Fit and proper due diligence

Most distributors are small enough that an AMC empanelling them faces limited risk. A few are large enough that a problem with them could hurt many investors at once. SEBI singles those out for extra scrutiny.

An AMC must run a due diligence process on any distributor who crosses one of four size thresholds — a multi-location presence, a large industry-wide book of assets, or commission earnings above a set level. The process checks the distributor is "fit and proper": sound business practices, a clean regulatory record, and controls that keep sales staff separate from the people who assess whether a product actually suits a client.

This is a different exercise from the due diligence a client runs when choosing a portfolio manager. Here, the AMC is the one investigating, and a mutual fund distributor is the one being investigated.

The trigger criteria (Chapter 6.7, any one of which is enough): more than 20 locations; AUM raised over Rs 100 crore across the industry in the non-institutional category, including HNIs; commission received over Rs 1 crore per annum across the industry; or commission received over Rs 50 lakh from a single mutual fund.

Once a distributor crosses a trigger, the AMC's due diligence must cover: business model, experience and proficiency; the distributor's record of regulatory or statutory levies, fines, penalties and legal suits, and the corrective action taken; the same review extended to associates and subsidiaries; and organisational controls that keep two functions delinked from sales and relationship management — customer risk/investment-objective evaluation, and scheme-to-risk-category matching. This review happens both at the time of empanelment and periodically thereafter, and the AMC must disclose consolidated data on it on the AMFI website.

A national distribution firm has grown to 35 branches and now carries Rs 240 crore of AUM across the mutual fund industry, well past the Rs 100 crore threshold and the 20-location threshold both.

Every AMC empanelling this firm must run the fit-and-proper review: checking its regulatory history, verifying that its risk-profiling desk is organisationally separate from its sales desk, and reviewing any subsidiaries under the same group.

Contrast a solo distributor earning Rs 8 lakh in annual commission from one fund house — nowhere near the Rs 50 lakh single-fund threshold or the Rs 1 crore industry-wide one. No fit-and-proper trigger applies, though the AMC still runs its ordinary empanelment checks.

Chapter 6 (Fund Distribution and Channel Management Practices), section 6.7, gives the SEBI circular reference (CIR/IMD/DF/13/2011, dated 22 August 2011) and all four thresholds. Expect a question that gives a distributor's branch count, AUM, or commission figure and asks whether the fit-and-proper process applies — often with one figure just under a threshold and another just over it.

• Any one of the four triggers is sufficient — a distributor does not need to cross all of them.
• The Rs 1 crore commission threshold is industry-wide; the Rs 50 lakh threshold is from a single fund. A distributor earning Rs 40 lakh each from three funds (Rs 1.2 crore total) trips the industry-wide test without tripping the single-fund one.
• This "due diligence" and the client-on-manager Due diligence used in portfolio management are different processes with different subjects — here the AMC investigates the distributor.
• Sales and risk-assessment functions must be organisationally delinked — a single person doing both is exactly the control gap this rule targets.