Wednesday, January 25, 2017

SEBI Order under the Investment Advisers Regulations

A whole-time member of the Securities and Exchange Board of India passed an order involving CapitalVia Global Research Limited under the SEBI (Investment Advisers) Regulations 2013 (the “IA Regulations”). The case arose out of an inspection carried out by SEBI on CapitalVia, which resulted in an interim order being passed by SEBI on November 11, 2016. Since then, SEBI has held hearings and received representations from CapitalVia, based on which it passed the present order on January 20, 2017.

The case involved several alleged violations by CapitalVia of provisions of the IA Regulations. Before considering the individual allegations, the SEBI order does a helpful job of laying out the scope and object of the IA Regulations as follows:

6. It is relevant to appreciate the role of an Investment Adviser as contemplated under the IA Regulations in order to actually ascertain and assess the scope of breaches and its impact on the securities market on a holistic basis. The object of the IA Regulations, inter alia, was to lay down a framework for independent financial advisers which was absent till 2013 and to address the conflict of interest arising due to the dual role (advisory and sale) played by the distributors of financial products. Investment Advisors perform a pivotal role in the securities market of securing investor confidence in the integrity of the markets. This stems directly from the quality of advice provided to the investors which has to be honest and unbiased without being, in any way, swayed by short term profit motives. In addition to the statutory mandate under section 12 of the SEBI Act, 1992 to get registered, the regulation of investment advisory activity is necessary to avoid unscrupulous advisory business wherein investors could be misguided towards making investments in the securities market without providing them with an honest assessment of risks involved. There is thus a need to ensure discipline and transparency in this field of intermediation business in the securities market to protect the interest of the investors.

7. Investment advisers are understood to be persons who, for consideration, render advice relating to investment in securities or a portfolio of securities. Advice given as incidental to other primary activity are exempt from the purview of registered investment advisers. By definition therefore, the primary role of an investment adviser is to render, in good faith, advice that is suitable for investors. Consequently, the role of an investment adviser revolves around how accurately the risk assessment/profiling of a client is done , and how suitable is the advice rendered to the clients' risk profile and more importantly, the continuous channel of communication that an IA establishes with the clients to strengthen investor confidence. Prospective clients who approach investment advisers do so because their ability to evaluate the complexities of the securities market may be inadequate, or because confidence in the investment will be enhanced by the advice of an informed professional. In any case, the high level of trust that the client/investor reposes in the adviser is the fulcrum on which the entire edifice of IA profession is predicated upon. The framework of the SEBI (Investment Advisers) Regulations, 2013 (hereinafter referred to as "IA Regulations") is structured towards protecting this trust, in addition to ensuring integrity of the securities market. The scheme of the IA Regulations makes it clear that besides laying down the registration requirements, and capital adequacy requirement, it elaborates on the general obligations and responsibilities in detail and step-wise risk profiling processes and how the advice should be methodically arrived at with respect to each client taking into consideration the clients' financials and investment objectives etc. The assessment of suitability of a product to a particular client, the necessity for all disclosures to be in place about the investment adviser itself and the pecuniary connections with the products as well as its affiliations to other entities associated with the securities market are all aimed at ruling out a potential conflict of interest. The success of the regulatory framework lies in the implementation of the same by the registered Investment advisers imbibing the spirit of the Regulations coupled with timely inspections conducted by the regulator.

Based on these objectives, SEBI considered the individual violations alleged in the case of CapitalVia. It found several violations of the IA Regulations (which are detailed in the order), including the following:

- The products of CapitalVia were not simple enough for the investors to understand their inherent risks; that products with short term horizon, which were more appropriate and suitable for only high risk investors, were sold to low/moderate risk investors, thereby diluting the norm of suitability;
- The responsibilities of an investment adviser highlight the fiduciary relationship it has with its client, and that it is expected to function in the best interests of the client and not shrug off the responsibility for its advice;
- There were false and inadequate disclosures regarding SEBI’s interim order, due to which CapitalVia continued to solicit new business rather than to dissuade fresh advisory business;
- CapitalVia failed to maintain records, including KYC details;
- It charged exorbitant fees to the clients, which violated the principle that investment advisers are to act with due care due to its fiduciary relationship with their clients.

Finally, before passing orders against CapitalVia, including requiring it not to undertake fresh advisory business for another period of four months, and not to accept funds from clients for such period, SEBI again highlighted the importance of the role of investment advisers on the broader markets:

10. Registration of investment advisers is a statutory mandate flowing from section 12 (1) of the SEBI Act, 1992. Regulation of Investment advisory activity was considered necessary to avoid unscrupulous advisory business wherein investors could be misguided towards making investments in the securities market. There was a need to ensure discipline in this field of intermediation business in the securities market. Quality of advice rendered to investors has an impact on investors confidence in the integrity of the markets. Consequently, it is statutorily and ethically important to view seriously any infraction on the part of investment advisers. This is all the more so in the case of a large organization like CapitalVia which by its own statement is considered to be a pioneer in the field of investment advisory business. The more significant an organization, the bigger the ripple effect its actions or omissions have on the confidence in the system. …

In relation to oversight on the capital markets, the IA Regulations are relatively new, and SEBI’s orders such as the present one will pave the way for a deeper understanding of the regulatory regime.


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