[Aamir Kapadia and Avinash Kotval are penultimate and final year BBA LL.B. (Hons.) student at Jindal Global Law School, Sonipat, respectively]
On August 25, 2023, the Securities and Exchange Board of India (‘SEBI’) released a consultation paper on ‘Association of SEBI Registered Intermediaries/Regulated Entities with Unregistered Entities (including Finfluencers)’. The purpose behind the consultation paper is to solicit public comments on various measures intended to clamp down on the association of SEBI-registered entities and intermediaries with unregistered ‘finfluencers’. While the proposed regulation purports to protect the interests of the average retail investor who may unseeingly heed to the guidance of unregistered finfluencers, certain vital questions remain unaddressed.
Applicable Legal Regime
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 be registered Investment Advisors (‘IA’) or Research Analysts (‘RA’), most operate as unregistered entities, often associated with a SEBI-registered entity or intermediary.
Currently, finfluencers belong to a regulatory ‘grey area’. The SEBI (Investment Advisors) Regulations, 2013 (‘IA Regulations’) and the SEBI (Research Analysts) Regulations, 2014 (‘RA Regulations’) prohibit any person from acting as an IA or RA, respectively, without having obtained a certificate of registration from SEBI. Regulation 7 of the IA Regulations stipulate specific academic qualifications (and further certifications), and “at least five years of experience in “activities relating to advice in financial products or securities or fund or asset or portfolio management” to qualify for IA certification. The RA Regulations specify similar educational and professional qualifications required to be registered as a research analyst.
Concerning compensation, an IA may not receive any payment from anyone other than the client being advised. Furthermore, an RA cannot accept any form of royalty/referral bonus from the entity employing them for research, and their compensation must also be reviewed annually by the Board of Directors or a committee appointed by them.
More importantly, an IA must open their securities transactions to scrutiny, as they cannot make any trades contrary to their own recommendations. Additionally, IAs need to customize their recommendations for every client based on their respective risk profiles. On the other hand, an RA, whose trades must be monitored, is prohibited from dealing in securities that they recommend or follow within thirty days before and five days after the publication of their report. RAs are also prohibited from making any trades contrary to their recommendations.
Additionally, the National Stock Exchange, vide Circular PNSE/COMP/55482, requires that any payment made by brokers to influencers is approved by the stock exchange and includes disclosures. It also prohibits influencers having more than 10 lakh followers from being part of advertisements.
Regulatory requirements on possessing appropriate qualifications, scrutiny of trades and non-gratuitous contact with anyone other than those being advised are arguably the primary reasons finfluencers are hesitant to obtain requisite registrations as IAs and RAs. Frequently, finfluencers receive what the consultation paper notes as undisclosed financial compensation from SEBI-registered entities and intermediaries. In return for such compensation, they influence their followers by providing investment advice despite often lacking qualifications mandated by the law to be an IA. Not only will a considerable number of finfluencers not qualify to be registered as an IA or RA, even if they do have the necessary qualifications, there will be a regulatory bar from obtaining any compensation from the registered entities or intermediaries, as the finfluencers are not providing any investment advice to these entities.
SEBI noted concerns with unregistered finfluencers, who may entice their followers to purchase products, services or securities in return for compensation from platforms or producers which are not disclosed to the followers. Therefore, it recognised a need to curb the flow of such compensation from registered intermediaries or regulated entities with such unregistered entities. Furthermore, being unregistered, such finfluencers may not have the requisite qualifications or expertise on the subject, nor are they subject to a code of conduct requiring disclosures of conflicts of interests, etc.
Therefore, SEBI has proposed to prohibit registered intermediaries, regulated entities or their representatives from, directly or indirectly, having any association/relationship with any unregistered entities for the promotion of their services or products. They would also be prohibited from sharing confidential information of their clients with such unregistered entities. It has also proposed prohibiting registered intermediaries or regulated entities from paying any trailing commission based on the number of referrals as a referral fee. However, it has proposed a carve-out for limited referrals from retail clients and payment of fees for such limited referrals by stockbrokers. Furthermore, SEBI registered intermediaries/registered entities may be required to take active measures to dissociate themselves from any unregistered entity using their name, product or service, and take necessary action through enforcement agencies, including by registering cases under Section 420 of the Indian Penal Code.
Critical Analysis of the Proposed Regulations
The proposed regulations outlined in the consultation paper appear to be a positive step in addressing the negative impacts that may arise from biased and potentially financially motivated advice provided by unregistered finfluencers to their followers. However, some critical questions regarding the practical implementation of these regulations have not been addressed.
The first important question vis-à-vis the implementation of the proposed regulations pertains to the lack of clarity regarding how content published by unregistered finfluencers, in violation of any existing or proposed regulations on this matter, will be dealt with. Today’s finfluencers give investment advice through various social media and content-hosting platforms like Instagram, Facebook, and YouTube. Currently, matters pertaining to taking down content on the internet are governed by the Information Technology Act, 2000, read with the Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Rules, 2021 and the Information Technology (Procedure and Safeguards for Blocking of Access of Information by the Public) Rules, 2009. The procedures for the same are arduous and lengthy – blocking content in breach of the statutory framework through this route would be impractical and could hinder the effective implementation of the proposed regulations. By the time necessary procedures and formalities are completed, irreversible damage, vis-à-vis influencing retail investors, will have likely occurred.
A second important question that could be worthwhile for the securities watchdog to consider would be the applicability of the proposed regulations on non-resident unregistered finfluencers dispensing advice to Indian residents. The Supreme Court in Securities and Exchange Board of India v. Pan Asia Advisors Ltd. held that SEBI’s jurisdiction extends to any person, including “citizens abroad” and those not “corporally present” in India committing an act which “affects the legitimate interest of this country”. Therefore, clarity on enforcement of the proposed regulations to such influencers may be beneficial. Further, jurisdictions like the United States and Hong Kong require investment advisors (or their domestic equivalents) to be registered with, or obtain requisite licenses from regulatory authorities to provide investment advice. Thus, recognition of finfluencers registered in their respective jurisdictions may also be looked into.
Finally, while the proposed regulations seek to address the threat posed by finfluencers through the regulation of registered intermediaries, SEBI has also expressed an intention to take enforcement action against all finfluencers in breach of existing SEBI Regulations. Therefore, a critical question left unanswered is the very applicability of the IA and RA Regulations to finfluencers. SEBI, in the consultation paper, refers to finfluencers as “effectively unregistered and unauthorized Investment Advisers (IAs) or Research Analysts (RAs)”. However, the proviso to Regulation 2(l) of the IA Regulations, defining ‘investment advice’, explicitly excludes “advice given through newspaper, magazines, any electronic or broadcasting or telecommunications medium, which is widely available to the public” from the ambit of investment advice. This seemingly results in a conundrum concerning the applicability of the regulations on finfluencers. This question has become relevant in light of SEBI’s recent Settlement Order in respect of Mansun Consultancy Private Limited, Mr. P.R. Sundar and Ms. Mangayarkarsi Sundar. Mr. P.R. Sundar, who provided investment advice through his website and telegram channels, was said to have provided said investment advice without obtaining the requisite registration under the IA regulations. The Settlement Order was issued without considering the proviso to the definition, by which arguably Mr. P.R. Sundar was not providing any investment advice to his followers. A modification to this definition to the necessary extent of including the advice usually dispensed by finfluencers would resolve this theoretical regulatory roadblock.
The widespread dissemination of unchecked investment advice by unregulated finfluencers poses a significant threat to the public. This threat is magnified by the potentially financially incentivized nature of investment advice given by such influencers, which is not disclosed to the unassuming retail investor. The consultation paper represents a commendable stride toward essential regulatory measures to mitigate these potential harms, safeguarding the financial interests of investors and promoting responsible financial content. Resolving the questions raised in this post would aid in establishing a robust mechanism for mitigating the potential risks associated with such advice.
– Aamir Kapadia & Avinash Kotval