‘Incidental advice is an area where there is a lot of misuse’

Suresh Sadagopan of Ladder7 Financial Advisories shares his take on the new consultation paper for RIAs.
By Guest |  23-01-20 | 
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There is a new consultation paper from SEBI seeking to update the Investment Adviser (IA) Regulations 2013.  There are several proposals made to improve the current regulatory framework and make the regulation more investor friendly.

The various provisions need to be examined carefully to see how they may impact various stakeholders and examine whether the provisions will be truly helpful and acceptable to all stakeholders.

Client level segregation

This is a radical, out of the box thinking from SEBI, which is a welcome move. This allows the clients to be segregated into advisory and distribution clients for the family or group level.

This means that for Individual Advisers & their family members, a client is either an advisory or a distribution client. For corporate advisers & their group entities again, the client is either an advisory or a distribution client.

This brings parity to do both activities for individual & corporate entities, which addresses one of the standing complaints that people had about advisory regulation.

Also, this is the least disruptive model for a distributor who intends to transition to advisory role.

But, there are still aspects which need to be ironed out. For instance, a family entity is defined as the couple along with dependent parents & dependent children. The word dependent will need to be defined.

A parent who has Rs 10 lakh income may still be dependent on their children as their expenses are higher than that. Can a person having such level of income be termed as dependent and who will decide that?

Can children who have income on their own and living with parents be called dependent? Up to what point can they be termed as dependent? What happens when a person wants to avail advisory services whereas the parent or even the spouse wants to avail distribution services?

These need to be clarified for client segregation to work well.

Implementation of Advice

The proposal seeks to allow implementation services, if the client wants, in non-commissionable (Direct plans) wherever available. IAs are not supposed to charge any fee for these services.

IAs should be allowed to charge for implementation services if this is within the overall fee limits prescribed by SEBI. Also, all products do not have a non-commissionable version. In such cases, the IA should be allowed to adjust the commissions received from such products by offsetting against the fee charged, retaining the conflict-free nature of the model and being fair to the clients.

Terms of Investment Advisory Services

The paper rightly directs the Investment Adviser to enter into a proper agreement with the client, detailing the terms and conditions of the advisory engagement.  This part which mentions the salient points that needs to feature in the agreement with the client is well brought out.

Terms of Fees

This paper makes it mandatory for fee collection to be through banking channels which are traceable. It also deals with matters like periodicity of billing, liabilities of the Investment Adviser, provisions in relation to continuation / termination of advisory services in the event of client’s death/ disability etc.

There is an interesting provision in this paper.  Every individual adviser must appoint one of its legal heirs, executor, trustee etc. as person-in-charge in the event of advisers’ death/disability. A document disclosing what this person is expected to do in such an eventuality so that the clients are not inconvenienced or are put through minimum trouble.

Fee & fee collection

The extant IA Regulation allows an Investment Adviser to charge clients a fair and reasonable fee. This paper seeks to dictate the fees, fee models and when they can be changed, how much can be collected in advance etc.

The paper states that the justification for this intrusive intervention are the complaints received by SEBI regarding unreasonably high fees charged, forcing clients to pay multiple fees etc. An examination of the complaints points out that the complaints are almost entirely against stock-tip providers, who come under the same IA Regulation.

The fixed fee has been limited to Rs 75,000 for a year and only two quarter fees can be charged in advance. Asset Under Advice (AUA) fee can be up to 2.5% pa. Only one model can be active at any time.

The fixed fee allowed is too low and in a comprehensive financial planning situation, only 50% of the fee and not the entire fee can be collected in advance, as per this paper. Also, there is no escalation clause for the fee over the years.

If the fee is Rs 60,000 and if only Rs 30,000 can be collected in advance, the adviser needs to wait for six months to collect the balance fee for something where the work is entirely completed in the first 30-45 days. If the client refuses to pay after six months, the adviser does not have any recourse, but for arbitration or courts. This makes the advisory practice vulnerable to the client’s whims and fancies and throws a spanner in the works of those practising the trade ethically.

Proscribing fee levels and the way it can be charged will directly impact the business viability of the advisory practice. The collateral damage for good advisers in unacceptable high and hence none of these should be introduced.

Those flouting it and causing problems should be isolated and brought to book. The stock-tip providers are essentially dealing in equities and related instruments. The stock-tip providers offer tips or calls across the board, with the idea of helping their clients get good returns. There is no real advice based on the client’s specific situation and hence may fit better under stockbrokers’ regulations rather than under an advisory regulation like Investment Adviser Regulations. They can be under better surveillance under a stock exchange which will control & regulate their members.

Eligibility criteria for IAs

The Investment Adviser needs to have a Professional qualification or a Post graduate degree and five-year experience in securities, investment products, fund management etc. The IA also needs to have a certification directly related to the investment advice.

In case of non-individuals, a principal officer satisfying the condition can be appointed who satisfies these eligibility conditions. Persons associated with investment advice will also need to comply with the above requirements but with a minimum experience of two years.

The eligibility criteria has gone up significantly as compared to existing IA Regulation. While it is good to have high standards, this should not become a barrier for people to come in as advisers. Also, asking even persons associated with investment advice to comply with the eligibility criteria (albeit with lower two years’ experience) is going to pose an impediment in getting people who qualify difficult. Staying with the eligibility criteria as specified in the existing IA Regulations, albeit with two years’ experience criteria for persons associated with investment advice, would work better.

Net worth requirements

Net worth requirements have gone up from Rs 1 lakhs to Rs 10 lakhs for individuals and Rs 25 Lakhs to Rs 50 Lakhs for corporates.

Also, for those who have over 150 clients or Rs 40 Crores AUA compulsory corporatization is necessary. This is a very low threshold and is troublesome if seen alongside fee restrictions and the net worth requirement of Rs 50 Lakhs for those transitioning into a corporate advisor.

Let us take an example. Let us say an individual adviser charges, on an average, Rs 20,000 fixed fee for a financial plan. For 150 clients, the gross revenue would be Rs 30 Lakhs.

If the same individual has 150 clients and has an average asset per client of Rs 27 Lakhs, the asset base is about Rs 40 crore. The revenue potential assuming 1% charge in assets is about Rs 40 Lakhs.

In both the above situations, they need to corporatize. The net revenue in both cases may be half or less. A person at this stage of earning would hardly be in a position to transition to a corporate structure with Rs 50 lakhs net worth requirement.

Ideally, the structure under which one conducts the business should not be regulated. Even if it is needed, the criteria should be much higher net revenue of say Rs 5 crore and a much higher AUA of at least Rs 500 crores.

What is missing

Incidental advice is an area where there is lot of misuse. Many are conducting full advisory services, without registering under IA Regulations & complying with the provisions, under the guise of giving incidental services. There is a need to define this and prevent misuse of this provision.

There is a clear need to pin down people to use a nomenclature that correctly represents what they are doing.  MF Distributor should call themselves as such; stockbroker should call themselves that & Investment Advisers should state that as their identifier instead of any creative names like Financial Architect, Financial Guru, Wealth coach etc., which tends to confuse and mislead clients.

SEBI wants advisers to offer advisory services on a fee-only basis. It should hence enable a direct, commission-free version of the various products under its jurisdiction to enable advisers to suggest such products, which is a natural fit for them.

On the whole, the consultation paper has its positives. Some of the provisions which have the capacity to impact the advisory community adversely should be taken cognizance of and corrected before bringing them in the regulations.

Suresh Sadagopan runs Ladder7 Financial Advisories which is a fee-only practice registered with SEBI as RIA.

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Mukund Pawar
Jan 28 2020 12:45 AM
 Nice article!
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