Investment Advisers often consider expanding their services to include portfolio management. However, SEBI mandates strict arms-length structuring and segregation of activities. This article examines the regulatory requirements and compliance considerations.
The Regulatory Framework
Separate Registrations
Investment Advisers are registered under the SEBI (Investment Advisers) Regulations, 2013. Portfolio Managers are registered under the SEBI (Portfolio Managers) Regulations, 2020. Each registration is separate and requires separate compliance.
Permissibility of Dual Registration
An Investment Adviser can also register as a Portfolio Manager provided it:
- Is a body corporate
- Meets the net worth requirement of ₹5 crore
- Appoints a qualified Principal Officer
- Appoints a Compliance Officer
- Has necessary infrastructure
The Arms-Length Structuring Requirement
Legal Basis
The PMS provider shall act in a fiduciary capacity towards its Client and shall maintain arm's length relationship with its other activities.
Enforcement Precedent
SEBI has taken action against entities that failed to maintain an arm's-length relationship between PMS and other activities. In one case, the PMS arm had not maintained an arm's-length relationship with the mutual fund arm by clearly segregating its activities as a portfolio manager or investment adviser from mutual fund activity.
Key Requirements
Functional Segregation:
- Separate teams for IA and PMS activities
- No sharing of resources or personnel
- Independent decision-making processes
Operational Segregation:
- Separate office spaces or clearly demarcated areas
- Separate systems and technology
- Separate record keeping
Financial Segregation:
- Separate bank accounts
- Separate books of accounts
- Independent financial reporting
Client-Level Segregation
The Principle
The same client cannot be offered both investment advisory services and portfolio management services within the group. Client-level segregation at group level is required.
Implications for IAs
If an IA also operates a PMS:
- A client receiving investment advisory services cannot also receive portfolio management services
- The client must choose one service
- This segregation applies at the group level
Disclosure Requirements
Disclosure Document
The portfolio manager shall disclose in the Disclosure Document:
- Details of conflicts of interest related to services offered by group companies or associates of the portfolio manager
- Complete disclosures of transactions with related parties
- Details of investment of client's funds by the portfolio manager in the securities of its related parties or associates
Client Communication
The portfolio manager shall provide to the client:
- The Disclosure Document prior to entering into an agreement
- Details of any conflict of interest
- Information about the arms-length relationship with other activities
Practical Compliance Considerations
Infrastructure
The IA and PMS must have:
- Independent Board of Directors (common directors should not be in majority in both the Boards)
- Arm's length relationship with reference to operations
- Independent key personnel and infrastructure
- Independent regulatory control and supervisory mechanism
Compliance Mechanisms
The IA must ensure:
- Separate compliance monitoring for IA and PMS activities
- Independent compliance officers for each activity
- Separate regulatory reporting
Internal Policies
The IA must have:
- Written policies for segregation of activities
- Conflict of interest policies
- Arm's length transaction policies
Consequences of Non-Compliance
Regulatory Action
Failure to maintain arms-length structuring can result in:
- Enforcement action by SEBI
- Monetary penalties
- Suspension or cancellation of registration
Recent Enforcement
SEBI has emphasized that the PMS arm must maintain an arms-length relationship and clearly segregate its activities from mutual fund activity or other activities.
Expert Legal Guidance
Anuj Desai & Associates provides expert legal advisory services on arms-length structuring for investment advisers and portfolio managers. Our securities law experts help clients ensure proper segregation, maintain compliance, and avoid regulatory action. Contact us for guidance on arms-length structuring and other regulatory matters.