the beneficiaries of that potential future.

We will do this exercise in three parts-

1. Understand the need or otherwise, for the advisory regulation;
2. Figuring out at brass tacks level the purpose (or lack of it) for excluding commissions as income for advisors and
3. Reviewing the real potential impact of the regulation on Fund houses, Advisory services, and consumers.

The Need for Advisory Regulation

Like most things in the world, although it may appear that regulation influences economics, reality is often the other way round. It is economics which shapes the regulation. We need to look at the background and mechanics of our economy to understand why this regulation came into being.

Since 1991 we have moved a very long way in economic liberalization. In terms of our immediate environment, we have come from one, government owned, fund manager to a plethora of vendors and distributors. The role of the government or any regulator, as demanded by the modern consumer, is to get out of the way of markets EXCEPT for ensuring transparency and fairness.

So the role of good governance is not in creating or destroying any business or profession. It simply is to make sure that the consumer knows what he is buying. Good governance does not make choices for the consumer but makes sure that she is making the choices she wishes to make e.g. that she isn’t buying a hybrid car thinking that she has bought an electric car. It is in this context that it had become important for a statutory authority to define who is an advisor and who is a sales representative. The point of the differentiation is not to tell which is a better profession, it is not to ask the consumer to go to one instead of the other. It is simply to call an apple, an apple.

The Purpose of Differentiating Fee and Commission Income

While everyone is interpreting the new regulations as belittling of the distributor, nowhere in the regulation do we find language to the same effect. So while the distributors are going to be restricted from giving advice, the advisors are also being restricted from distributing products. While the advisors are being asked to comply with SEBI rules, distributors are being asked to comply with AMFI rules.

The advisory regulation is not belittling commissions as a source of income. It is only articulating the status of a person or entity, based on the structure of his or her contractual relationship. In simple words, it says that if you represent a product buyer, you cannot represent a product seller. And that is a simple legal reality. Just like a lawyer cannot represent the plaintiff as well as the defendant, or a judge cannot be on the payroll of a law firm, no person can represent the investor as well as the investment issuer aka Mutual Funds.

It is not about income at all. Mutual Fund distributors have a principal-agent relationship with Mutual Funds. Their contract is that of representing Mutual Funds. Hence they cannot legally represent Mutual Fund buyers. Therefore if you want to have a contract with a buyer i.e. be in an Advisory Relationship with an investor, you necessarily cannot be a distributor and hence cannot have commission income.

In short, it is not about  source of income, it is not about what is a better thing to do, it is simply the legality of the defining a role so that the consumer, who is not savvy in legal terms, understands the difference.

Potential Impact

While there was always advice delivered to the consumer, by articulating the difference, SEBI has given recognition to what was hitherto taken for granted by the consumer as well as the Product sellers. Until three years back, and in a large sense even today, “advisors” served the purpose of asset gatherers in the role of distributors. The fortunes of “advisors” were tied to the fortunes of product sellers. If the same professionals take this opportunity, close their contract with product sellers and instead contract with the product buyers, they will tie their fortunes to a more evergreen part of the business i.e the consumer.

The concern regarding the willingness of the consumer to pay fees is relevant only to a scenario where they could avail advice without paying fees. Once SEBI disallows that, the choice consumers will have, is not whether not to pay fees but how much to pay, assuming they want advice.

If the industry decides to spend energy on establishing the need of advisors and the value of advice, everyone will prosper. What SEBI has done is not a political diktat. It is a natural ‘next step’ in any liberalizing economy i.e bringing transparency and accountability to what we claim to be representing. The product sellers might probably want to fight it because this could mean loss of representatives for them. The profession needs to make a conscious choice whether they would like to take sides in the fight or take a business call on who they would like to represent. That will truly clarify what they should fight for.

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