In this week's newsletter, we talk about ₹25 Lakhs, Karnataka's reservation bill, brushing teeth and more.

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How to get fined by SEBI if you're an Investment Adviser

Investment planning can be daunting, especially for those new to the financial world.

You have two options at your disposal.

Roll up your sleeves, do your research, and take charge of your investments. Invest your money in financial instruments you believe will generate and protect you from risks.

Alternatively, you can take the second route: Let an investment adviser (IA) cherry-pick a few investment instruments and curate a diverse, well-rounded portfolio for you.

Imagine you choose the latter route and seek advice from a SEBI-registered IA on how to get started.

Now, you trust your adviser because you know they are duly governed under SEBI’s regulations and possess the necessary qualifications.

Further to your relief, your IA’s website boasts numerous client testimonials about how it helped its clients earn great returns. These reviews bolster your trust, and you do precisely what they ask of you.

Unfortunately, one day, you discover that your investment adviser is under SEBI’s investigating lens for allegedly flouting many of its regulations.

Instantly, you stress about your investments and are sceptical about whether you made the right decision when choosing your IA.

Fast-forward to September 2022, and clients of the investment adviser Monetary Solutions must have experienced a similar sense of concern when SEBI decided to examine the firm closely.

Let’s explain.

See, investment advisers are not just freewheeling stockpickers. They must adhere to a string of rules designed to protect clients and ensure transparency.

Let's break down some of these key regulations.

First, before any advice is given or fees charged, there must be a signed investment advisory agreement detailing all the terms and conditions.

Next, to ensure that IAs are up to the task, they must meet the qualification and certification requirements set out in Regulation 7 of the IA Regulations.

See, Regulation 7 of the SEBI mandates that individual investment advisers or principal officers must possess a postgraduate degree or professional qualification in finance-related fields and at least five years of relevant experience. They and their associates must continuously upgrade their certifications from institutions like NISM (National Institute of Securities Markets).

Every conversation an IA has with a client or prospective client is crucial, and records of these interactions must be meticulously maintained for at least five years.

Annual audits are another critical aspect. IAs must undergo these audits within six months of the financial year’s end to ensure they comply with all IA regulations and circulars. Any adverse findings must be reported to SEBI within a month.

Additionally, IAs must necessarily do a deep dive into each client's risk tolerance and financial goals to make sure their investment strategy is on point. This includes looking at factors like age, investment objectives, income, existing investments, liabilities, and risk appetite.

Also, IAs can't offer free trials for their products or services—it's a strict no-go. Further, they have to use the SEBI Complaints Redress System (SCORES) to handle investor grievances and share any complaints on their websites or apps.

And guess what?

SEBI's investigation into Monetary Solutions uncovered some pretty shocking stuff. Several regulatory breaches were uncovered.

For instance, seven employees of Monetary Solutions dealt with clients without the required qualifications and certifications during SEBI's inspection.

On top of that, they were charging fees without any formal agreements in place, and they didn't even bother to keep essential client records like call recordings, agreements, KYC documents, invoices or even email communications.

But wait, there's more!

Their website was full of fake testimonials claiming big profits their clients made using their expertise, and they conveniently forgot to disclose the investor charter on their site. Now, this charter is vital as it provides investors with clear and concise information about their rights, responsibilities, the grievance redressal mechanism, and the dos and don'ts of investing in the securities market.

To add to this, the emails sent to the prospective clients mentioned offering free trials, which is a big no-no according to SEBI’s rules.

As if that wasn't enough, they were also operating from an unregistered location, totally ignoring regulatory requirements.

The discovery that clients were asked to deposit advisory fees directly into the proprietor's personal account was the last nail in the coffin, yet another blatant disregard for proper financial practices.

After all these breaches came to light and Monetary Solutions couldn’t offer any solid reasoning for its wrongdoing, SEBI took decisive action.

This Monday, SEBI fined Monetary Solutions Rs 25 Lakhs under the PFUTP (Prohibition of Fraudulent and Unfair Trade Practices) and IA (Investment Advisers) rules. And with one fell swoop, SEBI has sent out a message to everybody in the market.

Play by the rules, or face the music.

Does reserving jobs for locals make sense?

The Karnataka state cabinet’s latest job reservation Bill for locals has become the talk of the town, stirring up quite a bit of controversy.

And unless you’ve been living under a rock, you probably already know that the state government in Karnataka wants to create jobs for locals by reserving half or more private jobs. Now, this may not mean that people moving to Karnataka won’t get jobs. They just need to live in the state for at least 15 years and know Kannada, the local language. If they meet these criteria, they’re considered locals, no matter where they originally come from. Essentially, it’s a preference for people of the state.

But this begs the question ― Do these domicile-based job reservations make sense, especially in the private sector?

Well, there are three ways to look at it.

For starters you could look at it through the constitutional lens.

See, Karnataka isn’t the first state to come up with this idea. States like Haryana, Maharashtra, Madhya Pradesh, Andhra Pradesh and Jharkhand have tried introducing similar laws before. But many of these laws have either been struck down by the courts or haven’t been implemented yet.

You could look at Haryana’s law that reserved 75% of private sector jobs for locals. Last year, the Punjab & Haryana High Court quashed it, saying that the law created unfair discrimination among citizens and labelled it ‘unconstitutional.’ Despite that, the Haryana government challenged this in the Supreme Court, and the case is still pending.

These laws often run into trouble because of constitutional protections accorded to the people of India.

1. Article 14 (Right to Equality) - The Act unfairly discriminates against non-locals.
2. Article 19(1)(g) (Freedom to Practice Any Profession) - It restricts the right to work anywhere in India.
3. Article 16(2) (Equality of Opportunity in Employment) - It imposes unreasonable restrictions based on residency.

Besides, there's an old Supreme Court ruling that suggests that total reservations shouldn’t exceed 50% of available jobs or posts. Sure, this ruling was about caste-based reservations, but it also sets a precedent for domicile-based reservations.

So, when you look at it constitutionally, there are quite a few issues with these kinds of ideas.

Then there's the economic perspective.

A local person who may not be the best fit for the job could be hired over a more qualified non-local. This can lead to a shortage of skilled workers in the state.

It also makes it tough for businesses. They have to follow state laws, and not complying could mean hefty fines and penalties. Plus, the cost of compliance goes up as businesses might need to consistently prove to the government that they're following the rules.

The biggest issue, though, is investment. Policies like this can scare away capital investment, making the state less attractive to investors and hurting its economic prospects in the long run.

The proof is in the pudding. In FY23, Haryana, once a hot spot for investments, especially in skill-driven sectors like automobiles, saw a sharp decline. Its share of new investment projects in the country dropped to a six-year low of 1%, down from almost 3% the year before. Total investment outlays in the state fell by 30% from nearly ₹56,000 crore in FY22. This decline pushed Haryana from the ninth-best state for new investment projects to the thirteenth rank in a rather short span of time. And this drop may have had a lot to do with the introduction of Haryana’s job reservation law, which was later quashed by the state’s High Court.

In Karnataka’s case, the real estate sector might take a hit. Over half of the mid and senior-level employees who come to Karnataka from other states invest in local property.

Plus, there's the construction labour market to consider. Real estate developers in Karnataka already face a shortage of construction workers, with about 80% coming from outside the state, mainly from places like Jharkhand, Odisha, and Bihar. And a reservation for locals could disrupt this crucial workforce.

So, instead of boosting the state’s economy, such a law might actually open a can of worms and do more harm than good.

And finally, you could look at migration trends to see if Karnataka really needs a law like this.

See, despite the constitutional issues, laws like these often emerge due to political pressures and might be drawn up hastily without a keen eye for details.

Take Maharashtra, for example. In 2008, the state government mandated that private companies receiving state incentives reserve 50% of supervisory jobs and 80% of non-supervisory jobs for locals. Even though data in 2019 showed that locals held 84% of supervisory jobs and 94% of non-supervisory jobs, the government still pushed for more local representation. This suggests that such laws might be more about political relevance than actual need.

Then you could look at the migration data. About 4% of India’s population lived outside their state of birth according to the 2011 census. Even if that's the latest available official figure, it's over a decade old. And more recent data from the Centre for Economic Data and Analysis (CEDA) in 2021 showed that Delhi had the highest percentage of interstate migrants at 65%, followed by Goa, Meghalaya, Arunachal Pradesh and Punjab. Karnataka was much lower at less than 10%. So, it's safe to say that interstate migrants aren’t taking away a large number of jobs from local residents in Karnataka at least.

So, if the government wants to bring in such a law, maybe what’s needed is some thorough data analysis to see if it is really necessary. Or maybe even look for better ways for the state to create jobs for locals without relying on reservation laws?

For instance, the state could incentivise the growth of local industries and train locals with the necessary skills. The government could even engage with industry representatives to understand the skills they need or employ think tanks to analyse future job trends. This could help the government adjust the education system to prepare locals for these jobs and could ensure they get jobs based on merit, not just because of a reservation.

But this is easier said than done. And we’ll only have to wait and see how the government navigates this.

Money Tips 💰: Brushing teeth

What if we told you that there’s a relationship between how much you earn and how frequently you brush your teeth?

Don’t believe us?

Well, in 1974 economist Alan Blinder published a paper titled ‘The Economics of Brushing Teeth’ in the Journal of Political Economy which observed that people who earned less, brushed more.

The logic was simple. And the assumption based on the human capital theory which asserts that people do whatever they do, to maximize their income. In this case ― brushing teeth.

Think chefs and waiters working in a restaurant. Chefs are often working behind the scenes, while waiters have to be presentable to customers. Now if you have a person with bad breath or yellow teeth waiting to take your order at a restaurant, there’s a higher chance of the chap losing their tips.

On the contrary, chefs have none of this to worry about. And if you look at it, chefs bag a higher pay than waiters. So if waiters had to pocket more money, they had to well, take care of their teeth.

Another observation Blinder noted was of professors at a leading university. He found that assistant professors brushed 2.14 times daily on average, while associate professors brushed only 1.89 times and full professors only 1.47 times daily.

Notice the pattern? Higher the rank, lower the frequency of brushing teeth. Which meant that assistant and associate professors brushed more often than their seniors, so that they could get promoted and earn more.

Interacting with people with a bad breath can sure dampen your chances of going up the career ladder eh?

So, even if you argued that your brushing habit came from how much your mum pushed you into doing it, she still had an outlook of maximising your income when she told you so.

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