Does advice on foreign securities fall under RIA regulations?

If you are providing advise on foreign stocks to Indian investors with a US broker tie up – does RIA registration suffice? Where do you stand in the eyes of SEBI?

This must have been the thought when SEBI RIA – SV Capital (SVC) – wrote to SEBI using the informal guidance route.

SEBI’s reply turned out to be a spanner in the works and, I imagine, must have left the RIA running for cover.

Let’s get a brief background on the company.        

1. SVC has a contractual agreement with a US company, which has a platform for investors, whether Indian or foreign, to deal in foreign securities.
2. The dealing in foreign securities happens through a US Stock Broker.
3. The platform also provides an option to investors to invest in pre-configured basket of foreign securities aka “Stacks” aka model portfolio.
4. The Stacks will be created based on pre-defined financial or qualitative parameters. SVC will also rebalance the Stacks on quarterly basis.
5. There will be no involvement or input from any investors in creating or rebalancing the Stacks.
6. SVC will get a service fee from the US company for creating Stacks. SVC will also get trail commissions on the brokerage charged by the US Stock Broker.

Now SVC wanted to know whether:

1. Providing Stacks to the US Company constitutes ‘investment advice’ under IA regulations.
2. Arrangement with the US Stock Broker to facilitate purchase in foreign securities constitutes distribution services.
3. Can SVC, as a proprietorship firm (i.e. an individual RIA), receive both, fee from US Company and commissions from US Stock Broker.

If you have been in the game, you probably are already feeling a churn in your stomach. Well, let’s check out SEBI’s response.

1. IA Regulations concern themselves with activities in the nature of providing an investment advice for consideration.
2. Creating and rebalancing Stacks for a US Company and receiving compensation for the same does not appear to be an activity for providing investment advice.
3. Hence, the services provided by SVC will not come under the purview of the IA regulations.
4. SVC cannot provide such services as an IA.

This is the spanner in the works. Somehow, I am not convinced with this.

Is advising on foreign securities an issue?

Now, if you are a SEBI registered investment adviser, you can provide advice on

• securities and investment products or
• on an investment portfolio containing securities or investment products.

Though the definition of securities is given in the SEBI Contracts (Regulation) Act, 1956, (SCRA), the definition of investment products is not given in any of the SEBI regulations.

Interestingly, the case here is that of dealing with foreign securities. Let us first see whether foreign securities are covered under the definition of securities.

As per Section 2(h) of the SCRA, “securities” include— shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.

Body corporate?

As per section 2(11) of the Companies Act, 2013, body corporate includes a company incorporated outside India.

So, concluding:

1. securities of a company incorporation outside India are included in the definition of “securities”
2. advice on foreign securities to Indian investors falls under the purview of IA regulations.

SVC is providing model portfolios to the US company, which in turn will also be used by Indian investors. Advice on an investment portfolio containing securities is included in the definition of “investment advice” under IA regulations.

So, providing Stacks containing foreign securities does come under the definition of investment advice.

Clear so far?

Then why did SEBI’s guidance note say that an RIA cannot do this activity. Here’s where the waters become muddy.

SVC is not providing advice directly to the investors but through the US company. Unfortunately, indirect advice is not included in the IA regulations.

IA regulations also state that an investment adviser should receive fees from the client only. An IA cannot receive any consideration by way of remuneration or compensation or in any other form from any person other than the client being advised.

In this case, SVC is receiving the fees from the US company and not directly from the investors.

Since SVC is not providing advice directly to investors and not getting fees directly from them, SEBI seems to have taken a stand that this activity does not come under IA regulations.

SEBI also clearly mentioned that in the capacity of RIA, SVC cannot do this activity.

Would the case be different if SVC would have received fees directly from the investor? In my view, yes it would be. Because then SVC will then know who is taking its advice. And since Indian investors will also be taking the advice, the activity will fall under IA regulations and SVC will have to comply with the regulations. Also there is no exemption to providing investment advice to NRIs or Persons of Indian Origin.

In that case, it also means that if SVC wants to provide implementation service, it will have to forgo the commissions from the US Stock Broker to comply with client level segregation requirements.

The big question:

Assuming SVC was not registered with SEBI in any capacity, would SEBI have allowed such kind of activity?

Does this mean that SVC can continue the activity by surrendering the license?

SEBI has given a disclaimer at the end that the response by SEBI is only with respect to the clarification sought with respect to the IA regulations and does not affect the applicability of any other law and requirements of any other SEBI regulations.

If not RIA, then under the given set of various SEBI regulations, which one applies?

Looks like the informal guidance has left a lot of questions unanswered.