The prohibition on co-mingling of client funds is a fundamental principle of portfolio management regulation. This article explains why client funds cannot be pooled and the compliance requirements.
The Regulatory Prohibition
Legal Basis
Regulation 24(14) of the SEBI (Portfolio Managers) Regulations, 2020 requires that the portfolio manager shall segregate each client's funds and portfolio of securities and keep them separately from his own funds and securities and be responsible for safekeeping of clients' funds and securities.
Co-Mingling Defined
Co-mingling refers to the mixing of client funds with the portfolio manager's own funds or with funds of other clients. This is strictly prohibited.
Rationale
The prohibition ensures that:
- Client assets are protected
- There is no misuse of client funds
- Clients can verify their holdings
- There is clear ownership of assets
What is Permitted
Separate Bank Account
A portfolio manager can keep the funds of all clients in a separate bank account maintained by it.
Conditions for Pooled Bank Account
- There shall be a clear segregation of each client's fund through proper and clear maintenance of back office records
- Portfolio managers shall not use the funds of one client for another client
- Portfolio managers shall reconcile the client-wise funds with the funds in the bank account on daily basis
Aggregation of Transactions
Portfolio managers may aggregate buy or sell transactions for achieving economies of scale. This is not co-mingling but operational efficiency.
What is Prohibited
Mixing Client and Manager Funds
Client funds cannot be mixed with the portfolio manager's own funds.
Mixing Client Funds
Client funds cannot be mixed with funds of other clients without proper segregation.
Using Client Funds
Client funds cannot be used for the benefit of the portfolio manager or other clients.
Investing Based on Others' Advice
The portfolio manager shall not invest client's fund based on the advice of any other entity.
Consequences of Non-Compliance
Regulatory Action
Co-mingling can result in:
- Enforcement action by SEBI
- Monetary penalties
- Suspension or cancellation of registration
Recent Enforcement
SEBI has taken action against portfolio managers for violations including:
- Outsourcing core investment functions
- Investing client funds based on advice of another entity
Compliance Requirements
Record Keeping
Portfolio managers must maintain:
- Separate records for each client
- Clear segregation through back office records
- Daily reconciliation
Reporting
Portfolio managers must provide:
- Periodic statements to clients
- Details of holdings
- Transaction reports
Audit
The segregation must be verified during:
- Annual compliance audit
- SEBI inspections
Expert Legal Guidance
Anuj Desai & Associates provides expert legal advisory services on fund segregation compliance for portfolio managers. Our securities law experts help clients implement compliant processes, maintain proper records, and ensure regulatory compliance. Contact us for guidance on fund segregation and other regulatory matters.