Chapter 11: Regulatory, Governance and Ethical Aspects of Portfolio Managers
11.1 Prevention of Money Laundering Act (PMLA 2002), KYC, UBO Identification, and FIU-IND Reporting
Portfolio Managers as Reporting Entities under PMLA, 2002
Under Section 2(1)(wa) of the Prevention of Money Laundering Act, 2002 (PMLA), a registered Portfolio Manager is classified as a Reporting Entity. Consequently, portfolio managers carry legal obligations to prevent the securities market from being utilized for money laundering, terrorist financing, or placement of illicit funds.
Client Application ---> Identity Verification (CKYC/KRA) ---> Beneficial Ownership (UBO) Determination
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Ongoing Transaction Monitoring v
- Cash Transaction Reports (CTR) Politically Exposed Persons (PEP)
- Suspicious Transaction Reports (STR) Sanctions Screening (FATF / UN)
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v
FIU-IND (Financial Intelligence Unit - India)
Know Your Client (KYC) Architecture
Portfolio managers must ensure every client completes standardized KYC verification prior to onboarding:
- Central KYC Records Registry (CKYCR): Intermediaries retrieve digitized KYC records using the 14-digit CKYC identification number.
- KYC Registration Agencies (KRAs): SEBI-regulated KRAs (e.g., CVL, NDML, CAMS, Karvy) maintain centralized databases of identity (PAN, Aadhaar/Passport) and address proofs.
- In-Person Verification (IPV): Mandated physical verification or digital Video In-Person Verification (VIPV) with geo-tagging and live facial matching.
Identification of Ultimate Beneficial Ownership (UBO)
When onboarding non-individual clients (companies, trusts, partnerships), the portfolio manager must peel back corporate layers to identify the natural person(s) who exercise ultimate controlling ownership:
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| Non-Individual Client Entity Type | Statutory UBO Ownership Threshold |
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| Company / Corporate Body | Natural person(s) holding > 10% of shares or capital |
| Partnership Firm / LLP | Natural person(s) holding > 10% of capital or profits |
| Unincorporated Association / Body | Natural person(s) holding > 15% of property or interest |
| Trust | Author of trust, trustee, beneficiaries with >= 10% share |
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If no natural person satisfies the ownership threshold, the senior managing official is designated as the UBO.
Reporting Mandates to FIU-IND
Every portfolio manager must appoint a designated Principal Officer for AML who reports directly to the Financial Intelligence Unit - India (FIU-IND):
- Suspicious Transaction Reports (STR): Must be filed with FIU-IND within 7 working days of arriving at a conclusion that any transaction (attempted or executed) lacks economic rationale, involves proceeds of crime, or suggests terrorist financing.
- Record Retention: PMLA mandates that all client identification records, account files, and transaction logs be securely retained for a minimum period of five (5) years after the business relationship has ceased.
11.2 SEBI Prohibition of Insider Trading (PIT) Regulations, UPSI, and Structured Digital Database (SDD)
SEBI (Prohibition of Insider Trading) Regulations, 2015
The integrity of capital markets depends upon ensuring that market participants do not exploit non-public material information for unfair financial gain. Under SEBI PIT Regulations, portfolio managers, research analysts, and dealers are classified as Connected Persons and Insiders whenever they possess or have access to unpublished price sensitive information (UPSI).
Definition of UPSI (Regulation 2(1)(n)):
Any information relating directly or indirectly to a company or its securities that is NOT GENERALLY AVAILABLE,
which upon becoming generally available, is likely to materially affect the price of the securities.
Includes:
- Financial results (quarterly, annual earnings)
- Dividends (interim, final)
- Mergers, de-mergers, acquisitions, delistings, expansions
- Changes in key managerial personnel (KMP)
Prohibited Conduct under PIT Regulations
- Trading when in possession of UPSI: No insider shall trade in securities that are listed or proposed to be listed when in possession of UPSI.
- Communication of UPSI: No insider shall communicate, provide, or allow access to any UPSI to any person except in furtherance of legitimate purposes, performance of duties, or discharge of legal obligations.
- Trading Window Restrictions: Employees and designated persons of the portfolio manager are prohibited from trading in securities during designated trading window closures.
Structured Digital Database (SDD) Mandate
To ensure an unbreakable, verifiable audit trail of information sharing, SEBI mandates that every entity handling UPSI must maintain an internal Structured Digital Database (SDD):
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| STRUCTURED DIGITAL DATABASE (SDD) REGULATORY MANDATE |
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| Non-Tamperable Architecture | - Database must be internally maintained with time-stamping |
| | - Software must prevent any editing, deletion, or tampering |
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| Mandatory Data Points Logged | - Exact nature of UPSI shared |
| | - Names and Permanent Account Numbers (PAN) of persons sharing|
| | - Names and PANs of persons/entities receiving the UPSI |
| | - Date, time, and documented 'Legitimate Purpose' for sharing |
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| Statutory Preservation Period | - Preserved securely for not less than eight (8) years |
| | - In the event of SEBI investigation, preserved indefinitely |
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Personal Securities Trading Policy and Chinese Walls
Portfolio managers must establish strict internal Chinese Walls separating research and fund management from corporate advisory wings. Furthermore, all employees must pre-clear personal securities transactions and adhere to minimum 30-day holding periods to prevent front-running client trades.
11.3 SEBI PFUTP Regulations, Code of Conduct for Portfolio Managers, and Investor Charter
SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003
The SEBI (PFUTP) Regulations protect the securities market from fraudulent devices, market manipulation, and misleading schemes:
- Market Manipulation: Artificially inflating, depressing, or causing fluctuations in the price of any security through wash sales, circular trades, or matched orders where there is no genuine change in beneficial ownership.
- Front-Running: Buying or selling securities for personal accounts or favored clients ahead of an anticipated large institutional client order to profit from the subsequent price impact.
- Churning: Executing excessive and unnecessary trades in a discretionary client portfolio for the primary purpose of generating brokerage commissions rather than advancing the client's investment objectives.
Front-Running : Knowledge of impending ₹50 Cr PMS buy order ---> Buy in personal account first ---> Sell at higher price (ILLEGAL)
Churning : Rapid unnecessary buying and selling in PMS demat to capture broker commissions (ILLEGAL)
Code of Conduct for Portfolio Managers (Schedule III)
Schedule III of SEBI (Portfolio Managers) Regulations, 2020 establishes the mandatory statutory Code of Conduct:
- Fiduciary Standard of Care: The portfolio manager shall observe high standards of integrity, fairness, and diligence in all dealings with clients and other market participants.
- Client Paramountcy: The portfolio manager must administer client portfolios with utmost good faith, giving priority to client interests over personal or corporate interests.
- Execution Quality: Strive for best execution in terms of price, execution speed, and transaction costs.
- Fair Allocation: Allocate trades across clients on a fair, objective, and equitable basis (VWAP and pro-rata) without favoring any client category.
- Conflict Avoidance: Avoid transactions involving potential conflicts of interest; where unavoidable, disclose full details to clients prior to execution.
The Investor Charter for Portfolio Management Services
SEBI mandated an official Investor Charter to educate investors regarding their fundamental rights, responsibilities, and protections:
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| SEBI PMS INVESTOR CHARTER HIGHLIGHTS |
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| Investor Rights | - Right to receive Form C Disclosure Document 2 days in advance|
| | - Right to choose Direct Plan with zero distributor fees |
| | - Right to receive monthly portfolio and transaction reports |
| | - Right to escalate disputes to SCORES and ODR portal |
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| Investor Responsibilities | - Thoroughly review and understand the IPS before signing |
| | - Provide accurate KYC, tax status, and bank demat details |
| | - Maintain statutory ₹50 Lakh minimum investment threshold |
| | - Keep login credentials and demat authorizations secure |
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