Are You Aware Of All Conflicts Of Interest?
Okay, so you have signed up with a fee based “Advisor”. Well, have you? Having a fee agreement DOES NOT make any intermediary an “Advisor”. It needs to be compliant to many SEBI rules and regulations as part of the Investment Advisors Act 2013 and provide essential disclosures.
So, what are the things that a client needs to keep in mind, verify with the advisor on a regular basis and make sure to get all necessary declarations in writing?
Let’s first take a look at some SEBI FAQs on Investment Advisors Act 2013:-
- •An investment adviser 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.
- An investment adviser shall act in a fiduciary capacity towards its clients and shall disclose all conflicts of interests as and when they arise. He shall act honestly, fairly and in the best interests of its clients and in the integrity of the market.
- If the client desires to avail the execution services, an investment adviser shall, before recommending such services of a stock broker 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 investment adviser from such intermediary
These are crucial obligations and call for disclosure of all “conflicts of interest”. What it means is that any fact that may make the advisor biased towards or against selecting an asset class, fund manager, product etc. will have to be clearly disclosed before the investment is made.
Common Conflicts of Interest and Disclosures
If the advisor is receiving any commission/brokerage, referral fee, placement fee etc. of any kind, whether cash or otherwise for selecting a particular product — This is a very common source of conflict of interest. If the intermediary receives any monetary or non-monetary benefit in lieu of choosing a particular product or investment opportunity that has to be disclosed before the investment is made.
- Monetary benefits may include a commission for selling a mutual fund, PMS scheme, Alternate Investment Fund (AIF), startup equity deal, a real estate property, etc. In some cases, the payment may be in multiple layers inside the same product, e.g. setup fee, trail fee, and in some cases share from the Carry.
- Non-monetary benefits may include situations like a particular fund manager acting as a catalyst to give more client referrals to the intermediary in exchange for selling a particular fund to the intermediary’s clients.
Important to mention that these payouts may be over and above the fee charged by the intermediary from the client.
Savvy marketing will aggressively sell a lower advisory fee to attract the client while other payouts as listed above will add to the total earnings for the intermediary. Sometimes the fee-charging vehicle and the commission/brokerage receiving vehicles may be sister companies or have a Holdco-subsidiary relationship.
The product selected is manufactured by the Asset Management Company (AMC) which partially or fully owns the Advisor (or vice-versa)
The intermediary & the AMC are owned by the same company directly or indirectly (in-house products) — This conflict is very prevalent in large financial services groups. This arises when the intermediary purposefully includes products/deals manufactured/structured by a group entity with an intent to benefit the group.
- The conflict might lead to a monetary gain of having additional income from management fee/carry from the in-house product over and above the Advisory fee contracted with the client.
- Another hidden intent might be to shore up the AUM of a group company (possibly for a valuation gain) by adding the products to the client’s portfolio even though the product may not be of adequate quality and performance.
- In some cases, investment banking deals may be distributed to the client as the investment banking arm may be running an important mandate which is crucial to the business. Many a time when the deal is rejected by institutions it is re-packaged to make it seem attractive to unsuspecting clients. With all the buzz around startup investing many relationship managers may push such deals to their clients without proper risk diligence or need in the portfolio.
If any individual in the product manufacturer setup is in any way related to the advisor by way of any personal linkages — This conflict arises due to nepotistic intent to help a family member. As with all conflicts of interest, this can also add low-quality products or deals into the client portfolio.
The intermediary may be intending to help a relative by choosing his/her managed product or to provide any other monetary benefit in their career or business
Clients must be incredibly careful about these “Facades or Propriety” and insist on all disclosures in writing from the intermediary. The global financial crisis of 2008 clearly showed that large brand names also do not safeguard client’s interest as their priority. While we cannot paint everybody with the same brush it is important for the client to not just go by brand, size, or even fancy awards!