Financial services field is replete with cases where client interests have been sacrificed at the altar of self-interest. The worst form of abuse of trust (by packaging risky securities and offering them as high-quality assets) happened in the US, which precipitated a global financial crisis in 2008.
Regulators across the globe since then have started looking closely at investor protection. They started ringing in regulations to rein in the dubious practices that the financial services industry uses to ensnare the unsuspecting public.
The investors had nowhere to turn to when they wanted conflict-free advice. They just had product sellers who also offered advice to their clients about financial matters. But, their role is conflicted as they are agents of a principal and represent them. True advisers, who worked only in the client’s interest, were marked by their absence.
SEBI Investor Advisor Regulation 2013
There was a dire need for advisors who would work in the client’s interest. The capital market regulator, Securities and Exchange Board of India (SEBI) had debated about this and finally came out with SEBI Investment Adviser Regulations 2013.
This regulation was intended to create a new class of advisors who would work only in the client’s best interests. These Registered Investment Advisers (RIA) were now required to work in the capacity of fiduciaries. Fiduciaries are those who put the client’s interest above everything else. This was a major thrust area of the regulation.
The regulation also sets higher benchmarks for RIAs which they need to adhere to - in education, experience and certification. It is also expected from them to follow proper processes while advising clients, ensure suitability of advice rendered, do proper risk profiling and consider other information before providing advice, etc. The compliance is also of a higher order which includes process and compliance annual audits.
This regulation also allowed a corporate entity to offer advisory and distribution services within the same entity, provided they were properly segregated, maintained arms’ length dealings, disclosed conflicts of interests to the clients and gave them a choice to go anywhere for product sourcing. There were many corporate entities which had both departments within them.
Individual advisors had to decide between advisory and distribution. In many cases, one became an advisor and the distribution business was anchored by a relative, friend or an associate. Again, in this model too, all safeguards were to be followed – arms’ length dealings, a choice to investors to go wherever they want to source products, disclosure of conflicts of interest, etc.
Fine-tuning the regulation
The 2013 regulation was the first salvo. SEBI wanted to fine-tune the regulation to make it more sharply defined and sought to remove the potential conflicts of interests that were inherent in the regulation. Hence, they came with consultation papers which sought to redraw the regulatory framework. There have been three of them till now.
The consultation papers have confused rather than clarify matters. The consecutive consultation papers have mapped quite different paths. The third consultation paper released on January 2, 2018 was the most radical in its prescription. It sought to sharply divide between advisory and distribution.
It wanted to proscribe advisors from doing product distribution, through a separate department or even through an associate company (defined as anything where the advisory firm/ directors/ partners collectively have 15 percent or more beneficial interest).
In the case of individual advisors, it wanted them to choose either advisory or distribution and sought to prohibit near relatives from agency work. It also wanted to restrict MF distributors to no longer offer any advice but rather stick to just explaining the product and ensure product appropriateness.
Existing investment advisers who were offering both advisory and distribution were to decide what they want to do before March 31, 2019, as per this consultation paper.
RIAs are mostly those who have been distributors before who have made the transition. Based on the extant regulations, they have created their corporate/ individual structures and business models.
When the regulatory intent suddenly tightens, it will result in turmoil in the advisory community and the velocity of the advisory practice will slow down for the entire industry.
The intent of SEBI is clear. It wants to create conflict-free advisors who can offer truly aligned advice to investors. It wants the advisors to play a fiduciary role, where client interest is pre-eminent. SEBI needs to keep this as the central percept around which it needs to further weave the regulation.
They can allow the existing RIAs to offer both advisory and distribution, and offer them a path to pure advisory, over time. These RIAs would need to play a fiduciary role and the centrality of client-interest and conflict-free nature of advisory needs to be maintained.
They can have another category of RIAs who are fee-only, don’t have any distribution arrangements and are pure play advisors. They will be advisors in letter and spirit, playing the fiduciary role for their customers. This would be the ultimate position that an advisor would want to be in terms of client centricity and professional maturity.
SEBI can further distinguish these two categories of RIAs to differentiate them from each other and can give them a suitable name to position them correctly to the investing public at large.
It can be something like RIA-composite and RIA-pure advisory. The existing mutual fund distributors would perform their role but SEBI can clarify exactly what they can & can’t do.
It is important to ensure continuity and enable smooth transitions in the regulatory regime so that it is not disruptive for the industry or the investors at large. A calibrated approach would ultimately achieve SEBI’s objectives of having advisors who are entirely fee-only, unbiased and client-focused. Hoping that SEBI also sees it this way.The writer is the founder of Ladder7 Financial Advisories, a financial planning firm.