October 20, 2020

RIA regulations: 5 ways to move forward

Amit Trivedi
Owner, Karmayog Knowledge Academy

The last week of September, 2020 saw a sudden rise in a certain activity that many mutual fund distributors were not prepared for – changing the names of their respective firms. This was triggered by a letter sent by AMFI (Association of Mutual Funds in India) to all the AMFI Registered mutual fund distributors. Suddenly, an amendment issued by SEBI (Securities and Exchange Board of India) to the SEBI Investment Adviser Regulations, 2013 was in the news. There have been many discussions and write ups about the regulations since. Network FP also invited three prominent panellists for a discussion on the road ahead for Mutual Fund Distributors and Investment Advisors. The panellists for the discussion were Mr. Dhruv Mehta, Chairman-FIFA, Mr. Lovaii Navlakhi, Chairman-ARIA and Mr. Sandeep Parekh, Managing Partner, Finsec Law Advisors.

Some questions still remain in the minds of many. The chief question bothering many is about the future of this business, by whatever name one calls it – distribution of financial products or investment advisory business. So, let us first tackle that. As of October 2020, there are 1,345 SEBI registered investment advisers (including individuals and non-individuals). At the same time, there are just over 1,00,000 ARN holders (once again, including individuals and non-individuals). As against that, there are more than 43.50 crore PAN cards issued in the names of individuals, as on 31st March 2019 (Source: Income tax Department – PAN allotment statistics up to 31.03.2019). A simple calculation is enough to realize the size of the opportunity.

Having said that, let us look at some provisions that apply to both the distributors as well as investment advisors.

1. Nomenclature:

a) What words are allowed in the name of an MFD’s firm?

There is a lot of confusion about the name. As mentioned earlier, AMFI sent a letter to all the ARN holders to change the name of the firm to comply with the IA regulations. This was done in light of some provisions in the SEBI Investment Advisers Regulations. An MFD is required to read the regulations and understand the spirit of the same while changing the name of the entity. Broadly, avoid using words in the name that indicate that you are either an investment advisor or financial planner. This is in line with various other regulations of SEBI, which could be related to naming of mutual fund schemes (true to label) or even regarding the naming of listed companies, where the words used in the name must be indicative of the business the firm is in. This regulation was introduced after the infrastructure boom, when many companies rushed to change their names to include words like “infra”, “projects”, etc. in the names.

SEBI has not authorized any entity like AMFI or ARIA or FIFA or CAMS or this panel to approve which names are fine. At the same time, many asset management companies, the various associations of MFDs and AMFI are trying to help the MFDs in this matter.

2.The Business of MFDs:


a) Can MFDs give any kind of advice to their clients?

There are three important places where the regulations talk about investment advice with respect to the MFDs:

i. Under the SEBI Investment Adviser Regulations, 2013 mutual fund distributors are exempted from registering as investment advisors so long as the advice offered to the clients is incidental to the primary activity of distribution of mutual funds.

ii. SEBI Prohibition of Fraudulent and Unfair Trade Practices consider mis-selling in mutual funds as a fraudulent practice. This clause was subsequently broadened to include all securities. The regulation defines mis-selling as under:

For the purpose of this clause, “mis-selling” means sale of securities or services relating to securities market by any person, directly or indirectly, by –

  • knowingly making a false or misleading statement, or
  • knowingly concealing or omitting material facts, or
  • knowingly concealing the associated risk, or
  • not taking reasonable care to ensure suitability of the securities or service to the buyer.

 iii.  Under the SEBI circular about due diligence of distributors, the following is detailed

In this respect, customer relationship and transactions shall be categorized as:

  • Advisory – where a distributor represents to offer advice while distributing the product, it will be subject to the principle of ‘appropriateness’ of products to that customer category. Appropriateness is defined as selling only that product categorization that is identified as best suited for investors within a defined upper ceiling of risk appetite. No exception shall be made
  • Execution only – in case of transactions that are not booked as ‘advisory’, it shall still require:

i. The distributor has information to believe that the transaction is not appropriate for the customer, a written communication be made to the investor regarding the unsuitability of the product. The communication shall have to be duly acknowledged and accepted by the investor.

ii.  A customer confirmation to the effect that the transaction is ‘execution only notwithstanding the advice of inappropriateness from that distributor’ be obtained prior to the execution of the transaction

iii. That on all such ‘execution only’ transactions, the customer is not required to pay the distributor anything other than the standard flat transaction charge.

b) Can MFDs do IAPs? What care must be taken?

In the SEBI Investment Adviser Regulations, 2013 define “investment advice” as under:

“Investment advice” means advice relating to investing in, purchasing, selling or otherwise dealing in securities or investment products, and advice on investment portfolio containing securities or investment products, whether written, oral or through any other means of communication for the benefit of the client and shall include financial planning:

Provided that investment advice given through newspapers, magazines, any electronic or broadcasting or telecommunications medium, which is widely available to the public shall not be considered as investment advice for the purpose of these regulations”

This means that an IAP should be out of the scope of being considered as investment advice, since it is general in nature.

c) How can we market ourselves as MFDs? Not sure how appealing “mutual fund distributor” sounds in comparison to terms like advisors/planners/etc.

The SEBI Investment Adviser Regulations, 2013 warrant that anyone desirous of delivering investment advice or financial planning services to the clients must register with SEBI as investment advisors. The regulations do not permit an unregistered entity to deliver investment advice or position one as an investment advisor. In such a case, the mutual fund distributors must position oneself as an MFD and source business. So long as the MFD is doing a great job for one’s customers, there is enough business.

3.The Business of RIAs

a) What kind of fee structures are possible for the RIAs now?

The regulations allow RIAs to charge fee from the clients in either of the two modes:

  • Assets under Advice (AuA) mode, or
  • Fixed fee mode

No other mode of charging fees is permitted under the regulation.

b) Can Financial Plan agreement be less than 1 year? If so, then how can advance fee be collected with a gap of 2 quarters.

The regulation does not specify a minimum term for the agreement. An IA and the client must enter into an agreement on that basis.`

c) The client is an advisory client. Existing assets of the client are with family member of an individual IA. How long can this arrangement continue? Ditto for a corporate IA.

The question is essentially around the client level segregation. The regulation and the subsequent circular clarify this point. The old assets could continue to be held under the old ARN – be it the firm’s or company’s ARN (or any other such suitable code), if the customer wishes so. No new investments could be made in that code.

d) Can a family member of an individual RIA do insurance business with advisory client?

Yes.

e) An existing RIA is not a post-graduate. What are the options?

In case of an individual IA, the only option is to complete the post-graduation as specified under the regulation within 3 years from the date of the regulation. In case of a non-individual IA, one can appoint a principal officer, who complies with the educational and certification requirements. However, the regulation regarding post-graduation applies to anybody categorized (and defined in the regulation) as ‘persons associated with advice’.

Investment advisors who are above 50 years of age as on September 30, 2020 are exempted from the educational requirement.

4.Miscellaneous:

a)  What would be the consequences if we take up an RIA license for the time being and eventually surrender it if that model doesn’t work for us? Are we always going to be subjected to additional scrutiny? Or is that just an irrational fear?

The compliance requirements are applicable to the IAs registered with SEBI. The moment the license is surrendered, the compliance requirements do not apply, except where the regulation warranted maintenance of records for a certain number of years. One would still be responsible for any matter related to advice delivered during one’s active tenure as an investment adviser.

 b)   Can a mutual fund distributor distribute the services of an investment adviser and earn a referral income from the RIA?

Yes, that should be fine.

5.The last advice for all

Read the regulations, even if you seek professional guidance. If you want to play a game, it is important to know the rules of the game.

You may check out the detailed discussion uploaded on YouTube:

 

 

Spread the love

Share Your Thoughts