Evaluating SEBI’s Interpretation of RA and Investment Advisor Regulations Against its Ramifications
[Aditya is a student at National Law School of India University.]
In May 2022, the Securities and Exchange Board of India (SEBI) passed a settlement order against Amit Jeswani, a research analyst (RA) for marketing model stock portfolios. The same was predicated by the fact that his actions were in violation of the SEBI (Research Analyst) Regulations 2014 (RA regulations) and SEBI (Investment Advisors) Regulations 2013 (IA regulations). In the aftermath of the same, there is news that SEBI has constituted a working group to deliberate on the role of RAs.
This interpretation of the RA regulations has multiple ramifications. A pertinent one is its impact on the services of fintechs such as Smallcase, WealthDesk, ET Money, etc., as many of the curated portfolios they offer are made by RAs. To look at the industry leader Smallcase, many of the portfolios listed on it are designed by firms such as Windmill Capital, Weekend Investing, Green Portfolio, etc. which are RA firms. Excluding RAs from participating in this market will probably lead to a rise in the investment costs in these products. The other negative effects also include reduced operational efficiency of the markets and reduction of freelance work avenues for RAs, hence jeopardizing their independence, which is antithetical to the objective of RA regulations.
The objective of this article is to present an alternative to SEBI’s interpretation of the regulations. Further, this article also brings out the need to allow RAs to model portfolios because it benefits all stakeholders including fintechs, consumers, analysts and the market dynamics, consequentially furthering the regulatory objective of the RA regulations.
To that end, the article will, at first, analyse the relevant regulations to prove that the act is permissible. Thereafter, the article will explore the nexus of the portfolios and their low cost to market efficiency, while also proving that it furthers the regulation’s objective of ensuring RA’s independence. Subsequently, this article will suggest a way forward to prove that it is feasible to carry the proposal forward due to its regulatable nature.
On the Point of Legal Interpretation
The analysis of RA regulations and IA regulations requires a two-stage engagement. Firstly, coming to IA regulations, the simplest argument to prove that an RA posting model portfolios on an online platform will not be considered investment advice, would be that the same is available to the public at large hence falling under the stated exception in Regulation 2(l).
Apart from that, Regulation 2(l) includes ‘advice on investment portfolio,’ hence it should not cover the activity of just making portfolios based on research and marketing them within its ambit. This is because the definition also requires the act to be in the capacity of ‘financial planning’ [as defined in Regulation 2(h)] which includes identification of various personalized aspects such as the client’s financial situation, goals, etc. Therefore, as long as a portfolio is not made specific to a client’s requirements after consultation, it cannot be said that it is exclusively in the domain of an investment advisor.
Moving on to RA regulations, while Regulation 2(u) defines the duties of an RA, they are labelled as ‘primary duties’ and hence the list cannot be interpreted exhaustively. They should not be prohibited from doing something unless the activity strictly falls under the role of an investment advisor or in public interest in case the conflict of interest is inevitable and cannot be prevented by regulation. Even while preparing model portfolios, the RAs in the process have to make adjoining research reports, hence they are not discarding their primary duty per se. The nature of their work makes them well suited to design and rejig model portfolios owing to their general research on buy and sell points of various stocks without any client-specific considerations.
Efficiency in the Markets
While transactional efficiency has been achieved, leading to the addition of more retail investors in the market, the second front of having adequate coverage of various listed companies, availability of quality research at affordable prices and the tools to fructify its usage is necessary. This is a facet of the ‘efficient markets theory’ which states that the true value of an asset is only reflected when all the information is factored in. In the instant scenario, while analysts fulfil one end by aggregating vast amounts of financial data, it must also be traded upon to be factored in the prices. However, for a piece of information to be tradable, there must also be platforms with instruments that enable the same to be converted into a purchase.
The described fintechs perform both these roles by putting together quality research of analysts as they use the same to build these portfolios. At the same time, it also assists people in investing by enabling them to choose broad trends and sectors as opposed to hand-picking stocks which is a more ambiguous and uneconomical alternative. This theory was also employed by SEBI in their 2013 consultation paper on the proposal to regulate RAs to state their importance in aggregation of raw data and its timely delivery. However, their narrow interpretation of the RA regulations can be a hindrance to achieving the objective. While the article in the next section discusses how the probability of conflict of interest and biased reporting reduces in this model, there is no additional risk of the same as compared to the status quo. Hence, the cost-benefit scale weighs in favour of allowing the RAs to create and list model portfolios on these fintech platforms.
Independence of RAs
Ensuring the independence of RAs and managing the disclosures of their conflicts of interest happens to be one of the key objectives of the RA regulations. The whole of Chapter III, starting from the requirement of affixing internal regulations to prevent conflict of interests from reflecting in reports in Regulation 15, recording the rationale behind arriving at recommendations in Regulation 25, preventing former company managers from issuing recommendations related to their former companies in Regulation 19(iv), etc. is provisioned to prevent an analyst’s work from being prejudiced by their or their employers’ interests.
Now to view this in light of the practical operations in the stock market, these fintechs provide RAs with a platform to freelance and earn revenue out of their independent research while also building their forum. The alternative line of profession for them is to work for conventional investment banks, brokerages, etc. There is a historical record to show that the probability of production of biased reports is much higher in this setup as there is an inclination to cater to the employer’s requirements. The most suitable example of this would be the ‘Global Analyst Research Settlement’ where the ten largest investment banks in the USA were made to pay a monetary compensation of $875 million to remedy the damages their biased reports had caused. While measures were taken to ensure the independence of analysts and prevent conflict of interests, several banks stopped purchasing external research when the settlement duration ended in 2009.
There cannot be a better method of ensuring the independence of analysts than promoting avenues of freelancing because the demand for a RA’s work will sustain with consistent returns, the key to which is a portfolio built on unbiased and objective factors.
Duties of the Intermediary and the Way Forward
While the SEBI’s concern about analysts’ bias and investor exploitation is valid, a complete ban on RAs from creating these instruments is not the way forward because of its benefits and there being scope for regulation. As stated, most of the listed model portfolios available on fintechs currently are by RAs.
The way forward is to nurture a tech interface with the maximum transparency possible without overregulation because of the above-stated benefits. This can be achieved by displaying various details such as the methodology and strategy based on which the portfolio was compiled and the credentials including the academic qualifications of the analyst or the background of the company in case the analyst is a corporation. There must also be a list of all the institutional affiliations and potential conflicts of interest while also keeping the analyst’s personal portfolio trackable by the intermediary and SEBI to enable self-regulation wherever possible. The display should also include other details such as the return of the portfolio since its offer date and not just the CAGR of a blanket timeframe such as a year or 5 years. To increase awareness and make assessment easier for the investors, an intermediary vetted SWOT analysis of every portfolio should be present since one of the regulator’s concerns is also of accountability. Furthermore, to ensure that there is no manipulation later on, the analysts in line with Regulation 25 of the RA regulations should also provide the rationale behind rejigging and rebalancing the portfolio, and discretion should be given to the investor wherever possible.
These are all fintech interface-specific guidelines that are convenient to implement, enable self-regulation and also further the objectives of the RA regulations that is broadly to promote objective and reliable research which is unbiased. This also satisfies Principle 26 of IOSCO Principles and Objectives of Security Regulation which requires that there should be disclosures “necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor’s interest in the scheme", and neither does it violate any of the other principles of regulation of collective investment schemes.
With only 820 RAs and 1,328 investment advisors as opposed to staggering 11.2 crore investors registered with BSE alone, it would not be logical for SEBI to stick with the current interpretation especially when the sector can be efficiently regulated through both self-regulation and oversight.
 Settlement Order No: SO/GR/BM/2022-23/663 .  Windmill Capital has a total of 54 listed portfolios on Smallcase.  See also; Fisch (n 9); Jaimee L. Campbell, ‘Analyst Liability and the Internet Bubble: The Morgan Stanley/Mary Meeker Cases’ (2001) 7 Fordham J. Corp. & Fin. L. 235.  International Organization Of Securities Commissions, ‘Objectives and Principles of Securities Regulation’ (2017), Principles 24-28.