New Delhi, May 28 -- The Securities and Exchange Board of India (SEBI) has barred portfolio manager First Global Finance (FGF) from onboarding new clients for 21 days and fined the firm and its directors, Devina Mehra and Neeraj Khanna, for investing client funds based on recommendations from a third-party algo provider and for mis-selling services, among other violations.
Portfolio management services (PMS) firms routinely use technological tools to execute trades and hire vendors to design and make such tools.
However, SEBI's May 26 order, which imposed a total penalty of Rs 42 lakh on the company and its directors, said such arrangements can blur the line, making a PMS firm rely on these vendors to provide investment advice rather than merely execute trades. Here is a quick explainer:
What was the arrangement?
First Global had hired Algo One and its personnel, Achin Agarwal, for technology consulting and analytics support.
Why did the regulator have a problem with it?
The order, issued by SEBI's chief general manager N Murugan, found that Agarwal was not just a technical consultant but was part of the investment decision-making process as a member of the PMS' Investment Committee (IC), and on an equal footing with other members.
SEBI also found that Algo One was involved in client-specific capital allocation and reallocation by generating and modifying "basket files", trade automation tools that include names of scrips to be traded, quantities, buy or sell recommendations, client codes and timings for each client.
FGF and its directors argued that these basket files merely automated the process of aligning individual client portfolios with the PMS-approved model portfolio and did not involve any independent security selection by Algo One.
While Murugan partly conceded this, he noted that the basket-file generation process may still have needed investment-related decision-making for making client-specific modifications. For example, if a client chose not to include certain securities from the PMS' model portfolio, the Algo One-generated basket file would have been modified to allocate the excess capital to alternative securities or sectors.
The regulator also investigated the fee-sharing mechanism between FGF and Algo One, under which the latter received 45% of FGF's net performance fee and 20% of its net management fee. SEBI noted that the notices could not adequately explain why the compensation was specifically tied to PMS performance rather than ordinary metrics associated with technology services.
SEBI concluded that FGF had "invested client funds based on the advice and investment-related inputs received from another entity, namely Algo One and Mr Achin Agarwal", in violation of PMS regulations.
What were the other violations?
Other violations included making exaggerated statements and comparisons in various documentation sent by FGF to clients, mis-selling PMS services by knowingly making false and misleading statements relating to its services, and being inconsistent in methods used for disclosing PMS performance.
Why did SEBI fine Devina Mehra and Neeraj Khanna?
The regulator found that both were involved in and aware of the operational arrangement with Algo One and Agarwal, including his inclusion in the IC, and the approval and implementation of the basket-file process.
Published by HT Digital Content Services with permission from VC Circle.