Consultation Paper by SEBI on RIA Regulation

HIGHLIGHTS OF SEBI’S CONSULTATION PAPERS ON RIA REGULATION

IA Regulations were notified on January 21, 2013. The object of the IA Regulations, was to lay the framework for independent financial advisers.

SEBI had issued a consultation paper on October 07, 2016 seeking public comments on the clarifications/amendments to IA Regulations. A revised consultation paper was issued on June 22, 2017 clarifying certain issues raised by the market participants. Based on the feedback received, the proposals were revised in the consultation paper issued on January 02, 2018. The most recent consultation paper rolled out on January 15, 2020. This is the 4th consultation paper issued by SEBI in the past 3 years. The overall and basic objective of all the consultation papers was to specify uniform standards across all the intermediaries and to address the gaps or overlaps in legal or regulatory standards.

Let us now glance through the important proposals and try to understand their aftermath:

1.   Segregation of Advisory & Distribution Services:

So far, a majority of RIAs offer both advisory and distribution services. SEBI’s latest consultation paper calls out for investment advisers to clearly segregate between its activities as an investment adviser and as a distributor of financial products. Non-individual entities are required to have client level segregation that is the same client cannot be accepted for offering both advisory and distribution services within the group of the non-individual entity. So basically, if this proposal is implemented a client can either be an advisory client where no distributor consideration is received at the group level or vice versa. The same is proposed for individual investment advisers where client level segregation is to be adhered at family level. This proposal addresses the issue of conflict of interest arising due to the dual role played by the entity.

2.   Cap on fees charged to clients:

SEBI has received various complaints from investors against investment advisers charging extraneous fees like service fees, file handling fees apart from the advisory fees. Hence these instances lead SEBI to further define the reasonable fees chargeable to the client. It has proposed that an Investment Adviser can charge fees either on the basis of asset under advice (AUA) or a fixed fee. SEBI has also put a cap on fees to give an idea what is reasonable fees. This standardization in fee structure will rule out the possibilities of advisers charging unreasonable fees to their clients.

3.      Eligibility Criteria for IA’s:

SEBI has enhanced the eligibility criteria to become an Investment Adviser. As per the proposal, all persons associated with the provision of advisory services should be duly qualified and experienced. Accordingly, an individual investment adviser, principal officer (for corporates) and persons associated with investment advice should have qualification as well as 5 years of relevant experience along with NISM certification. This is to ensure that an adviser providing investment advice have practical understanding of the business risks.

4.      Higher net worth requirements:

SEBI has proposed a steep increase in the net worth for individual RIAs from Rs. 1 lakh to Rs. 10 lakhs. For non-individuals, the net worth is proposed to be increased from Rs. 25 lakhs to Rs. 50 lakhs. Adding to this, SEBI has also proposed that an individual investment adviser having more than 150 clients or having asset under advice exceeding forty crore rupees, must compulsorily re-register as corporate investment adviser within 6 (six) months of the trigger event.

5.      Maintenance of record:

With a view of strengthening the process of grievance handling, SEBI in its latest consultation paper proposed that along with the maintenance of other records, the records of interactions with the client including prospective clients shall also be maintained by IAs. These records will help in substantiating the statements made by the concerned parties. These records can be in the form of physical records written & signed by client, telephone recording, emails, SMS and any other legally verifiable record.

6.      Compliance audit requirement:

In the current scenario, an investment adviser is only required to conduct yearly audit in respect of compliance with the regulations from a Chartered Accountant or Company Secretaries, however is not required to report on the adverse findings to SEBI. In order to have a strict adherence to the audit requirement, it is proposed that the audit should be completed within three months from the end of each financial year and post completion of the said audit, a report of adverse findings along with action taken thereof shall be submitted to SEBI within a period of one month from the date of audit report.

Conclusion:

By referring to the above, it is fairly evident that all the proposals as put forth by SEBI in its consultation papers are intended to safeguard the interest of the investors. Protection of investor’s funds is the primary concern of SEBI and drives its proposals. Higher net worth requirements, cap on the maximum fees that can be charged to the clients, higher qualification requirements etc are all designed to strengthen investor’s confidence which in turn would lead to higher investments and ultimately growth in the advisory sector.

In addition to the above, in our view, following should be considered for the purpose of amendments to IA Regulations:

1.      Inclusion of the definition/ reference to the relevant act for the definition of free reserves to be specified in the IA regulations- Since ‘free reserve’ is not specifically defined in the IA regulations, there is a confusion in the minds of the investment advisers, as to the specific items that should be considered for the purpose of calculation of net worth. Therefore, free reserves should be specifically defined by the regulator.

2.      Audit Report Format- In order to bring consistency in reporting and enhance comparison, it is necessary to have a standard audit report format for all the investment advisers.

3.      IA’s should be free to fix their own fees: RIA is a professional who renders investment advice. Hence a cap of 75,000 is not enough considering that it also requires complex product handling.

4.      Higher net worth- Looking at the limited success of adoption of the RIA model till date, it is to be noted that these proposals increases the financial and operational burden of the investors.

Though SEBI has taken the first step to think about the problem areas, it is important for it to relook at the regulations from an investors point of view to achieve an overall success in the RIA model.