SEBI’s Compliance Framework for Investment Advisers

SEBI - Investment Advisers - Gaurav Pingle - Taxscan

In 2013, SEBI issued Investment Advisers Regulations (IA Regulations) and prescribed a framework for the registration, compliance, disclosures, SEBI’s power for inspection, investigation, and adjudication. To start with, let us discuss a few important concepts under the said Regulations:

  1. Investment Adviser (IA): According to the said Regulations, means any person, who for consideration, is engaged in the business of providing investment advice to clients or other persons or groups of persons. To keep the scope wide, the definition of IA even includes a person who holds out himself as an IA, by whatever name called. ‘Investment Advice’, which is referred to in the definition of IA, is an exhaustive definition. Also, consideration means any form of economic benefit including non-cash benefit, received or receivable for providing investment advice. Therefore, the payment of fees in cash by the client is not an essential condition. Such fees can be a non-cash benefit.
  2. Investment Advice: According to the Regulations, ‘Investment Advice’ means advice relating to investing in, purchasing, selling, or otherwise dealing in securities or investment products, and advice on investment portfolio containing securities or investment products. Such advice can be written, oral, or through any other means of communication for the benefit of the client. Investment advice shall include financial planning, as well, which includes analysis of clients’ current financial situation, identification of their financial goals, developing and recommending financial strategies to realize such goals.
  3. Exemptions from registration:IA Regulations have also prescribed exemptions from registration, which includes – any person who gives general comments in good faith in regard to trends in financial/securities market/economic situation, IRDA registered insurance agent, PFRDA registered pension fund adviser, SEBI or AMFI registered Mutual Fund broker, Advocate, Member of ICAI, ICSI, ICWAI, SEBI-registered stockbroker, portfolio manager, merchant banker, Fund Manager of Mutual Fund/AIF, any person who provides investment advice exclusively to clients based out of India
  4. The IA shall conduct yearly audits in respect of compliance with IA Regulations from a member of ICAI or ICSI. This is article is an analysis of the relevant provisions from the perspective of the audit.
  5. Registration requirements:IA can be registered as an individual or a body corporate (company or LLP) or a firm (partnership firm). SEBI has prescribed qualification and certification for each class of applicants. SEBI has also prescribed capital adequacy for IAs. The IAs which are body corporate shall have a net worth of not less than Rs. 25 lacs. IAs who are individuals or partnership firms shall have net tangible assets of value not less than Rs. 1 lac. The certificate of registration granted by SEBI shall be valid until it is suspended or canceled.
  6. Representation as ‘IA’: The IA, not being an individual, shall include the words ‘investment adviser’ in its name. The individuals registered as IAs shall use the term ‘investment adviser’ in all their correspondences with their clients.
  7. General responsibilities of IA: The IA shall act in a fiduciary capacity towards its clients and shall disclose all conflicts of interest as and when they arise. The IA shall not receive any consideration by way of remuneration or compensation or in any other form from any person other than the client being advised, in respect of the underlying products or securities for which advice is provided. IA shall maintain an arms-length relationship between its activities as an investment adviser and other activities. IA which is also engaged in activities other than investment advisory services shall ensure that its investment advisory services are clearly segregated from all its other activities. IA shall ensure that in case of any conflict of interest of the investment advisory activities with other activities, such conflict of interest shall be disclosed to the client. IA shall not divulge any confidential information about its client, which has come to its knowledge, without taking prior permission of its clients, except where such disclosures are required to be made in compliance with any law for the time being in force. IA shall not enter into transactions on its own account which is contrary to its advice given to clients for a period of 15 days from the day of such advice. IA shall follow Know Your Client (KYC) procedure as specified by the SEBI from time to time. IA shall abide by the prescribed Code of Conduct. IA shall not act on its own account, knowingly to sell securities or investment products to or purchase securities or investment product from a client. In case of a change in control of the investment adviser, prior approval from the SEBI shall be taken. IA shall furnish to the SEBI information and reports as may be specified by the SEBI from time to time. It shall be the responsibility of the IA to ensure that its representatives and partners, as applicable, comply with the certification and qualification requirements at all times.

The said responsibilities would be part of the letter of engagement and the Auditor shall verify the same during the compliance audit.

  1. Risk profiling: IA shall ensure that it obtains from the client, certain prescribed information as is necessary for the purpose of giving investment advice. Such information includes age, investment objectives, income details, existing investments/assets, risk appetite/tolerance, liability/borrowing details. IA shall have a process for assessing the risk a client is willing and able to take. Where IA uses tools for risk profiling, it should be ensured that the tools are fit for the purpose and any limitations are identified and mitigated. Any questions or descriptions in any questionnaires used to establish the risk a client is willing and able to take are fair, clear, and not misleading. The risk profile of the client is communicated to the client after a risk assessment is done. The information provided by clients and their risk assessment is updated periodically.

The Auditor would access the documents relating to risk profiling maintained by IA for the purpose of a compliance audit.

  1. Suitability: IA shall ensure that all investments on which investment advice is provided is appropriate to the risk profile of the client. It has a documented process for selecting investments based on the client’s investment objectives and financial situation. It understands the nature and risks of products or assets selected for clients. Whenever a recommendation is given to a client to purchase of a particular complex financial product, such recommendation or advice is based upon a reasonable assessment that the structure and risk-reward profile of the financial product are consistent with client’s experience, knowledge, investment objectives, risk appetite and capacity for absorbing the loss.

The Auditor would access the documents/information maintained by IA w.r.t. suitability of investment products for the purpose of a compliance audit.

  1. Disclosures to clients: IA shall disclose to a prospective client, all material information about itself including its business, disciplinary history, the terms and conditions on which it offers advisory services, affiliations with other intermediaries and such other information as is necessary to make an informed decision on whether or not to avail its services. IA shall disclose to its client, any consideration by way of remuneration or compensation or in any other form whatsoever, received or receivable by it or any of its associates or subsidiaries for any distribution or execution services in respect of the products or securities for which the investment advice is provided to the client. IA shall, before recommending the services of a stockbroker or other intermediary to a client, disclose any consideration by way of remuneration or compensation or in any other form whatsoever, if any, received or receivable by the IA, if the client desires to avail the services of such intermediary.

IA shall disclose to the client its holding or position, if any, in the financial products or securities which are the subject matter of advice. IA shall disclose to the client any actual or potential conflicts of interest arising from any connection to or association with any issuer of products/ securities, including any material information or facts that might compromise its objectivity or independence in the carrying on of investment advisory services. An IA shall, while making investment advice, make adequate disclosure to the client of all material facts relating to the key features of the products or securities, particularly, performance track record. IA shall draw the client’s attention to the warnings, disclaimers in documents, advertising materials relating to an investment product which it is recommending to the client.

The said disclosures to the client should be part of the letter of engagement or letter of appointment. The Auditor shall verify the same during the compliance audit.

  1. Maintenance of records: IA shall maintain certain records, which includes KYC records of the client, risk profiling and risk assessment of the client, suitability assessment of the advice being provided, copies of agreements with clients if any, investment advice provided, whether written or oral, rationale for arriving at investment advice, duly signed and dated, Register or record containing a list of the clients, the date of advice, nature of the advice, the products/securities in which advice was rendered and fee, if any charged for such advice. All records shall be maintained either in physical or electronic form and preserved for a minimum period of 5 years. These are important documents that are considered by the auditor at the time of compliance audit. IA shall keep these records ready for the audit. The Auditor shall verify the records during the compliance audit.
  2. Appointment of Compliance Officer: An IA (which is a body corporate or a partnership firm) shall appoint a compliance officer who shall be responsible for monitoring the compliance by the investment adviser in respect of the requirements of SEBI Act, regulations, notifications, guidelines, instructions issued by the SEBI.The resolution for the appointment of such Compliance Officer should be passed by the body corporate and should be available at the time compliance audit. There is no specific appointment of a compliance officer for individual IA. In such a case, the proprietor shall be deemed to be the compliance officer.
  3. Redressal of client grievances: An IA shall redress client grievances promptly. IA shall have adequate procedures for expeditious grievance redressal. Client grievances pertaining to financial products in which investments have been made based on investment advice shall fall within the purview of the regulator of such financial products. Any dispute between the IA and his client may be resolved through arbitration or through Ombudsman authorized or appointed for the purpose by any regulatory authority, as applicable. With an objective to bring more transparency and enable the investors to make an informed decision regarding availing of advisory services, IAs shall display the prescribed information on the homepage (without scrolling) of their website/mobile app: Number of complaints – at beginning of the month, received during the month, resolved during the month, pending at the end of the month, reasons for pendency.

The Auditor will ask for the documents and information w.r.t. such as redressal of client grievances. The auditor will also access the website and obtain the necessary information.

  1. Receiving fees through banking channel only: With an objective to bring transparency in dealing with the clients, IAs shall accept fees strictly by account payee crossed cheques/demand draft or by way of direct credit into their bank account through NEFT/ RTGS/IMPS/UPI. IAs are directed to not accept cash deposits. Depending on the number of transactions, the Auditor may ask for a declaration or bank statement or both.
  1. Restriction on free trial: SEBI has clarified that IAs shall not provide a free trial for any products/services to prospective clients. The IAs shall not accept part payments (where some part of the fee is paid in advance) for any product/service. The Auditor may ask for a declaration or letter of engagement for compliance of this clause.

The compliance audit by the practicing professional would develop standards of legal compliance by the IA and at the same time, SEBI would primarily rely on the independent audit conducted by the practicing professional for compliance of IA Regulations. The compliance audit would also help the IAs in developing the best legal and disclosure practice in rendering the service.

Gaurav Pingle is a Practising Company Secretary. His areas of practice are Corporate Laws, Corporate Compliance Management, Securities Law – compliance & advisory, and Transaction Advisory Services. He has authored books on Companies (Amendment) Act, 2017, and Related Party Transactions. He is a visiting faculty for ‘Company Law’ and ‘Investment and Securities Laws’ at ILS Law College, Pune.