SEBI's investment advisor regulations have come into effect on 21st October, 2013. From this date, no individual or entity is allowed to offer investment advice to investors without obtaining a registration from SEBI as an Investment Advisor, unless specifically exempted by the regulation. Most intermediaries including mutual fund distributors and financial planners believe that they are exempt and therefore can continue to do business as usual. SEBI on the other hand is extremely unhappy that only 70 odd applications have come to it so far, for registration as an investment advisor (RIA). SEBI's Chairman and ED have expressed surprise at this very low level of applications, and clearly believe that many more entities ought to have applied within the deadline stipulated before the regulation became enforceable (21st Oct 2013). Where then is the gap between the market's interpretation of these regulations and SEBI's own interpretations? Are you now running a business that is illegal, and you don't even know that it is so? What clarifications do we need from SEBI in order to bridge this gap that clearly exists between the understanding of the market and its regulator? And, most importantly, what needs to be done to make the RIA recognition a coveted one rather than one that has to be side-stepped?

It appears that there are 4 major grey areas which are causing a big gap in understanding between the market and the regulator. These are :

1. Do all financial planners (CFP certificants) have to register as an RIA?

2. Does a mutual fund distributor who charges fees for advice have to register as an RIA?

3. Do individuals who distribute multiple products (mutual funds, insurance) have to register as RIAs?

4. Can a distributor create a structure which has two businesses - distribution and advice?

Lets take each one and try and explore what the gap is and what needs to be done to bridge this gap.

1. Financial Planners

SEBI seems to be very surprised that most financial planners (CFP certifications who are practicing as financial planners) have chosen to stay away from seeking the RIA license. Many financial planners we spoke to believe that since they do not offer "investment advice", but a broader proposition called financial planning (which entails risk planning, estate planning etc in addition to investment planning), and since they do not use the phrase "investment advisor" in their name or in any promotional material, they need not become RIAs compulsorily. They have an option to do so, if they see merit. Moreso, since most financial planners also hold an ARN and are mutual fund distributors, they argue that the exemption available to mutual fund distributors anyway is applicable to them as well. So, either way, they don't see a compulsion to become an RIA - rather they see it as an option available for them to decide on.

SEBI's senior management doesn't seem to be very appreciative of this logic - as it was precisely the example of financial planners that SEBI Chairman gave at AMFI's AGM, when he expressed disappointment at the low level of RIA applications. After carefully reading the regulations again, hearing SEBI ED Mr. Ananta Barua at the IFA Galaxy conference last Saturday and after interacting with several market participants who have discussed this issue with SEBI at various levels, I believe SEBI may have a point that perhaps the market has not fully understood.

The crux of the exemption for mutual fund distributors is that they are primarily distributors and offer advice that is incidental to their distribution business. A financial planner cannot however hold out that advice is an incidental activity - as long as he holds out to investors that he is a financial planner, he is effectively holding out that he is an advisor. And, once you represent yourself as an advisor, you can't really say that advice is incidental to your business, which is actually distribution.

Why do I say that financial planning is deemed as investment advice? Because this is explicitly covered in the definitions in the RIA regulations. Take a look at these three definitions that are covered in Clause 2 of the regulations:

2 (l) "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, whether written, oral or through any other means of communication for the benefit of the client and shall include financial planning

2 (h) "financial planning" shall include analysis of clients' current financial situation, identification of their financial goals, and developing and recommending financial strategies to realise such goals

2 (m) "investment adviser" means any person, who for consideration, is engaged in the business of providing investment advice to clients or other persons or group of persons and includes any person who holds out himself as an investment adviser, by whatever name called

Full text of regulations available here :
http://www.sebi.gov.in/cms/sebi_data/attachdocs/1358779330956.pdf

A simple reading of these three definitions suggests that the act of financial planning is clearly seen as "investment advice" for the purpose of these regulations. An investment advisor can call himself whatever (financial planner, consultant etc) - but as long as he is doing the activities defined within "investment advice", he is an investment advisor and therefore by extension, needs to seek an RIA license.

A financial planner who charges a fee for writing plans is clearly offering "investment advice" for consideration, and therefore cannot seek exemption because he is an ARN holder. As mentioned above, I believe such an individual will find it very hard to support an argument that his advice was merely incidental to his distribution business, as he is holding out to investors at large that he is an advisor.

Now, the question is about financial planners who do not charge for writing plans, but earn only through commission income on product distribution. This is an aspect where we need clarity from SEBI. Is the emphasis on the "for consideration" aspect or is the emphasis on the act of offering investment advice? If somebody is doing an activity that clearly falls within the ambit of "investment advice", but doesn't charge for advice, can he claim exemption because he is not an "investment advisor who for consideration, is engaged in the business of offering investment advice". One school of thought is that once you hold out to investors at large that the service you offer is financial planning (which is included in the definition of investment advice), you can't stay away from seeking an RIA license, merely because you don't charge for writing plans. The other school of thought is that as long as you don't charge for advice, you are not technically within the definition of "investment advisor" though what you are doing may well be "investment advice".

This is a matter that we need more clarity from SEBI. A clarification on this aspect will enable hundreds of CFP certifications who are offering financial planning and distribution services to figure out whether what they are doing today is legal or illegal, and enable them to take the necessary steps to be on the right side of the law.

2. Mutual fund distributors who charge fees

Lets say you are not a CFP. You are a mutual fund distributor with an ARN who earns commissions on products and who also offers written advice to clients and who charges a fee for that advice. Are you exempt? The clause which offers this exemption is reproduced below :

4 (d) Any distributor of mutual funds, who is a member of a self regulatory organisation recognised by the Board or is registered with an association of asset management companies of mutual funds, providing any investment advice to its clients incidental to its primary activity

The concept of what is incidental was discussed by SEBI's ED Mr. Ananta Barua at the recent IFA Galaxy conference. From his comments as well as from comments made in various meetings that industry participants have had with SEBI officials, it appears that a mutual fund distributor can not only offer advice but can also charge a fee for his advice, so long as this entire proposition of advice is incidental to his primary activity of MF distribution. So, while there does not appear to be a blanket statement that any fees charged will mean RIA application, what is left to interpretation is how much is "incidental". If fees constitutes 10% of your income and commissions 90%, is the advice construed as incidental? What is the proportions change to 35% fees and 65% commission? At what stage does the fee based advice activity cease to be seen as incidental and become a mainstream activity?

There are a number of mutual fund distributors - particularly in metros - who are making determined efforts to include a fee component in their overall revenue model. Many of them are in a dilemma as they are not sure of what SEBI will finally see as the threshold of "incidental". It is only fair that SEBI provides some clarity to enable this set of distributors with a hybrid revenue model to understand where they stand from a regulatory point of view and what they need to do to remain compliant.

3. Distributors of multiple products

This frankly is the biggest googly of them all. There appears to be a view that while insurance agents are exempt and MF distributors are exempt, if you happen to be both an insurance agent as well as a mutual fund distributor, you may not be exempt and that you may need to seek a RIA licence. This view stems from the specific wording of the exemption given to insurance agents:

4 (b) Any insurance agent or insurance broker who offers investment advice solely in insurance products and is registered with Insurance Regulatory and Development Authority for such activity

There is a view that if an insurance agent is not offering advice solely on insurance products, but for example also offers advice on mutual funds, he may not be exempt. It may be pertinent to note that the phrase "solely in" has been omitted from the clause that provides for an exemption for mutual fund distributors:

4 (d) Any distributor of mutual funds, who is a member of a self regulatory organisation recognised by the Board or is registered with an association of asset management companies of mutual funds, providing any investment advice to its clients incidental to its primary activity

It is interesting to note the use of the word "any" prefixed to investment advice. This could mean that a mutual fund distributor can offer advice on any investment product - whether mutual funds, insurance products, company deposits etc and still be within the exempt category.

It appears that in meetings that some industry participants have had with SEBI officials, SEBI's view is that it is desirable for distributors of multiple products to become investment advisors - perhaps the thinking is that if you are distributing a variety of financial products, you are in fact advising every client on alternative product categories and suggesting which instrument you think is appropriate for him. If this is indeed SEBI's official position on distributors of multiple products, it can have very serious implications, particularly for IFAs. As is known, a large proportion of mutual fund distributors are also insurance agents - but the reverse is not true. If a large cross-section of mutual fund distributors are now seen as distributors of multiple products and therefore people who should seek an RIA license, it can have fairly large ramifications on the IFA channel.

A significant proportion of the IFA fraternity needs urgent clarity from SEBI on this issue. Does the fact that they also distribute other financial products besides mutual funds in any way suggest that they are no longer exempt under 4(d)? One would seriously hope not.

4. Structuring a hybrid model

The regulations are quite clear on how companies can adopt a hybrid model - of having an advisory arm and a distribution arm within the same entity - by creating a separately identifiable division or department (SIDD). There are explicit guidelines on creating an arms-length distance between the two units and exhaustive guidelines on disclosures to be made to clients when following such a hybrid model. Large distribution houses, banks and some of the larger IFAs who have corporate entities and teams will be able to create their SIDDs and be compliant with their hybrid models. They do not face the prospect of making a choice between fees and commissions - their companies will get both revenue streams. They can actually leverage the RIA license and position themselves stronger in the market place.

The issue is with individual distributors who are keen to become RIAs. A potential solution would have been to have an ARN in a family member's name while the most qualified and experienced individual in the family applies for an RIA licence. A few IFAs who sought SEBI's guidance on such a modus operandi have apparently been informed by SEBI that this will not be looked at favourably by SEBI. SEBI's ED also suggested likewise at the IFA Galaxy conference last week.

An IFA who wishes to become an RIA has to necessarily take a choice between commission vs fees. He has to give up all commissions and start building a fee income stream - unlike his larger counterparts who can create hybrid models and enjoy both revenue streams.

SEBI may perhaps want to re-examine its informal guidance on this aspect, on the following grounds:

1. When the regulations permit a corporate entity to operate a hybrid model and specify the disclosures to be made to investors, why discriminate against an individual advisor who may refer clients to a distributor within his family, with the same disclosures?

2. If an individual becomes an RIA, does that mean automatically that no family member of his can become a mutual fund distributor? On what grounds can an individual's choice of business be restricted or barred because of the nature of business of another family member?

3. Conversely, if the son or daughter of a mutual fund distributor wishes to take up the investment advisory profession, can he be barred from entering this profession because his father is a distributor?

Apart from the legalities involved and potential infringements of constitutional rights that this informal guidance may imply, the basic point here is that there are indeed a large number of IFAs who would love to be seen as investment advisors, who are willing to take their business to the next level - but who are deterred only because of the thought of giving up their commission income streams that they have worked so hard to build up. If SEBI is indeed keen on seeing many more RIA applications than 70, it may want to consider providing the same playing field for individual distributors as they have provided for larger corporate entities : allow them to set up hybrid structures within their families, with the same disclosure requirements as are spelt out for SIDDs of corporate entities.

Make the RIA tag a coveted one rather than one that must be avoided

For the vast majority of distributors, the reality is that they would rather duck the RIA licence rather than take on a lot more work for less income. There is clearly no financial incentive for existing market participants to convert their business models. If SEBI says that it is time for you to choose whether you want to be an advisor or a distributor, it may also want to consider the commercial viability of a stand-alone advisory entity. Until such time that the commercial viability of a stand-alone fee based advisory model is clearly established in the market place, permitting a hybrid model - across distribution channels - is the prudent way forward.

What we would really like to see is a prudent and commercially viable model, which is then backed by a concerted education effort to help upskill the current participants and then followed by a media campaign that educates investors about the benefits of seeking advice from an RIA. This will make the RIA tag a coveted one rather than one that needs to be avoided.

The reality is that under the present regulations, we will have most large distribution firms opting for a hybrid model, the vast majority of individuals remaining as distributors (even if some of them wanted to be seen as advisors), and a small niche segment of individual advisors. Advice will then become available mostly from larger institutionalised entities - which is completely counter-intuitive, as it is often felt that well qualified and well regulated individuals are perhaps better positioned to offer truly personalised advice on a long term basis to investors. It would indeed be unfortunate for the industry and for investors if we are deprived of this important link to investors because a commercially viable model could not be created.

Meanwhile, the crucial aspect that deserves regulatory attention is to find ways to address the gap between interpretations of the market participants and the regulator on who needs to and who does not need to seek an RIA licence. Market participants are understandably anxious - now that they have seen SEBI's displeasure over a mere 70 RIA applications - whether the business they are currently conducting is deemed legal or illegal by the regulator.

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