[By Rajdeep Bhattacharjee and Aayush Ambasht]
The authors are students of Symbiosis Law School, Pune.
Introduction
By way of Circular dated April 5, 2023, the Securities Exchange Board of India (“SEBI”) devised a regulatory cobweb in order to regulate the code of conduct with regards to advertisements; which are to be strictly complied by the Investment Advisers (“IAs”) and Research Analysts (“RAs”) or who are popularly paralleled as social media handles which offer “financial and investment advice.” The Circular aims to clear pertinent conundrums pertaining to the behavioural aspect of both RAs and IAs in the aforementioned regard as well as aims to impose a degree of affirmative correspondence to conduct fair trade of securities in the Indian capital markets.
In due furtherance of such interest, this research piece aims to dissect this Circular’s binding rationales and address its larger applicable discourse in the securities exchange regime. Further, the authors also highlight the following conundrums namely:
- Third party liability considerations,
- One-on-one communication concerns
- Limited material purview of registrations;
of the SEBI’s Circular in conjunction with the U.S. Securities Exchange Commission’s amendment in this regard.
Third Party Liability Considerations: A Double Edged Sword?
The U.S. Securities Exchange Commission (“SEC”) vide amendment to Rule 206(4)-1, makes an explicit reference to ‘Marketing Rules” and “Third Party Statements” holding that any form of such advisers indulging in advertising financial insights (which may fuel market irregularities) shall also be liable to costs, as under the “Marketing Rules” concerning such communications with third parties. Pursuant to the same, it also outlines a requisite requirement for such advisers to comply with such marketing rules, independent of any third-party disseminations in this regard. As far as materiality thresholds are concerned pertaining to such third-party ratings, there is a definitive minimal imposition of $1,000 per calendar year backed by the adviser’s written statement as a blanket agreement to the same. Thus, the SEC not only clears the murkier waters of third-party liability, but also seems to hold a rational ground for ring fencing coherence on behalf of both: advisers and third-parties in the strictest regard.
In the present instance, the SEBI fails to outline a parallel gordian knot of regulatory clarity as far as third-party liability in instances of falling under the verbiage of “advertisement” according to such IAs and RAs. Inadequacy along such lines leads to creating further arbitrary bottlenecks in identifying lapses and tracking grounds for holding the employees and/or subsidiaries who may also be liable in this regard. Further, the present Circular does not posit any clear regulatory dialogue as to whether third party statements such as disclaimer(s), endorsement(s) and testimonial(s) are to be incorporated under the definition of “advertisement” as an implied concern; including the treatment of proceeds arising out of such forms of advertisements. Lastly, affixing vicarious liability in cases revolving around a principal agent and/or master-servant contractual arrangements is another smokescreen, the aspect of which is absent in the present Circular.
Therefore, the SEBI must furnish an informed interpretational autonomy in light of these pertinent discrepancies and address the growing salience of such lacunae at the earliest.
One on One Communication Concerns: Are Physical Interactions Unguarded?
One of the major lacunas of this Circular in question is that nothing is explicitly mentioned regarding one-on-one communication. The ambit of the definition of advertisement as is given is an umbrella one and mostly incorporates every form except the aforementioned form. This may amount to be problematic and defeat the entire purpose of the Circular as there are a plethora of finfluencer , IAs and RAs who conduct physical meet-ups wherein they extensively discuss stock trading. Furthermore, this could amount to prospective influencers accepting any solicited information and, as a result, this strengthens a veiled affirmation of inflating and/or deflating a stock without any accountability whatsoever, underlying such verbally communicated opinions.
This loophole has proven to be exploited in other jurisdictions as well, especially the United States post which the SEC had to step in and extensively address this issue. Finally, failing to hold accountable such verbal tips and one on one communications, the SEC was compelled to exclude such communications from the advertisement regulatory regime. The backing behind such exclusion was cited to be the inability of tracking and garnering of material evidence.
In the SEC’s amendments to Rule 206(4)-1 of the Investment Advisers Act of 1940 which went on to implement the regulator’s new Marketing Rule, it was firmly held that the exclusion shall be applicable to both – a single person with an account as well as multiple persons bearing the representation of a single account. However, such exclusion is not applicable in the case of electronic communication that is being disseminated in bulk. Duplicated advise herein inserts into otherwise tailored one-on-one communications to individual investors, for example, constitute advertisements, while the tailored portions are exempted.
Therefore, this lacuna could have been addressed by SEBI in a more tacit manner, taking in cognizance the wide mode of personal methods of dissemination, barring the forms of publications.
Enforceability of Registrations: Demystifying its Materiality Purview
At the very outset of the Circular, it can be found that the people addressed are registered IAs and RAs. However, keeping in mind the problem that SEBI has sought to solve vide this Circular has somewhat remained un-addressed due to the principal blanket of registration that the regulator has propounded at the very inception of this document.
The principal predicament in the current epoch with the rise of social media influencing, which has given rise to unregulated financial advisory related to investing in securities, was sought to be addressed by the regulator and the fundamental essence of the Circular puts forward the same as the definition of advertisement has been made somewhat exhaustive. However, despite such endeavour, the major conflicting issue of being able to regulate such unregulated and unaccountable financial advisory is defeated due to the incorporation of registration criteria, which in turn jeopardises the entire stratagem envisaged by the regulator; to deal with such unsolicited social media content with an extensive and comparatively inexperienced following base.
The disclosure section of the Circular, in its very first point mentions that the principal disclosure shall include among other things, the name of the IA/RA as is registered with SEBI. This does not take into consideration the odd cases wherein a finfluencer who has no registration with SEBI or is a foreign resident/NRI who analyses the securities market basis which sets out their advisory/advertising. An analytical view of the SEC Marketing Rules depicts the absence of such blanket registration and critically only addresses every natural person doing any sort of advertisement as is mentioned in the definition of their rules. According to the SEC, there is a compulsory disclosure provision regarding whether the person providing the testimonial or endorsement is a client and whether the promoter is receiving any form of compensation for the same.
Therefore, SEBI should clarify and incorporate a provision wherein compensation and conflicts of interest must be disclosed in greater detail by the promoter and, extend the ambit of the regulation to incorporate natural persons and not only registered IAs and RAs.
Conclusion
While the Circular permeates a yearning proclivity towards binding the RAs and IAs under a requisite regulatory ballot box, SEBI seems to set a welcoming tone to the securities enforcement regime underlying such a rational behavioural constant. However, despite such fundamental steps taken by the regulator, the lacunae are diverse which are still to be addressed. One of the fundamental ones is the absence of penalty provisions or provisions regarding the issuance of show cause notice/s. This again gives the Circular a recommendatory air rather than a sanctionable one which questions the very premise on which this Circular is to be bolstered; cornering liability, accountability as well as materiality concerns around the regulatory umbrella of advertisements in the Indian securities regime.
Therefore, while this Circular is a step in the right direction, there still remain exigencies and smokescreens to be obliterated and repositioned effectively by the SEBI. Barring the absence of penalty provisions alongside show cause notices which highlight a procedural mirage, SEBI’s preliminary solution herein would revolve around fuelling a greater degree of legitimacy and accountability. Parallel to the ESMA’s proposed regulatory framework, SEBI ought to work in tandem with the Ministry of Information Technology of India to bolster a definitive framework vis-a-vis disclosure requirements to oversee verification and allied technical grievances. Further, establishing a licensing route for such entities i.e. RAs, IAs and Finfluencers would deem to be fit as a pre-emptive filtration mechanism before the verification stage. All in all, SEBI must earnestly aim at de-risking concerns in the “finfluencing” tangent and effectuate its regulatory prowess in light of the same.