Author name: CBCL

[By Arnav Gulati] The author is a student of Jindal Global Law School.   Introduction:  In the burgeoning digital finance arena, financial influencers, termed as ‘finfluencers’ have emerged as influential arbiters of financial decision-making, however their actions continue to be uncontrolled. The absence of regulatory oversight in this domain has created a vacuum that has been used by such finfluencers, who often lack the requisite credentials, to propagate inaccurate and deceptive financial information. The Securities and Exchange Board of India (SEBI) has acknowledged the significant effect of social media on stock markets, the process of price discovery, and the susceptibility of novice investors who are prone to being swayed by “tips” or suggestions. Through the notorious ‘Telegram Case,’ i the dark underbelly of unregulated financial advice was brought to the fore. In the aforementioned case, titled “Re: Stock Recommendations using Social Media Channel (Telegram)” – the trading activity in a particular stock was momentarily influenced by the quantity of channel members and the number of tips/recommendations shared on Telegram, which gave rise to concerns within the framework of the Prevention of Unfair Trade Practices Regulations (PFUTP). The decision made by SEBI signified a noteworthy advancement in acknowledging the impact of social media on stock markets, while simultaneously ensuring market integrity by combating unregistered operations and unfair activities. This decision of January 2022 served as a strong indication from SEBI that persons without sufficient regulatory control are prohibited from offering financial advice or suggestions, hence imposing challenges on finfluencers seeking to perform their services in an unregulated way. The Telegram case, along with other cases such as Sadhna Broadcast Limitedii and Mansun Consultancyiii have drawn attention to the recognition by SEBI of the potential for stock price manipulation associated with a substantial subscriber base.   SEBI’s new consultation paper and the Advertising Standard Council of India’s (ASCI) revised guidelines mark India’s foray into uncharted regulatory waters. Herein, I critically appraise these emerging regulatory propositions, dissecting their potential efficacy, overreaches, and the nuanced challenges they may inadvertently usher in.  The Double-Edged Sword of Transparency Mandates:  Right off the bat, I firmly believe that SEBI’s insistence on rigorous disclosure norms is a commendable attempt to infuse transparency into the finfluencer ecosystem. However, the mandate’s viability teeters on practical enforcement. The digital sphere’s fluidity, coupled with the sheer volume of finfluencer-generated content, raises significant concerns about the effective monitoring of these disclosures. Moreover, there’s a thin line between ensuring transparency and inundating consumers with excessive information, potentially leading to decision paralysis rather than informed financial choices.  Furthermore, the requirement for finfluencers to disclose all affiliations (Paragraph 4.4 of the consultation paper) could inadvertently create a skewed perception. For instance, a finfluencer with multiple disclosures might either be seen as more trustworthy due to transparency or be perceived as biased due to numerous affiliations, regardless of the actual content quality. This paradox underscores the need for a more nuanced approach to disclosures, perhaps emphasizing the quality and relevance of affiliations over sheer quantity.  The Quagmire of Defining ‘Financial Advice’:  One of the most contentious aspects of the emerging regulations will be to define what constitutes as ‘financial advice.’ SEBI currently defines ‘investment advice’, but not ‘financial advice’.   This legislative uncertainty might place influencers, regulatory agencies, and consumers at risk. Without a defined, legally enforceable definition of ‘financial advice,’ content providers might design their messages to avoid seeming to give explicit investment advice while nevertheless driving audience behaviors. Known as “dog-whistling” in other situations, this phenomenon uses coded language to send specialized signals to those who understand it.  This offers a complicated issue for regulators. First, monitoring the large amount of information on numerous platforms, each with its own language and regulations, is logistically tough. Not only is content volume important, but linguistic complexities demand sophisticated comprehension and interpretation, which is not readily scalable for wide regulatory supervision. Second, regulating this disguised communication without infringing on casual financial talk is very difficult. Regulators must safeguard customers from deceptive information that might harm their finances without intruding on free speech and expression, protected under Article 19 of the Constitution. The framework should define what is and is not ‘financial advice’, giving content providers and customers more clarity and safety. To empower people in this digital era of information overload, authorities should examine ways to spread awareness on how to distinguish expert financial advice from informal comments.  Potential Pitfalls in the Enforcement Mechanism:  As we delve deeper into the regulatory landscape, it becomes clear that good intentions alone may not suffice. The real test lies in how these rules are put into practice. While the emerging regulations are well-intentioned, their success hinges on the robustness of the enforcement mechanism. SEBI has used the current framework comprising of the SEBI PFUTP Regulations, Settlement Proceedings Regulations 2018, and Investment Advisers’ Regulations 2013 to address the activities of social media influencers. To create investment advisors as a separate category of market intermediaries, SEBI enacted the Investment Advisers Regulations. These rules were created to protect investors’ interests and avoid any potential conflicts of interest that could result from advisors also serving as financial product distributors. Additionally, SEBI significantly changed these laws in July 2020 to coincide with the rise in finfluencer activity during the COVID-19 lockdown period. The consequences of non-compliance are not sufficiently addressed by these adjustments, which included revisions to the qualification, certification, and net worth criteria for investment advisers. This strategy is not, however, streamlined. The upcoming regulations run the danger of becoming paper tigers without severe fines and a methodical enforcement strategy. Furthermore, platforms that host finfluencer material will bear the bulk of the responsibility for maintaining compliance. This assumption might result in uneven enforcement as platforms with different competencies will try to implement laws consistently. As a result, there is a growing risk of “regulatory arbitrage,” in which finfluencers move to less restrictive platforms, so evading the same scrutiny that regulations aim to provide.   Overlooking the Consumer’s Role:  The Ministry of Consumer Affairs’ most recent “Endorsements Know-hows” will have

[By Aniket Panchal & Shubhankar Sharan] The authors are students of Gujarat National Law University.   Introduction An interesting chain of events transpired centered on Edelweiss (a registered Professional Clearing Member (“PCM”), against whom appeals were filed in response to directives from the Member and Core Settlement Guarantee Fund Committee (“Committee”) of NSE Clearing Ltd (“NCL”). These directives ordered Edelweiss to reinstate securities that were disposed of in violation of the Securities and Exchange Board of India (“SEBI”) Circular and NCL Regulations. The contentious issue arose when Edelweiss, providing clearing and settlement services, sold collateral worth Rs. 460 Crore from broker and trading member Anugrah to fulfill clearing obligations.   The central issue here was that the PCM liquidated the securities of the Trading Member’s clients to offset the trading member’s debit balance. The Committee found Edelweiss on the wrong side, underlining a failure to ensure that clients’ securities were used solely for meeting their obligations, thus violating NCL Rules. Similarly, accusations regarding the misuse of client securities emerged in appeals involving other Clearing Members, including Yes Bank and SMC Global.   The Edelweiss order sheds light on the pressing issue of intermediary misconduct in handling client funds.  In light of this, the authors examine SEBI’s previous initiatives in curbing such malpractices and then discuss the roles of clearing members and the ambit of powers vested with NCL.   Past to Present: SEBI’s strides in countering misuse of client funds  Throughout the course of its existence, SEBI has actively tried to curb the menace of misuse of clients’ funds by Stock Brokers (“SB”) and Clearing Members (“CM”). A string of circulars has been released to further the objective. The premise was set by its 1993 circular, which prescribed maintenance of separate accounts of Member Brokers and their clients. It set the course for future actions against misuse. A brief leap in time necessitated SEBI to release another set of circulars in this regard. More importantly, all of them have been laid out prima facie to combat misuse of funds and client collaterals. Several actions in the form of alerting and monitoring mechanisms and enhanced supervision over SBs have been devised by SEBI. Not to mention, SEBI has been proactive in not only outlining the measures but also prescribing guidelines for implementing those measures. A look at some of the circulars, as mentioned in the SAT Order, underscores the principle highlighted in the 1993 Circular.   Precisely, the Circular dated 20 June 2019 proscribes the usage of clients’ funds by SBs for themselves or any other client (as provided in Securities Contracts (Regulation) Act 1956 (“SCRA”) and Securities Contracts Regulation Rules, 1957 (“SCRR”). Lastly, some of the immediate circulars dated 11 November 2022 and 12 December 2023 fortify SEBI’s position on misuse of clients’ funds. The former deals with handling clients’ securities by Trading Members (“TMs”)/CMs, while the latter lists the criteria for receipt/payment of funds by SB and CMs from/to clients. An essential requirement that stands out is establishing clear time frames for completing the transactions with clients.  Stock Exchanges, too, have been on the heels of SEBI. NSE circulars, for instance, reproduce the intent of the SEBI circulars. A case in point can be that of its June 2023 circular, wherein it established detailed guidelines for immediate actions against misuse of clients’ funds. “Enhanced Supervision” principles form the bedrock of implementing those administrative guidelines. The administrative actions referred to in the circular are in addition to pre-defined measures against Trading Members, as existing in the NSE circular no. 82/2022.   Several cases have been reported on misutilization of clients’ funds, of which the case of Karvy Group takes most of the light. The concerned company was involved in creating a labyrinth of transactions in order to misuse clients’ securities. Subsequently, it was expelled by the NSE and deregistered by SEBI on account of misutilizing clients’ funds and securities.  Analysis PCM and CM – Cut from the same cloth?   On this count, the main contention of Edelweiss was that based on the bye-laws of NCL, a PCM cannot be considered as a CM; therefore, circulars issued by SEBI/NSE/NCL will hold no applicability on the PCM. As a corollary, it was argued that the word “constituent” under NCL bye-laws can only encompass trading members with which a PCM has an agreement and not the end clients of the trading member. Based on this, it was contended that a PCM has no duty of care to a TM’s clients. Edelweiss urged that the clients of trading members do not have any legal or beneficial ownership over their shares once the trading members transfer the same to a PCM.  To rebut Edelweiss’s contention that a PCM is not the same as a CM, the tribunal referenced two provisions of the Futures & Options (“F&O”) Regulations. Firstly, the definition of F&O CM defines it as a member of the Clearing Corporation and includes all categories of clearing members. Secondly, a PCM is defined as a clearing member admitted by the relevant authority. Based on this, the tribunal noted that a PCM is nothing but a type of CM.   In any case, the whole discussion, at best, was academic since the tribunal found Edelweiss was registered as a CM and not as a PCM. As stated in the Order too, it is by virtue of the recent amendment to the Securities and Exchange Board of India (Stock Brokers) Regulations, 1992, that a PCM got defined under Section 2(ca). the reason being that, as per the Schedule appended to the Regulations PCM requires higher net worth than other sub-categories of CM. Otherwise, any member having clearing and settlement rights is a CM.   Interestingly, Edelweiss drew parallels between a PCM and a Senior Counsel to further its contention that PCM bears no liability to the trading member’s client. The analogy rested on the premise that Senior Counsel’s accountability lies only with the instructing advocate and not the end client. Likewise, PCM shall be answerable only to trading members (its client) and

[By Srishti Multani & Aryan Birewar] The authors are students of Symbiosis Law School, Pune.   Introduction   The Securities and Exchange Board of India (‘SEBI’) on 31st August 2023, issued a Consultation Paper to propose a Performance Validation Agency (‘PVA’). The objective of such an institution is to validate performance claims of SEBI-registered intermediaries. Such validation will enable the entities to catapult their customer-base in the securities market. There was a pressing need ​for transparency and authenticity in the claims made to attract investors. In this article, the authors examine the rationale behind a PVA, stress-points of the consultation paper, and critically analyze the benefits and challenges posed by the establishment of a PVA. Furthermore, they suggest certain solutions to address the forthcoming said challenges.   Need & Rationale   The urging requirement of credibility in the securities market pushed the regulator to produce this proposal. All the SEBI-registered intermediaries seek to increase their customer-base, which requires them to build investor trust. Such validation by the PVA will allow the intermediaries to attract investor clients in the market by highlighting their performance claims. An independent body like the PVA will facilitate the trust-building process ​between market intermediaries and investor entities.   Presently, SEBI has imposed differential restrictions on the market intermediaries in making performance claims to expand their service-base to more investor clients.   ​​​Claims of Asset Management Companies (‘AMC’) and Portfolio Managers are self-verified. There is absence of any independent body to validate their claims.   Claims of Investment Advisers (‘IA’) and Research Analysts (‘RA’) cannot be made in reference to their past performance. As per the existing SEBI Advertising Code, any ‘buy/sell/hold’ recommendation by these intermediaries cannot be made in reference to past performance and by usage of any superlative terms. For example, ‘best’, ‘top’, ‘leading’, etc.   Claims of Stockbrokers pertaining to past or future returns ensuing from algorithmic trading is not permissible.   The regulator recognized the need for intermediaries like IA’s, RA’s, Stockbrokers, etc. to showcase their performance claims to increase their clients. The same must be predated with an independent and impartial performance claim validation agency to ensure accuracy and correctness of claims floated in the securities market.   The functioning of such an agency will preclude eventualities of false, misleading, and inflated performance claims floated to attract investors. It will ensure that all participating intermediaries resort to fair and correct practices to expand their services to the investor clients. It is important to recognize that relying on verification from just one brokerage company can be misleading for investors, as it does not offer a comprehensive view of trading performance across all accounts. This makes the existence of a PVA all the more important.   Proposal by SEBI  The following proposals encapsulate the major highlights in SEBI’s Consultation Paper:  Criteria for Grant of Recognition   SEBI has mandated the PVA’s to be subsidiary entities of Market Infrastructure Institutions (‘MII’s). The rationale provided by them is that MII’s are the sole components of the securities market, which deal with ​a large​​ amount of investor data daily. As per the Bimal Jalan Panel (2010), they defined MII’s to be inclusive of Stock Exchanges, Depositories, Clearing Corporations, etc.   PVA’s are thus mandated to be wholly-owner or jointly-owner subsidiary entities of MII’s.   PVA’s will be recognized by SEBI only, when their parent MII fulfill the eligibility criteria prescribed by SEBI.   Obligations of a PVA  The paper prescribes the task of claim validation to be based on the parameters of risk, return, volatility, or any other parameter deemed suitable by SEBI. It is PVA’ duty to ensure that all information shared to them by the investors or intermediaries is kept confidential. Since, the major function is validation of investor data, SEBI permits ​PVA to partner with credit rating agencies for the purpose of validation, who aid in evaluating credit worthiness of debt securities and their issuers. Notably, the PVA can charge a reasonable fee for the validation of performance claims.   Categories of Claims validated by PVA.   Actual Profit – The PVA validates the actual profit minted by the investor basis the advice rendered by the SEBI-registered intermediary.   Algorithm – The recommendation rendered by PVA is derived from a certain algorithm. PVA undertakes performance evaluation of such algorithms over a prospective reasonable test period.   Stock/Portfolio – In order to evaluate recommendation of a stock/portfolio, the PVA must ​furnish​​ the recommendation on the day of recommendation and period of holding by the SEBI-registered intermediary.   Display of Recommendations   ​​​Exclusive Access– The validation of such recommendations is required to be published on their websites with access exclusively with clients.  Public Recommendations – Once the intermediaries publish the recommendations they can be accessed on the websites of the intermediaries and PVA both.  Specific Recommendation – When the intermediaries seek validation of a specific portfolio recommendation, then it shall be published on the websites of the intermediary and PVA in the format prescribed by the industry practice.  The unique attribute in these proposals is the “No Cherry-Picking” principle. As per this principle, the PVA cannot arbitrarily select clients, results, or events to their favor. Any validation of a performance claim must be done for all clients to prevent ​biases in the results. Furthermore, all such claims must be verified from third-party independent sources excluding the entity making the claim.  Analysis of the Proposals   The principal reason for this proposal was the pressing need ​for transparency​​ ​and investor reliance. By virtue of ​being an​​ independent verification body, it benefits both the investor and registered intermediaries – eliminating inflated performance claims and permitting marketing of successful investment advice, respectively.   For the investors, they place reliance on the stock and portfolio recommendations furnished by the SEBI-registered intermediaries to reap good returns. It becomes vital that an independent, third-party evaluator validates these recommendations. Especially, in cases of claims made by Asset Management Companies and Portfolio Managers, they are self-verified sans being subject to any external system of checks.  For the SEBI-registered intermediaries, they pressed the regulator for such an initiative as they want to increase their service-base to maximum investors. By