Sucheta Dalal :SEBI’s Serial Slip-ups
Sucheta Dalal

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SEBI’s Serial Slip-ups  

March 24, 2010

Things don’t always work like in the nursery rhyme that goes…
“For want of a nail the shoe was lost; for want of a shoe the horse was lost.

For want of a horse the rider was lost; for want of a rider the battle was lost…” and so on… all for the want of a horseshoe nail.

Sometimes, a little nail or, in this case, a complaint by the wife of a colleague, can trigger a war between two independent financial regulators.

On 24 November 2009, KN Vaidyanathan, executive director (ED) at the Securities and Exchange Board of India (SEBI) who heads the mutual fund portfolio, shot off a memorandum to the SEBI chairman CB Bhave and P Saran, a whole-time member of the SEBI board. It said that a complaint had been received from Rekha Gupta, wife of JN Gupta (another SEBI ED), about unit-linked insurance products (ULIPs). That, say SEBI insiders, is what triggered the debate on whether ULIPs, as collective investment schemes, ought to be regulated by SEBI, and has blown up into a war with the Insurance Regulatory and Development Authority (IRDA) and landed at the doors of the finance ministry.

The imperative to resolve Ms Gupta’s complaint in a hurry was probably why SEBI did not even pause to notice that it had not followed up on the show-cause notice that was already issued to art funds, such as Osian, which have remained unregulated investment pools, even after causing losses to investors. It did not bother to reflect that, if the logic that SEBI’s writ extends over any pool of funds invested in the market was justifiable, its show-cause notices ought to have covered a far larger set of insurance products.

As it happened, when SEBI slapped show-cause notices on insurance companies, they rushed off to IRDA which not only joined the battle but, also, promptly took the issue to the finance ministry. Insiders tell us that the two regulators were told to find an amicable solution between themselves; they also say that there are several reasons why the ministry is unlikely to support SEBI’s attempt to extend its regulatory turf. More important, we learn that on 5 February 2010, SEBI received a legal opinion from the Attorney General, Goolam E Vahanvati, which says that SEBI will need to change its mutual fund regulations if it wants ULIPs under its regulatory ambit.

ULIPs are products that combine life insurance with a mutual fund by allocating part of the premium towards the sum assured while the rest is invested in capital market instruments based on the chosen risk profile. These schemes are notoriously mis-sold, mainly because they offer hefty commissions to sellers while they seem to offer the buyers unbeatable protection covering their money as well as life! In fact they don’t. The costs and commissions on ULIPs are outrageously high and their returns are not in the public domain, unlike those of mutual funds. ULIP forms ought to carry statutory warnings, like in cigarette advertisements, which inform the buyer that the agent selling him/her the unit is likely to earn anywhere between 25% to 75% of the first-year premium. The calculation of net asset value (NAV) of ULIPs is also rather shadowy, unlike the transparent NAV of mutual funds. Ironically, while the insurance industry laments about how Indians are badly under-insured, ULIPs are the big focus of its marketing efforts and it is these products that give the insurance industry the power to move market prices as well as clout with the finance ministry.

SEBI’s anxiousness to regulate ULIPs is understandable—it must be galling to be a capital market regulator without any control over the biggest players in the capital market today. The situation needed smart handling and an effort to level the playing field—not a series of foolish actions that alienated retail investors (whose numbers are dwindling rapidly) as well as the fund industry.

Having embarked on the path of resolving Rekha Gupta’s complaint, SEBI was aiming for an international first by making India the first country to scrap entry-load (a mere 2.25%) on mutual funds while its officials arrogantly declared that investors must learn to pay for advice. So, it offered the retail investor a choice of several bad options—to invest through bank distributors (who charge more than what was paid out in the form of a 2.25% entry-load), listen to financial advisors who now hawk ULIPs with greater aggression, or sign up advisory contracts with unregulated financial advisors.

What was needed was a clear assessment of the situation. First, as IRDA has pointed out in a letter to SEBI (4 February 2010), the government took a conscious decision to have separate regulators for the four components of the financial sector—banking, insurance, capital markets and pensions. Even when there is an overlap of regulatory jurisdiction (as with currency derivatives), it is a conscious decision with some delineation of responsibility. Surely, no regulator can arrogate regulatory authority by issuing show-cause notices to entities under another statutory regulator. A level playing field between ULIPs and mutual funds is clearly necessary, but if SEBI had listened to mutual funds, it could have raised the issue with the finance ministry. Instead, it embarked on a series of actions that debilitated the fund industry, and is now working overtime at a cover-up by going after ULIPs to deflect attention from the mess.

Here again, it would have received a more sympathetic hearing from the finance ministry if there had been greater media discussion about the lack of transparency and exaggerated claims about ULIPs. Unfortunately, the advertising muscle of insurance companies works to ensure that the media plays a negligible role in warning investors about the pitfalls of ULIPs. Insurance companies keep the media in check by consciously refusing to advertise in publications that criticise unit-linked products. It is a game that the market regulator knows how to play too.

One also expected SEBI to be smart enough to recognise that as long as the Life Insurance Corporation of India (which has a 50% market share) is being called to bail out public sector issues, it is pointless to expect government support even for a level playing field, let alone for a ham-handed action like seeking to regulate a product that is cleared by another independent regulator under a clearly established set of guidelines. What then should SEBI have done? Here is what we think:
• It should have attempted to find out what investors want. And, although it has messed up, it must recognise that exchange-based trading and other adventures are not working.

• SEBI must recognise that the finance ministry is unlikely to support its move to get commissions on ULIPs reduced to zero at least until the disinvestment (of public sector units) target is reached. It is another reason to restore status quo until a broader solution is found.

• SEBI must recognise the role of financial advisors as intermediaries. Many of them genuinely work to give investors the best deal. Instead, many think that SEBI wants the smaller ones out of the business and is forcing investors to a few large private networks or bank distributors.

• Regulating financial advisors will ensure a check on the unscrupulous ones and give the good ones a voice in the system.

Fortunately, SEBI’s blundering over mutual fund regulation has successfully killed the delusion that industry experience makes for better regulation.

-- Sucheta Dalal