The Securities and Exchange Board of India (Sebi) has just issued a discussion paper on tightening the role of investment advisors. The move will take Sebi’s dream of bringing everyone who provides some kind of financial advice under regulation a step forward. Sebi had decided to bring absolutely everyone who provides investment advice on products that come under its ambit – stocks, bonds, mutual funds – under regulations. This would have, for the first time, made investment advisors accountable.
Unfortunately, not too many people took Sebi seriously. One has only to surf the net to know how many people were active in the business of advising without bothering to register with Sebi. One reason was that Sebi’s regulations were not drafted carefully. Too many types of advisors were exempted. This exempt list included anyone making general comments in good faith on market trends without specifying particular securities, insurance agents or insurance brokers providing advice on insurance products, anyone advising solely on pension products and also stock brokers, sub-brokers, portfolio managers and fund managers. Even chartered accountants and lawyers were exempt if they provided investment advice incidental to their practice.
Exempting lawyers and CAs made no sense. I know of many CAs who are clueless about correct financial planning. I know of one who invested in the fixed deposit of a bankrupt company and in endowment plans of a life insurance company. Lawyers are even worse. It does not matter how exemplary these people are in their area of work. They need help with their investments.
In fact, the better they are in their fields, the worse they are about their own investments. They have no time to study investment products; and long hours of study are essential to arrive at the right investment decisions. They themselves need investment advice. Treating them as experts was presumptuous.
But there was an even worse exemption reserved for mutual funds distributors. Sebi explicitly exempted a distributor from its advisor regulations for “providing any investment advice to its clients incidental to its primary activity.”
Market watchers were aghast at this. Over the years Sebi has been relentlessly trying to separate advice from transactions. Indeed, advisor regulations were created precisely to distinguish between those who sell financial products for a commission and those who provide advice for a fee. To then say distributors could also advice undermined the very logic of trying to regulate advisory activity. Indeed, the draft regulations did not offer a blanket exemption. It exempted only “distributors registered with AMFI who receive fees from investors.” Of course, it is another matter that you will not find a single entity under that category.
The regulations were notified in January 2013. Almost four years have passed but only 500-odd people have registered. This is partly because of the perception that investors will not pay for advice, and so it is pointless to register, and also because Sebi’s exempt category was too long. It included mutual fund distributors who Sebi has long been nudging to choose between acting as an advisor and seller earning a commission.
Against this background, Sebi is now proposing to take several steps to beef up the advisor regulations. Firstly, all the exemptions are being dropped. Everyone who offers advice will have to be registered. This is a great big step forward. The question is, will investors get to know about this? Will it work for them on the ground?
Investors are completely unaware that they can only get investment advice from registered advisors. Today, they are in the habit of seeking advice from just about anyone. Indeed, Sebi has put an onerous responsibility on advisors on how they should behave. This responsibility takes two forms: Risk profiling of customers and assessing suitability of investment products. An investment advisor cannot offer any advice without establishing the risk profile of their clients. Sebi has even specified how the risk profiling has to done. The advisor has to know the client’s age, duration of investment, income details, risk appetite, loans and liabilities, assessing the investor’s capacity to absorb a loss and identify whether the client is unwilling or unable to accept the risk of loss of capital, etc.
The second part, suitability of financial products, requires the investment advisor to have a documented process for selecting investments based on the client’s objectives and financial situation, have a reasonable basis for believing a recommendation or transaction meets the clients objectives and risk profile.
While these are commendable ideas, they are far ahead of what “clients” face in real life. Insurance companies and their agents, media, tipsters and so on have no obligation to do risk profiling and suitability assessment. Indeed, if any financial information and advice has to rest on these two principles (risk profile and suitability), financial sector and financial media will shrink to a tenth of its current size. Is Sebi tilting at the windmills with its earnestness?
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