This post was triggered by Deepak Shenoy’s article about the regulator…

I was a little amused that the cases mentioned even got ‘caught’ .

First things first. What is a soft dollar commission or should i say soft rupee commission…

I will have to go a little into technical details, so please bear with me.

An asset management company (amc) gets a contract to manage money which is LEGALLY owned by a TRUST, but BENEFICIALLY owned by the unit holders.

For doing this the amc is paid a fee (called the management fee) and the amc is also allowed to charge. The expenses that they are allowed to charge are:

statutory charges, statutory advertising expenses, scheme audit fees, marketing expenses attributed to the scheme, custodian charges, bank charges, …etc.

(IF you are wondering why the BROKERAGE paid for buying and selling securities is not mentioned ….? well that is part of the COST of the security!).

OBVIOUSLY some expenses CANNOT be charged and this is mentioned in a NEGATIVE list. They cannot pay for ‘software’ charges. If they buy a software which helps them analyze say market movements (equity)…THAT CANNOT BE CHARGED to a fund scheme. Obviously, the amc cannot pay for RESEARCH REPORTS, ….etc..

So what can an amc with not so high standards of ethics do to improve their profitability?

Well if I were a broker, I could give my OWN office and give it to the asset management company at a very low rate. The asset management company starts paying a higher brokerage to me. The total money that I get from the asset management company = brokerage + rent. 

So to me the broker it does not matter whether I get it as a brokerage or as rent….and I may actually take the rent in a different entity (so save on taxes -eeek once a bean counter, always a bean counter!!).

How does it help the asset management company?

Simple the brokerage (higher brokerage) is borne by the unit holder (who keeps wondering why is my fund’s portfolio turnover so high) and the lower rent benefit is passed on to the shareholders of the fund.

Who should be seeing all this? Who should be alert to such mischief?

This was of course a more blunt example…but it could be in various transactions. For example a life insurance distributor could own an office and give it to the insurance company on rent. If the rent is far higher than the market rent, this would be a ‘soft dollar commission’ which is more than what IRDA allows.

Similarly a life insurance company could pay salaries to people on the rolls of the bank…well it is a little complicated, but given an Indian mind solutions are many.

IRDA should not have Mickey Mouse rules which are IMPOSSIBLE to probe, and very difficult to prove.

Instead it should say…term insurance must be offered first, and get the client to say “I know that there is term insurance, however because I want to combine an insurance product with my investment, I am choosing unit linked ….”

And then put a cap on the charges. How much is paid as a commission should not be a worry for IRDA. It hardly matters to IRDA if the client is willing to pay more or less.

Look at the brokerage business! SEBI has an UPPER LIMIT on the brokerage – at 2.5%, but the whole world pays less 0.5% for delivery based business. Look at civil aviation, cell phone business, etc….

HOWEVER, banks, insurance companies, housing finance companies, asset management companies…..DO NOT COMPETE in any sensible way….

Over to you Deepak Shenoy of capital mind….:-)