Regulation, Governance and Ethics — the ground floor

Why a distributor must know the rulebook

A PMS distributor is often the first person an investor meets. If the distributor does not know what the law demands — on money laundering, inside information, fraud, and what a portfolio manager may and may not do — the investor pays for it. This chapter collects those rules.

1. Prevention of Money Laundering Act, 2002 (PMLA)

PMLA is the core of India's legal framework against money laundering. Its provisions came into force on 1 July 2005. Its objective is "to prevent money-laundering and to provide for confiscation of property derived from, or involved in, money-laundering…".

Which transactions must be recorded

Every banking company, financial institution and intermediary must keep records of, report, and verify client identity for:

The offence

Section 3 defines money laundering: directly or indirectly attempting to indulge, knowingly assisting, being a party to, or being involved in any process connected with the proceeds of crime — including concealment, possession, acquisition or use — and projecting it as untainted property. Punishment is under Section 4.

Obligations — Section 12

Every reporting entity must:

• (a) keep records of all transactions so individual transactions can be reconstructed — for five years from the date of transaction.
• (b) furnish information on transactions, attempted or executed, to the Director within the prescribed time.
• (c) keep records of identity documents of clients and beneficial owners, account files and correspondence — for five years after the business relationship ends or the account closes, whichever is later.

All such information must be kept confidential.

Record retention — the workbook gives two figures. Earlier on the same pages the workbook says records "have to be maintained for a period of 10 years from the date of cessation of the transactions". The Section 12 text it then reproduces says five years. See the Exam-Ready level.

Enhanced due diligence — Section 12AA

Before each specified transaction, the reporting entity must:

• verify identity by Aadhaar authentication (or another prescribed mode if the person cannot get Aadhaar).
• examine ownership and financial position, including sources of funds.
• record the purpose of the transaction and the intended nature of the relationship.

This information is kept for five years from the date of transaction. If the client fails these conditions, the entity shall not allow the transaction. Where a transaction looks suspicious, future monitoring of the relationship must be increased.

Specified transactions include cash withdrawals or deposits and foreign exchange transactions above prescribed amounts, high-value imports or remittances, and other high-risk classes.

For SEBI intermediaries

Intermediaries registered under the SEBI Act must follow PMLA and designate a Principal Officer responsible for PMLA compliance. SEBI circulars on KYC, AML and Client Due Diligence (CDD) set minimum requirements — intermediaries may ask clients for additional disclosures.

2. SEBI (Prohibition of Insider Trading) Regulations, 2015

Trading on information not available in the public domain gives insiders an undue advantage and hurts market integrity. Schedule C sets minimum standards for the code of conduct of intermediaries and fiduciaries to regulate trading by designated persons.

Material financial relationship — a person receives payment (such as a loan or gift) from the designated person in the preceding twelve months equal to at least 25% of the designated person's annual income, excluding arm's length transactions.

Intermediaries must also have a process for bringing people "inside" on sensitive transactions and making them aware of their duties and liability.

3. SEBI (PFUTP) Regulations, 2003

The Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market Regulations prohibit fraudulent, unfair and manipulative practices.

Regulation 2(1)(c) defines fraud as including any act, expression, omission or concealment committed to induce another person or his agent to deal in securities.

Chapter II prohibits a person, directly or indirectly, from: buying, selling or dealing in securities fraudulently; using manipulative or deceptive devices in connection with securities listed or proposed to be listed; employing any scheme to defraud; engaging in practices operating as fraud or deceit; and indulging in fraudulent or unfair trade practices.

Dealing is deemed manipulative, fraudulent or unfair if it involves, among others:

• (a) creating a false or misleading appearance of trading.
• (b) dealing not intended to transfer beneficial ownership, only to move the price.
• (c) inducing subscription to fraudulently secure minimum subscription.
• (d) paying people to deal so as to artificially move prices.
• (e) manipulating a security's price, including its reference or benchmark price.
• (f) knowingly publishing untrue information — financial results, M&A, regulatory approvals.
• (g) transactions with no intention of performing or changing ownership; dealing in stolen, counterfeit or fraudulently issued securities.

4. SEBI (Portfolio Managers) Regulations, 2020

Portfolio = total holdings of securities and goods belonging to any person.

Principal officer = an employee designated by the portfolio manager, responsible for (i) decisions on managing client portfolios or funds and (ii) all other operations of the portfolio manager.

No person shall act as a portfolio manager without a certificate from SEBI.

Conditions of registration

• Abide by the SEBI Act and PM Regulations.
• Prior approval of SEBI for change in control.
• Forthwith inform SEBI in writing if information submitted is false or misleading, or materially changes.
• Pay registration fees.
• Redress investor grievances within the time prescribed by SEBI, and keep SEBI informed about complaints.
• Maintain the specified net worth at all times (not applicable to a co-investment portfolio manager).

Managing client portfolios

• Money and securities can be managed only in terms of the agreement with the client.
• Renewal on maturity is deemed a fresh placement (not applicable to co-investment PMs).
• Client may withdraw before maturity on: (a) voluntary or compulsory termination by either side; (b) suspension or cancellation of the PM's SEBI registration; (c) bankruptcy or liquidation of the PM.

Money market instruments include commercial paper, trade bills, treasury bills, certificates of deposit and usance bills.

Other duties:

• Segregate each client's funds and securities from its own, and be responsible for safekeeping.
• Must not hold client securities in its own name.
• May do securities lending only with the client's written authorisation.
• FPIs may use portfolio managers.
• Appoint a custodian — except PMs giving only advisory services and co-investment PMs.
• Furnish a net worth certificate from a chartered accountant when SEBI requires.

Reports to the client

Periodic reports as agreed, but at intervals not exceeding 3 months, and whenever the client asks. They contain:

• (a) composition and value of the portfolio, securities, goods, cash and aggregate value.
• (b) transactions during the period.
• (c) beneficial interest received — interest, dividend, bonus, rights.
• (d) expenses incurred.
• (e) risks foreseen by the PM.
• (f) coupon or payment defaults and downgrades to default rating.
• (g) commission paid to distributors for that client.

Reports may be put on the PM's website with restricted access for each client. On termination the PM gives a detailed statement of accounts and settles. Deficiencies in the auditor's report must be rectified within two months of the report.

Disclosures to SEBI and related-party investments

On SEBI's request: particulars of portfolio management; changes affecting the certificate; names of clients; net worth particulars.

Investing in securities of associates or related parties needs the client's prior consent. The consent form must have an option to dissent, and the client can set a limit. Records must be kept of consents, passive breaches of limits, steps to fix them and waivers on rebalancing.

5. Code of conduct for PMS distributors

Distributors must:

1. Follow the PM Regulations 2020 and APMI circulars on distribution and advertising.
2. Maintain integrity, promptitude and fairness.
3. Act with due skill, care and diligence.
4. Consider investor's interest, risk profiling and suitability while marketing.
5. Protect clients' interests.
6. Ensure commission or incentive never forms the basis for recommending PMS.
7. Be fully conversant with the Disclosure Document, investment approaches, fees and agreement terms.
8. Disclose all material information including distribution commissions for each investment approach.
9. Assist with KYC and In-Person Verification.
10. Give full, latest information on investment approaches and highlight assumptions in performance calculations and projections.
11. Explain risks and level of control for discretionary, non-discretionary or advisory services.
12. Never assure returns or misrepresent.
13. Not attract clients through rebates or gifts.
14. Keep infrastructure to support timely receipt of disclosure document, statements, fees and audit report.
15. Keep client details confidential.
16. No negative statements about other PMs; compare only similar and comparable products with complete facts.
17. No manipulative, fraudulent or deceptive practices, or spreading rumours.
18. Hold valid SEBI-specified certification at all times.

APMI registration. For collective industry oversight, any person or entity distributing PMS must register with APMI, and portfolio managers must ensure their distributors have done so (SEBI circular dated 2 May 2024).

6. Investor Charter for PMS

Issued by SEBI to raise awareness of what investors deal with when using PMS. All registered PMs must notify it to clients and display it prominently on their websites. It contains:

• A. Vision and mission statements.
• B. Details of business with investors — risk profiling, providing the Disclosure Document, executing the agreement, and making (discretionary), executing investor-decided (non-discretionary) or advising on (advisory) investments.
• C. Services and estimated timelines — e.g. account opening (with demat; plus bank and trading accounts for non-residents), nominee registration, uploading to KRA and CKYC, type of account, copy of agreement, custodian details, fees, PoA powers, risks, tenure, negative list of securities taken at signing as part of the account opening form, related-party and conflict-of-interest details in the Disclosure Document on the website, bank accounts holding client funds, and grievance redressal.
• D. Grievance redressal mechanism and how to access it.
• E. Responsibilities of investors.