SEBI asks MFs not to pay upfront commission from load accounts  

March 31, 2010

In a move to bring protect investors’ interests, market watchdog Securities and Exchange Board of India (SEBI) has mandated all asset management companies (AMCs) not to pay upfront commission to distributors from the load account. They can now pay upfront commission only from the recurring expenses account or from their own pockets. AMCs will have to comply with this new rule from 1 April 2010.

It may be recalled that Moneylife had earlier reported on how fund houses were paying upfront commissions for ELSS and other schemes to garner assets. (Read here).

After the ban on entry load by SEBI, fund houses were paying upfront commission from the load account. If an investor exits from the fund before the lock-in period, the exit load was transferred to this account. The commissions were as high as 2.5%-3%. Money held in a load account is supposed to be invested for the schemes and investors but AMCs were using this fund to pay upfront commission and for marketing purposes.

The new rule spells good news for investors but Independent Financial Advisors (IFAs) are up in arms. They feel cornered and discriminated against especially since insurance companies are able to offer lavish incentives to their agents.

According to sources, AMCs may now increase the trail commission or decrease the exit load in order to stop churning. AMCs were paying upfront commission which included trail of either one to three years or after negotiating the terms with the distributor. Distributors will now have to depend on the trail commission which is around 0.25% to 0.50%. If an investor holds Rs1 lakh investment in a mutual fund for six months, then the distributor gets Rs125 (0.25%) as trail commission.

“People expect to get money from the advisor rather than giving money to the advisor. The IFA does not get any money for selling Rs10,000 in a mutual fund. He may get it only if the investor holds on to it for six months or one year. The day-to-day survival of small IFAs will become difficult after the new SEBI rule, “said Ramesh Bhatt, CEO, Aniram, a Chennai-based IFA.

“Most of our customers give cheques of Rs10,000-Rs15,000. IFAs have to do 10 times more business now. Most of them will move out from the fund industry,” added Mr Bhatt. According to sources, AMCs will now only be able to pay 25 to 30 basis points of upfront commission. “It will mainly affect the smaller IFAs. The market will not expand,” said an IFA. “Sundaram Entertainment Fund had paid 1.50% upfront commission for one week. They had announced a dividend and wanted to capture maximum money by paying an upfront commission. Earlier when 2.25% commission was paid, we paid 25 paise as service tax and were left with 2% out of which we paid cash back of 1.75% to the investor,” said a distributor.

SEBI had earlier mandated AMCs not to pay dividend out of the unit premium reserve. The hefty dividend payout was merely a marketing tool by fund houses to attract more investors. The AMCs contacted by us did not wish to react to the new SEBI directive.  — Ravi Samalad