Regulatory Environment & Ethical Issues - Chapter 6

Regulatory Environment & Ethical Issues - Chapter 6

Why does investment advice have to be regulated? The regulation has gradually evolved over time for a number of reasons. Normally, the investment advisory function began with the sales staff of brokers and distributors. They had a clear conflict between the needs of the customer and the pressures of the product originator. It is to handle this conflict that the regulatory environment was set up. Secondly, the regulatory environment also became essential because financial planning is a complex and technical job and requires the highest levels of knowledge, skill and commitment. To ensure that the interests of the customers are protected, the regulatory environment becomes a must.

What is investment advice all about?

The term “investment advice” has been specifically defined under the existing regulations. In this context, investment advice constitutes any form of advice provided in relation to investment, purchase, sale or dealing in securities or investment products. It also includes advice on a portfolio of securities or investment products and financial planning. Portfolio advice is critical as it also factors in asset correlations and diversification of risk. Also portfolios need to be constantly evaluated and rebalanced.

Investment advice may be provided as a written advice or an oral recommendation or through any other mode which could be physical, electronic or even telephonic. The moment the communication is established between a product originator / seller and a potential customer, investment advice is deemed to come into existence. However, advice that is widely available to the public through newspapers or internet or magazines is more information based and generic in nature and therefore it is not considered as investment advice under the regulations.


Qualifications / Certification / Capital Requirement for Investment Advisors

The SEBI regulations read with the AMFI code of conduct for advisors can be combined to understand the actual breadth of the regulations surrounding investment advisors. Here are some key highlights.

Qualifications: The Regulations specify certain minimum qualifications for a person to be eligible to be an investment adviser. If an individual seeks registration as an investment adviser, or a partner or representative of an investment adviser then he / she must possess one of these required qualifications as under.

  • A professional qualification or a post graduate degree or post graduate diploma in finance, accountancy, business management, commerce, economics, capital market, banking, insurance or actuarial science from a university or an institution recognized by the central government or any state government or a recognised foreign university or institution or association OR
  • A graduate in any discipline with an experience of at least five years in activities relating to advice in financial products / securities / fund / asset / PMS.


Certification Requirement: An investment adviser must obtain valid certification on financial planning or fund or asset or portfolio management or investment advisory services from NISM or from any other organization or institution including Financial Planning Standards Board India or any recognized stock exchange in India provided that such certification is accredited by NISM. All such certificates have a fixed period validity and on expiry of that period, they must be renewed well in advance.


Capital Requirement: In order to ensure financial stability, the Regulations have mandated that investment advisers must have net worth above a minimum threshold at all times. For investment advisers which are body corporate, net worth of not less than Rs.25,00,000 has been stipulated. Investment advisers who are individuals or partnership firms shall have net tangible assets of value not less than Rs.1,00,000.

Investment Advisor Responsibilities for Advisory Services

The Investment Adviser Regulations have cast upon investment advisers certain obligations and responsibilities while providing investment advisory services.

  • Conflicts of interest: It is imperative that the investment adviser discloses all conflicts of interest to the client as and when they arise
  • Only advisory income: An investment adviser must not receive any consideration or remuneration or in any other form from anyone except the client in respect of securities or investment products for which he has provided advice
  • Segregation of other activities: There must be segregation of other business activities from investment advisory activity of the investment advisor. An arm’s length relationship must be maintained between investment advisory activity and such other activities. If a conflict of interest arises, the same shall be disclosed to the client
  • Confidentiality: The investment adviser must maintain strict confidentiality with respect to the information received from the client
  • Own transactions: The investment adviser should not carry out transaction contrary to his advice to clients on his own account unless 15 days have passed from the date of providing the advice. However, during the 15 day period, if in the opinion of the adviser the situation has changed, he should first make a revised assessment to client at least 24 hours before carrying out such a transaction.
  • KYC compliance: An investment advisor shall follow Know Your Client procedure as specified by SEBI from time to time
  • Code of Conduct: An investment adviser must abide by the Code of Conduct as specified in Third Schedule of the Investment Adviser Regulations
  • Reporting to SEBI: The investment adviser must file periodic reports or information to SEBI as may be required from time to time and take prior approval from SEBI if there is a change in control of the investment adviser
  • Certification and Qualification: It shall be the responsibility of the Investment Adviser to ensure that its representatives and partners comply with the certification and qualification requirements stipulated by the Investment Adviser Regulations at all times
  • In addition, risk profiling, suitability assessment and disclosure, avoiding conflict of interest, record maintenance, segregation of execution services, etc. are also the roles involved

SEBI Code of Conduct for Investment Adviser

The SEBI (Investment Advisers) Regulations, 2013 has set out a code of conduct for Investment Advisers.

  1. Honesty and fairness: An investment adviser shall act honestly, fairly and in the best interests of its clients and in the integrity of the market.
  2. Diligence: An investment adviser shall act with due skill, care and diligence in the best interests of its clients and shall ensure that its advice is offered after thorough analysis and taking into account available alternatives.
  3. Capabilities: An investment adviser shall have and employ effectively appropriate resources and procedures which are needed for the efficient performance of its business activities.
  4. Information about clients: An investment adviser shall seek from its clients, information about their financial situation, investment experience and investment objectives relevant to the services to be provided and maintain confidentiality of such information.
  5. Information to its clients: An investment adviser shall make adequate disclosures of relevant material information while dealing with its clients.
  6. Fair and reasonable charges: An investment adviser advising a client may charge fees, subject to any ceiling as may be specified by the Board, if any. The investment adviser shall ensure that fees charged to the clients are fair and reasonable.
  7. Conflicts of interest: An investment adviser shall try to avoid conflicts of interest as far as possible and when they cannot be avoided, it shall ensure that appropriate disclosures are made to the clients and that the clients are fairly treated.
  8. Compliance: An investment adviser including its representative(s) shall comply with all regulatory requirements applicable to the conduct of its business activities so as to promote the best interests of clients and the integrity of the market.
  9. Responsibility of senior management: The senior management of a body corporate which is registered as investment adviser shall bear primary responsibility for ensuring the maintenance of appropriate standards of conduct and adherence to proper procedures by the body corporate.


Key Excerpts from the SEBI Code of Conduct

Investor Protection

  • Investors/Clients: Every intermediary shall make all efforts to protect the interests of investors and shall render the best possible advice to its clients having regard to the client’s needs and the environments and his own professional skills.
  • High Standards of Service: An intermediary shall ensure that it and its key management personnel, employees, contractors and agents, shall in the conduct of their business, observe high standards of integrity, dignity, fairness, ethics and professionalism and all Professional dealings shall be affected in a prompt, effective and efficient manner. An intermediary shall be responsible for the acts or omissions of its employees and agents in respect to the conduct of its business.
  • Exercise of Due Diligence and no Collusion: An intermediary shall at all times render high standards of service, exercise due skill and diligence over persons employed or appointed by it, ensure proper care and exercise independent professional judgment and shall not at any time act in collusion with other intermediaries in a manner that is detrimental to the investor(s).
  • Fees: An intermediary shall not increase charges/ fees for the services rendered without proper advance notice to its clients/investors.

Disbursal of Amounts

An intermediary shall be prompt in disbursing dividends, interests or any such accrual income received or collected by it on behalf of its clients/investors.

Dissemination of Information

  • An intermediary shall ensure that adequate disclosures are made to the clients / investors in a comprehensible and timely manner
  • An intermediary shall not make any misrepresentation and ensure that the information provided to the clients/investors is not misleading.
  • An intermediary shall not make any exaggerated statement whether oral or written to the client/investor
  • An intermediary shall not divulge to anybody, either orally or in writing, directly or indirectly, any confidential information about its clients/investors.


AMFI Code of Conduct - For Intermediaries of Mutual Funds

The AMFI code of conduct prescribes as under for intermediaries in the mutual fund industry:

  • Consider investor’s interest as paramount and take necessary steps to ensure that the investor’s interest is protected in all circumstances
  • Adhere to SEBI Mutual Fund Regulations and guidelines issued from time to time related to distributors, selling, distribution and advertising practices
  • Comply with SEBI guidelines / requirements issued from time to time in preparation of sales, promotional or any other literature about any schemes. Performance disclosures should also comply with the requirements specified by SEBI. Provide full and latest information of schemes to investors in the form of SAI, SID, addenda, performance reports, fact sheets, portfolio disclosures and highlight risk factors of each scheme, desist from misrepresentation and exaggeration and urge investors to go through SAI / SID/ KIM before deciding to make investments
  • Abstain from indicating or assuring returns in any type of scheme, unless the SID is explicit in this regard
  • Maintain necessary infrastructure to support the AMCs in maintaining high service standards to investors, and ensure that critical operations such as forwarding forms and cheques to AMCs/registrars and despatch of statement of account and redemption cheques to investors are done within the time frame prescribed in the SID/SAI and SEBI’s Mutual Fund Regulations
  • Desist from colluding with investors in faulty business practices such as bouncing of cheques, wrong claiming of dividend/redemption cheques, splitting of applications in the schemes to circumvent regulations for any benefit, etc
  • Abstain from commission driven malpractices such as: recommending inappropriate products for higher commissions there from; encouraging churning of Mutual Fund investments to earn higher commissions; or splitting of applications to earn higher commissions
  • Abstain from making negative statements about any AMC or scheme and ensure that comparisons are factual
  • Intermediaries shall keep themselves abreast with the developments relating to the Mutual Fund Industry as also changes in the scheme information and information on mutual fund / AMC like changes in fundamental attributes, changes in controlling interest, loads, liquidity provisions, and other material aspects
  • Maintain confidentiality of all investor details, deals and transactions and keep investor’s interest and suitability to their financial needs as paramount and that extra commission or incentive should never form the basis for recommending a scheme to the investor
  • Intermediaries shall not rebate commission back to investors and abstain from attracting investors through temptation of rebate/gifts etc
  • To protect the investors from potential fraudulent activities, intermediary should take reasonable steps to ensure that the investor’s address and contact details filled in the mutual fund application form are investor’s own details, and not of any third party.
  • Where the required information is not available in the application form, intermediary should make reasonable efforts to obtain accurate and updated information from the investor. Intermediaries should abstain from filling wrong / incorrect information or information of their own or of their employees as the investor’s address and contact details in the application form, even if requested by the investor to do so. Intermediary should abstain from tampering in any way with the application form submitted by the investor
  • Intermediaries, including the sales personnel of intermediaries engaged in sales / marketing, shall obtain NISM certification and register with AMFI and obtain an Employee Unique Identification Number (EUIN) from AMFI apart from AMFI Registration Number (ARN). The Intermediaries shall ensure that the employees quote the EUIN in the application form for investments. The NISM certification and AMFI registration shall be renewed on timely basis. Employees in other functional areas should also be encouraged to obtain the same certification
  • Intermediaries shall comply with the Know Your Distributor (KYD) norms issued by AMFI
  • Co-operate with and provide support to AMCs, AMFI, competent regulatory authorities, due diligence agencies (as applicable) in relation to the activities of the intermediary, or any regulatory requirement and matters connected thereto
  • Provide all documents of its investors in terms of the Anti-Money Laundering / Combating Financing of Terrorism requirements, including KYC documents / Power of Attorney / investor’s agreement(s), etc. with Intermediaries as may be required by AMCs from time to time
  • Be diligent in attesting / certifying investor documents and performing In Person Verification (IPV) of investor’s for the KYC process in accordance with the guidelines prescribed by AMFI / KYC Registration Agency (KRA) from time to time
  • Adhere to AMFI guidelines and Code of Conduct issued from time to time related to distributors, selling, distribution and advertising practices
  • Intimate the AMC and AMFI any changes in the intermediary’s status, constitution, address, contact details or any other information provided at the time of obtaining AMFI Registration
  • Observe high standards of ethics, integrity and fairness in all its dealings with investors, Mutual Funds/ AMCs, Registrars & Transfer Agents and other intermediaries.
  • Advisor shall render at all times high standards of service, exercise due diligence, and ensure proper care
  • Intermediaries satisfying the criteria specified by SEBI for due diligence exercise, shall maintain the requisite documentation in respect of the “Advisory” or “Execution Only” services provided by them to the investors
  • Intermediaries shall refund to AMCs, either by set off against future commissions or payment, all incentives of any nature, including commissions received, that are subject to claw-back as per SEBI Regulations or the terms issued by respective AMC
  • Advisor shall not indulge in fraudulent or unfair trade practices of any kind while selling units of schemes of any mutual fund. Selling of units of schemes of any mutual fund by any intermediary directly or indirectly by making false or misleading statement, concealing or omitting material facts of the scheme, concealing the associated risk factors of the schemes or not taking reasonable care to ensure suitability of the scheme to the investor will be construed as fraudulent / unfair trade practice.

Ethical Issues in Investment Advisory

For a financial advisor, there are also some ethical issues that they need to address. Here is a sampler.

  • Has the advisor managed to create Chinese walls between the advisory and the product function? That is the primary ethical issue to be addressed.
  • Is the product the best option available for the specific need of the customer? The advisor cannot push products just for the sake of higher commissions.
  • Has the risk profiling of the customer been down in an elaborate manner? That should be the basis for offering advisory service to customers.
  • Advisor cannot ethically give monetary or non-monetary inducements in direct or indirect form to the customers just to show higher sales.
  • Has the financial advisor exercised the same due diligence and care with the customer’s money as he / she would do with their own hard earned money?
  • What is the escalation matrix for the advisor if there are real ethical issues that come up in the course of business?