Are you complying with this PMS client onboarding requirement?

I am in the process of doing an internal audit for one of the SEBI registered portfolio managers for submission of the corporate governance report.  

While going through the client agreements, I observed there was a separate annexure which had details of all fees and charges payable to the portfolio manager as required.

However, it was neither signed nor was there any handwritten declaration by the client.

When I enquired with the Principal Officer and the Compliance Officer, they looked at me with surprise.

“Is that even a requirement?”

“Well, yes. All new clients availing portfolio management services are required to separately sign the annexure on fees and charges and add in their own handwriting that they have understood the fees / charges structure.”

“When was this introduced? Have we missed out on any SEBI communication recently?” The Principal Officer asks the Compliance Officer.

This is not a new requirement. This was published in the SEBI Circular dated October 5, 2010 and now included in the Master Circular for Portfolio Managers issued by SEBI on March 20, 2023.

The Compliance Officer was still surprised, “So, do the clients have to write in their own handwriting that they have understood the fee structure?”

I nodded and added that the intent of such a requirement is that the fees / charges are clearly disclosed to the clients and ensure that the clients have understood the same with their acknowledgement.

“But, in this digital world, accepting the same in “own handwriting” becomes practically difficult, especially when signing of the agreement is online. Is there any other way?” asked the Principal Officer.

Well, much like you, others tried reasoning this as well. Recently (in February 2023), there was an informal guidance sought by Motilal Oswal Asset Management Company Ltd., a SEBI Registered Portfolio Manager.

Earlier, even Purnartha Investment Advisers Pvt. Ltd., a SEBI Registered Portfolio Manager, sought informal guidance on the same requirement.

Purnatha mentioned that they wanted to provide a seamless electronic on-boarding system and providing the annexure on fees and charges separately for signature of the client defeats the purpose.

For the same, Purnartha proposed that “clients can sign the annexure using electronic signature as per Information Technology Act, 2000 and write electronically that they have understood the fee structure using their fingers or stylus pen on the relevant portion of the annexure, accessed by them on touch sensitive screen of their personal computing device.”

SEBI analysed this proposal keeping in mind the Information Technology Act. (IT Act)

As per the IT Act, digital signatures and electronic signatures are legally valid. The main condition for validity of any electronic signature is that they should be reliable.

As per section 3A of the IT Act, electronic signature or electronic authentication technique will be considered reliable if—

(a) the signature creation data or the authentication data are, within the context in which they are used, linked to the signatory or, as the case may be, the authenticator and to no other person;

(b) the signature creation data or the authentication data were, at the time of signing, under the control of the signatory or, as the case may be, the authenticator and of no other person;

(c) any alteration to the electronic signature made after affixing such signature is detectable;

(d) any alteration to the information made after its authentication by electronic signature is detectable.

To explain in brief, the electronic signature will be considered reliable if –

1. It is linked to the signatory / authenticating authority and should be under the control of the signatory / authenticating authority and no other person.
2. If there is any alteration to the electronic signature or to the information / document where the electronic signature is affixed, then such alteration should be detectable.

Electronic signing also includes the action where a person affixes his / her hand written signature or a mark on any document.

Taking into consideration the IT Act, SEBI accepted the proposal of Purnartha for electronically signing the annexure and using fingers or stylus pen on touch sensitive screen of computer, laptop or phone instead of having a handwritten declaration that the clients have understood the fee structure.

“But not all clients are comfortable using a stylus pen. What if the client provides all consents and declarations required for the onboarding by clicking on the appropriate checkboxes? Will SEBI accept this?” asked the Compliance Officer.

“Yes indeed and that is what Motilal Oswal went to SEBI with, a different proposal.”

Taking the base of the Purnartha’s informal guidance, Motilal Oswal raised the concern of e-writing and pointed out that not all investors are well equipped with relevant software / hardware to support electronic writing through stylus pen or using their fingers on the relevant portion of the said annexure.

Some of the points which Motilal Oswal proposed to comply with SEBI’s requirement are as follows:

1. During the verification process, the new clients will capture his/her live photo and accept the declaration pre-typed for the terms and fee structure, and upload their specimen signature in this panel.
2. The client must provide all consents and declarations required for the PMS application by clicking on the appropriate checkboxes in this panel.
3. Keeping client’s convenience in mind as well as the complete compliance parameters, they would implement a systematic electronic on boarding, wherein clients have to mandatorily provide consent on the fees and charges structure and then can submit the account opening forms.

SEBI did not accept the proposal stating that clients’ acceptance to fees and charges through pre-typed declaration and ticking the appropriate checkboxes is not in compliance with the requirement of the circular. Such a process avoids the requirement of clients writing the required text understanding the fees and charges.

In simple terms, SEBI requires that the clients should write the required text either physically or electronically. Clicking the checkbox for acceptance of the terms or any declaration is NOT acceptable to SEBI. This also applies to signing the agreements.

The Portfolio Managers have to also keep in mind that the client’s signature, whether wet or electronic, needs to be there on the annexure for fee and charges.

“I think we have understood the requirement clearly now. We need your help in getting compliant on this”

“Happily!”

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Note:

On March 20, 2023, SEBI issued a Master Circular for Portfolio Managers.

This Master Circular is a compilation of all the circulars applicable to the Portfolio Managers as on the date of issue of the circular. The individual circulars stand rescinded.

But any action taken under the rescinded circulars before the issue of the Master Circular will still be valid.