By Priyanshi Bhargav
Image Source: https://www.bankinfosecurity.asia/sebi-firms-must-disclose-fraud-a-8067
“Association of SEBI Registered Intermediaries/Regulated Entities with Unregistered Entities (including Finfluencers)” is the title of a consultation paper published by the Securities and Exchange Board of India (‘SEBI’) on August 25, 2023. The consultation paper’s goal is to gather public feedback on various approaches aimed at preventing SEBI-registered firms and intermediaries from working with unregistered “finfluencers.” While the new rule aims to safeguard the interests of the ordinary retail investor who might blindly follow unregistered finfluencers’ advice, some crucial issues remain unanswered.
Applicable Legal Provision
As the Consultation Paper notes, financial influencers, or finfluencers, are “usually unregistered entities providing catchy content, information, and advice on various financial topics to their several followers”.
While some finfluencers may act as registered Investment Advisors (IA) or Research Analysts (RA), the majority are unregistered entities and are frequently connected to an intermediary or SEBI-registered entity.
Finfluencers currently fall under a regulatory “grey area.” The SEBI (Investment Advisors) Regulations, 2013 (‘IA Regulations’) and the SEBI (Research Analysts) Regulations, 2014
prevent anyone from performing the task of either IA or RA without first obtaining a registration certificate from SEBI. Specific academic requirements (and further certifications) as well as “at least five years of experience in “activities connected to counseling in financial services or securities, fund, asset, or portfolio management” are required to qualify for IA certification, according to Regulation 7 of the IA Regulations. Corresponding educational and professional requirements are listed in the RA Regulations as prerequisites for registration as a research analyst. An IA is only permitted to receive payment from the client being advised in terms of compensation. Likewise, an RA is not permitted to collect any kind of royalty or referral incentive from the organization that hires them for research. The Board of Directors or a committee that the Board of Directors appoints must also assess the RA’s compensation each year.
Moreover, an IA must allow others to watch their securities transactions because they are unable to engage in any transactions that go against their own advice. IAs must also tailor their suggestions for each client based on their unique risk profiles. An RA, on the other hand, is not allowed to trade in stocks they advise or follow between the thirty days prior to and the five days following the release of their report since their trades must be closely watched. Additionally, RAs are not allowed to execute any trades that go against their recommendations.
Obtaining the necessary registrations as IAs and RAs may be difficult for finfluencers for a number of reasons, the most important of which are probably the regulatory restrictions on having the necessary qualifications, examination of transactions, and non-gratuitous communication with anyone other than those being advised. The consultation record highlights that SEBI-registered businesses and intermediaries frequently give finfluencers concealed financial benefits. They influence their followers by offering financial advice in exchange for such payment, although frequently missing the legal requirements to be an IA. Even if they meet the requirements, many finfluencers will not be eligible to register as an IA or RA. As they are not delivering any services to the registered businesses or intermediaries, they will also be prohibited by regulation from receiving any payment from them.
Proposed Law
Unregistered finfluencers who might persuade their followers to buy goods, services, or stocks in exchange for payment from producers or platforms that is not disclosed to the followers have raised concerns with SEBI. Therefore, it acknowledged the necessity to limit the flow of such compensation between such unregistered entities and registered intermediaries or regulated entities. Furthermore, since they are not registered, such finfluencers can lack the necessary credentials or subject-matter knowledge, and they are not bound by a code of conduct that requires them to disclose conflicts of interest, among other things.
Therefore, SEBI has suggested to make it illegal for registered intermediaries, regulated organizations, or their agents to have any associations or relationships, whether direct or indirect, with any unregistered entities in order to promote their services or goods. Additionally, they would be forbidden from giving such unregistered organizations access to the private information of their clients. Additionally, it has been suggested that any trailing compensation depending on the volume of referrals be prohibited from being paid by regulated or registered intermediaries as a referral fee. It has, however, suggested a carve-out for a small number of referrals from retail customers and the payment of fees for such a small number of referrals by stockbrokers. Additionally, SEBI registered intermediaries and registered entities may be required to take proactive steps to distance themselves from any unregistered entity using their name, product, or service and to take the necessary enforcement agency action, including by filing cases under Section 420 of the Indian Penal Code.
Critical Analysis of Proposed Law
The consultation paper’s proposed regulations seem to be a step in the right direction toward mitigating the negative effects that can result from biased and possibly financially driven advice given to followers by unregistered finfluencers. Some important issues about the actual application of this legislation, remain unanswered. The lack of clarity regarding how content published by unregistered finfluencers, is in violation of any current or planned regulations on this topic will be handled, raises the first crucial concern with regard to the implementation of the proposed regulations. Through various social media platforms like Instagram, Facebook, and YouTube, today’s finfluencers offer investment advice. The Information Technology Act of 2000, read with Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Rules 2021 officially governs issues pertaining to removing content from the internet. The procedures for the removal are cumbersome and it would be impractical to ban content that violates the legal framework in this way and it would prevent the proposed regulations from being implemented effectively. By the time the required formalities and procedures are finished, it’s possible that irreparable harm will have been done in terms of influencing retail investors.
Another important issue that the securities watchdog might find worthwhile is to take into account the applicability of the new laws on non-resident, unregistered finfluencers providing advice to Indian nationals. This is a second crucial issue. The Supreme Court in Securities and Exchange Board of India v. Pan Asia Advisors Ltd. stated that any person, even “citizens abroad” and those not “corporally present” in India, who commits an act that “affects the legitimate interest of this country” is subject to SEBI’s jurisdiction. Therefore, providing such influencers with clear guidance on how the proposed legislation would be enforced may be helpful.
Finally, SEBI has stated an intention to pursue enforcement action against any finfluencers who violate current SEBI laws, even if the proposed laws aim to address the threat posed by finfluencers by regulating registered intermediaries. The IA and RA Regulations’ actual applicability to finfluencers is thus a crucial subject that remains unsolved. According to SEBI, finfluencers are “effectively unregistered and unauthorized Investment Advisers (IAs) or Research Analysts (RAs)” in the consultation document. However, the proviso to Regulation 2(l) of the IA Regulations expressly excludes “advice given through newspaper, magazines, any electronic or broadcasting or telecommunications medium, which is widely available to the public” from the definition of “investment advice”. This appears to create a problem with the rules governing finfluencers’ applicability.
Conclusion
The public is seriously threatened by the broad transmission of unlicensed finfluencers’ unchecked investing advice. This concern is exacerbated by the fact that the unassuming retail investor is unaware of the potential financial incentives behind the investing advice provided by such influencers. The consultation paper is an admirable step in the direction of necessary regulatory measures to reduce these potential harms, protect investors’ financial interests, and promote responsible financial content. A strong method for reducing the potential risk associated with such guidance would be established with the help of answering the questions posed in this article.
