Investing in Mutual Funds through Your Stock Broker? Read This!

The Securities and Exchange Board of India (SEBI), on Thursday, in a circular dated March 31, 2022, announced the extension of the deadline by three months for implementation of the rule to discontinue pooling of funds and/or units in mutual fund transactions by stock brokers/clearing members, and other entities operating online.

Considering representations from the Association of Mutual Funds in India (AMFI), the SEBI has provided more time to fund houses. The ban on this activity was supposed to be effective from April 01, 2022. However, it will now be implemented from July 01, 2022.

The SEBI stated in the latest circular, "On examination of the representation of the AMFI, in the interest of the investors, it has been decided to extend the date of applicability of "Circulars" including the clauses relating to 2FA for redemption and source account verification to July 01, 2022."

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In addition, as per the circular for Discontinuation of usage of pool accounts for transactions in the units of Mutual Funds dated October 04, 2021. The SEBI had said that stock brokers and clearing members should not accept payment through one-time mandate or issuance of mandates or instruments in their name for mutual fund transactions.

However, earlier this month, the regulator stated in the circular (for clarifications) dated March 15, 2022, "stock brokers/clearing members facilitating mutual fund transactions shall not accept payment through one-time mandate or issuance of mandates/instruments in their name for mutual fund transactions. However, one-time mandates in favour of SEBI recognized Clearing Corporations may be accepted from April 01, 2022."

Now that the deadline has been extended as per the SEBI's latest circular, "On or after July 01, 2022, new mandates shall be accepted only in favour of SEBI recognised Clearing Corporations, and those mandates shall exclusively be for subscriptions to units of mutual fund schemes and not for any other purpose."

The primary intent behind the SEBI's moves for discontinuation of usage of pool accounts for transactions in the units of Mutual Funds, Two Factor Authentication ('2FA') for redemption, and other related requirements were to ensure the safety of investors' money and prevent its possible misuse by intermediaries involved in such transactions.

At present, some online mutual fund transactions platforms and stock brokers can easily pool in money from the investors meant for purchasing mutual fund units in a nodal account based on the arrangement with the mutual fund house. Here, the distributor, stock brokers, or online transaction platform are holding investors' money for some time, which entails counterparty risk for the investors.

In order to prevent this practise, the SEBI has asked the fund houses to ensure that on the purchase of units of the mutual fund by the investor, the money is directly credited to the bank account of the mutual fund scheme and not to any other third party pool account. Similarly, when the investor sells the units of the mutual funds, the money will be transferred from the bank account of the mutual fund scheme directly to the investor's bank account.

When SEBI observed that based on a bilateral understanding with AMCs, a few mutual funds and broking platforms pool clients' funds into a nodal account and subsequently transfer them to AMCs either on a per transaction basis or lump sum basis, it announced a ban on 'intermediate pooling' of funds and units with effect from April 01, 2022, which is now extended to July 01, 2022. This move has been taken in a bid to safeguard the interest of mutual fund investors.

Mutual fund units, whether in Demat mode or not, will be directly credited to investors' accounts without the need for an intermediary pooling by the distributor. There will be no modifications for investors who invest through systematic investment plans (SIPs) at this time. SIP investments are made as a result of signing a one-time mandate. Although these existing investor mandates for running SIPs are currently in the name of distributors or intermediaries, fund houses must ensure that the money collected through such mandates is directly credited to the fund houses' bank accounts as per their agreement with payment aggregators and distributors. Depending on the arrangements used by the intermediary, new SIP mandates will be signed in the name of the fund house or in the name of the exchange's clearing corporation.

The SEBI has also requested the Association of Mutual Funds in India (AMFI) to give guidelines for AMCs on how to reduce the risk of funds being intermingled at payment aggregators or payment gateways involved in mutual fund transactions. This step is taken in order to maintain transparency of the mutual fund transactions and prevent any loss due to unauthorised transactions arising out of fraud, negligence, or deficiency.

SEBI notification read, "The onus of compliance with PMLA (Prevention of Money Laundering Act) provisions and not permitting transactions with third party bank account continues to lie with the AMCs. AMCs may avail of the services of the SEBI-recognized clearing corporations to validate the investors' source bank account information. In such cases, clearing corporation shall make the necessary source account details available to AMCs."

Thus, AMCs and other entities will be liable to compensate for losses to a unitholder due to unauthorised transactions resulting from fraud, negligence, or deficiency on the part of the AMCs.

Furthermore, the regulator has mandated the use of two-factor authentication for the redemption transaction of units of mutual funds. The two-factor authentication works, such as the first step will be a one-time password sent to the email or mobile number sent to the unitholder. In the case of an offline transaction, the signature validation method continues for honouring redemption transactions. This should ensure that the redemption transactions cannot be initiated without the consent of the unitholder.

While the SEBI has given relief to the MF industry until July 01, 2022 it also made clear in its letter to AMFI that since it had given "sufficient time" to mutual funds to implement its October 2021 order on pool accounts, and "wide consultations were held with all stakeholders, including the AMFI, before issuing the circulars dated October 2021".

Given that, SEBI has reminded AMFI on its earlier promise that all new scheme launches may be kept on hold until the pool accounts are discontinued.

Therefore, soon the mutual fund transaction platforms will directly credit the money received from you to the mutual fund's bank account and there will not be any 'intermediate pooling' anymore.

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Warm Regards,
Mitali Dhoke
Jr. Research Analyst