Regulatory, Governance and Ethics — the rulebook a PMS lives by

Why this chapter carries 10 marks

A portfolio manager handles other people's money with wide discretion. That power is exactly why the law surrounds it with rules. This chapter collects those rules in one place, in six blocks:

1. Prevention of Money Laundering Act, 2002 (PMLA)
2. SEBI (Prohibition of Insider Trading) Regulations, 2015.
3. SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 — usually shortened to the PFUTP Regulations.
4. SEBI (Portfolio Managers) Regulations, 2020 — with the codes of conduct for portfolio managers and PMS distributors.
5. Best practices — research objectivity and soft dollar arrangements.
6. Investor Charter and the Cyber Security and Cyber Resilience Framework (CSCRF)

Most questions here are straight recall of a number or a rule. Learn the numbers.

1. Prevention of Money Laundering Act, 2002

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

What must be recorded

Every banking company, financial institution and intermediary must keep a record of these transactions, verify client identity and furnish information:

How long to keep records — the workbook gives two figures

Read this carefully, because the workbook itself is not consistent:

• On page 194 it says these records must be kept for 10 years from the date of cessation of the transactions between the client and the intermediary.
• On page 195, quoting Section 12, it says the transaction records are kept for five years from the date of transaction, and identity records, account files and business correspondence for five years after the business relationship ended or the account was closed, whichever is later.

Both statements appear in Chapter 11. Know both, and read the question's wording to see which passage it is drawing on.

The offence — Section 3

Money laundering is committed by whoever directly or indirectly attempts to indulge, knowingly assists, is knowingly a party to, or is actually involved in any process or activity connected with the proceeds of crime — including its concealment, possession, acquisition or use and projecting and claiming it as untainted property. Punishment is under Section 4.

Obligations — Section 12

Every reporting entity must:

• maintain a record of all transactions so that individual transactions can be reconstructed.
• furnish to the Director information on prescribed transactions, whether attempted or executed.
• maintain records of identity of clients and beneficial owners, account files and correspondence.
• keep all such information confidential.

Enhanced due diligence — Section 12AA

Before any specified transaction, the reporting entity must:

• verify identity by Aadhaar authentication (another prescribed process for people not entitled to an Aadhaar number)
• 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 transaction must not be allowed. If a specified transaction looks suspicious, the entity must increase future monitoring of the relationship.

Specified transactions include cash withdrawals or deposits and foreign exchange transactions above a prescribed amount, high-value imports or remittances, and other high-risk classes that may be prescribed.

For SEBI intermediaries

Every SEBI-registered intermediary 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. Insider Trading Regulations, 2015

Trading on information that is not in the public domain gives insiders an undue advantage and damages market integrity. Schedule C of these regulations lays down minimum standards for the code of conduct that intermediaries and fiduciaries (a portfolio manager is one) must adopt to regulate, monitor and report trading by Designated Persons.

Annual disclosures by designated persons

Name and PAN (or other legal identifier) of immediate relatives and of persons with whom they share a material financial relationship, plus phone and mobile numbers used by them — annually and whenever it changes. Educational institutions and past employers are disclosed one time.

A material financial relationship exists when one person received payments (loan, gift etc.) from the designated person in the immediately preceding twelve months equal to at least 25% of the designated person's annual income — excluding arm's length transactions.

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

3. PFUTP Regulations, 2003

These prohibit fraudulent, unfair and manipulative trade practices. Regulation 2(1)(c) defines fraud to include 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 in a fraudulent manner; using manipulative or deceptive devices; employing schemes to defraud; or engaging in practices that operate as fraud or deceit.

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

• knowingly creating a false or misleading appearance of trading.
• dealing not intended to transfer beneficial ownership, only to inflate, depress or move prices.
• inducing subscriptions to fraudulently secure minimum subscription of an issue.
• paying or offering money to people to deal so as to move prices artificially.
• manipulating the reference price or benchmark price.
• knowingly publishing untrue information — results, mergers, regulatory approvals.
• entering transactions without intention of performing them or of changing ownership; dealing in stolen, counterfeit or fraudulently issued securities.

4. SEBI (Portfolio Managers) Regulations, 2020

Two definitions

• Portfolio — the total holdings of securities and goods belonging to any person.
• Principal officer — an employee designated by the portfolio manager who is responsible for (i) the decisions made in managing or administering client portfolios and (ii) all other operations of the portfolio manager.

Registration

No person can act as a portfolio manager without a SEBI certificate. Conditions of registration:

• abide by the SEBI Act and the regulations.
• prior SEBI approval for a change in control.
• forthwith inform SEBI if information submitted is false, misleading or materially changed.
• pay registration fees.
• redress investor grievances within SEBI's timelines and keep SEBI informed of complaints.
• maintain the specified net worth at all times (not applicable to a co-investment portfolio manager)

Managing the client's money

• Money or securities are invested only in terms of the agreement. A renewal on maturity is a fresh placement.
• The client can withdraw before maturity if: services are terminated (voluntary or compulsory) by either side; SEBI suspends or cancels the manager's registration; or the manager goes bankrupt or into liquidation.

Where the money may go

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

Mutual fund units may be bought only through the direct plan.

Safekeeping

• Segregate each client's funds and securities, and keep them apart from the manager's own.
• Never hold client securities in the manager's own name, by contract or otherwise.
• Securities lending only with the client's written authorisation.
• Foreign portfolio investors may use a portfolio manager.
• Every portfolio manager must appoint a custodian — except one offering only advisory services and a co-investment portfolio manager.
• Furnish a net worth certificate from a chartered accountant when SEBI requires.

Reports to the client

Periodically as agreed, but at intervals not exceeding 3 months, and whenever the client asks. The report may be placed on the manager's website with restricted access. It covers:

• composition and value of the portfolio, cash balance and aggregate value.
• transactions during the period.
• benefits received — interest, dividend, bonus, rights.
• expenses incurred.
• risks foreseen by the manager.
• defaults in coupon or other payments on debt, and downgrades to default rating.
• commission paid to distributors for that client.

On termination: a detailed statement of accounts and settlement. The client always has the right to obtain portfolio details. Deficiencies in the auditor's report must be rectified within two months of the report.

Disclosures to SEBI (when required)

Particulars of portfolio management; changes bearing on the certificate; names of clients whose portfolios were managed; net worth particulars.

Investing in associates and related parties

Only with the client's prior consent. The consent form must allow the client to dissent, and the client can set a limit. Records must be kept of consent or dissent, passive breaches, rectification steps and waivers on rebalancing.

These limits apply to direct investments in associates' securities, not to mutual fund investments.

Regulatory sandbox exemption

To promote innovation, SEBI may exempt a person or class of persons from any provision of the regulations for not more than 12 months, for testing in a regulatory sandbox — a live testing environment on a limited set of eligible customers for a specified period.

Code of conduct for portfolio managers — Schedule III

The key duties:

• High standards of integrity and fairness with clients and other portfolio managers.
• Deploy client money as soon as possible; pay money due forthwith.
• Due diligence and independent professional judgement; avoid conflicts or ensure fair treatment and disclose sources of conflict; never place own interest above the client's.
• No trade against client interest in the proprietary account.
• No statements harmful to other portfolio managers.
• No exaggerated statements about qualifications, capability or past achievements.
• At contract, obtain in writing the client's interests in corporate bodies that could give them UPSI.
• No disclosure of confidential client information to other clients or the press.
• Handle transfers, dividends, interest, rights, conversions per the client's instructions.
• Not be party to false markets, price rigging, or passing price-sensitive information to brokers and intermediaries.
• No trading on UPSI obtained during a professional assignment, directly or through associates, family or relatives.
• Advice in public media only with disclosure of long or short position; an employee also discloses the positions of dependent family members and the employer.
• Comply with the SEBI Act, regulations and the Insider Trading code of conduct.
• Not use status as another registered intermediary to influence clients.

Eligible Fund Managers

An overseas fund that uses an India-based manager is an Eligible Investment Fund; that India-based manager is an Eligible Fund Manager. Chapter III of the 2020 regulations covers them. Both existing portfolio managers and new applicants must comply with Section 9A of the Income Tax Act, 1961. An existing portfolio manager can start on intimation and declarations to SEBI; a new applicant seeks registration under Chapter III.

Several PMS provisions do not apply to their work for eligible investment funds, including: the high water mark principle on fees and fee disclosure; the obligation to act in a fiduciary capacity; audit of the overseas fund; the agreement between manager and overseas fund; reporting requirements for the overseas fund; and the minimum investment requirement of ₹50 lakh.

An eligible fund manager must, among other things: comply with Section 9A; segregate each fund's money and securities and keep them apart from other clients; appoint a custodian (unless the fund already has one); keep funds in scheduled commercial banks (unless the fund will not invest in Indian securities); give quarterly reports to SEBI; and comply with PMLA.

The workbook also notes that portfolio managers must not organise portfolios as "schemes" like mutual fund schemes when marketing.

Code of conduct for PMS distributors

Eighteen duties. The ones questions like:

• Consider risk profiling and suitability; commission or incentive must never be the basis for recommending PMS.
• Know the disclosure document, investment approaches, fees and agreement thoroughly.
• Disclose distribution commissions for each investment approach.
• Assist with KYC and In-Person Verification.
• Highlight assumptions behind performance calculations and projections.
• Explain risks and the level of control in discretionary, non-discretionary and advisory services.
• Never assure returns; no rebates or gifts to attract clients.
• No negative statements about other managers; comparisons only with similar products, with complete facts.
• Hold valid SEBI-specified certification at all times.

The workbook adds that distributors have to mandatorily obtain registration from APMI (citing a SEBI circular dated 2 May 2024).

5. Best practices

Research objectivity

The CFA Institute has developed Research Objectivity Standards (ROS) — specific, measurable norms for managing and disclosing conflicts of interest. The founding principle: the client's best interests always come before those of investment professionals and their employers.

Firms adopting ROS must: have a formal written research objectivity policy; make employees disclose conflicts in public appearances; ensure recommendations have a reasonable and adequate basis; segregate research analysts from investment banking; link analyst pay to research quality and accuracy, not to investment banking deals; manage analysts' relationships with company managements; control personal trading; fully disclose conflicts; and use a rating system useful for investors.

Soft dollar practices

A soft dollar arrangement is where the investment manager pays a higher brokerage commission in return for extra services — research reports, hardware, software, even non-research services.

In PMS, the investor pays the brokerage, so the client funds the manager's perks.

For mutual funds, SEBI's 2016 circular limits AMC–broker arrangements to benefits in the interest of investors (like free research reports), suitably disclosed. Portfolio managers may follow the same as good ethical practice.

6. Investor Charter and CSCRF

Investor Charter

Issued by SEBI to build investor awareness. It sets out services with estimated timelines — account opening, the agreement, periodic statements, grievance redressal, and the investor's own responsibilities. Every registered portfolio manager must notify it to clients and display it prominently on its website.

Cyber Security and Cyber Resilience Framework

Part of operational risk management. CSCRF follows a graded approach with five categories of Regulated Entities (REs):

1. Market Infrastructure Institutions (MIIs)
2. Qualified REs.
3. Mid-size REs.
4. Small-size REs.
5. Self-certification REs.

The category is fixed at the start of the financial year using the previous year's data, and stays the same all year even if parameters change. For portfolio managers:

Self-certification PMS entities with fewer than 100 clients are exempt from mandatory Market-SOC (M-SOC) — a shared Security Operations Centre built for smaller entities.