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Combating Finfluencer Conundrum: The unregistered Investment Advisors

Guest Writer

This post has been authored by Owais Khan, Final year student at Government Law College (GLC), Mumbai. He is also pursuing a Post- Graduate Diploma Course in Securities Law from GLC, Mumbai.


Introduction

On 10 December, 2024 the Securities and Exchange Board of India (“SEBI”), in an Order, held Ravindra Bharti Educational Institute Private limited (“RBEIPL”) and its directors, liable for engaging in unregistered Investment Advisory (“UIA”) activities and mis-selling of securities to the detriment of retail investors. Consequently, a penalty as well as disgorgement of the amount received in the course of UIA was directed by SEBI.


The present article deliberates on the unique modus operandi applied by RBEIPL in the present matter, the nature of relationship between the Investment Advisors (“IA”) and its clients, and finally SEBI’s active scrutiny in unveiling and regulating the rising tide of UIA undertaken by finfluencers.

 

Factual Background and Findings:

The present UIA activity unveiled in the order came to light when SEBI carried out the inspection of Mr. X, an Authorised Person (“AP”) of a stock broker. It was observed that the trades carried out by the AP for the stock brokers client was initiated by the representatives of the AP acting on behalf of the clients, rather than clients taking their own decisions.


It was revealed that RBEIPL used APs premises as well as its trading terminal, thus acting as the representatives of AP. These trades were often made through trading accounts opened with the same stock broker where Mr. X acted as the AP. Mr. X was the father of the director of RBEIPL.


The said complex trading mechanism was designed only for the limited purpose of displaying that the IA services was provided by the AP of the stock broker, rather than by RBEIPL. Thus, the investigation found that the AP was involved in directing clients trade through RBEIPL, which was found to be violative of the regulations of the stock exchange.


The present order does not state the Stock Exchange with which the stock broker was engaged.  However, all the stock exchanges provide that the AP shall not engage in any scheme which provides for assured returns, in contravention of the SEBI or Exchange rules and regulations. Only for the purpose of clarity in understanding, the author refers to the National Stock Exchange Circular prescribing the same.


Similarly, Delegatus Non Potest Delegare, which means a delegate cannot delegate. Thus, the AP is a delegate of a stock broker thus cannot delegate its functions further. Thus, through this investigation, RBEIPL emerged as a suspicious entity before SEBI. 


Wealth Management Agreement

RBEIPL acted as a training institution, which sold stock market trading related course and wealth management plans to their clients. For the said purpose, Wealth Management Agreement (“Agreement”) was executed with the clients, which explicitly demonstrated RBEIPL as an IA. The Agreement provided for wealth management plans which included investment research, advice and stock recommendation on payment of management fees, along with a provision for profit sharing with the clients.


The Agreement also assured unrealistic high returns ranging from 25% to 1000%. Also, the Agreement contained a standard clause allowing RBEIPL to carry out 100% allocation in equity. Clients were induced to trade in specific scrips using the trading terminal operated by the AP, who was RBEIPLs related entity.


The whole-time member found RBEIPL and its directors had thereby violated the Securities and Exchange Board of India Act, 1992 (“SEBI Act”), the SEBI (Investment Advisors) Regulations, 2013 (“IA Regulations”) and the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (“PFUTP Regulations”) by acting as IA without any certification from SEBI.


Analysis

Surely, SEBI deserves the highest form of appreciation for unveiling this said UIA activity undertaken by the directors of RBEIPL, in light of the complicated web established for the same. The terms of the Agreement and the clarifications outlined against the same by SEBI, is what makes this order unique and novel.


Firstly, it elaborated on the exemption provided to the intermediaries under the IA Regulations. It was argued that Sub broker as an intermediary is exempted from obtaining registration under Regulation 4(g) of IA Regulations and AP comes within the ambit of sub broker. Thus, it was the AP who acted as the IA and not RBEIPL, and thus it is exempted from registration.


SEBI held that AP is not an intermediary registered with SEBI, and does not constitute Sub- broker. Also, RBEIPL explicitly displayed itself as a registered IA, and thus it was RBEIPL and not AP, undertaking the UIA activities. Also, the Agreement for investment was undertaken with RBEIPL and not the AP.


There is another violation undertaken by the AP. However, the order is taciturn on the same. In the matter of Century Finvest Private Ltd., SEBI has held that allotment of trading terminals to unauthorized persons constitutes a violation of the SEBI and Exchange circulars. In the present case, AP allowed its terminal to be operated by the employees of RBEIPL. Thus, this is another violation by the AP.


Secondly, RBEIPL claimed that its activities fall within the ambit of investment research, but not investment advice. SEBI held that RBEIPL managed the portfolio of its clients unilaterally. Further, a management fee was charged for providing the same advice, which is a “consideration”. Thus, the activities undertaken aptly falls within the ambit of the definition of IA, as outlined in Regulation 2(m) of the IA Regulations.


There have been several previous orders like in the matters of M/s India Infoline Ltd. and Kabir Financial Services Pvt. Ltd. where SEBI had held IA liable for undertaking UIA without requisite certification on the basis of a consideration charged by them, and also directed disgorgement of the consideration.


Thirdly, the Agreement incorporated a standard clause allowing RBEIPL to undertake 100% allocation in Equity. Regulation 16 of the IA Regulation imposes a liability even on registered IA to undertake risk profiling of its clients. Thus, though the order does not go into it, RBEIPL may have also violated Regulation 16 of IA Regulations, for not undertaking the risk profiling to evaluate the risk profile of the clients and also the PFUTP regulations.


We have the order in the matter of Capital Via Global Research Ltd., wherein SEBI held Capital Via liable under Regulation 16 of IA Regulations for not communicating the risk profile and failing to ensure that whether the advice provided to the client was suitable as per their risk appetite.


Fourthly, RBEIPL assured clients of unexpectedly high returns ranging from 25% to 1000%. It has been held in various orders including in the matter of MSS Trading System Centre, that assurance of profit is a fraudulent activity within the PFUTP Regulations. Also, since the Agreement provided for a profit-sharing clause with the clients, RBEIPL induced clients to trade in specific scrips. Thus, RBEIPL was held to be violative of Regulation 3 (a), (b), (c) and (d) of the PFUTP Regulations, read with Regulation 15(1) of IA Regulations that require IA to act in fiduciary capacity with the clients.


Finally, RBEIPL claimed itself as a finfluencer, who is outside the ambit of registration as per the present regulations and are genuine educators. However, SEBI held that providing investment advice, without mandatory certifications constitutes UIA which is violative of the Regulation 3 of IA Regulations as well as the provisions of Regulation 3 and 4 of PFUTP Regulation, read with Section 12A of SEBI Act.


At present, PFUTP Regulations in Regulation 4(2)(k) contains explicit provisions which prohibits disseminating information or advice through any media, whether physical or digital, which the disseminator knows to be false or misleading, Regulation 4(2)(o) prohibiting fraudulent inducement of any person and Regulation 4(2)(s) which prohibits mis-selling of securities.


SEBI has been at the forefront of targeting entities displaying as educational institutes and disseminating investment advisory, as can be can be corroborated by a recent SEBI Order in the matter of Baap of Charts.


SEBI in the consultation paper titled Association of SEBI Registered Intermediaries/Regulated Entities with Unregistered Entities (including Finfluencers) dated August 25, 20223 (“Consultation Paper”) defined finfluencer as “persons  who  provide information and/or advice on various financial topics such as investing in securities, personal  finance,  banking  products,  insurance,  real  estate  investment,  etc. through social/digital media platforms/channels,  and have the ability to influence the financial decisions  of  their  followers”.


It highlights the active use of social media platforms used by these entities and has laid down various mechanism to disrupt the revenue model of the finfluencers including prohibition on referral fee, commission, etc. SEBI its board meeting dated 27 June, 2024 SEBI has decided that entities registered with it, shall not have any association with persons who provide advise without any SEBI registration. This decision is aimed to dissuade the activities of finfluencers.


Conclusion

This order of SEBI highlights the evolving modus operandi of the finfluencers. The author advocates that a blanket ban on the finfluencers shall not be right approach for this conundrum. Thus, it is high time that SEBI formulates a specific regulation for finfluencers, as provided for other intermediaries, with statutory obligations and their role in the capital market ecosystem.


The views expressed in this Blog Post are solely of the Guest Author.

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