The market watchdog, the Securities and Exchange Board of India (SEBI), has now told stockbrokers, who provide algorithmic trading (algo trading), not to allow algo sellers to promise high returns on their trading platforms. Algos meant for retail investors, or retail algos as they are called, have been publicising extraordinary returns for a long time. It is good that SEBI is attempting to stop such mis-selling. However, is the promise of extraordinary returns the only problem with retail algos? In my view, the problem is much bigger and very basic. If you read SEBI regulations on investment advice, retail algos are an illegal product.
According to SEBI Investment Advisers Regulations, 2013, investment advice means “advice relating to investing in, purchasing, selling or otherwise dealing in securities or investment products, and advice on investment portfolio containing securities or investment products, whether written, oral or through any other means of communication for the benefit of the client and shall include financial planning.”
Aren’t retail algos offering advice on buying and selling of stocks which is an investment product? A cursory look at the algo creators will show that the very purpose of algos is to offer buy/sell recommendations embedded in their programmes, often marketed by making wild claims.
But are they registered as investment advisers (RIAs)? There are hardly any pure algo writers who are RIAs because the registration brings with it enormous bureaucratic compliance of risk profiling, recording suitability and rationale of every investment advice and storing it for five years.
RIAs also have to sign long agreements with clients, offer various disclosures and get yearly audits done.
It is almost impossible for anyone to follow SEBI rules, as applicable to RIAs, in a rapid-fire environment of programmed trading (SEBI’s rules do not distinguish between trading and investment as per its own definition of ‘advice’).
A plain reading of the rules shows retail algos are illegally offering investment advice. It doesn’t stop there. Algo marketplaces like Tradetron even violate the portfolio management services (PMS) regulation. Tradetron promises its users: “realise your dream of being a PMS provider.”
Tradetron will ensure its strategies “will get executed across all brokerage accounts of your subscribers at one go. Regardless of whether there are 3 or 3000 - in different quantities across different brokers.”
Despite such glaring violations, all SEBI has done so far is to ask brokers to ensure that algo-makers don’t claim extraordinary returns. Yet, SEBI does not hesitate to harshly penalise fully regulated and compliant entities for small mistakes.
Why is SEBI hesitant to ban retail algos, despite obvious illegality? Because they have become too big and pervasive and the time to regulate is long gone. Indeed, the size of the ‘illegal’ investment advisory business is massive and thriving.
Funnily, the course material issued by the National Securities Market Institute (NISM) says that mutual fund distributors, share brokers and insurance agents, who earlier acted as investment advisers, “can no longer claim the title.”
In reality, all these intermediaries anyway used to provide buy/sell advice. And now, joining the bandwagon are algo-writers, many websites, online platforms, numerous telegram channels and two new apps—Rigi and Cosmofeed—where unregulated people are minting money, offering advice on options, futures and stocks, which SEBI is perhaps unaware of. They are all violating SEBI investment advisory regulations. Collectively, they have probably 100 times the client base of regulated advisers.
So, what is the way out? The way out is not to crack down on the so-called ‘illegal’ advisory business but recognise that these illegal advisers have sprung up to meet a specific customer need. The market has exposed the limitations of SEBI's antiquated and stifling RIA regulations and it is an opportunity to align rules with the reality of what investors want.
After all, regulations ought to be built around products that customers want and use. Instead, SEBI regulations are built around academic theories about financial planning which nobody wants. In reality, customers want buy/sell recommendations, which is the main activity in the investment business. This is what every intermediary and unregulated entity provides, without bothering about the impossibly complex and restrictive regulations.
The writing on the wall is clear. We need a new paradigm of regulating advice. SEBI would do well to restrict advisory regulations to those offering financial planning and create a new simple framework for everyone offering buy/sell advice—advisers, research analysts, algo-writers, app-based tipsters, stockbrokers and distributors.
Otherwise, continuous 'illegal' supply of buy/sell advice by regulated and unregulated market players rising up to meet the demand of the market, will make a farce of SEBI’s archaic advisory regulations.
(This article first appeared in Business Standard newspaper)