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  • Santripta Swain

SEBI's Regulatory Rumble: Unraveling and Analyzing Investment Advisory Landscape

[Santripta is a student at National Law University Odisha.]


In India, there is a scarcity of registered investment advisors (RIAs). While SEBI Chairperson, Madhavi Puri Buch, aspires to have a minimum of 1 lakh RIAs annually, the actual figures and market values reveal a significantly contrasting reality. A lot of variable factors are to be blamed for such a sorry number. And it is difficult to attribute the low numbers to any entity or individual or industry associations or any decisive factor per se.


There lies a subtle distinction between investment advisory and portfolio management services which has created the problem in the first place. While the former charges a nominal fee for providing advises for investments, the latter charges for actively managing an investor’s portfolio. However, differentiating between the two is not that straightforward. Therefore, for the sake of simplicity, we can distinguish between the two based on the skillset required and the minimum corpus/portfolio size that is a mandate in case of portfolio management services. Yet, additional complexities have emerged within the realm of investment advisors in recent times.


Portfolio Manager v/s Investment Advisor: Overlapping Business Operations


According to Regulation 2(1)(l) of SEBI (Investment Advisers) Regulations 2013 (IA Regulations), 'investment advice' means advising clients on buying, selling, and further providing advice on various investment products. Further, according to Regulation 2(1)(m) of the IA Regulations, 'investment advisor' means someone who is into the business of providing such advice as mentioned under Regulation 2(1)(l).


According to Regulation 2(1)(o) of the SEBI (Portfolio Managers) Regulations 2020 (PM Regulations), 'portfolio manager' means someone who manages and oversees client portfolios. It is now clear that financial advisors are neither allowed to get power of attorney from their customers to manage their portfolios, nor can they charge for managing their portfolios.


It may appear peculiar as to why an investment advisor would offer portfolio management services. During an ARIA Conference, Madhavi Puri Buch revealed that numerous esteemed investment advisors have been engaging in illicit activities by offering portfolio management services.


According to SEBI FAQs on Investment Advisors released on August 2023, the net-worth of an individual seeking to be an investment advisor has to be a minimum of INR 5 lakhs. In contrast, portfolio managers are required to have a mandated minimum net-worth of INR 5 crores. Based on the given requirements and mandates, it is fairly possible that there has been an increase in the number of unregistered investment advisors in recent times, who might be thinking to get themselves registered in near future.


According to Regulation 23(2) of the PM Regulations, portfolio managers are not allowed to receive investment funds less than INR 50 lakhs. However, there is no similar requirement indicated for investment advisors. This statement explains two factors. First, the investment advisory service is attractive to retail investors due to the fixed cost of INR 1,25,000 as mandated by the SEBI notification. Furthermore, the absence of a minimum corpus requirement makes it convenient for regular investors to seek the guidance of an investment advisor.


Surveillance on Investment Advisors


The majority of retail investors lack knowledge and understanding of the securities market, making them susceptible to being easily controlled or manipulated. One of the primary concerns for investors is their lack of awareness regarding the unethical practices of investment advisors, whether they are registered or unregistered, who prioritize their personal financial gains over the well-being of their clients.


The consequences of financial illiteracy have been evident in the Indore investment advisory fraud scandal, when numerous retail investors tragically took their own lives due to losses they incurred by following the investing methods or advice of the so-called investment advisor.


Learning from the incident that happened in Indore, SEBI has started to crack down on financial influencers. In recent times many so-called fin-fluencers have come under the radar of SEBI. Many of these matters have been significantly dealt with strictest penalty being imposed on them, with the popular case of Arshad Warsi and the recent Baap of Chart, which has created a riff in the securities market as SEBI’s crackdown is getting stronger. Although the Securities Appellate Tribunal had to set aside the order against Arshad Warsi and his wife for lack of evidence, the various other entities who were involved in stock recommendation of Sadhna Broadcasting were held liable.


Unregistered Investment Advisors and Registered Investment Advisors: Preaching a Bad Example


The basic idea being an investment advisor is to help clients make a rational and reasoned decision as regards their investments. SEBI in such cases wants the investment advisors to do three things, and anything beyond this would be considered a contravention of the law. First, investment advisors should always make sure that they do not provide any trading tips whatsoever. Second, investment advisors should not charge fees based on the performance of their advice. Third, such advisors should stay away from managing their clients’ portfolio.


This scenario bears resemblance to the counterfeit retail product industry, where one can come across a wide range of imitations of branded clothing items such as shoes, watches, smartwatches, cellphones, and more. A counterfeit product is inexpensive and lacks the same level of quality as the original, yet it provides customers with the illusion of possessing a genuine branded item. Retail investors often find themselves in a situation where they are persuaded or influenced by investment advisors to become pseudo-portfolio managers, a knockoff of portfolio management services.


The vast majority of such fin-fluencers, when get caught, contend that it is very difficult to differentiate between fact and fake, and most importantly, it is equally difficult to establish the definition of advisory which is exclusive of trading tippers.


In order to address this issue, SEBI came with a consultation paper on performance validation agency on August 2023. In simple terms, SEBI, in order to protect the investors' interests, has proposed a solution – one can verify the authenticity of such advice or claims made by investment advisors and accordingly take decisions as to where and when to invest in securities market. These claims can be verified from a proposed independent agency known as performance validation agency. According to SEBI, this concept is a very radical concept having far-reaching consequences on the overall market.


Root-Cause of the Problem


During the COVID-19 pandemic, the number of retail investors increased substantially; this can be attributed to low price in stock markets and further the millennials' interest in stock market as the world was bearing with financial stress due to unemployment, mass lay-offs, health related issues, etc.


The problem with unregistered investment advisors is that it has created a riff in the market for its low-priced tips and acting as investment advisers in stocks, commodities, segments, etc. The major issues in the matters involving unregistered investment advisors (also in some cases are fin-fluencers) are two-fold. First, the low number of registered investment advisors can be attributed to the legal hurdles in form of eligibility criteria. Second, the retail investors in India are still in their nascent stage of understanding securities market and its technicalities, meaning they lack fundamental clarity on their rights and interests. One complementary issue to this is that there exists a thin line of difference between fake and fact which we already discussed above and how the unregistered investment advisors and in other cases the fin-fluencers have taken advantage of this loophole.


For the first issue – the SEBI IA Regulations came into effect on 2013, and 10 years down the line the number of RIA is 1304. The primary reason for such low number of RIA is strict IA Regulations. Regulation 7 of IA Regulation mandates that an individual seeking registration under SEBI’s IA Regulation must have a post-graduate degree. What is even more bizarre is the fact that there are many who can be considered as well experienced in the field of finance – but are not qualified enough to break the threshold set by SEBI.


In one case, a person residing in Chennai, applied for RIA, but SEBI gave him a rude shock, when it rejected its application. The person whose application was rejected was a graduate from IIT Madras and was a civil servant at Central Board of Indirect Taxes and Customs for 13 years, additionally, he also had a well-known experience in investment advisory for 6 years abroad. SEBI’s stringent amendment to RIA Regulation has led to some serious discouragement from the finance stakeholders – post graduation being a mandate rather than an additional/optional qualification.


For the Second issue, the lack of market literacy among the retail investors coupled with earn quick money scheme has been detrimental in increase in unregistered investment advisors and their fraudulent tactics to earn money from investors. The retail investors can be easily manipulated to the extent where investment advisors have allegedly taken the credentials of their clients and have taken trading calls on behalf of their clients, and were also simultaneously managing their portfolios. All of which were done without the knowledge and consent of their clients.


Many fin-fluencers are unregistered investment advisors who have started providing / preaching the art of trading in return of a non-refundable fee. A person related to securities market can very well guess that such teaching is basically a mask covering so-called proven strategy for guaranteed return. One might ask then - why the teaching way? This is because SEBI has assured that those who create awareness and preach the investors about the technicalities of securities market, would not be considered to have committed an offence under the securities regulations.


It is very much evident that one size cannot fit all shoes in case of every trading in every stock. Due to the low market literacy, these retail investors fall prey to these fin-fluencers' advertising practices. In order to stay away from SEBI’s radar, some fin-influencers have started using disclaimers which completely shifts the responsibility onto the investor – a mere gaslighting technique where it is the investors who came to them and not the other way around and hence caveat emptor.


Many enforcements have come by and may more to against the unregistered investment advisors, and the need of the hour is an enforcement / substantive regulation dealing with unregistered investment advisors. This is because we are at the point where every third investment advisor is unregistered, and the ever-growing securities market will only create more perpetrators than deterrence.


Conclusion


There has been a ray of hope when two consultation papers – one on performance validation agency and another on association of regulated entities with unregistered entities (fin-influencers) - have been released in order to address the growing defrauding of investment advisors. However, SEBI’s constant surveillance on the working of investment advisors, both registered and unregistered, and further ramifications of SEBI’s impending amendments in the market, are yet to be realised.


Beyond the horizon of deterrence, SEBI needs to look into the ancillary issues first, such as qualification threshold, SOPs for investment advisors, repeated renewal process, etc., and then move on to the bigger picture i.e., inviting registration of unregistered investment advisors into SEBI’s portal.


However, one can be confident that SEBI's unwavering commitment to safeguarding investors is progressively rendering the securities market more amenable to the public interests.




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