Investment advisor's arrangement with Smallcase faces regulatory heat; fintech denies any wrongdoing

Under Regulation 22 (a) of IA Regulations, the client shall not be under any obligation to avail the distribution or execution services offered by the investment advisor.

An investment advisor (IA), its directors and senior management were fined Rs 20 lakh in total for violating various regulations including obliging clients to use an execution platform and outsourcing core compliance functions.

An IA is a person or an entity that is paid for advising clients on how to  deploy their funds.

Some of the violations, according to the submissions made by the IA and its directors, arose from its arrangement with fintech company Smallcase.

In an email interaction with Moneycontrol, Smallcase denied that its platform enabled any of these violations. The fintech added that the regulator's observations are based on the information provided by the IA.

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What SEBI order noted

In a recent notice issued against a SEBI-registered IA Bharosa Technoserve, the Securities and Exchange Board of India (SEBI) said the entity had violated the rules in four different ways through its arrangement with Smallcase. The regulator fined Bharosa Techserve Rs 10 lakh, and its directors and senior management Sanjay Bhargava, Sahil Bhargava, Anita Bhargava jointly and severally Rs 10 lakh.

The first violation noted by SEBI was by making it mandatory for its clients to execute their trades through partner brokers of Smallcase.

As the order noted, "From the Help section of the entity's (Bharosa Tech) page on the said platform (Smallcase) it was observed that in order to subscribe to the entity's product the clients need to be a client of the partner brokers of Smallcase."

Under Section 22 (a) of the Securities and Exchange Board of India (Investment Advisers) Regulations, 2013, "the client shall not be under any obligation to avail the distribution or execution services offered by the investment advisor".

The order also quoted Bharosa Club's text on how to subscribe to its services. The text said: "Exclusive smallcases can be subscribed directly from the smllcase (sic) profile by following the steps below: Fill the subscription form with your name, email and phone number'; Choose your broker amongst the linst of our partner broker and login with your broker credentials; and Select the subscription plan and make the payment."

But Smallcase, in response to queries from Moneycontrol, said, "Subscribing to a smallcase does not mandatorily require the user to have an account with partner brokers. A broker account is required only to transact in the smallcase. The smallcase subscription and transaction flows are completely separate and are not interlinked with each other."

Outsourcing core functions?

Bharosa Tech, according to the SEBI notice, claimed to have outsourced the client's risk profiling, know your customer (KYC) documentation and processes for maintaining anti-money laundering standards to Smallcase, which again is against the rules because these fall under an IA's core functions.

The SEBI order noted that the IA was required to perform risk profiling as per the criteria provided under Regulation 16 of SEBI (IA) Regulations. Also, under the conditions of certificate issued, an IA is required to follow the KYC procedure as specified from time to time.

Smallcase told Moneycontrol that it does not do risk profiling or KYC of clients of IAs/research analysts (RAs).

Its spokesperson said, "The KYC of clients of IA/RA are not done by smallcase on their behalf. The smallcase Platform enables the IA/RA to download the KYC documents for their clients from the KRA (KYC Registration Agency). The KYC process of validation, updation and record keeping of these documents is performed by the respective IA/RA."

They added, "smallcase also does not do the risk profiling of clients on behalf of IAs. It offers a configurable tool to the IA to conduct the risk profiling of their clients."