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SEBI's RIA paper is completely anti-investor

Vijay Venkatram, Managing Director, Wealth Forum

8th October 2016

In a nutshell

Having gone through SEBI's consultative paper on RIA regulations (, I must say it strikes me as completely anti-investor even as it professes to promote investor protection. We have a piquant situation where our regulator is moving towards denying a large set of investors a level of protection they are currently enjoying within the present distribution regulations - in an environment where global regulators are focusing on raising the bar on investor protection across all intermediation channels. I believe investors' interests are best served by giving them choice of channels and then enforcing robust sales process regulations irrespective of which channel the investor chooses.

I am reproducing below extracts from the paper which I think give rise to more doubt, even as they attempt to clarify:

4.1.2 Under the existing framework, a mutual fund distributor can sell mutual fund products and also provide incidental or basic advice on mutual fund products and can also help in executing the transactions. Such distributors are required to conduct risk profiling and comply with the requirement of appropriateness of the product. Distributors are getting the commission from the fund houses i.e. AMCs and additionally can also charge execution/advisory fee to the client.

4.1.4 In order to have a level playing field in respect of investment advisory services offered on mutual fund products, it is proposed that:

a) Mutual Fund distributors shall not be allowed to provide incidental or basic investment advice in respect of mutual fund products. If they want to engage themselves in providing incidental or basic investment advisory services on mutual fund products, they need to register themselves as an investment adviser under IA Regulations. A period of three years shall be provided for those distributors who seek to migrate as an investment adviser to enable them to obtain necessary certification and to comply with other requirements specified in IA Regulations to act as an investment adviser.

b) Many persons engaged as distributors or agents call themselves by varied names such as 'independent financial adviser' or 'wealth adviser'. This creates confusion in the minds of the investors. In order to avoid such confusion as to their role and responsibility, it is proposed that no person shall be allowed to use the name 'independent financial adviser' or 'wealth adviser' unless he obtains registration from SEBI as an investment adviser. Accordingly, all the persons including existing mutual fund distributors who are using the nomenclature as independent financial advisers, wealth adviser, etc. shall comply with aforesaid requirement of changing the nomenclature within a period of three years.

c) The person who seeks to continue to engage in the distribution of mutual fund products shall use the nomenclature as 'Mutual Fund Distributor'. Such person shall not be allowed to provide basic or incidental advice in respect of mutual fund products except describing the product specification without recommending any particular product.

No more product suitability responsibility for distributors?

In 4.1.2, SEBI has stated that in the current dispensation, distributors are required to conduct risk profiling and establish product suitability before selling a mutual fund to an investor. In 4.1.4 ( c ), it goes on to recommend that going forward, a distributor will not be allowed to provide basic or incidental advice and has to restrict himself to describing product specifications, without making specific recommendations.

There is a clear regulatory intention that distributors should not make any specific recommendations. Does this therefore mean that in the new dispensation, all product suitability responsibilities are being explicitly taken away from mutual fund distributors? The regulator will need to clarify its position on this issue - and I suspect it is going to be very difficult for it to do so. Here's why:

Suitability responsibility only when recommendations are made

The International Organization of Securities Commissions (IOSCO) - of which SEBI is a member - put out a comprehensive guidance note in 2013 to all member regulators on the issue of product suitability requirements (

Here are two of its principles that are relevant in this context:

Protection of customers for non-advisory services

Principle 4: When an intermediary sells a complex financial product on an unsolicited basis (no management, advice or recommendation), the regulatory system should provide for adequate means to protect customers from associated risks.

Suitability protections for advisory services (including portfolio management)

Principle 5: Whenever an intermediary recommends the purchase of a particular complex financial product, including where the intermediary advises or otherwise exercises investment management discretion, the intermediary should be required to take reasonable steps to ensure that recommendations, advice or decisions to trade on behalf of such customer are based upon a reasonable assessment that the structure and risk-reward profile of the financial product is consistent with such customer's experience, knowledge, investment objectives, risk appetite and capacity for loss.

Principle 4 clearly states that when a distributor sells a product, the onus on product suitability rests on the regulatory system and not on the individual distributor. The report goes on to suggest ways for the regulator to discharge this responsibility - which include banning certain products for sale to certain categories of investors, heightened disclosures in product features of risk etc. Principle 5 clearly states that the intermediary will take on the responsibility to ensure product suitability only when he is making a specific recommendation - which means when he is offering advice.

So long as "advice that is incidental to distribution" was recognized within the purview of distribution services, SEBI's imposition of risk profiling and product suitability responsibilities on distributors had sound logic. If SEBI is now seeking to carve out "incidental advice" from distribution, it cannot expect a distributor to remain responsible for risk profiling and product suitability. SEBI will have to take on these responsibilities - as articulated in IOSCO's guidance to regulators.

If SEBI were to say it it wants distributors to continue with their responsibility towards risk profiling and product suitability, but that they are to refrain from even basic advice and must only confine themselves to describing product features, such a position can certainly be challenged. Ensuring suitability of a product to an investor can only happen when the intermediary makes himself familiar with the investor's needs and circumstances, on the basis of which he can come to a reasonable conclusion on suitability. And this is several steps ahead of simply describing what an equity fund is versus what a debt fund is. IOSCO's principles are very clear that product suitability responsibilities come into force only when there is a specific recommendation being made.

Is diluting a distributor's responsibilities in an investor's best interests?

If SEBI were to remain firm that a mutual fund distributor cannot offer basic advice and must restrict himself to describing product features without making any recommendation, it will naturally follow that it has to significantly dilute the distributor's responsibilities towards his investors. And that will be a very unfortunate and regressive step. Consider this:

  1. A distributor who only has to explain product features will not have any responsibility for example, to caution a senior citizen who is getting carried away in a bull market and committing far too much of his retirement corpus to high risk thematic equity funds.

  2. Several thousand distributors who have received goal planning training from fund houses and who have embraced goal based SIP selling to retail investors, will now have to stop this process and not help retail investors invest for their personal financial goals and adopt a disciplined long term goal based investment approach. They can only describe features of debt and equity funds, but cannot get into discussing how much an investor should put aside each month to secure a comfortable retirement and whether this investor ought to consider an equity component to beat inflation and how this investor can mitigate and manage risks that he perceives in equity markets. All of this is too much about the investor and not about the product - and the distributor has to only confine himself to describing product features.

  3. If an investor gets anxious about market volatility and asks his distributor whether he should exit the market completely, the distributor cannot review the investor's holdings, suggest rebalancing of his portfolio, suggest exiting certain thematic equity funds and move into hybrids like balanced funds, and find ways to address the investor's concerns, reduce portfolio risk but ensure that the investor remains invested in mutual funds. He has to restrict himself to describing features of debt and equity funds only, and avoid making any kind of specific recommendations.

There are lakhs of investors who have formed strong relationships with their distributors over the years, and have come to trust these distributors' advice and judgement. Now, when they turn to these distributors, they will be told that they cannot expect any guidance any longer, and can only expect descriptions of equity and debt funds in response to any questions they have.

Global regulators focus on raising the bar, not lowering it

The world over, regulators are keen to impose higher sales process regulations on intermediaries, in an effort to protect investors. SEBI is moving in the opposite direction - in its enthusiasm to promote RIA as its preferred intermediation model, it is trying to make fund distribution look unattractive, but in the process, exposing lakhs of investors to poorer protection than they currently enjoy. Is this really in the investors' best interests? Is the idea of propagating a "mutual fund distributor" channel that offers significantly lower investor protection than the current distribution model with incidental advice really in the best interests of investors? Or is it in the best interests of ensuring a significant jump in RIA registrations from a figure of 515, which the regulator considers embarrassingly low?

In the US, which our regulator keenly tracks, the current debate on DOL legislation is basically aimed at ensuring that all intermediaries - whether distributors or advisors - carry a certain minimum fiduciary responsibility. They are talking about raising the bar on distributors' responsibilities - not reducing it. No regulator is moving in the direction of reducing responsibilities of distributors in an effort to make it look unattractive and therefore promote a fee based advisory model.

All investors deserve adequate protection

I believe the regulator's focus on investor protection should be aimed at ensuring that investors are duly protected, irrespective of the channel they choose - rather than forcing a situation where you strip off any form of protection when they interface with distributors (who are today the primary last mile connect with retail investors) and then hope that this "non-protection" will create market pressure from investors and intermediaries to embrace RIA as the preferred intermediation option. Gambling on a potential outcome and leaving investors exposed as a consequence does not strike me as a mature regulatory stance.

Conflict of interest has been adequately dealt with

The regulator has thus far shown a lot of proactivity in dealing with conflict of interest in the fund distribution model. Commission caps and enhanced commission disclosures are steps in this direction. Distributors may not like it, but one cannot deny that there is an element of conflict of interest. And, if there is potential conflict of interest, heightened disclosures are perhaps the best way to curb potential conflict becoming actual conflict of interest.

Need to focus on implementation of sales process regulations

I believe the regulator now needs to shift focus towards ensuring robust protection from mis-selling, irrespective of channel chosen by the investor - whether direct or distributors or RIAs or for that matter e-commerce platforms. This is a far higher priority than trying to force the pace on adoption of a fee based model for intermediation. Investors already have a choice on the commercial aspects - no intermediation fee (direct), embedded intermediation cost (distribution) with full disclosures and segregated intermediation cost (fee based RIA). Its time we look at the other aspect of investor protection - which is the process of ensuring that investors get adequate guidance to enable and empower them to take informed investment decisions with confidence.

If the regulator is serious about investor protection, it needs to strengthen enforcement of what has already been enshrined into regulations. The correct approach in my view will be to focus on how to ensure that distributors actually deliver on the risk profiling and product suitability responsibilities they have. There should be mandatory certifications for distributors on risk profiling and product suitability assessment, to ensure they have adequate knowledge and skills to do this job well, for the benefit of investors. And, just as we have due diligence on large distributors to ensure that they follow these processes, we should look at extending the scope to include surprise random checks on smaller distributors once every few years. This should be akin to the principle that the IT department adopts for scrutiny of tax assessments. It has its rules on how it takes up cases for scrutiny. All assesses know that their files can be scrutinized, but only a small fraction of "sensitive" cases actually are. Taking up distributors for audit on the same principles will ensure that no distributor takes his responsibilities lightly towards his investors.

Don't direct plan investors deserve protection?

SEBI ought to also consider whether it is adequately protecting investors who opt for direct plans - many of whom go that route merely because it's cheaper and not necessarily because they know exactly what they want. Should there not be any form of suitability guidance when investors go across to AMC sales offices? How can the regulator be so sure that every investor who chooses to go direct is really knowledgeable and needs no guidance whatsoever? Moreover, as SEBI keeps stepping up its nudging to promote direct plans to retail investors, should it not consider investor protection measures for such investors?

Some recommendations are indeed logical

By all means, SEBI should deny any non RIA from using a nomenclature that includes the word "advisor" as it is certainly confusing for an investor. Let IFAs either call themselves MFDs as suggested, or migrate towards the RIA mode, if they choose to. Let SEBI mandate that only RIAs can charge any form of fees from investors and that non RIAs cannot, under any head of income. If you charge a fee, you must submit yourself to higher level of fiduciary responsibilities. All of these are sensible and logical steps. But, reducing investor protection currently offered within fund distribution in the hope that this will promote RIA - that doesn't seem sensible and logical to me.

Make RIA aspirational

The idea should be to make RIA an aspirational professional level rather than trying to force it down the throats of unwilling intermediaries and non-receptive investors. Comprehensive financial planning, multi-product advice, estate planning, advice on alternate products and so on should be the exclusive preserve of RIAs, as all of these call for higher skill sets than vanilla mutual fund distribution. But, mutual fund distribution cannot and should not be reduced to a farcical level of only describing product features - investors and the mutual fund product, both deserve better.

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