The Rise of Finfluencers and the Regulatory Dilemma in the Indian Financial Sector

In recent times, a group of individuals known as "finfluencers" have emerged as a controversial force in the Indian financial sector, prompting calls for regulatory measures. These financial influencers have revolutionized the way financial advice is disseminated, surpassing the role of traditional investment advisers, research analysts, and television stock market experts. Through their engaging and concise stories, reels, and videos, finfluencers have effectively connected with investors, presenting a new challenge for regulators. Finance Minister Nirmala Sitharaman and SEBI Chairperson Madhabi Puri Buch, both, have acknowledged the need for regulatory action, raising the question of why finfluencers gained prominence in the first place.

Over a decade ago, the Securities and Exchange Board of India (SEBI) introduced the SEBI (Investment Advisers) Regulations, 2013 (IA Regulations) to establish investment advisers as a new category of market intermediaries. The regulations aimed to ensure that advisers act in the best interest of their clients and avoid conflicts of interest arising from dual roles as advisers and distributors of financial products.

The importance of investment advisers in the Indian securities market has always been recognized. However, the scope of their role in individual investment decisions has evolved over time. In July 2020, SEBI made significant amendments to the IA Regulations, coinciding with finfluencers capitalizing on increased screen time during the COVID-19 lockdown to expand their follower base. These amendments not only revised the qualification, certification, and net worth criteria for investment advisers but also imposed restrictions on their ability to provide distribution or charge for implementation services. SEBI also set a cap on the fees investment advisers can charge, further limiting their services and potential earnings.

While these changes aimed to reinforce the objectives of the IA Regulations and ensure advisers act in their clients' best interests, they have become cumbersome for investment advisers and counterproductive for the securities market itself. As of January 31, 2020, SEBI had registered 1,277 investment advisers. However, despite more than three years passing, the number has only increased to 1,319. Out of these, only 894 entities, approximately two-thirds, are registered with BSE Administration and Supervision Ltd. (BASL). BASL, a wholly owned subsidiary of BSE Ltd., received recognition as the Investment Adviser Administration and Supervisory Board in June 2021 as a pre-regulator to SEBI. SEBI instructed all investment advisers to approach BASL for registration and post-registration activities.

During a period when the number of demat accounts in India rose from around 40 million in March 2020 to almost 115 million in March 2023, the number of active investment advisers decreased significantly. Presently, for every 1,30,000 demat accounts, there is only one BASL-registered investment adviser. In the United States, the ratio stands at one SEC-registered investment adviser for every 4,300 clients. It is this gap that finfluencers have stepped in to fill.

In April 2023, SEBI issued an advertisement code for investment advisers and research analysts to strengthen their compliance with the IA Regulations. The code stipulates that any communication, whether audio-visual, text messages, or messaging platforms, issued by or on behalf of an investment adviser that may influence investment decisions requires prior approval from BASL.

While these conditions are seen as a first step toward regulating finfluencers who are also registered investment advisers, they are likely to add to the compliance burden of existing advisers. The broad language of the advertisement code means that any communication by an investment adviser without prior approval from BASL could violate the code and face serious consequences. This demonstrates a regulatory body attempting to address its supervisory challenges by delegating authority to a private entity, inadvertently overregulating the entire sector.

SEBI could have drawn inspiration from its U.S. counterpart, the Securities and Exchange Commission (SEC), which has clearly defined the term "advertisement" and provided comprehensive conditions under which performance-related information can be used. In India, testimonials are entirely prohibited.

SEBI's restrictions have not only limited the services that investment advisers can offer but have also made their existing business increasingly burdensome. Therefore, SEBI must consider whether the current model even incentivizes finfluencers to register.

SEBI's recent introduction of the advertisement code for investment advisers sheds light on its potential approach to finfluencers. However, by imposing such onerous compliance requirements for every communication, SEBI is more likely to disrupt the finfluencer economy rather than regulate its growth. Finfluencers thrive in an environment where continuous content creation is vital for maintaining their following. Requiring prior approval for every communication is likely to undermine their entire business model. While it is true that the right to freedom of speech and expression under Article 19 of the Constitution of India is subject to reasonable restrictions, it is equally important for the state, or in this case, SEBI, to create an atmosphere of free speech and expression without fear and intimidation. SEBI's objective of promoting and regulating seem at odds in this code. An ideal approach for SEBI would be to establish a self-compliance-based regime that strictly penalizes violations, rather than regulating every action. This approach would benefit both finfluencers and SEBI, which is already burdened with existing regulatory oversight.

SEBI is striving to regulate a rapidly emerging segment of the securities market that did not exist half a decade ago. With no predefined playbook to follow, SEBI must chart its own path. Recent incidents involving the use of YouTube for running 'pump and dump' schemes (‘Arshad Warsi Case’) and the provision of unregistered advisory services by prominent YouTubers and options traders (‘PR Sundar Case’) highlight the fragility of this new segment.

It is not only SEBI but also the U.S. SEC that is attempting to address the undue influence of finfluencers. In December last year, even US SEC charged 8 social media influencers for running US$ 100 million ‘pump and dump’ schemes using Twitter and Discord channels. Previously, in December 2022, the SEC had fined Kim Kardashian US$1.26 million based on her Instagram posts that proclaimed the supposed benefits of EthereumMax and its EMAX tokens and failing to disclose that she was compensated for these promotions, or in 2020 when the renowned actor Steven Seagal was fined for failing to disclose payments he received for promoting an initial coin offering from Bitcoiin2Gen (B2G).

However, it is crucial to base rules on the broader picture rather than exceptional cases. SEBI should learn from the mistakes made with investment advisers to avoid repeating them while regulating finfluencers. To foster a robust securities market in India, it is essential to have a financially literate population, and SEBI should recognize the role finfluencers play in achieving this goal without undermining their contribution.

Sumit Agrawal and Pratham Darad, are seasoned securities lawyers from Regstreet Law Advisors and former officers of SEBI and PFRDA, respectively.

Views are personal.