Investment advisors have emerged in Russia

Starting December 21, 2018, amendments to securities market legislation came into force, introducing regulation for investment advisers, i.e., persons engaged in providing advisory services related to securities and derivative financial instruments, as well as transactions involving them, through the provision of individual investment recommendations.

Law on Investment Advisors

Amendments to Federal Law No. 39-FZ dated April 22, 1996 "On Securities Market" establish that such activity must be carried out under an investment consulting agreement exclusively by legal entities or individual entrepreneurs who are members of a self-regulatory organization in the financial market, uniting investment advisors, and included in the unified register of investment advisors.

Until recently, unlike, for example, countries in the European Union (hereinafter referred to as the EU), investment consulting activities in Russia were not regulated in any way. As a result, the barrier to entry into the investment consulting market was so low that virtually anyone could provide such services, often leading to numerous cases of poor-quality services being provided.

For comparison, to offer investment consulting services in the EU, one must set up an investment firm, which requires, among other things, paying a share capital of €50,000 or obtaining professional insurance coverage worth €1,500,000 per year.

Even currently, Russia does not impose such high barriers to entry as the European Union. Thus, following the enactment of legislative amendments, the Central Bank of the Russian Federation (hereinafter referred to as the CB RF) will maintain a register of investment advisors, and each investment advisor will be required to join a self-regulatory organization (hereinafter referred to as SRO). In turn, this self-regulatory organization sets certain requirements for potential SRO participants' capital, experience, and qualifications.

What Requirements Must an Investment Advisor Meet?

Individual entrepreneurs (IEs) acting as investment advisors, as well as members of management bodies and employees of legal entities (LEs) serving as investment advisors, must meet the requirements for business reputation. The following individuals are considered non-compliant with these requirements:

1) Those who served as sole executive officers of financial organizations at the time when these organizations committed violations resulting in the revocation of their licenses for relevant activities, or violations leading to the suspension of such licenses followed by their subsequent revocation due to failure to rectify these violations, if less than three years have passed since such revocation;

2) Individuals whose period of administrative punishment in the form of disqualification has not yet expired;

3) Persons with unexpunged or unspent convictions for crimes in the economic sphere or against state authority.

What Should an Investment Advisor Do?

According to the new regulations, an investment advisor must provide investment consulting services honestly, reasonably, and solely in the best interests of the client. This introduces a potential risk of situations involving conflicts of interest. Consider a hypothetical scenario where two major shareholders of a public company separately seek advice from the same investment consultant about potentially selling part of their shares. Such a sale might influence the stock price, meaning one shareholder could benefit from the transaction while another could lose. This situation could lead to a dispute between the losing investor and the investment advisor, possibly resulting in the advisor's exclusion from the self-regulatory organization (SRO), preventing them from further engaging in investment consulting activities.

Additionally, it's important to note that an investment advisor should provide individual investment recommendations to clients based on their investment profile. To determine this profile, the advisor must request necessary information from the client, such as their experience in financial markets, education level, and the amount of funds they are willing to risk.

To address this issue, we recommend that every investment advisor develop their own "Suitability Test," which will help identify the necessary information.

However, it should be taken into account that the investment consultant is not obligated to verify the accuracy of the provided information and bears no responsibility for losses incurred due to an individual investment recommendation based on false information supplied by the client. If a potential client refuses to provide the requested information, the investment advisor is not authorized to give an individual investment recommendation.

What Information Is Contained in an Investment Recommendation?

If a client passes the test and seeks consultation from an investment advisor, the advisor must include the following information in the provided investment recommendation:

1) Description of the security and description of the planned transaction and/or contract, which is a derivative financial instrument, for which the recommendation is given;

2) Description of risks associated with the respective security or derivative financial instrument, transaction with the security, and/or conclusion of a contract that is a derivative financial instrument;

3) Indication of whether there is a conflict of interest on the part of the investment advisor during the provision of services, or confirmation of its absence.

It is also worth noting that if computer programs are used by the investment advisor when providing individual investment recommendations, these programs must be accredited by the Central Bank of the Russian Federation (CB RF). However, the CB RF may delegate accreditation powers for these programs to a self-regulatory organization (SRO) in the financial market that unites investment advisors.

Despite the above, current laws do not establish special mechanisms for compensating damages suffered by clients due to actions of investment advisors. Therefore, an investment advisor is liable for improper performance of duties in accordance with the laws of the Russian Federation and the terms of the investment consulting agreement.