A year ago, the Securities and Exchange Board of India ("SEBI") had caused a stir among several research analysts ("RAs") when it passed a settlement order in respect of 'Mr. Amit Jeswani (Proprietor of Stallion Asset) – Research Analyst' ("Settlement Order"). In the Settlement Order, SEBI had inter alia noted that it was alleged that by virtue of being a RA, one could not sell model portfolio products to his or her clients, as it was against the 'defined responsibility of a research analyst'.
The Settlement Order
The Settlement Order came at a time when several RAs were well underway in the business of preparing and offering research reports on model portfolio of securities to their clients. As Mr. Amit Jeswani settled the adjudication proceedings initiated against him, without any admission, denial or finding of guilt, SEBI did not adjudicate on the merits of the matter and the alleged violations remained unproven. However, on account of SEBI's adverse observation in the Settlement Order, many RAs scrambled to seek legal advice regarding the established practice of preparing research reports on a portfolio of securities.
SEBI's stance in the Settlement Order seems to have gone against the spirit of its own SEBI (Research Analyst) Regulations, 2014 ("RA Regulations"). To elucidate, in terms of Regulation 2(1)(u) of the RA Regulations, a RA inter alia prepares or publishes a research report, makes research recommendations, gives price targets, and offers opinions concerning public offers in relation to listed or to be listed securities. Regulation 2(1)(w) of the RA Regulations goes on to define a research report as well, which has three essential ingredients; viz. it should be i) an analysis, recommendation, or opinion, ii) in relation to listed securities or to be listed securities or public offers which iii) provides a basis for making investment decisions in relation to listed or to be listed securities or public offers. Thus, the RA Regulations provide a broad and all-encompassing definition for 'research report', so long as the aforesaid ingredients are satisfied. A research report can comprise of any form of written or electronic communication including analysis or recommendations, or opinions related to listed securities which can be used as a basis for making investment decisions in such securities.
Upon an analysis of the definitions of 'research analyst' and 'research report', it can be concluded that the research services may be provided in respect of 'securities', as opposed to being provided with respect to a single 'security'. Had the legislative intent been to restrict the scope of services provided by a RA to a single security, the RA Regulations would have reflected the same appropriately.
In this context, model portfolios are nothing but a collection or basket of securities. The preparation and publication of reports on model portfolios may be considered as an efficient means of delivering research reports containing recommendations in relation to various securities, which can assist clients to make informed investment decisions. Based on the ingredients of a research report as discussed in the preceding paragraph, and upon dissecting a model portfolio, it is evident that a model portfolio includes an analysis, recommendation, or opinion with respect to listed securities and provides a basis for an investment decision, thereby satisfying the definition of a research report as defined under the RA Regulations. Moreover, Regulation 2(1)(u)(iii) of the RA Regulations allow RAs to make buy/ sell/ hold recommendations in respect of listed securities, and the publication of a model portfolio of listed securities that provides buy/ sell/ hold recommendations fits well within the scope of services of a research analyst.
The Informal Guidance
Offering some much-needed relief to RAs, on April 05, SEBI, by way of an informal guidance to LGT Wealth India Private Limited, a portfolio manager registered with SEBI ("LGT Wealth Informal Guidance"), inter alia clarified that as the definition of 'research report' under Regulation 2(1)(w), "expressly uses the term "securities", making recommendation in respect [of] a basket comprising more than one security to the clients, shall also be covered within the definition under regulation 2(1)(w)."
Thus, SEBI appears to have reversed its stance regarding a research analyst's ability to provide research reports on a basket of securities. However, while the LGT Wealth Informal Guidance quelled one inadvertent fire, it has sparked another one.
To provide some context, Regulation 3 of the RA Regulations require persons to register as RAs with SEBI in order to provide research analyst services. The second proviso to Regulation 3 inter alia allows intermediaries such as investment advisers, credit rating agencies, asset management companies and fund managers, who issue research reports or circulates or distributes it to the public, to do so without registering themselves as RAs, subject to compliance with provisions of the RA Regulations pertaining to disclosures and management of conflict of interest.
In this regard, one of the queries in the LGT Wealth Informal Guidance was as follows:
"3 (iii) as per exemption available under Regulation 3 of the RA Regulation, can LGT Wealth India, being a registered portfolio manager, provide separate RA services relating to providing recommendations, to any person, without registration under RA Regulations?"
In response, SEBI inter alia stated:
"9. [...] a portfolio manager would be eligible for the exemption from the requirement of registration as a Research Analyst under the RA Regulations. However, the exemption from the registration requirement under regulation 3(1) of the RA Regulations is restricted to the entities mentioned therein "... who issues research report or circulates/distributes research report to public or its director or employee who makes public appearance", subject to compliance with Chapter III of the RA Regulations.
[...]
- Thus, RA Regulations restrict the exemption provided under second proviso to regulation 3(1) to such intermediaries specified therein, only with respect to issuance, circulation or distribution of research report to the public, in clear contrast to the issuance of research report to specific clients or identified or selected persons. Further, for the purpose of availing such limited exemption under the provision, such intermediaries shall have to comply with the chapter III of the RA Regulations.
- Therefore, by virtue of regulation 3(1) read with 2(1)(g) of the RA Regulations, Portfolio Managers registered under PMS Regulations shall be exempted from obtaining a certificate of registration under regulation 3(1) of the RA Regulations, subject to compliance with Chapter III of the regulations, for the purpose of issuance, circulation or distribution of research report to the public. However, in order to issue research report/ recommendation to "any person", identified or selected, the PMS shall need to obtain a certificate of registration in terms of regulation 3(1) of the RA Regulations."
Thus, through its analysis, SEBI has limited the ability of certain intermediaries to issue research reports under the RA Regulations to specific clients, without being registered as a RA. These intermediaries, as mentioned above, are investment advisers, credit rating agencies, asset management companies, fund managers of a mutual fund, alternative investment fund or a venture capital fund, or a portfolio manager. It is safe to say that these intermediaries, by virtue of their role, perform functions akin to a RA in order to arrive at an investment decision, or provide their core services. In other words, such intermediaries are required to retain the ability to perform research activities, similar to that of a research analyst, and thereafter perform their core function, which would include managing a fund, or providing investment advice, or issuing a rating, as the case may be.
There is no discernible reason to exempt these intermediaries from registration as a research analyst if they provide a research report to the public at large, but not if the same is provided to clients of the said intermediary. The restriction on investment advisers, credit rating agencies, asset management companies and fund managers from providing the research report to specific clients does not appear to serve any real purpose. If anything, it requires the intermediary to set up another internal division or entity (subsidiary), and seek a research analyst registration for that specific division or entity, thereby adding onto the operational costs of the intermediary. Thus, a case may be made out to revisit the RA Regulations, in order to permit these intermediaries to provide research analyst services to their clients without having the need to register as RAs.
The contents of this article should not be construed as legal opinion. Recipients should take independent legal advice before acting on any views expressed herein. The comments in the article are as of the laws prevalent on the date the article was originally published. The views stated in the article are not binding on any authority or court, and so, no assurance is given that a position contrary to that expressed herein will not be asserted by any regulatory authority/courts. For any further queries or follow up, please contact Finsec Law Advisors.
