Analyzing SEBI (Investment Advisers) Regulations 2013

This article analyzes the laws that govern the operation of "Investment Advisers" but before we get into that...

A quick note on the new age of Investment Advisory Services

Wealth-Tech is changing investing is by the way of investment advisory services where they provide an investor with all the information (regarding a specific security or a class of securities) they need to make an investment decision.

Their system also involves market predictions, strike calls, recommendations as to the period of holding and market calls by financial analysts (working for the said broker, investment advisor or portfolio manager).

All these aspects of the modern investment sector have been a regulatory nightmare for the Board (SEBI). This is because the type and nature of services in this sector are changing almost every month i.e. there has been an emphasis on consistent innovation (in the terms of investment platforms and investment products).

For example, the popular investment app- GROWW provides a host of information on their trading screen for a particular share/company. Here’s a screenshot of how it looks:

All of the relevant information presented here can be interpreted as an indirect form of investment advisory services as Groww provides users with added information that is not available on other public forums or a news feed (especially the Analyst estimates --“Buy” and “Sell” segment).

If you are like me, you must be wondering "How is this any of this allowed under the law?"

Or "What exactly connotes an "Investment Advice" under the law?"

Well, the answer is not that simple, to understand what an "investment advice" is, we have to look at the relevant law in this regard. ....

How Investment Advisory services are regulated in India

Primarily, the SEBI (Investment Advisers) Regulations of 2013 regulates the operation of investment advisory services in the country. Apart from this regulation, the following are relevant while operating in this space:

• SEBI circular on Measures to strengthen the conduct of Investment Advisors (27th December, 2019)

• SEBI circular on Guidelines for Investment Advisor (23rd September, 2020)

• SEBI circular on Publishing Investment Charter and disclosure of Investor Complaints by Investment Advisor on their website / mobile applications (13th December, 2021)

• SEBI circular on Investment Advisory Services for Accredited Investors (21st December, 2021)

• BASL Circulars.

The regulation of 2013 was heavily amended in 2020 [by the SEBI (Investment Advisers) (Amendment) Regulations, 2020] to comply with the changing market conditions and the rapid emergence and acceptance of FinTech companies in the capital market.

We shall now take a deeper look into the various provisions of this Regulation.....

Important Definitions

Section 2(ac) defines “assets under advice”- to mean the aggregate net asset value (NAV) of securities and investment products for which the investment adviser has rendered advice and it does not matter if the said adviser has provided for an implementation mechanism to act upon such advice (i.e. it can be done through an alternative provider).

Section 2(g) defines “consideration” as any form of economic benefit (cash or non-cash) that is received or is receivable for providing investment advisory services.

Section 2(gb) & (gc) provide for the definition of “family members” under the ambit of this Act:

• “Family” of a Client- Client, dependent spouse, dependent children and dependent parents. (Notice the fact that, if any of these members are not infirm, or have gainful employment i.e. they are not “dependent” they would not fall under this definition.

• “Family” of an Investment Adviser- Investment Adviser, spouse, children and parents (not such condition of dependency is allowed as in the case of the client).

Section 2(m) defines an “Investment Adviser” as a person who is engaged in the profession of providing investment advice to clients or groups of persons in exchange for consideration.

Section 2(L) gives the statutory definition of “investment advice”

It means advice relating to:

• Investing in, purchasing, selling or otherwise dealing in securities or investment products;

• Advice on investment portfolio containing securities or investment products.

Whether communicated orally or in writing or through any other means of communication for the benefit of the client, shall include financial planning.

Exception: However, under this definition, any investment tip or advice given through newspaper, magazines, electronic or broadcasting telecommunications medium (all of which are widely available, to the public) shall not be considered “investment advice”

------That is why, we see the existence of newspapers, online portals and even YouTube channels providing investment advice, strategies and stock suggestions. This exception also allows the existence of online communities that trade together on Telegram, SeekingAlpha, TradeView, Motilal Oswal Trading etc.

-------------------So, in case you wondered if these sources were legal, they are as legal as something can be (probably because they exist in a loophole :) or rather a regulatory vacuum)

Section 2(r) provides the extent of “persons associated with investment advice”- Any person shall be deemed to be associated with the investment Adviser who is a ----

• Member, Partner or Director of the Investment Adviser’s firm or company OR

• Any Employee or any sales staff

• Any other person performing the investment advisory functions (irrespective of the nature of association with the investment adviser) to the clients of the said Investment Adviser.

• All Client-facing staff but not those who perform administrative functions of the firm/company.

Important provisions

Registration of Investment Advisers [Regulation 3 to 14]

The Application stage:

Regulation 3 provides that- No one shall act or hold himself/herself out as an Investment Adviser unless they have obtained a certificate of registration under this Regulation.

• Application Form- Form A (1st Schedule),

• Application fee (2nd Schedule)- Rs. 2000 for Individuals/Firms, Rs. 10,000 for Body Corporate and LLP

Reg. 3 further adds that no one shall use the nomenclature: “Independent Financial Adviser (IFA)” or “Wealth Adviser” when dealing in securities without obtaining a registration certificate.

Regulation 4 provides for the list of persons exempted from registration under Reg.3:

• Any person who gives general comments on the stock market or industry but does not comment on any specific security or investment product.

• An Insurance Agent registered with the IRDA (advice can be solely on insurance products).

• A Pension Advisor registered under the PFRDA (advice solely on pension products).

• A Fund Manager or Distributor of Mutual Funds or Alternative Investment Funds or any other intermediary registered with SEBI, providing advice incidental to its primary activity

• Any Advocate, Solicitor or Law Firm providing investment advice incidental to their legal practice.

• Any CA (under ICAI) or CS (under ICSI) providing investment advice incidental to their professional services.

• Any Stock Broker or sub-broker, Portfolio Manager or Merchant Banker registered their respective SEBI Regulations providing investment advice incidental to their primary activity.

• Any person who offers investment advice exclusively to clients based outside India (except an NRI).Any “person associated with investment advice” of an adviser registered under these regulations.

Regulation 5 requires the furnishing of further information, clarifications and personal representations regarding matters relevant to the investment advisory service and its pending application for registration.

Regulation 6 points out the factors/matters SEBI shall consider relevant for granting a certificate of registration [Eligibility Criteria] ----

• Whether the applicant is an individual or a non-individual (i.e. a firm, company or LLP).

• Whether the persons associated with investment advice (applicant) hold appropriate qualifications (as prescribed under Reg.7). If the applicant is a body corporate, the principal officer and everyone associated with the investment advisory service holds the said qualifications.

• Whether the applicant and persons associated fulfil the criteria for being declared “fit and proper person” (as under Schedule II of SEBI (intermediaries) Regulations 2008)

• Whether the applicant has the necessary infrastructure to ensure the effective discharge of investment advisory services.

• Whether the applicant fulfils the net worth (aggregate value of share capital + free reserves) requirements (as under Reg. 8): Non-individuals-50 Lakh Rupees, Individuals- 5 Lakh Rupees.

• If an NBFC or Bank wishes to register itself as an Investment Adviser, this Regulation requires them to furnish prior permission from the Reserve Bank of India. Also, they have to open either a subsidiary or a separately identifiable division to provide Investment Advisory services.

The Board also takes into account if any person directly or indirectly connected with the applicant has been refused a certificate of registration and if so, on what grounds.

Further, the Board also looks at foreign persons or entities providing investment advice and checks if they have set up an office in India or not (to regulate such persons or entities).

Regulation 9: Grant of Certificate of Registration

This regulation provides for the grant of a Certificate of Registration by the Board provided it is satisfied that the requirements specified in Reg.6 have been met by the applicant and the fees (under Schedule II) have been paid.

Conditions of a certificate (Regulation 13) --

• Investment Adviser (IA) abides by the provisions of the SEBI Act 1992 and the provisions of this Regulation.

• IA shall inform the Board in writing if any false information or misrepresentation was made during the application stage

• If the IA is a non-individual, it may add the words “Investment Adviser” to its name. If it is an individual, the same words shall only be used in correspondence with clients.

• If an individual IA exceeds more than 150 clients, it shall apply as a non-individual IA to the Board.

Certificate form- FORM B

Here's how it looks :)

This is the registration certificate obtained by Hum Fauji Initiatives, an investment adviser

Validity- Till the Board suspends or cancels it [Regulation 10]

Procedure when a certificate is refused (Regulation 12) –

• A certificate may be refused by the Board if the applicant fails to fulfil the requirements as stated in the aforementioned Regulations.

• The applicant shall not be refused registration without giving him a reasonable opportunity of being heard.

• The intimation of rejection has to be sent within 30 days of application.

• The applicant shall cease to act as an Investment Adviser if the certificate is refused.

This regulation will not affect the liability of the applicant towards its existing clients.

General Obligations and Responsibilities of Investment Advisers [Reg. 15 to 22]

Regulation 15 provides for a list of general responsibilities of a registered IA:

• The IA shall maintain a fiduciary relation (i.e. a relation of utmost trust) with its client. It shall disclose any conflict of interest if or when they arise. They are also required to abide by the ‘Code of Conduct’ as specified in the 3rd Schedule of this Regulation).

• An IA cannot receive compensation or consideration for its services from any person other than the client himself.

• An IA cannot disclose confidential information of the client without prior permission (except when done in compliance with the law).

• An IA engaged in other activities shall maintain an “arms-length relationship” with such activities i.e. keep them distinctly separate from their investment advisory service.

• An IA cannot enter into transactions (contrary to its advice) of its own volition.

• Every IA shall abide by the KYC norms set forth by SEBI from time to time

• Prior approval from SEBI must be taken in case of a change of control of the Investment Adviser. SEBI shall also be provided with reports of the activities of the IA from time to time.

Regulation 15 A provides an Investment Adviser to charge fees from the client for providing investment advice.

-------------------This regulation was recently amended in 2021 removing the set maximum fee chargeable (2.5% of total assets under advice). This came as a reaction to the developments in the case of Purnartha Investment Advisers v SEBI (June 18, 2021), where the constitutionality of the then Reg.15 A was challenged.

Even though the Bombay High Court decided that the said regulation did not violate the right to freedom of profession (as under Article 19), SEBI acted quickly to remove the maximum set limit of 2.5% by the SEBI (Investment Advisers) (Third Amendment) Regulations, 2021.

Regulation 16- Risk Profiling and reporting

Regulation 16(a) ensures that the IA obtains the following information from its client for investment advice:

• Age, income details and existing investments or assets.

• Investment objectives (time/tenor for which they want to invest)

• Risk appetite or risk tolerance

• Liabilities and borrowing details (includes credit score analysis)

16(b) further adds that IA has to ensure that it has a mechanism for assessing the client’s capacity for absorbing certain losses and, interpreting clients’ responses to certain questions relevant to its investment profile.

Lastly, under 16(e) and (f), the risk profile must be communicated to the client and, such assessment shall be updated periodically to ensure the client is never without the latest information concerning its investments.

Regulation 17 talks about the suitability of investment advice with the profiling done under Reg.16 i.e. it shall be the responsibility of the IA to ensure that all investments comply with the agreed-upon risk exposure of the client.

Regulations 18 and 19 – Disclosures to clients and Maintenance of records

Under Reg. 18, an IA has to disclose to a potential client all material information regarding:

• Its business

• Disciplinary History

• Terms and Conditions of its advisory services.

• Affiliation with other intermediaries

• Any other information that might be relevant to a client in weighing whether or not to avail of its services.

Further clauses under Reg. 18 require the IA to disclose its holdings (on behalf of the client), potential conflicts of interest, and key features of an investment product along with its disclaimers.

Under Reg. 19 (1), an Investment Adviser shall maintain the following records:

• KYC of the client.

• Risk profiling and assessment of the client.

• Suitability of assessment (as under Reg. 17)

• Copies of agreements/contracts with clients (incorporating the terms and conditions as specified by SEBI)

• Investment Advice provided- oral or written.

• A register of clients, investment products, exposure to such products and, the fee charged for such advice.

19(2) states that the aforementioned records should be maintained either in electronic or physical form for a period of a minimum of 5 years.

Further responsibilities:

1. Under Regulation 20, a Compliance Officer has to be appointed by the IA (if it is a body corporate or a firm)

2. Under Regulation 21, the IA should ensure that a set mechanism for the redressal of grievances is available to its clients. It shall also redress client grievances promptly.

3. Regulations 22 and 22A talk provide that for client-level segregation in terms of advisory and distribution services i.e. a non-individual entity cannot offer both advisory and distribution services (of investment products). The latter regulation states that an IA can only provide implementation services on set investment products available in the securities market.

---------------However, the client is not obligated to avail implementation services offered by its IA [under Reg. 22A (4)]

Inspection by the Board

Regulation 23- Right to Inspect

This regulation provides the Board with the right to inspect the conduct of investment advisers. Actions can be taken by the Board on its motion or upon receiving complaints from one or more persons. The Board shall inspect:

• To ensure books of account and records are kept in compliance with Reg.19.

• The specific investment advice or conduct of such adviser against whom the complaint is made.

• The affairs of the IA determine whether its conduct is in the interest of the market or the interest of investors.

• To ensure that the IA complies with the regulation.

Regulation 24, 25, 26- The procedure of inspection

• Before ordering an inspection under Reg.23, the Board has to provide a 10-day notice to the Investment Adviser [Reg.24 (1)]. However, an inspection can take place without such notice if the Board believes that is in the interest of the investors [Reg. 24(2)]

• It shall be the duty of every investment adviser to produce the books, records, accounts and all other relevant documents to the inspecting authority of the Board under Reg.25 (1).

• The inspecting authority can examine on oath and record statements of any employees, directors or partners for the inspection. It shall also extend to any person associated with the investment advice [Reg. 25(2)]

• The inspecting authority can obtain authenticated copies of documents of clients, records of transactions, and investment products from any person having control over such documents at the Investment Adviser’s place of work [Reg.25(3)]

• The inspecting authority shall furnish an inspection report or an interim report (if directed by the Board) under Regulation 26.

Regulation 27- Action on Inspection Report

This regulation provides that the Board, after considering the inspection report and giving a reasonable opportunity of being heard to the investment adviser, can make directions as it deems fit. These directions may include-

• Suspension from providing investment advice for a particular period.

• Refund client money collected as fees, charges or commissions (paid with requisite interest)

• Prohibiting the IA from operating or accessing the capital market for a specified period.

Further, under Regulation 28, if any Investment Adviser defaults on its responsibilities to the Board, this regulation or its clients, it shall be punished for the same in the manner provided under SEBI (Intermediaries) Regulations 2008.

There will be more articles in this regard which shall put an emphasis on each circular and discussion papers as provided by SEBI in due course of time.

Thank you for reading :)