SEBI Clarifies Key Aspects of Investment Advisers Regulations through Informal Guidance

The Securities and Exchange Board of India (“SEBI”), through its interpretive letter, issued upon the request of Paytm Money Limited (“Paytm”) under the SEBI (Informal Guidance) Scheme, 2003 (“Informal Guidance Scheme”), on April 09, 2021, has clarified that investment advisers (“IAs”), registered with SEBI under the SEBI (Investment Advisers) Regulations, 2013 (“IA Regulations”), may not: (i) be reimbursed from the asset management companies for any expenses incurred for services rendered to their clients, even though the adviser may not be charging any advisory or execution fees; (ii) seek electronic consent from clients prior to rendering any investment advice, instead of a signed investment advisory agreement; and (iii) appoint a department head, who is not a managing director or designated director or managing chairman or executive chairman or any other equivalent management body of the IA, as its ‘principal officer’.

SEBI’s Informal Guidance Scheme

Under the Informal Guidance Scheme, guidance may be sought from SEBI by, inter alia, intermediaries registered with SEBI by way of a no action letter or an interpretive letter. An interpretive letter involves a department of SEBI providing its interpretation of relevant laws in the context of any proposed transaction in securities or a specific factual position. Notably, an interpretive letter issued under the Informal Guidance Scheme is not a conclusive decision or determination of any question of law or fact by SEBI and cannot be construed as an ‘order’ under the provisions of the SEBI Act, 1992. Nevertheless, the Informal Guidance Scheme provides guidance on various practical implications that arise due to the interpretation of applicable laws.

Clarifications sought by Paytm and SEBI’s view

  • Query 1

Whether Paytm may avail reimbursement of service related to out of pocket expenses such as KYC, technology hosting, platform hosting, etc., from asset management companies of mutual funds whose direct plans it recommends to its clients?

  • Applicable law

As per regulation 22A of the IA Regulations:

    • IAs may provide implementation services to their advisory clients, provided that, no consideration, including any commission or referral fees, whether embedded or indirect or otherwise, by whatever name called, is received, directly or indirectly, at the IA’s group level.
    • IAs or their group entities shall not charge any implementation fees from their clients; and
    • A client of the IA shall not be under any obligation to avail implementation services from the IA.
  • SEBI’s view

SEBI has clarified that considering the prohibition under point (i) and point (ii) above, Paytm cannot avail reimbursement of any amount from the asset management companies whose direct plans are being recommended to their advisory clients.

  • Query 2

Whether Paytm may seek electronic consent from its clients containing all the necessary points mentioned under the relevant SEBI circular?

  • Applicable law

Per regulation 19(1)(d) of the IA Regulations, read with point 2(ii) of the SEBI circular dated September 23, 2020 (“Circular”), there has to be an investment advisory agreement between an IA and its clients, covering all the mandatory terms and conditions prescribed under the Circular, before any investment advice is rendered or any fee is charged for the services.  

  • SEBI’s view

SEBI has clarified that the IA Regulations and the Circular envisage that no investment advice should be rendered by an IA to any client unless consent is received on the terms and conditions prescribed thereunder. Moreover, from the perspective of enforcement of the rights and obligations of the parties, SEBI has required IAs to compulsorily enter into an agreement with their clients, incorporating the terms prescribed under the Circular and therefore, merely seeking electronic consent from the clients may not be sufficient compliance with the IA Regulations, read with the Circular.

  • Query 3

Whether (i) any member of a committee, appointed by the board of directors of Paytm to oversee advisory functions and operations, can be considered as ‘management body’; or (ii) the department head of the advisory business of Paytm, who is a member of the management advisory committee be appointed as a principal officer as defined under the IA Regulations?

  • Applicable law

As per regulation 2(1)(s) of the IA Regulations, the term ‘principal officer’ shall mean the managing director, or designated director, or managing partner or executive chairman of the board of directors or equivalent management body, who is responsible for the overall function of the business and operations of the non-individual IA.

  • SEBI’s view

SEBI has clarified the following:

    • The IA Regulations require the head/ member of the board of directors of the corporate IA to be responsible for the functions and business operations of the IA. Further, in the context of the term ‘equivalent management body’, the same is understood to mean equivalent management bodies in cases of a corporate IA other than a company (such as a limited liability partnership). In such instances, the corresponding person eligible to be appointed as a principal officer would be the executive chairman of the managing body of the limited liability partnership.
    • Unless the member of any committee, constituted by the board of an IA, is also the managing director or designated director or managing chairman or executive chairman or any other equivalent management body of the IA, he shall not be eligible to be appointed as the principal officer of the IA.

Concluding remarks

SEBI’s guidance is welcome as it clarifies some key aspects of the IA Regulations. The immediate impact of this informal guidance would be that IAs would need to review if any expenses for implementation of advice are being reimbursed from the product manufacturers for bona fide ancillary services rendered on their behalf in connection with the investment advice.

Notably, neither the submissions of Paytm pertaining to seeking e-consent from their clients, nor the analysis of SEBI, take into consideration (i) the provisions of the Indian Contract Act, 1872, or the Information Technology Act, 2000 (“IT Act”), which permit use of electronic signatures or Aadhaar based authentication of documents (except those documents which have been specifically provided under the first schedule of the IT Act, such as negotiable instruments and power of attorneys); and (ii) the difficulties of executing contracts physically due to lockdown related restrictions imposed by the government to contain the spread of COVID-19. Therefore, wealth and investment advisors, particularly web-based or mobile application-based advisers should review their internal processes to enter into signed investment advisory agreements with their clients using legally permissible methods.