Introduction to Financial Planning

Case Study: Giriraj Hoda Giriraj Hoda is about to sign a new contract with the Mohun bagan Football Club. The club has announced that Giriraj has been offered a Rs. 3.5 million five-year contract. Giriraj seeks your advice. You establish that the contract has a number of features: A signing-on fee of Rs.1 million with Rs. 100,000 payable now and the balance in five years time; An annual salary of Rs. 300,000 per annum paid at the end of each year; A loan of Rs. 500,000 now, repayable by amounts of Rs. 130,000 at the end of each year of the five years of the contract; and A deferred salary of Rs. 200,000 per annum, paid at the end of the five-year contract subject to suitable on-ground performance. If we assume that Giriraj Hoda will perform on the field to the satisfaction of the football club, what is the value of the contract in present value terms so that this offer can be compared with offers from other football clubs in the future? Giriraj believes that an appropriate rate of return is 11%. Money, Asset Values and Inflation Inflation erodes the real value of money over time, and it reduces the real value of assets that have fixed nominal values. The money tied up in assets such as bonds, debentures, bank accounts and so on, falls in real value during inflationary periods. While such deposits earn interest (which provides some protection against the effects of inflation), when the effects of taxation are considered, many investors in an inflationary environment find it hard to protect the real value of their capital. This comes about because interest payments are classified as income, which is liable for taxation. Let’s first consider the effects of inflation, without the issue of taxation. If, as an example, inflation is at 4% p.a., then we would need a return on an investment of 4% p.a. just to keep pace with that inflation; i.e. our real rate of return, after inflation, would be zero, but the asset would maintain its real value. Generalising, our real rate of return is the nominal rate of return (i.e. interest rate or capital growth rate) minus the rate of inflation. Expressing this mathematically: ir = In – Ip Where ir = real rate of return after inflation in = nominal rate of return ip = rate of inflation Now let’s add the effect of taxation (assuming that the investment return is income). Let’s assume the investor is subject to a 43% marginal tax rate. That means for every Rs. 100 earned as return income, 43% (or Rs. 43) will be lost as tax; the investor gets to keep Rs. 100 – 43% of Rs.100 [or, re-arranging as brackets, Rs. 100 (1 – 43%)] = Rs. 57. Using mathematical symbols, the nominal rate of return after tax is: in(1 – t), where t = rate of tax. 251

Reworking our original formula to include both the effects of inflation and taxation, we have, as the real rate of return: ir = in (1 – t) – ip where ir = real rate of return after tax and inflation The following table shows the impact of inflation on the real value of money over time and how both taxation and inflation substantially reduce the effective returns received by investors. It also shows the real effects of lower interest rates on return. Table 5.5: Effects of taxation and inflation on effective return Tax rate (%) Nominal rate on Effective return after Real return after tax &3% 10 Investment (%) tax (%) inflation (%) 20.4 4 3.60 0.60 30.6 6 5.40 2.40 8 7.20 4.20 4 3.184 0.184 6 4.776 1.776 8 6.368 3.368 4 2.776 -0.224 6 4.164 1.164 8 5.552 2.552 Table 4.1 highlights the desirability of including some investments that hold out prospects for capital growth. If investors can organise their investments so as to minimise the effects of taxation and inflation, they will be in a better position to protect their capital and to build wealth over time. The effective return figures are calculated by discounting the after-tax return by 3%. Example Tax rate 10% Inflation 3% p.a. Return 8.0% p.a. Return after tax 7.2% p.a. (calculated 8% X (1 – 0.1)) Return after tax and inflation 4.2% (calculated 7.2% – 3%) Therefore, the real return is 4.2% p.a. To calculate the minimum rate of return to maintain the value of an investment, divide the inflation rate by (1 – tax rate), e.g. where the marginal tax rate is 17%, and the inflation rate is 3%, 3% ÷ (1 – 0.17) = 3.6% p.a. 252

Solution to Case Study: Giriraj Hoda On the face of it, the Rs.3.5 million contract is as follows: Rs. Signing on fee 1,000,000 Annual salary 1,500,000 Deferred salary 1,000,000 3,500,000 If we assume that Giriraj Hoda will perform on the field to the satisfaction of the football club, what is the value of the contract in present value terms? The cash flow is outlined in the table below. The yearly totals are as follows: Rs. Year 0 600,000 Year 1 170,000 Year 2 170,000 Year 3 170,000 Year 4 170,000 Year 5 2,070,000 3,350,000 Note also that although the loan is for Rs.5,00,000, the repayments total Rs.650,000, the difference being interest that the club charges on the loan: a balancing figure of Rs. 150,000. The question we must consider is how much the contract is worth in today’s terms. The first thing we need to decide in order to answer this question is what return we would ordinarily expect to get from our money. Giriraj has suggested 11%, so using this as the discount rate the present value of the cash flows can now be calculated: PV = Rs.600 000 Rs. 170,000 Rs. 170,000 Rs. 170,000 Rs. 170,000 Rs. 170,000 = Rs. 2,355,860.02 + + + + + (1 + 0.11)1 (1 + 0.11)2 (1 + 0.11)3 (1 + 0.11)4 (1 + 0.11)5 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 900,000 Signing on fee 100,000 300,000 300,000 300,000 300,000 300,000 -130,000 -130,000 -130,000 -130,000 -130,000 Annual salary 1 000 000 170,000 170,000 170,000 170,000 2,070,000 Loan 500,000 Deferred salary Total 600,000 Financial Statement Analysis Personal financial statements are examined by different professionals for a variety of applications. The banker wishes to determine if the client has adequate resources to repay a loan as agreed. The life insurance broker is interested in examining resources available to support the client’s dependants should the client die. The accountant needs to understand the composition of assets and liabilities, as well as present and future cash flows, in order to map out a strategy for reducing present and future tax liabilities. The lawyer is 253

concerned about the client’s financial resources as legal documents are created. And the financial planner uses financial statements for all the above reasons as well as to assess potential wealth growth, and to ascertain the client’s progress toward goal attainment. Such professionals need to analyse their client’s financial condition to help him/her better manage financial resources, to develop effective spending patterns consistent with consumption and investment goals, and to guard against excessive use of debt. They need to know the effectiveness of current income tax reduction strategies and be able to identify potential tax or liquidity problems that may occur now or in the future. Properly analysed, financial statements should provide information essential in improving the financial planning process. Sources of information for personal financial statement analysis 1. Bank passbooks or statements They would give an idea of payments made and receipts of income from various sources 2. Return of income filed and Form 16A The return of income is useful from two perspectives. First it gives an idea of the income received from various sources and second it shows the tax paid. Form 16A is the form given by the employer detailing the tax deducted at source from the employee’s salary and again gives the income and deductions therefrom. 3. Other statements Other sources of information include bills received, insurance policies, fixed deposit statements and other investments. Points to Consider in Ratio Evaluation Before suggesting ratios for the analysis of personal financial statements, some general concepts concerning the ratio analysis should be discussed. An important point to remember is that ratios are not usually evaluated in a vacuum. All ratios need to be considered in light of the client’s situation. For example, in business financial statements, one cannot look at a current ratio of 1.5 and adequately assess the company’s liquidity situation. The analyst must look at the past current ratios of the company and the current ratios of other companies in the industry. The influence of national economic trends and the firm’s objectives should also be considered in the analysis of the ratio. The current ratio of 1.5 says little about the company unless it is evaluated in the context of these other factors. Ratios extracted from personal financial statements must also be evaluated in light of the client’s circumstances. In fact, the factors that affect the evaluation of personal financial statement ratios are often similar to those used in the analysis of business ratios. Just as one would compare the debt -asset ratios of companies in the same industry, one could also compare the debt -asset ratios of clients in the same stage in the life cycle. Economic trends and the person’s objectives should also be considered when evaluating an individual’s debt-asset ratio. Therefore, it is extremely important to evaluate ratios in the context of each client’s situation. The following five factors need to be considered when interpreting a client’s personal financial statement ratios: 1. Life Cycle 2. Family Status 254

3. Economic Status 4. Economic Environment 5. Client Objectives and Preferences Life Cycle Consideration of the client’s stage in the life cycle is essential in interpreting financial ratios. There are three basic stages in the financial life cycle of a client: accumulation, preservation, and distribution. Younger clients, who have not had the time to accumulate many assets, will have a larger percentage of assets represented by personal assets and a home. Such younger couples will usually have a higher ratio of their net worth financed by debt, and may even have a negative net worth. As clients move through the life cycle, dependence on credit declines. There is a larger asset base to appreciate, liabilities are paid down, and additional assets are acquired. Net worth should grow much faster than the rate of inflation, reaching its peak about retirement time when many families have repaid most, if not all, of their debt obligations. Preservation of capital becomes more important as they reposition assets so an increasing percentage generates income necessary to fund retirement. Although estate planning has been going on throughout the accumulation and preservation stages of the life cycle, a greater interest is shown near retirement in distributing assets to beneficiaries. The client is concerned that at death the estate not experience liquidity problems. Ratios calculated for clients in different stages of the life cycle will have to be carefully interpreted because the client’s financial concerns change as he or she ages. Family Status Single-parent households, dual-income families, and single clients can be expected to have different financial data because they have different income flows and asset bases. The client’s family status influences his or her goals and objectives, and must be kept in mind when analysing ratios that measure the client’s financial well-being. Economic Status The financial statement for someone making Rs. 200,000 annually will be significantly different from that of a millionaire. A client where both spouses are employed enjoys advantages and disadvantages compared to the household with one breadwinner. The composition of assets and liabilities on the financial statements of doctors are in marked contrast to those of farmers. The occupation as well as the income level results in significantly different statements. Judgments about financial position need to take many factors into consideration when com-paring individuals from different economic backgrounds. Economic Environment The economic environment is another factor that has a powerful effect on an individual’s position. For example, in an environment with 10% annual inflation, a nominal increase in net worth of 8% indicates that the client’s net worth in real terms has actually decreased. Evaluating the 8% increase in net worth without considering the inflationary environment would lead the analyst to some faulty conclusions. The stage in the business cycle needs to be considered when evaluating a client’s investment strategies and financial position. The client’s portfolio mix and debt position should be appropriate for the current phase of 255

the cycle; some investments that are extremely attractive during one stage in the cycle should be avoided in another. Analysts of personal financial statements need to consider carefully the age and other economic factors as they evaluate their client’s financial ratios. Client Objectives and Preferences The client’s financial ratios must be evaluated in light of the client’s goals, objectives, and preferences. These objectives and preferences, although influenced by stages in the life cycle, client status, economic status, and the economic environment, are also influenced by closely held values and beliefs. For example, an individual who grew up during the Depression may have an aversion toward incurring debt and taking financial risks, while an individual growing up in the 1950s or 1960s may have no such hesitancy. Because of these differing backgrounds, the second individual may be more comfortable with a higher debt-asset ratio than the first. Planners and other professionals must consider these kinds of personal objectives and attitudes as they talk with the client about his or her financial situation. Personal Financial Statement Ratios This topic provides a set of ratios that will enable the financial professional to increase his or her insight in analysing personal financial statements. However, the determination of standards for judging ratios, even after decades of usage, is still somewhat subjective. There are some accepted rules of thumb, but an analyst’s judgment often comes down to what the analyst is comfortable with. Each of these ratios should provide information that is either predictive or diagnostic about the client’s financial situation. The ratios should also lend themselves to a generally accepted interpretation by an informed user. To compute the following ratios, the financial professional would need the client’s statement of financial position (similar to a balance sheet), statement of changes in financial condition, spending records, and recent tax returns. The ratios we will suggest provide information about the following six aspects of the client’s financial situation: 1. Liquidity 2. Debt 3. Risk Exposure 4. Tax Burden 5. Inflation Protection 6. Net Worth A financial professional performing a comprehensive financial analysis of a client would address at least these six areas. A Case Example To illustrate the suggested ratios, data is provided in Figures 4.8 and 4.9 for Vijay and Meera. Example, a couple who live in a hypothetical city. They are in the in their mid-forties and have two children - Priyanka, age 18, and Ajay, age 15. Vijay is a manager who works for a technology company. Meera has not been employed full-time but writes computer programs from time to time on special contracts with two firms. 256

Vijay and Meera became aware of the need for better financial planning and have prepared their personal financial statements. To show how each ratio is computed, data from their Statement of Financial Condition (Figure 4.8) has been used. Figure VIJAY AND MEERA EXAMPLE STATEMENT OF FINANCIAL CONDITION MARCH 31, 20XX ASSETS 20,000 Liquid Assets 60,000 Cash on hand 200,650 Checking account 0 Money 280,650 Other liquid assets Total 110,300 Other Financial Assets 210,300 Fixed rupee assets: 400,000 Fixed deposit 160,000 Bonds 100,000 560,000 Total Equity assets: Marketable stocks 200,000 Mutual funds 0 Total 50,000 0 Tangible Assets 250,000 Real Estate (vacant lot) Business 160,700 Precious metals 50,000 Other tangibles 90,000 Total 1,450,000 1,750,700 Personal Assets Auto(s) 900,000 Furniture & appliances 20,000 Clothing, jewelry 1,020,000 Home 4,071,650 Total 257 Deferred Assets Vested interest in pension plan Value of provident fund 1 Total Total Assets

LIABILITIES AND NET WORTH Liabilities Income taxes 50,850 0 Accounts payable 30,000 80,000 Credit Card Balance Installment Contracts Mortgage 490,600 Other margin account 100,000 Total Liabilities 751,450 Net Worth 3,320,200 Total Liabilities and Net Worth 4,071,650 It is obvious that a client’s financial situation changes from year to year. A Statement of Changes in Net Worth is also a useful statement to prepare for analysis. Figure VIJAY AND MEERA EXAMPLE STATEMENT OF CHANGES IN NET WORTH APRIL 1 TO MARCH 31 Realised Increases in Net Worth Salary of Meera 250,000 Salary of Vijay 750,000 Dividend and interest income 69,500 Gains on sale of marketable securities 13,500 Total Realised Increases in Net Worth 1,083,000 Realised Decreases in Net Worth Income taxes 280,500 Interest expense 55,000 Living expenses 596,800 Real estate taxes 67,000 Total Realised Decreases in Net Worth 999,300 Unrealised Increases in Net Worth Marketable securities 37,000 Residence 200,000 Jewellery 25,000 Total Unrealised Increases in Net Worth 262,000 Unrealised Decreases in Net Worth 258

Stock options 200,000 Total unrealised Decreases in Net Worth 200,000 SUMMARY 1,083,000 Total Realised Increases in Net Worth 262,000 Total Unrealised Increases in Net Worth Total Increase in Net Worth 1,345,000 Total Realised Decreases in Net Worth 999,300 Total Unrealised Decreases in Net Worth 200,000 Total Decrease in Net Worth 1,199,300 Net Increase in Net Worth 145,700 Net Worth at the Beginning of the Year 3,174,500 Net Worth at the End of the Year 3,320,200 Liquidity Liquidity ratios are useful in analysing a client’s ability to handle financial needs when faced with a decline in income, or to take advantage of a financial opportunity that may suddenly appear. A basic measure of liquidity can be formed by relating liquid assets to the monthly expenses that must be met: Basic Liquidity Ratio = Liquid assets / Monthly expenses For Vijay and Meera this would be: 280,650 / ((55,000 + 596,000 + 67,000)/12) = 4.69 Such a number indicates the number of months their liquid assets could support the couple. A target of 3-4 would seem to be reasonable. A similar measure would recognise that other financial assets are to some extent also liquid. Expanded Liquidity Ratio = Liquid Assets and Other Financial Assets / Monthly Expenses However, the advisability of counting assets such as stocks, bonds, and mutual funds at their full current value in such a calculation is questionable. Counting only a portion of their value would allow for their lower liquidity and, more important, the possibility of declines in their market values. Taking stocks, bonds and mutual funds at 50% of current value would give the following measure for Vijay and Meera: 280,650 + (0.50 (100,000 + 560,000) + 110,300)/ 59,900 = 12.04 A minimum of six for this measure would correspond to the common rule of thumb of having a reserve fund or emergency fund equal to six months income or expenses. People with more stable employment can afford a lower ratio. Debt First, we examine the debt burden, including the relationships between liquid assets and debt position. It is important that adequate liquid assets are available to repay debt if necessary. Sometimes a client’s financial 259

position can be improved through the wise use of debt financing. Often, however, the client has used debt financing inappropriately, either because the usage of debt is in conflict with the client’s attitudes about the types of risk the client is willing to assume, or simply because the debt financing is excessive. These ratios examine the client’s use of debt and his or her risk exposure. Liquid Asset Coverage Ratio = liquid assets / total debt For Vijay and Meera this would be: 280,650 / 751,450 = 0.37 It is difficult to set a standard on such a measure, but having over 20% as Vijay and Meera do should be comfortable since most of their debt is long term. The next measure combines liquid and financial assets: Solvency Ratio = liquid and other financial assets / total debt For Vijay and Meera: 1,050,950 / 751,450 = 1.39 Here is a ratio that is definitely related to stage in the life cycle. Perhaps 30 to 40% should be a minimum target for the couple, which suggests that Vijay and Meera are in good shape. The mortgage loan is a long- term debt, so it is worthwhile to look at the relationship of liquid assets to debt, other than the mortgage debt: Current Ratio = liquid assets / non-mortgage debt For Vijay and Meera this would be: 280,650 / 260,850 = 1.07 Anything over 1.00 could be considered excellent. A similar measure could take into account the payments that must be made on debt over the next year: Risk Exposure The risk exposure of the client is also important to examine from several different perspectives. From a preventative position, how adequately are financial risks covered? Does the client have adequate property and liability protec-tion? Would the client’s dependants be adequately provided for if the client should die? How much of the client’s current cash flow is derived from salary? An effective risk management program must be in place before the financial adviser can focus on increasing net worth. Life Insurance Coverage Ratio = Net Worth + Death Benefits of Principal Wage Earner / Salary of Principal Wage Earner 3,320,200 + 2,500,000 / 750,000 = 7.76 where death benefits are assumed at Rs. 2,500,000. This ratio is not to be used in place of a needs analysis to determine adequate life insurance coverage. However, a ratio from seven to ten would indicate that beneficiaries of the principal wage earner ’s policy could support themselves for an extended period of time. 260

Of course, such a ratio must be carefully interpreted since the liquidity of each person’s net worth is quite different. Tax Burden Most clients are interested in paying the least amount of taxes required in compliance with current tax laws and rulings. The financial professional must evaluate how effective tax planning has been. Tax planning is one of the most effective ways to enhance a client’s net worth. The following ratios are useful in indicating how well such planning has been implemented. Effective Income Tax Ratio = Income Tax Liability / Total Realised Increases in Net Worth = 280,050 / 1,083,000 =.25 The effective income tax rate represents the percentage of realized increases in net worth paid out in taxes by the client. It should be understood that this ratio is almost always significantly lower than the average income tax rate which is aggregate tax liability divided by taxable income. Since it is a primary goal of almost all financial advisers to assist clients in legally avoiding or postponing the payments of taxes, this measure is useful to calculate when examining the income tax burden of the client. Inflation Protection While there is no general worry about inflation today as there was a few years ago, the following measures give a rough indication of how well the client’s financial position is protected against inflation. The first ratio compares the total of assets that may give some protection against inflation to net worth: Inflation Hedge Ratio = equity, tangible and personal assets / net worth Equity assets do not automatically increase with inflation, but they have the possibility of doing so while fixed rupee assets do not. Owning a home gives considerable protection against increases in housing costs. Like equities, other tangibles don’t necessarily increase in value with inflation, but have the possibility of doing so. Personal assets provide insulation from the effect of inflation in the near-term in the sense they can be used without the need to buy their services at the higher prices that occur with inflation. For Vijay and Meera this measure was: 2,560,700 / 3,320,200 = 0.77 A suitable figure for this ratio depends largely on how concerned you are about the danger of inflation. If you expect inflation to be similar to that of the early 1990s, a ratio close to 1.00 would seem to be a prudent goal. It is also worthwhile to make a comparison of equity and tangible assets with fixed rupee ones: Balance Ratio - Equity plus tangible assets / Liquid + fixed rupee assets Vijay and Meera’s position in this regard was: 810,000 / 490,950 = 1.65 261

Someone expecting inflation would think the latter ratio inadequate if less than 1.00. From these measures we could conclude that Vijay and Meera have a reasonable degree of overall protection against inflation. Net Worth More clients are extremely interested in the growth of their financial assets. A primary reason clients seek professional investment help is their desire to increase the growth rate of assets so they are more likely to achieve important financial goals. With today’s inflationary cycles and ever- changing tax policy, financial advisers need to be able to document how effective they have been in managing the growth of financial assets for their clients. Net Cash Flow Ratio = 1 – (Realised Decreases in Net Worth / Realised Increase in Net Worth) ) Realised Increases in Net Worth 1 – (999,300 / 1,083,000) = 0.07 A positive ratio indicates that cash flow is generated during the year for saving and investing. To ensure adequate funds for investing, younger couples should have a ratio of at least 0.10. A negative ratio is usually a red flag and indicates that living expenditures are being financed by using credit, or investment assets are being liquidated. Net Worth Growth Ratio = Net Increase in Net Worth / Net Worth at Beginning of the Year = 145,700 / 3,174,500 =0.04 This is the key growth ratio for measuring the progress of the client. For the client to even maintain his or her present position, net worth must increase at least as quickly as the present inflation rate. For most clients, the growth rate easily increases several percentage points more than inflation because the increase comes from both net unrealized increases in net worth due to appreciation and investment of net cash flow. If inflation is 0.03 for the past 12 months, a ratio of 0.04 indicates that net worth is staying only marginally ahead of inflation. Net Worth Entities It is useful to see what proportion of net worth each of the net worth categories is in order to help judge how well situated the client is for meeting goals. For each net worth category we can calculate: Segment as % of Net Worth Ratio = asset category less debt / total net worth The personal property portion for Vijay and Meera is: 1,750,700 – (490,600 + 80,000) / 3,320,200 = 0.35 262

If a substantial portion of a client’s net worth consists of personal assets, it shows that they are not making much progress toward fulfilling their financial goals. Vijay and Meera don’t seem to have a problem here since personal assets represent less then 50% of net worth. The relation to net worth of investment assets can also indicate how well clients are advancing toward goals other than the important one of home ownership. The ratio of investment assets (other financial and tangible assets) is: (1,020,300 - 100,000) / 3,320,200 = 0.27 This figure is not bad for a couple as young as Vijay and Meera. Finally the liquid asset portion was: 280,650 / 3,320,200 = 0.08 These seem in reasonable balance since they have attained their home ownership goal. Summary and Conclusion Given the lack of comprehensive published work in this area, the ratios presented should not be taken as the final word on client’s financial statement analysis. They can however, be a valuable start in helping financial planners evaluate a client’s financial situation. They are also a starting place for the empirical research needed to evaluate the predictive and diagnostic usefulness of personal financial ratios. Each ratio that is eventually widely used may have several standards, each reflecting the stage in the life cycle, as well as social and economic circumstances, of the client under analysis. Financial advisers who develop the expertise to perform a ratio analysis of current value personal financial state-ments will be able to provide a very valuable service to their clients. Input is needed from academicians and practitioners before competent ratio analysis can become standardized and widely used. 263

264

Part - IV FPSB India’s Financial Planner Code of Ethics, Professional Responsibility and Model Rule of Conduct 265

266

Part – IV - FPSB India’s Financial Planner Code of Ethics, Professional Responsibility and Model Rule of Conduct 4.1 The Code of Ethics and Professional Responsibility Professionalism in Financial Planning The notion of ‘professionalism’ refers not only to appropriate behaviour (what to do, and how to do it), it extends to a range of personal attributes associated with attitudes (to one’s work and career development; to clients, colleagues, and the community at large) and personal values. Here, we focus on the community’s expectations of the professional financial planner and look at one aspect as it relates to written advice provided to the client. The Community’s Expectations of a Professional What does the community expect of a professional? Consider what you expect when you go to your medical practitioner or your solicitor, accountant, architect, survey or or any other professional from whom you have sought advice and service. What do you expect of that professional in terms of his/her educational background? What do you expect in terms of that person’s experience? How do you expect that person to communicate with you both verbally and in writing? How do you expect to be greeted and treated by the professional’s staff? How do you expect to pay for the services that you receive from a professional? You, as part of the community, have been conditioned to expect certain basic pre-requisites of a person offering professional services. You have been conditioned to expect that your medical practitioner will have achieved minimal education standards before practising. You would further expect that your medical practitioner has demonstrated his/her competencies in the practical treatment of patients in a supervised environment. Trainee general practitioners achieve this as an ‘intern’ and then as a ‘resident’. As well, some aspiring medical practitioners are required to undergo a further two years ’ training before being able to practice in their own right. Can we say that financial planners are members of a profession or are they merely part of the broader finance and securities industry? What distinguishes ‘a profession’ from other groupings in business? Traditionally, society has recognised different categories of professional people: lawyers, doctors, engineers. There are several features that might be said to characterise the membership of a profession. They include: 267

A confidential relationship between the professional advisor and his/her client that is recognised and protected in law; A relationship of special trust between the professional advisor and his/her client; A high level of expertise in the professional advisor acquired through an involved process of education and apprenticeship; Strict standards and regulations for admission to practice of the profession; Strict standards concerning educational qualifications to qualify for professional practice; Requirements for practical experience for professional practice; and The more recent requirement for continuing professional education linked to a person’s continuing qualification to practice. However, while these might be seen as characteristics of a person who practices a profession, there is more to being a member of a profession. That membership carries important responsibilities to clients with whom they have a direct relationship; to the wider community; to authorities responsible for the conduct of members of the profession; and to their colleagues. The environment and context of a profession should be recognised through high standards in conduct, behaviour and attitude in the practice of professional skills and in dealings with all people. There is also a certain collegiality between colleagues that is respectful and trusting. For example, a member of a profession will usually refrain from commenting on a colleague that would bring that colleague into disrepute. Being professional is perhaps best explained as aspiring in conduct and behaviour towards those standards and expectations required of members of a profession. It could be argued that professionalism implies: Pride in work, Commitment to quality, Dedication to the interests of the client, and A sincere desire to help. As discussed, the established professions have a major emphasis on education and experience for their practitioners, and the community, over several hundred years, has come to expect such minimum competencies and standards. Furthermore, the established professions endeavour to uphold such community expectations through professional standards and codes of conduct for their members. In addition, they have procedures for disciplining members who betray the community’s expectations and trust. This is the basis for the FPSB Code of Ethics and Rules of Professional Conduct, which we will ask you to read shortly. Financial planners also deal with the community and they can only continue to do so while the integrity of the trust which is implicit in the client/planner relationship is maintained. Therefore, for an industry desiring to be truly recognised as a profession by the community at large, it follows that financial planning must emulate the accepted and established models of professionalism. The FPSB India has recognised these requirements and has set in train changes to the minimum education standards and has established the Certified Financial Planner Programme of professional education. People aspiring to CFP status are required to have completed the CFP Programme along with having a minimum three years’ experience that can also be attained after completion of the programme. Now, let us consider further what the community expects of a professional service provider. 268

There are a number of professional attributes that the community expects and yet which cannot be quantified in law or professional membership regulations. Such attributes include the dress and demeanour of the professional. In addition, such expected attributes include the standard of the decor and surroundings at the processional’s business premises. In terms of meeting the community’s expectations of a professional, many successful financial planners have mirrored the environment (both physical and perceived) of the established professions. Such emulation helps to communicate to the client a commitment to professionalism and high standards. FPSB India Code of Ethics and Rules of Professional Conduct Ethics It is indeed quite difficult to be exact in the way we try to communicate our understanding of ethics to others, be they colleagues, staff, clients, or employers. The stumbling block seems to be a lack of familiarity and that the topic is in some strange way perceived to be not a part of our everyday experience, reactions and decisions. Though it is very easy to become reflective while discussing ethics, we need to remain very practical. Ethics finds relevance and application for financial planners when it is situated within real, everyday experiences. Although we may not always be directly conscious of it, our values and guiding principles inform and influence our choices in advising clients. Why should it be important to talk about business ethics in financial planning? The answer is that it affects how we want to describe or interpret generally understood values in the context of particular business decision-making environments. Thus, the broader ideas of justice and honesty find more practical expression for financial planners through the FPSB Code of Ethics as: integrity, objectivity and fairness. The FPSB India Code of Ethics and Rules of Professional Conduct specifies the means to enforce the minimum ethical conduct expected of all members, as professionals, and to facilitate voluntary compliance with the Code to a considerably higher standard than the required minimum. Accordingly, the Rules of Professional Conduct are specifically tailored for practitioners. The Code also deals with the matter of complaints, which we deal with in Topic 9. As we have already stressed, the reliance of the public and the business community on sound financial planning and advice imposes on financial planning professionals an obligation to maintain high standards of technical competence, morality and integrity. In so far as there is a link between professionalism and ethics, it lies in explaining what values and principles inform and guide how that ‘relationship’ is lived and experienced. It is important to remember that being professional and being ethical are not synonymous, even though what they suggest is related. These standards are referred to throughout the remainder of this module. The Code of Ethics are statements expressing in general terms the ethical and professional ideals expected of members and which they should strive to display in their professional activities. They articulate the core values expected to be applied by members in their dealings with all their stakeholders: clients, colleagues, employers, and the community. The values are not prescriptively described but are fashioned in the context of the financial planning business environment. The values of integrity, fairness and objectivity reflect broad relationship standards. Those of competence, diligence and compliance are more concerned with how financial planning decisions are carried out in meeting stakeholder expectation. 269

Alternatively, the Rules of Professional Conduct focus in a more prescriptive way on the functional responsibilities and obligations of planners centred around their core tasks. The Rules are derived from the tenets embodied in the Code of Ethics. As such, the Rules set forth the standards of ethical and professionally responsible conduct expected to be followed in particular situations. As you read this, reflect on how well this Code is known and adhered to by financial planners you may know. FPSB India’s Financial Planner Code of Ethics and Professional Responsibility By adhering to ethical standards, Financial Planning professionals agree to provide Financial Planning in the interests of clients and with the highest ethical and professional standards, and agree to uphold and promote the interests of the Financial Planning profession for the benefit of society. Such ethical standards have been developed and promulgated by FPSB India in line with global ethical and professional standards. As part of their professional commitment, Financial Planning professionals should provide appropriate disclosures and agree to be bound by ethical standards when delivering Financial Planning services to clients. FPSB India expects that meeting of a globally accepted set of ethical standards by the Financial Planning professionals will benefit their clients. Format of the Code of Ethics and Professional Responsibility FPSB India’s Ethical Principles are statements expressing in general terms the ethical standards that Financial Planning professionals should adhere to in their professional activities; the comments following each Principle further explain the intent of the Principle. The Principles are aspirational and are intended to provide guidance for Financial Planning professionals on appropriate and acceptable professional behavior. Applicability of Code of Ethics and Professional Responsibility FPSB India’s Ethical Standards reflect Financial Planning professionals’ recognition of their responsibilities to the public, clients, colleagues and employers. The Principles guide the performance and activities of anyone involved in the practice of Financial Planning; however the concept and intent of these Principles are adapted and enforced on CFPCM professionals by FPSB India. Code of Ethics and Professional Responsibility Code of Ethics Introduction FPSB India adopted the Code of Ethics to establish the highest principles and standards. These Principles are general statements expressing the ethical and professional ideals CFPCM Certificants are expected to display in their professional activities. As such, the Principles are aspirational in character and provide a source of guidance for Certificants. The Principles form the basis of FPSB India’s Model Rules of Conduct, Practice Guidelines and Disciplinary Rules and these together reflect FPSB India’s recognition of Certificants’ responsibilities to the public, clients, colleagues and employers. 270

Code of Ethic 1 – Client First Place the Client’s Interests First Placing the client’s interests first is a hallmark of professionalism, requiring the Financial Planning professional to act honestly and not place personal gain or advantage before the client’s interests. Code of Ethic 2 - Integrity Provide Professional Services with Integrity Integrity requires honesty and candor in all professional matters. Financial Planning professionals are placed in positions of trust by clients, and the ultimate source of that trust is the Financial Planning professional’s personal integrity. Allowance can be made for legitimate differences of opinion, but integrity cannot co-exist with deceit or subordination of one’s principles. Integrity requires the Financial Planning professional to observe both the letter and the spirit of the Code of Ethics. Code of Ethic 3 - Objectivity Provide Professional Services Objectively Objectivity requires intellectual honesty and impartiality. Regardless of the services delivered or the capacity in which a Financial Planning professional functions, objectivity requires Financial Planning professionals to ensure the integrity of their work, manage conflicts and exercise sound professional judgment. Code of Ethic 4 - Fairness Be Fair and Reasonable in all Professional Relationships. Disclose and Manage Conflicts of Interest Fairness requires providing clients what they are due, owed or should expect from a professional relationship, and includes honesty and disclosure of material conflicts of interest. It involves managing one’s own feelings, prejudices and desires to achieve a proper balance of interests. Fairness is treating others in the same manner that you would want to be treated. Code of Ethic 5 – Professionalism Act in a Manner that Demonstrates Exemplary Professional Conduct Professionalism requires behaving with dignity and showing respect and courtesy to clients, fellow professionals, and others in business-related activities, and complying with appropriate rules, regulations and professional requirements. Professionalism requires the Financial Planning professional, individually and in cooperation with peers, to enhance and maintain the profession’s public image and its ability to serve the public interest. Code of Ethic 6 - Competence Maintain the Abilities, Skills and Knowledge Necessary to Provide Professional Services Competently 271

Competence requires attaining and maintaining an adequate level of abilities, skills and knowledge in the provision of professional services. Competence also includes the wisdom to recognize one’s own limitations and when consultation with other professionals is appropriate or referral to other professionals necessary. Competence requires the Financial Planning professional to make a continuing commitment to learning and professional improvement. Code of Ethic 7 - Confidentiality Protect the Confidentiality of all Client Information Confidentiality requires client information to be protected and maintained in such a manner that allows access only to those who are authorized. A relationship of trust and confidence with the client can only be built on the understanding that the client’s information will not be disclosed inappropriately. Code of Ethic 8 - Diligence Provide Professional Services Diligently Diligence requires fulfilling professional commitments in a timely and thorough manner, and taking due care in planning, supervising and delivering professional services 4.2 Ethical and Professional Considerations in Financial Planning FPSB India’s Financial Planning Practice Standards Statement of Purpose for Practice Standards The Practice Standards have been developed and promulgated by FPSB India in line with global best practices on Financial Planning. These can be defined as standards of performance that: Establish the level of practice expected of a Financial Planning professional engaged in the delivery of Financial Planning to a client;  Establish norms of professional practice and allow for consistent delivery of Financial Planning by Financial Planning professionals;  Clarify the respective roles and responsibilities of Financial Planning professionals and their clients in Financial Planning engagements; and enhance the value of the Financial Planning process. Financial Planning is the process of developing strategies to assist clients in managing their financial affairs to meet life goals. The process of Financial Planning involves reviewing all relevant aspects of a client’s situation across a large breadth of Financial Planning activities, including inter-relationships among often conflicting objectives. FPSB India’s Financial Planning Practice Standards establish the level of professional practice reasonably expected of Financial Planning professionals during Financial Planning engagements, regardless of practice type, setting, location or method of compensation. Format of the Statement of Practice Standards Each Practice Standard is a statement that relates to an element of the Financial Planning process. The statement is followed by an explanation of the Practice Standard’s intent, which guides interpretation and application of the Practice Standard (based on a standard of reasonableness). The explanation is not 272

intended to establish a professional standard or duty beyond what is contained in the Practice Standard itself. The Practice Standards are not intended to prescribe the services to be provided or step-by-step procedures for providing any particular service. The Financial Planning process is an integrated one; functions may be combined and/or revisited based on the ongoing relationship between the Financial Planning professional and the client. Applicability of Practice Standards Practice Standards apply to CFPCM professionals while performing the tasks of personal Financial Planning regardless of the person’s title, job position, type of employment, or method of compensation. Conduct inconsistent with a guideline in and of itself is not intended to give rise to a cause of action or to create any presumption that a legal duty has been breached. These are intended to provide CFPCM professionals a structure for identifying and implementing expectations regarding the professional practice of personal Financial Planning, and not intended to prescribe step-by-step procedures for providing any particular service. Financial Planner Competency Profile A comprehensive analysis that identifies the abilities, skills and knowledge required to competently perform the tasks of a profession is the cornerstone of a quality professional credentialing program. FPSB India’s Financial Planner Competency Profile – comprised of Financial Planner Abilities, Financial Planner Professional Skills and Financial Planning Body of Knowledge – describes the abilities, skills, attitudes, judgments and knowledge that a financial planning professional draws on when working with clients in financial planning engagements. To competently deliver financial planning to a client, a financial planning professional needs to combine the ability to carry out the tasks of financial planning (defined in the Financial Planner Abilities) using appropriate professional skills (defined in the Financial Planner Professional Skills) drawing on his or her knowledge of financial planning matters (defined in the Financial Planning Body of Knowledge). The effective combination of abilities, skills and knowledge is what defines the financial planning professional’s performance as competent. FPSB India Financial Planner Competency Profile reflects what a financial planning professional does today as well as expectations for the financial planning profession over the next five years. The Competency Profile describes the full range of abilities, skills and knowledge needed to competently deliver financial planning to clients. Financial planning professionals who have chosen to specialize or limit the scope of their practice (e.g., in one or two Financial Planning Components such as Estate Planning or Tax Planning) consider the entire set of financial planner abilities to identify which Financial Planner Ability to employ during a client engagement. In creating its Financial Planner Competency Profile, FPSB India described the abilities, skills and knowledge expected of anyone practicing financial planning. FPSB India expects that clients of financial planning professionals will benefit from a globally accepted set of competency standards for financial planning professionals. A comprehensive analysis that identifies the abilities, skills and knowledge required to competently perform the tasks of a profession is the cornerstone of a quality professional credentialing program. 273

FPSB India’s Financial Planner Competency Profile – comprised of Financial Planner Abilities, Financial Planner Professional Skills and Financial Planning Body of Knowledge – describes the abilities, skills, attitudes, judgments and knowledge that a financial planning professional draws on when working with clients in financial planning engagements. To competently deliver financial planning to a client, a financial planning professional needs to combine the ability to carry out the tasks of financial planning (defined in the Financial Planner Abilities) using appropriate professional skills (defined in the Financial Planner Professional Skills) drawing on his or her knowledge of financial planning matters (defined in the Financial Planning Body of Knowledge). The effective combination of abilities, skills and knowledge is what defines the financial planning professional’s performance as competent. FPSB India Financial Planner Competency Profile reflects what a financial planning professional does today as well as expectations for the financial planning profession over the next five years. The Competency Profile describes the full range of abilities, skills and knowledge needed to competently deliver financial planning to clients. Financial planning professionals who have chosen to specialize or limit the scope of their practice (e.g., in one or two Financial Planning Components such as Estate Planning or Tax Planning) consider the entire set of financial planner abilities to identify which Financial Planner Ability to employ during a client engagement. In creating its Financial Planner Competency Profile, FPSB India described the abilities, skills and knowledge expected of anyone practicing financial planning. FPSB India expects that clients of financial planning professionals will benefit from a globally accepted set of competency standards for financial planning professionals. CFP marks usage for CFPCM Certificants CFP Marks usage CFP Marks enforcement is consistent with the efforts of US- based principal body Financial Planning Standards Board Ltd. (FPSB Ltd.) globally in their mission to benefit and protect the public. The CFPCM, CERTIFIED FINANCIAL PLANNERCM and marks are owned by FPSB Ltd. outside the United States. The CFPCM Certification Program is administered and monitored within India by Financial Planning Standards Board India (FPSB India) through a license agreement with FPSB Ltd. CFP Marks stand for a globally accepted competency level, ethics and professional practice standards in order to protect the public and other stakeholders in Financial Planning. It is important that the CFP Marks do not fall into common use. If the marks fall into common use, the public may not be able to differentiate a personal financial planner who has completed FPSB Ltd.’s rigorous certification requirements from the one who has not. It is necessary that the stakeholders in Financial Planning use CFP Marks in the correct perspective in all usages -soft content as well as printed material. The mark usage guidelines are given below with illustrative examples. The CORRECT usage is highlighted in BLUE color, whereas INCORRECT usage is highlighted in RED color. 1. Use “Financial Planning Standards Board India” or “FPSB India” or “FPSBI” when referring to the Indian Affiliate to distinguish from the US based FPSB Ltd., which is the Principal Body. For instance, incorrect usages when referring to FPSB India could be, “Financial Planning Standards Board”, Financial Planning Standards Board of India, Financial Planning Standards Board (FPSB), India Financial Planning Standards Board, India Financial Planning Standards Board India (FPSB) etc. 274

2. Use the following tagline in all content wherever a reference is made to CFPCM Marks or to FPSB India: CFPCM, CERTIFIED FINANCIAL PLANNERCM are certification marks owned outside the US by Financial Planning Standards Board Ltd. (FPSB Ltd.). Financial Planning Standards Board India (FPSB India) is the marks licensing authority for the CFP Marks in India, through agreement with FPSB Ltd. 3. Always use CFP in capital letters and without periods between letters, and with the symbol CM in superscript, as in CFPCM Certification, CFPCM Certificant, CFP+CM Professional, etc. For instance, incorrect usages could be CFPCM C F P C.F.P. cfp 4. Always use CFPCM as an adjective instead of a noun, e.g. always use CFPCM certification, CFPCM certificant, CFPCM credential, CFPCM designation, CFPCM exam/examination, CFPCM professional, CFPCM practitioner or CFPCM mark. These are eight approved noun usages with CFPCM Marks. Incorrect usages are CFP advisor, CFP course, CFP education, CFP program, CFP syllabus, etc. 5. Never use CFPCM as standalone noun but it can be used as an acronym to qualify a noun, as in A N Sharma, CFPCM. 6. Always use CERTIFIED FINANCIAL PLANNERCM in capitals followed by Certification, Certificant, Practitioner, Professional, Mark as mentioned in (4) above. It should always be used as a descriptive adjective. Incorrect usages could be Certified Financial Planner, certified financial planner 7. Do not use plurals as in CERTIFIED FINANCIAL PLANNERs or CFPs. The correct usages are CERTIFIED FINANCIAL PLANNERCM Professionals CFPCM Practitioners. The incorrect usages could be CFPs, CFP s, CFPs 8. Do not use CERTIFIED FINANCIAL PLANNERCM as a parenthetical abbreviation for CFPCM or vice versa. For instance, Incorrect use could be CERTIFIED FINANCIAL PLANNERCM (CFPCM) CFPCM (CERTIFIED FINANCIAL PLANNERCM ) The correct usage is CFPCM or CERTIFIED FINANCIAL PLANNERCM Professional. 9. The CFPCM flame logo must always be reproduced from original artwork with proper compliance for the three components, viz. the „flame, the acronym„ CFP and the „symbol in appropriate color, size and background specifications as elaborated on website www.fpsbindia.org. For following requirements for using the Logo Mark may be noted:\\  Always use the three components of the logo – flame, the acronym “CFP” and the appropriate symbol CM in superscript, in which the mark is being displayed.  Always reproduce the logo mark from original artwork.  Never alter or modify the logo mark. 9.1 The CFP Logo mark is comprised of three components: the flame element, the letters “CFP” and symbol CM in superscript. These three components must be used together as one unit at all times to protect the visual integrity of the mark. Correct Use: Incorrect Use: Any deviation from the three components above is a misuse and is unacceptable use. 275

9.2 All reproduction of the CFP Logo mark must be made from original reproduction artwork provided by FPSB India. Correct Use: Incorrect Use: Do not use without the appropriate territory-specific symbol. Do not use without the flame. Do not use the flame alone. Do not separate the graphic elements. Do not add other elements. Do not re -proportion the elements. Do not reproduce the mark in unapproved colors. Do not reproduce the mark on complex backgrounds. 9.3 Under no circumstances may the CFP Logo mark be altered, modified or hand drawn, nor may it be typeset, reproduced or electronically scanned in such poor quality as to distort or significantly alter its appearance. Correct Use: Incorrect Use: Do not use poor quality reproduction art. Do not try to recreate the mark. Do not skew or distort the mark. Do not use the mark in outline form. 9.4 The CFP Logo mark must be clearly associated with the individual certified by an FPSB India. Correct Use: Sanjay Jain, Incorrect Use: Jain Financial Services Corp. 10. The consistent use of color in the mark is important to establish immediate recognition of individuals certified by an FPSB affiliate. The logo should be legible, should not be compressed or stretched and should not be in any color other than PANTONE® 280 Blue for the flame element and Black for the „CFP . 276

Part - V Regulatory Environment Related to Financial Planning 277

278

Part – V Regulatory Environment Related to Financial Planning 5.1 Regulation Relating to Individuals CONTRACT The term contract is defined in the Indian Contract Act, 1872 as: Section 2(h) : an agreement enforceable by law is a contract. Thus for a formation of a contract there must be: 1. an agreement and 2. an agreement should be enforceable by law. Agreement is defined as ‘every promise and every set of promises forming consideration for each other.’ Whereas promise is defined in Section 2(b) as ‘a proposal which when accepted becomes a promise.’ Therefore a contract is an agreement, an agreement is a promise and a promise is an accepted proposal. Now an important question arises: what agreements can be called contracts? Or in other words, are all agreements, contracts under the Indian Contract Act,1872? All agreements are contracts if they are made by the free consent of parties competent to contract, for a consideration and with a lawful object. Thus every contract is an agreement but for every agreement to become a contract, it has to satisfy the following conditions: 1. there is some consideration for it, 2. the parties are competent to contract, 3. their consent is free, 4. their object is lawful. Another important aspect of a contract is that a proposal or acceptance of any promise can be made in words (when it is said to be express) or otherwise (when it is said to be implied). According to Section 4 of the Indian Contract Act, 1872, the communication of the contract is complete when it comes to the knowledge of the person to whom it is made, therefore an offer cannot be accepted 279

unless and until it has been brought to the knowledge of the person to whom it is made. And in order to convert a proposal into a promise, the acceptance must be absolute and unqualified. An important aspect of any contract is the capacity of the parties to contract. Therefore according to the Contract Act every person is competent to contract who is of the age of majority according to law to which he is subject and who is of a sound mind and is not disqualified from contracting by any law to which he is subject. However neither Section 10 nor Section 11 of the Indian Contract Act, 1872 makes it clear whether if a minor enters into an agreement it would be voidable at his option or altogether void. But this controversy was resolved by the Privy Council in Mohiri Bibi Vs Dharmodas Ghose (1903 (30) IA 114), where it was held that a minor’s agreement is absolutely void. The most important and essential requirement of every contract is that it is made with a ‘free consent’ of either party. Section 14 of the Contract Act defines ‘free consent’ as: A consent which is not caused by 1. coercion, 2. undue influence. 3. fraud, 4. misrepresentation or 5. mistake. After the formation of a contract, the next stage is reached namely the fulfilment of the object the parties have in mind. When the object is fulfilled the liability of either party under the contract comes to an end. The contract is then said to be discharged. But ‘performance’ is not the only way in which a contract may be discharged. There are 4 ways by which a contract may be discharged— 1. by performance, 2. by impossibility of performance, 3. by agreement, 4. by breach. There are many situations in which law as well as justice require that a certain person be required to conform to an obligation, although he has neither broken any contract nor committed any tort, e.g. a person in whose home certain goods have been left by mistake is bound to restore them. Such obligations are generally described as quasi- judicial contracts. However the theory on which these obligations/contracts are based is not yet finally settled. Lord Mansfield, who is considered to be the real founder of such obligations explained them on the principle that law as well as justice should try to prevent ‘unjust enrichment’ i.e., enrichment of one at the cost of the other. Chapter V of the Indian Contract Act, 1872 deals with such situations. The chapter avoids the words ‘quasi contract’ and in the view of the clear statutory authorisation, courts in India are not hindered in allowing relief under different sections of the Act by theoretical considerations concerning quasi-contracts. TORT Law has to procreate, recreate and generate in order to satisfy the needs of the fast-changing society. Law should not and cannot in any manner afford to remain static or create hurdles in the path of a new order of the changing society. The field of law that is most susceptible to change is the law of torts. 280

Law of tort is mainly sourced from the common law as opposed to statute law. There are different ways in which liability in tort may arise:- a) tort may be committed by a positive act, or by an omission where there is a legal duty to act b) fault of the defendant, which may require intention e.g. deceit b) negligence c) strict liability Damages resulting to the plaintiff which is not too remote a consequence of the defendants conduct, such as trespass in its various forms and libel, do not require proof of actual damages. In other words in the law of torts there has to be a nexus or proximity with the action which caused the damage and the consequence thereof. In any action there would a series of sequences and a line has to be drawn where the proximity of the cause and effect comes to an end to maintain action for damages. Law cannot take account of everything that follows a wrongful act. It records some subsequent matters as outside the scope of its selection because “it were infinite to trace the causes of causes or the consequences of consequence”. For example, the loss of a ship by collision due to the other vessel’s sole fault may force the ship owner into bankruptcy, which again may involve the ship owner’s family in suffering, loss of education or opportunities in life, no such loss could be recoverable from the wrong doer. Tort can be defined as a civil wrong for which the remedy is a common law action for damages and which is not exclusively the breach of a contract or the breach of a trust or other merely equitable obligation. As Winfield had put it “people cannot create tortuous liability by agreement”. This means that tort need not necessarily arise from a breach of a contractual obligation between the parties or breach of trust between two parties. Tortuous liability arises from the breach of a duty primarily fixed by law, whereas in the case of contract the duties are fixed by the parties themselves. In certain cases the same incident may give rise to liability both in contract and tort. For example, when a passenger while travelling with a ticket is injured owing to the railway company’s negligence, the company is guilty of a wrong, which is both a breach of contract and tort. Similarly, a dentist who contracts to pull out a tooth of a patient is liable to the patient for the breach of contract if he injures the patient by an unskillful extraction. The dentist is also liable for the tort of negligence, for everyone who professes skills in any profession is bound by the law, agreement or no agreement, to show a reasonable amount of such skill. There are four distinct classes of wrong which stands outside the sphere of tort: a) criminal b) civil wrong, which creates no right of action, but gives rise to some other form of civil remedy exclusively; c) civil wrong which are exclusively breaches of contract; d) civil wrongs, which are exclusively breaches of trust or of some other merely equitable obligation. In simple terms tort law is associated with a claim for pecuniary compensation in respect to damages suffered as the result of the invasion of a legally protected interest. In contract, liability is imposed by the law for the protection of a single limited interest, backed by promises of the parties entering into it to perform. 281

In criminal law, protection of interests common to the public at large is represented by the state, and it accomplishes its end by punitive action on the wrong doer. Tort law is directed towards the compensation of individuals, rather than the public for the losses suffered in respect to all their legally recognised interests. There are some general defences which may be taken by the defendant in an action initiated under tortuous liability: a) Volenti non fit injuria – i.e. the defence of ‘consent’; b) Plaintiff the wrong doer; c) Inevitable accident; d) Act of God; e) Private defence; f) Mistake; g) Necessity; h) Statutory Authority. Volenti Non Fit Injuria: a) The defence is available till the limits of consent and not beyond. The consent must be free. However, the consent obtained by fraud, or compulsion is not accepted as a good defence. Mere knowledge does not imply consent. The maxim of ‘Volenti non fit injuria’ apply when the two conditions are proved : i) Plaintiff knew of the risk. ii) and agreed to suffer the harm. The application of the doctrine is limited in cases of rescue. Plaintiff the Wrong Doer b) If the basis of action of the plaintiff is an unlawful contract he will not, in general, succeed in his action. However, he may claim compensation if his wrongful act is independant of the harm caused to him. But compensation payable will be reduced in proportion to his own fault. Inevitable Accident c) If the defendant can show that he neither intended to injure the plaintiff nor could he avoid the injury by taking reasonable care. Act of God d) Act of God is a good defence to the rule of strict liability. It is an extraordinary occurrence of circumstances which could not have been foreseen and which could not have been guarded against, or could be defined as an accident due to natural causes, directly and exclusively without human intervention and which could not have been avoided by foresight or reasonable care reasonably to be expected of the person sought to be made liable for it. Two conditions are essential for taking up this defence: i) the occurrence must be attributed to natural force, 282

ii) the occurrence must be extraordinary and not one which could be anticipated and reasonably guarded against. Private Defence e) The law permits use of reasonable amount of force to protect one’s person or property. If the defendant uses the force which is necessary for self defence he will not be liable for the harm caused thereby. Mistake f) Mistake, whether of fact or of law, is generally no defence to an action for tort. The defendant may be able to avoid his liability by showing that he acted under an honest but mistaken belief. Honest belief is the truth of a statement which is a defence to an action for deceit. Necessity g) Damage caused under necessity to prevent a greater evil is not actionable even though harm was caused intentionally. However it should be distinguished from private defence. Statutory Authority h) The damage resulting from an act, which the legislature authorises or directs to be done, is not actionable even though it would otherwise be a tort. When an act is done under the authority of an Act, it is complete defence and the injured party has no remedy except claiming such compensation as may be provided by the statute. As per the principles of vicarious liability: a) Liability of principal for the tort of his agent, meaning thereby that the act of an agent is the act of the principal. Their liability is joint and several. The agent must be acting in the ordinary course of the performance of his duties as an agent. b) Liability of the master for the tort of the servant. The act should be committed in the course of employment. Exceptions are: fraud of servant, theft of servant, mistake of servant, negligence of servant, act outside the course of employment, negligent delegation of authority by the servant, Tortuous liability can take the shape of: a) Trespass, b) Defamation, c) Nuisance, d) Abuse of legal procedure, d) Negligence, e) Liability of dangerous premise, f) Dangerous chattels. AGENCY According to Section 182 of the Contract Act 1872, an agent is a person employed to do any act for another or to represent another in dealings with a third person. The person for whom such an act is done, or who is represented is called the ‘principal’. 283

Therefore the expression ‘agency’ is used to connote the relation which exists where one person has an authority to create legal relations between a person occupying the position of principal and third parties. Essentials of Agency The first requisite of agency is that the principal should be competent to contract. Therefore, an infant is not competent to create an agency as he does not have sufficient discretion to choose an agent to act for him. However an agent need not be competent to contract. A consideration is not necessary to create an agency. Generally an agent is remunerated by way of commission for services rendered but no consideration is immediately necessary at the time of appointment. An agent is more or less like a servant but the main points of distinction between the two are as follows: 1) an agent has the authority act on behalf of his principal and to create contractual relations between the principal and a third party. This kind of power is not generally enjoyed by a servant. 2) a principal has the right to direct what the agent has to do, but a master has not only that right but also the right to say how it is to be done. 3) a servant is paid by way of salary or wages, an agent requires commission on the basis of work done. 4) a master is liable for a wrongful act of his servant if it is committed in the course of the servant’s employment. A principal is liable for his agents wrong doing within the ‘scope of authority’. 5) A servant usually serves only one master, but an agent may work for several principals at the same time. Creation of Agency The relationship of principal and agent may be created in any of the following ways: 1) by express appointment; 2) by the conduct of the parties; 3) by necessity of the case; or 4) by subsequent ratification of an act. Duties of Agent 1) The foremost duty of an agent is to carry out the mandate of his principal. 2) The agent is bound to conduct the business of his principal according to the directions given by the principal and to keep himself within the confines of his authority. 3) An agent is bound to conduct the business of agency with as much skill as is generally possessed by persons engaged in similar business. 4) It is the duty of the agent, in cases of difficulty, to use all reasonable diligence of communicating with his principal and seeking to obtain his instructions. 5) It is the duty of the agent to avoid conflict of interest with his principal. 6) It is the duty of the agent not to make a secret profit. 7) An agent is bound to render proper accounts to his principal on demand. 284

Determination of Agency The following are the modes of determination of an agency: 1) by revocation, 2) renunciation by agents, 3) completion of business, 4) principal’s or agent’s death, 5) principal or agent becoming person of unsound mind, 6) insolvency of principal, 7) expiry of time. Negotiable Instruments Negotiation and arriving at a consensus are the two most important steps in the world of commercial relation. The law of this commercial world is, to a very large extent, covered by the law relating to negotiable instruments. This is due to the fact that it consists of ‘certain principles of equity and usage of trade which general convenience and common sense of justice had established to regulate the dealings of people of the commercial world’. Generally speaking, it applies to any written statement given as security, usually for the payment of money, which may be transferred by endorsement or delivery, vesting in the party to whom it is transferred, or delivered a legal title on which he can support a suit in his name. Therefore, a negotiable instrument is one, which when transferred by delivery or by endorsement and delivery, passes to the transferee a good title to payment according to its tenor and irrespective of the title of the transferor, provided he is bona fide holder for value without notice of any defect attaching to the instrument or in the title of the transferor. In the present day context, negotiable instruments are now merely instruments of credit, readily convertible into money and easily passable from one hand to another. The law as to bills of exchange and other negotiable securities forms a branch of the general body of the law merchant and is comparatively of recent origin. The instruments can be traced to the usage and customs of merchants and traders which courts of law have recognised and adopted as settled law, in view of the general interests of trade and convenience of the public. The Negotiable Instruments Act is a codification of the Common Law or Law of Merchant. The Act defines negotiable instruments as promissory notes, bills of exchange or cheques payable either to order or to bearer. A promissory note is an instrument in writing (except a currency note) signed by the maker, containing an unconditional undertaking to pay a certain sum of money only to a certain person or his order or to the bearer. However, restricted documents between parties merely recording the terms on which repayment of debt may be made cannot be negotiable instruments. A bill of exchange is also an instrument in writing signed by the maker, but it is an unconditional order addressed to a third person to pay a certain sum of money only to a certain person or his order or bearer. A cheque is a special form of bill of exchange drawn on a specified banker and always payable on demand. In all these kind of negotiable instruments it is essential that either promise or order, must be unconditional, amount mentioned must be certain and incapable of variation, for certainty is an essential requisite of 285

negotiable instruments. Further, the person to whom money is promised must be indicated to provide for certainty. In a bill of exchange, the name of the person to be resorted to in case of need and such person is called ‘drawee in case of need’. Where a ‘drawee in case of need’ is named in a bill of exchange, or in an endorsement thereon, the bill is not dishonoured until it has been dishonoured by such drawee. A drawee in case of need may accept and pay the bill of exchange without previous protest. Except for these essential requisites, the instrument may be in any form, no date or place is essential, no statement that any value was received is necessary. Generally, where an instrument is construed either as a promissory note or as a bill of exchange, the holder has the option of treating it as either and the instrument shall be treated accordingly. Often in mercantile transaction, parties lend their credit by signing blank stamp papers to be filled up by the person to whom it is delivered later on. Such instruments are called inchoate instruments. They are deemed to give authority to the holder to complete it for not more then the amount covered by the stamp. Certain rules to be followed regarding negotiable instruments are: (i) If amounts are different in word and in figure then amount in word is to be taken. (ii) Where no time is specified it is payable on demand. The expression ‘at sight’ and ‘on presentment’ means on demand. (iii) The expression ‘after sight’ means after presentation for sight, in case of a promissory note. (iv) In a bill of exchange, after acceptance or noting or non-acceptance or protest for non-acceptance. (v) Every person cable of contracting may become a party to a negotiable instrument and is bound in the same way as in other contracts. One of the distinctive characteristic of negotiable instruments is that the date due under it may be assigned over to a third party by what is called negotiation. Such negotiation takes place in two ways: 1. if the instrument is payable to bearer – it is negotiable by delivery thereof, 2. if it is payable by order - negotiation can take place only by endorsement of the holder and delivery by him. The basic essence of negotiable instruments relates to the provision for alternative payment. The foundation of negotiable instruments is its being endorseable. Therefore endorsement is the signing of the instrument for the purpose of negotiation and the negotiation takes place when the bill or promissory note is transferred to any person. The effect of an endorsement followed by delivery is to transfer to the endorsee not only the property in the instrument but also the right to further negotiate with other persons. The intention to pass the property in the bill or note is essential to make the delivery effective. Where there has been a dishonour of an instrument like a cheque in order to fix liability, the holder must give notice that the instrument has been dishonoured and holder seeks to make liable parties whom he seeks to fix liability on. Notice must be give within reasonable time as specified under the Negotiable Instruments Act,1881. 286

Professional Liability It is common that professionals, irrespective of their line of specialisation are prone to committing errors in the course of their professional work particularly in the present prevailing scenario where a professional has to work under a tremendous amount of pressure, tension and other demands of life. A professional has to exercise a reasonable degree of care and skill, though it does not necessarily mean that he under takes to use the highest possible degree of skill. There could be professionals specialising in similar areas who have better education but the other professionals specialising in the same area though not endowed with the same high degree of education or skills, in any event, can be relied upon to bring a fair, reasonable, competent degree of skill while dealing with his clients. In simple words higher degrees in education need not necessarily bring about better and more professionalised services from the professional who is holding such a high degree. There would be professionals though not endowed with very high qualifications as others may give equal or better services compared to professionals who have higher degree in that particular field. The criteria is to be determined as to whether other persons in the same profession would or would not give the same opinion or provide the same conclusion as the defendant in a case who is accused of negligence. A person who is specialised in the medical profession while dealing with the patient owes to the patient certain duties, the duty of care in treating the patient, the duty in charting out the treatment to be given as also the administration of that treatment. A breach of any of these duties would give rise to a cause of action to the patient against the doctor. Liability is based on professional negligence, which pre-supposes the existence of the duty of care. The duty is owed to whom the professional is under some contractual or fiduciary relationship, which is generally the client. This can be elaborated by stating that even in the absence of a contract, a duty of care may arise, in which trust or confidence is placed in the person, or in other words there is a fiduciary relationship. The professional has to use care and skill in the conduct of duties assigned to him. Professional risk may entail professional negligence, which may result in financial losses. Financial consultants, accountants, solicitors, advocates, chartered accountants fall into this group. Professional risk may also take the form of professional negligence resulting in financial loss and/or bodily injury. Architects would fall into this category. There could be a third group in which the professional risk could take the shape of professional negligence resulting in bodily injuries. Doctors could fall into this category. It is pertinent to mention that an employer is liable for the negligence of his employee and the employer’s liability arises when the act so complained of is committed in the course of, and within the scope of employment. The doctrine of vicarious liability could also be attracted when the relationship of master and servant is established. The employer is held liable if any act is performed by an employee in an unauthorised manner. Similarly, the employer would be held liable if the employee has performed an act which was prohibited within the scope of employment. The doctrine of vicarious liability could even extend to an act which is performed by the employee in breach of instructions from the employer. The employer could yet be held liable for the consequence of such acts. In any event, the employee would also be personally liable for his own negligence. In other words, a professional is vicariously liable for the negligence of his employees arising out of and in the course of their employment. 287

In the light of the above, there has been a need for professionals to cover themselves against the legal liability to pay damages arising out of negligence, in the performance of their professional duties. This has led to the proliferation of professional indemnity policies to cover the legal liabilities and to take care of the risk to the professionals keeping in view the increasing claims which are being made by clients against the professionals who are advising or attending to the clients. The professional indemnity policies contain clauses, dealing with limits of indemnity, defence cost, claims, exclusions and conditionalities. For example, for doctors and medical establishments, the indemnity applies to claims arising out of bodily injury and/or death of a patient which has been caused by error, omission or negligence in the services rendered or which should have been rendered by the professional insured. For financial advisors, management consultants, lawyers, chartered accountants, the indemnity clause in such policies states that the indemnity applies to claims arising out of losses and/or damages during the period of insurance first made in writing against the professional insured. The professional insured is indemnified for any breach of professional duty by reason of any negligent act, error or negligence committed during the period of insurance by the insured, or any employee of the insured firm or the predecessors in the business of the insured firm in respect of whom insurance cover is expressly provided in the insurance schedule of the policy. It would also be pertinent to mention that the policy excludes claims with respect to any dishonest, fraudulent, criminal or mali- cious act by the professional or a deliberate non-compliance with technical standards, commonly observed in professional practice laid down by official bodies of such professions, and such other conditionalities. It is, therefore, clear that due care and diligence has to be exercised by a professional irrespective of the field of specialisation to ensure that no claims or demands are made against such professionals by the clients for any negligence, omission or deficiency on the part of the professional or its employees. Any deviation from normal reasonable standards would invite a legal action by the client against the said professional, which would be prejudicial not only to the personal interest of the professional but would also bring disrepute to the profession which is practised by the said professional. Consumer Protection A. THE ACT-A SPECIAL STATUTE : The Consumer Protection Act (CPA), 1986, amended by Act, 2002 is to provide for better protection of the interests of consumers and for that purpose to make provision for the establishment of Consumer Councils and other authorities for the settlement of consumers disputes and for matters connected therewith. B. DEFINITIONS : In this Act, unless the context otherwise requires, (b) ‘Complainant’ means (i) a consumer; or (ii) any voluntary consumer association registered under the Companies Act, 1956, (1 of 1956) or under any other law for the time being in force; or (iii) the central government or any state government, who or which makes a complaint; or (iv) one or more consumers, where there are numerous consumers having the same interest 288

(v) in case of death of a consumer, his legal heir or representative; who or which makes a complaint; (c) ‘Complaint’ means any allegation in writing made by a complainant that: (i) an unfair trade practice or a restrictive trade practice has been adopted by any trader; (ii) the goods bought by him or agreed to be bought by him suffer from one or more defects; (iii) the services hired or availed of as agreed to be hired or availed of by him suffer from deficiency in any respect; (iv) a trader has charged for the goods mentioned in the complaint a price in excess of the price fixed by or under any law for the time being in force or displayed on the goods or any package containing such goods; (v) goods which will be hazardous to life and safety when used, are being offered for sale to the public in contravention of the provisions of any law for the time being in force requiring traders to display information in regard to the contents, manner and effect of use of such goods. (d) “consumer” means any person who, (i) buys any goods for a consideration which has been paid or promised or partly paid and partly promised, or under any system of deferred payment and includes any user of such goods other than the person who buys such goods for consideration paid or promised or partly paid or partly promised, or under any system of deferred payment, when such use is made with the approval of such person, but does not include a person who obtains such goods for resale or for any commercial purpose; or (ii) hires or avails of any services for a consideration which has been paid or promised or partly paid and partly promised, or under any system of deferred payment and includes any beneficiary of such services other than the person who hires or avails of the services for consideration paid or promised, or partly paid and partly promised, or under any system of deferred payment, when such services are availed of with the approval of the first mentioned person, but does not include a person who avails of such services for any commercial purpose : Explanation For the purposes of this clause, “commercial purpose” does not include use by a person of goods bought and used by him and services availed by him exclusively for the purposes of earning his livelihood by means of self-employment. (e) “consumer dispute” means a dispute where the person against whom a complaint has been made, denies or disputes the allegations contained in the complaint; (f) “defect” means any fault, imperfection or shortcoming in the quality, quantity, potency, purity or standard which is required to be maintained by or under any law for the time being in force or under any contract, express or implied, or as is claimed by the trader in any manner whatesover in relation to any goods; 289

(g) “deficiency” means any fault, imperfection, shortcoming or inadequacy in the quality, nature and manner of performance which is required to be maintained by or under any law for the time being in force or has been undertaken to be performed by a person in pursuance of a contract or otherwise in relation to any service. (i) “goods” means goods as defined in the Sale of Goods Act, 1930 (3 of 1930); (j) “manufacturer” means a person who — (i) makes or manufacturers any goods or parts thereof; or (ii) does not make or manufacture any goods but assembles parts thereof made or manufactured by others; (iii) puts or causes to be put his own mark on any goods made or manufactured by any other manufacturer; (m) “person” includes — (i) a firm whether registered or not, (ii) a Hindu undivided family; (iii) a co-operative society (iv) every other association of persons whether registered under the Societies Registration Act, 1860 (21 of 1860) or not; (o) ‘Service’ means service of any description which is made available to potential users and includes, but not limited to, the provision of facilities in connection with banking, financing, insurance, transport, processing, supply of electrical or other energy, board or lodging or both [housing construction] entertainment, amusement or the purveying of news or other information, but does not include the rendering of any service free of charge or under a contract of personal service; (p) “spurious goods and services” mean such good and services which are claimed to be genuine but they are actually not so; (q) “trader” in relation to any goods means a person who sells or distributes any goods for sale and includes the manufacturer thereof, and where such goods are sold or distributed in package form, includes the packer thereof; (r) ‘Unfair Trade Practice’ means a trade practice which, for the purpose of promoting the sale, use or supply of any goods or for the provision of any service, adopts any unfair method or unfair or deceptive practice including any of the following practices, namely: 1. the practice of making any statement, whether orally or in written or by visible representation which- (i) falsely represents that the goods are of a particular standard, quality, quantity, grade, composition, style or model; (ii) falsely represents that the services are of a particular standard, quality or grade; (iii) falsely represents any re-built, second-hand, renovated, reconditioned or old goods as new goods; (iv) represents that the goods or services have sponsorship, approval, performance, characteristic, accessories, uses or benefits which such goods or services do not have; 290

(v) represents that the seller or the supplier has a sponsorship or approval or affiliation which such seller or supplier does not have; (vi) makes a false or misleading representation concerning the needs for, or the usefulness of any goods or services; (vii) gives to the public any warranty or guarantee of the performance, efficacy or length of life of a product or of any goods that is not based on an adequate or proper test thereof; Provided that where a defence is raised to the effect that such warranty or guarantee is based on adequate or proper test, the burden of proof of such defence shall lie on the person raising such defence; (viii) makes to the public a representation in the form that purports to be :— (i) a warranty or guarantee of a product of any goods or services; or (ii) a promise to replace, maintain or repair an article or any part thereof or to repeat or continue a service until it has achieved a specified result; if such purported warranty or guarantee or promise is materially misleading or if there is no reasonable prospect that such warranty, guarantee or promise will be carried out; (ix) materially misleads the public concerning the price at which products or goods or services, have been, or are, ordinarily sold or provided, and, for this purpose, a representation as to price shall be deemed to refer to the price at which the product or goods or services has or have been sold by sellers or provided by suppliers generally in the relevant market unless it is clearly specified to be the price at which the product has been sold or services have been provided by the person by whom or on whose behalf the representation is made; (x) gives false or misleading facts disparaging the goods, services or trade of another person. Explanation - For the purposes of clause(1) a statement that is: (a) expressed on an article offered or displayed for sale, or on its wrapper or container; or (b) expressed on anything attached to, inserted in, or accompanying an article offered or displayed for sale, or on anything on which the article is mounted for display or sale; or (c) contained in or on anything that is sold, sent, delivered, transmitted or in any other manner whatsoever made available to a member of the public, shall be deemed to be a statement made to the public by, and only by, the person who had caused the statement to be so expressed, made or contained. 2. Permits the publication of any advertisement whether in any newspaper or otherwise, for the sale or supply at a bargain price, of goods or services that are not intended to be offered for sale or supply at the bargain price, or for a period that is, and in quantities that are, reasonable, having regard to the nature of the market in which the business is carried on, the nature and size of business and the nature of the advertisement. Explanation: for the purposes of clause (2) ‘bargaining price’ means: (a) a price that is stated in any advertisement to be a bargain price, by reference to an ordinary price or otherwise; or (b) a price that a person who reads, hears, or sees the advertisement, would reasonably understand to be a bargain price having regard to the prices at which the product advertised or like products are ordinarily sold; 291

3. Permits: (a) the offering of gifts, prizes or other items with the intention of not providing them as offered or creating impression that something is being given or offered free of charge when it is fully or partly covered by the amount charged in the transaction as a whole; (b) the conduct of any contest, lottery, game of chance or skill, for the purpose of promoting, directly or indirectly, the sale, use or supply of any product or any business interest. (A) with holding from the participants of any scheme offering gifts, prizes or other items free of charge, on its closure the information about final results of the scheme. Explanation — For the purposes of the sub-clause, the participants of a scheme shall be deemed to have been informed of the final results of the scheme where such results are within a reasonable time published, prominently in the same newspapers in which the scheme was originally advertised. 4. permits the sale of supply of goods intended to be used, or are of a kind likely to be used, by consumers, knowing or having reason to believe that the goods do not comply with the standards prescribed by competent authority relating to performance, composition, contents, design, construction, finishing or packaging as are necessary to prevent or reduce the risk of injury to the person using the goods; 5. Permits the hoarding or destruction of goods, or refuses to sell the goods or to make them available for sale or to provide any service, if such hoarding or destruction or refusal raises or tends to raise or is intended to raise, the cost of those or other similar goods or services. 6. manufacture of spurious goods or offering such goods for sale or adopting deceptive practices in the provision of services. 7. Any reference in this Act to any other Act or provision thereof which is not in force in any area to which this Act applies shall be construed to have a reference to the corresponding Act or provision thereof in force in such area. FIDUCIARY RESPONSIBILITY The fiduciary relationship, a confidential relationship necessary to bring this doctrine into operation extends to certain ties. Cases relating to fiduciary relationships under the Indian Contract Act, 1872 are generally dealt with as part of the doctrine of “undue influence”. When two persons stand in such a relation that while it continues, confidence is necessarily reposed by one, and the influence which naturally grows out of that confidence, enables the other in whom the confidence is reposed to exert influence or dominion over the confiding party to his own benefit and advantage at the expense of the person trusting him, the relation existing between them is of a “fiduciary character”. It means and includes various kinds of relations in which one holds the position of influence and dominion over the other. Relationships existing between a parent and child, guardian and ward, husband and wife, doctor and patient, principal and agent, lawyer and client, trustee and beneficiary, spiritual adviser and disciple are of fiduciary character. 292

A fiduciary relationship may be established without the use of the word trust, and a person may become a trustee by his act and conduct so as to deprive himself of all beneficial ownership of a property and declare that he will hold the same in trust for another. An advisor (including a financial planner) stands in a fiduciary position to his client. Whenever a transaction between such parties is questioned, the burden of proving the good faith of the transaction is on the party who stands in a fiduciary relation to the other. The rule is however not confined to relationships mentioned above and is applicable to a variety of other relationships where confidence is reposed by one party to the other. Fiduciary relationships are not confirmed to a certain defined category. The test is whether in the eyes of equity, the relationship between the parties gives rise to a constructive trusteeship which imposed on one party certain fiduciary duties towards the other party. Therefore, wherever the parties stand in such a relation that while the relation is continuing, confidence is necessarily reposed by one, and the influence which naturally grows out of that confidence, enables the other in whom the confidence is reposed to exert influence or dominion over the confiding party to his own benefit and advantage at the expense of the person trusting him, the relationship which develops between the parties is a fiduciary relationship. 5.2 Function, Purpose and Regulation of Financial Institutions Banks Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India, which started in 1786, and Bank of Hindustan, which started in 1790; both are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. For many years the Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in 1921 to form the Imperial Bank of India, which, upon India’s independence, became the State Bank of India in 1955. In the early 1990s, the then Narasimha Rao government embarked on a policy of liberalization, licensing a small number of private banks. These came to be known as New Generation tech-savvy banks, and included Global Trust Bank (the first of such new generation banks to be set up), which later amalgamated with Oriental Bank of Commerce, Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, revitalized the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks. The next stage for the Indian banking has been set up with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%, at present it has gone up to 74% with some restrictions. Currently banking in India is generally fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. In terms of quality of 293

assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true. With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong. Adoption of Banking Technology The IT revolution had a great impact in the Indian banking system. The use of computers had led to introduction of online banking in India. The use of the modern innovation and computerisation of the banking sector of India has increased many folds after the economic liberalisation of 1991 as the country’s banking sector has been exposed to the world’s market. The Indian banks were finding it difficult to compete with the international banks in terms of the customer service without the use of the information technology and computers. Apart from the above mentioned innovations the banks have been selling the third party products like Mutual Funds, insurances to its clients. Numbers of ATMs are opened by all the banks. With so many ATMs and the facility to withdraw money any time from any bank’s ATM is an added advantage. The primary role of the government of countries all over the world is to promote the economic growth and economic welfare of its citizens. This is to improve the standards of living of the citizens. With this point in view, the governments undertake to pass appropriate laws to ensure orderly growth of institutions. The smooth functioning of institution and processes are achieved by entrusting such functions to identified institutions. Need for Regulatory Environment Generally, the central banks of the country serve as the apex body of a country’s financial system, for example, RBI in India and Bank of England in the UK. These are the channels through which the plans and monetary policy initiative are implemented. The banking and financial sector in India have an objective to promote the economic growth and economic welfare of the citizens. For this purpose, various regulatory bodies are set up with specific objectives and functions. In order to promote the interest and welfare of consumers in the banks, financial institutions, and the capital market, there is a need to follow business ethics and consumer protection initiatives. The enlargement of market and the economic growth, with the added burden of managing the effects of globalization, has created the need to evolve umbrella organizations specifically designed to look after certain aspects of the market activities. Many institutions such as HDFC, National Bank for Agriculture and Rural Development [NABARD], and administrative and controlling institutions like Securities and Exchange Board of India [SEBI] and Insurance Regulatory and Development Authority [IRDA] have been established in response to the growing needs of economic development. These specialized institutions are created with specific objectives such as:-  Protection of investors’ interest  Registration requirements 294

 Controlling the orderly development of the institutions and intermediaries  Advance of undue speculations  Ensuring the financial strength of organizations in the industry The reserve bank of India, as an apex body, serves as a conduit for implementation of the monetary policy, which is articulated by the government. The Securities and Exchange Board of India [SEBI] serves as a watchdog and controller over the institutions and intermediaries associated with capital market. The Insurance Regulatory and Development Authority [IRDA] concentrates on the insurance industry in India, which has a large complementary association with the capital market and its development. RBI has from time to time introduced broad guidelines about the processes to be followed by banks, financial institutions and intermediaries to know their customers. These guidelines are commonly known as Know Your Customer [KYC] guidelines. The primary objectives of these guidelines are:  Verification of the identity of the customer  Identify the location of the customer  Manage risks associated with customers in a prudent manner  Prevent unintentional introduction of anti-social, criminal, or terrorist elements to the banking system. The KYC guidelines prevent banks, financial institutions, and intermediaries from being used, intentionally or unintentionally by criminals, for money laundering activities. They enable such institutions to know and understand their customers and their financial dealings better, which in turn, help them to manage risks prudently. Brokerage Companies Stock Exchanges are established for the purpose of assisting, regulating and controlling business of buying, selling and dealing in securities SE provides a market for the trading of securities to individuals and organizations seeking to invest their saving or excess funds through the purchase of securities and provides a physical location for buying and selling securities that have been listed for trading on that exchange People who buy or sell stock on an exchange do so through a broker. The broker takes your order to the floor of the exchange, looks for a broker representing someone wanting to buy/ sell. If a mutually agreeable price is found the trade is made. This was the system earlier (Open outcry). But trading has become simpler with the help of online system of placing order and finding a matching order.  Some type of orders  Limit order  Market order  Day order  Open  All or none 295

At its core, the role of the stock broker and brokerage firm is to execute the demands of their client. At most, a full-service brokerage will offer analysis and participate in shaping a financial plan. After the profession took on a negative image in the 1980s and ’90s, stock brokers have come to prefer calling themselves “investment counselors” or “financial advisers. Function Only registered brokers can initiate transactions on the floors of the major stock exchanges and other financial markets. Thus, the primary function of the broker is to provide access to the investor. The full- service brokerages of the past have not disappeared, but the advent of electronic trading has allowed the vast majority of retail investors to route their orders, through the platform of their discount broker, directly to the exchange. Because of their experience and expertise, stock brokers are still in a position to give investment advice to those who are paying for the full-service experience, and some may even be given permission by their clients to act on their behalf at the broker ’s own discretion. Features Individual stock brokers develop their own clients and contacts, even if they work as part of larger or smaller brokerage firms. Familiarity with a client’s portfolio, goals and risk tolerance allows for a smooth relationship. Of course, the fees for this priority treatment are much higher than many people are willing to pay. Benefits Whether an investor chooses to make her own investment decisions and execute them through a broker, or prefers to capitalize on the expertise of a reputable firm in designing a financial strategy to meet her needs, the ability to participate in financial markets is the single greatest benefit provided by stock brokers. Along the way, brokers, as financial intermediaries, will conduct and oversee each transaction—from placement and execution to clearance— provide liquidity to investors through margin accounts. Considerations Many small - to medium-sized investors increasingly choose to manage their own money and forgo the cost of full- service brokerage—but this decision should be balanced by a working knowledge of markets and a balanced temperament throughout the potentially high-stress rigors of money management. If a full -service broker is used, the personal relationship between the parties is crucial. Not only should a client consider the broker ’s track record and the recommendations of other clients, but he must also be explicit about his goals and expectations and the authority he grants the broker. Insurance Companies Indian insurance companies play a major role in the economy of India as well as on the lives of the people of this country. As the population of India is getting more affluent and globalized these days, the insurance sector, a federal subject in India, is growing at an enviable pace. With an increasing market, one can find the presence of good number of companies in the Indian insurance market, which lead to a stiff competition among themselves. 296

The insurance sector in India has seen several changes over the years. The year 1999 was quite significant in this perspective when government opened up the insurance market for the private companies to offer insurance. It also allowed FDI up to 26%. As a result, besides government-owned players, a number of private insurance companies have also plunged into the Indian insurance market. However, the largest insurance company in India is still owned by the government. A Brief History The history of Indian insurance companies goes back to 1818 when Anita Bhavsar, in order to meet up the needs of the European community, opened up Oriental Life Insurance Company in Kolkata. However, this couldn’t help the Indians as the Indians needed to pay higher premiums for the insurance. Later, it was the Bombay Mutual Life Assurance Society which became the first Indian insurance company, established in 1870, to offer services to the Indian lives at a normal rate. With the rapid growth of economic liberalization, banks and insurance companies has grown rapidly in India in terms of capital and the number of customers. Insurance offers a variety of portfolios, including individual life insurance, car insurance, health insurance, medical student insurance, foreign travel and home insurance, travel insurance. There is someone who earns and his family comprises of wife, kids, parents. If not all there is a subset of these family members. The head of the family earns and his family lives happily. All the expenses are met from the earnings of this main member, most of the time the husband. Now consider this person dies in an accident or for that matter because of any event. What happens? What happens to his family members other than the psychological trauma? If they don’t have money to take care for themselves ,either someone from family have to take up the job and start working which may not be possible for them, or They have to decrease their standard of life to maintain the expenses . They are now totally unsecured from future’s point of view. In short they are totally messed up, which should not have happened. I gave this detailed explanation for the circumstances because i wanted you to understand how bad can happen and proper measures must be taken care for this. Solution Adequate Coverage!!! , this can’t be compromised… You must have a backup plan which can give your family the same kind of income which confirms that they are not short of money in case the main earner is gone. If there are some debts like Home Loan, or any other tasks which need money apart from regular income, the cover must be good enough to cover that too. For example : Rohit has a family expenses of 25,000 per month and there is a Home loan of Rs 25 lacs to be paid within 10 yrs. He is 27 yrs. old. He has a wife , 2 kids and parents. All of them are dependant on him financially. He has investments of 5 lacs. Now in this case. In case he dies , who will take care of Home loan, how will provide them enough money to live life comfortably. They need 25k * 12 = 3 lacs per year. Which they can get per month if they have 35-40 Lacs of money. If they put this in bank, they will get Rs 25,000 per month as interest which they can use. Considering inflation it will not be enough after some years, but lets leave it now for this example. Add home loan of 25 lacs to this 40 lacs and what we come to know is that this family must be covered with minimum Rs. 65 lacs. Rs. 75-80 Lacs is a decent cover for this family. Now if he takes a cover of 80 lacs for his family, from that day he can happily live all his life without any tension, thinking what will happen if he is not there. He will be attaining peace of mind, and not be worried for it. He must get a lot of internal peace because his family is protected with a good enough cover to take care for 297

them. And this is what you get in “return” from Insurance. No monitory return can give you more satisfaction than peace of mind. One point to remember and not forget is that this is the minimum cover required for family and anything less than this will be taking risk with family future. The Insurance Regulatory and Development Authority (IRDA) is a national agency of the Government of India, based in Hyderabad. It was formed by an act of Indian Parliament known as IRDA Act 1999, which was amended in 2002 to incorporate some emerging requirements. Mission of IRDA as stated in the act is “to protect the interests of the Policyholders, to regulate, promote and ensure orderly growth of the Insurance industry and for matters connected therewith or incidental thereto.” IRDA has been given following responsibility: 1. To protect the interest of and secure fair treatment to policyholders. 2. To bring about speedy and orderly growth of the insurance industry (including Annuity and Superannuation payments), for the benefit of the common man, and to provide long term funds for accelerating growth of the economy. 3. To set, promote, monitor and enforce high standards of integrity, financial soundness, fair dealing and competence of those it regulates. 4. To ensure that insurance customers receive precise, clear and correct information about products and services and make them aware of their responsibilities and duties in this regard. 5. To ensure speedy settlement of genuine claims, to prevent insurance frauds and other malpractices and put in place effective grievance redressal machinery. 6. To promote fairness, transparency and orderly conduct in Financial markets dealing with insurance and build a reliable management information system to enforce high standards of financial soundness amongst market players. 7. To take action where such standards are inadequate or ineffectively enforced. 8. To bring about optimum amount of Self-regulation in day to day working of the industry consistent with the requirements of prudential regulation. Section 14 of IRDA Act, 1999 lays down the duties, powers and functions of IRDA: 1. Subject to the provisions of this Act and any other law for the time being in force, the Authority shall have the duty to regulate, promote and ensure orderly growth of the insurance business and re- insurance business. 2. Without prejudice to the generality of the provisions contained in sub-section (1), the powers and functions of the Authority shall include, 1. Issue to the applicant a certificate of registration, renew, modify, withdraw, suspend or cancel such registration; 298

2. protection of the interests of the policy holders in matters concerning assigning of policy, nomination by policy holders, insurable interest, settlement of Insurance claim, surrender value of policy and other terms and conditions of contracts of insurance; 3. specifying requisite qualifications, code of conduct and practical training for intermediary or insurance intermediaries and agents; 4. specifying the code of conduct for surveyors and loss assessors; 5. promoting efficiency in the conduct of insurance business; 6. promoting and regulating professional organisations connected with the insurance and re-insurance business; 7. levying fees and other charges for carrying out the purposes of this Act; 8. calling for information from, undertaking inspection of, conducting enquiries and investigations including audit of the insurers, intermediaries, insurance intermediaries and other organisations connected with the insurance business; 9. control and regulation of the rates, advantages, terms and conditions that may be offered by insurers in respect of general insurance business not so controlled and regulated by the Tariff Advisory Committee under section 64U of the Insurance Act, 1938 (4 of 1938); 10. specifying the form and manner in which books of account shall be maintained and statement of accounts shall be rendered by insurers and other insurance intermediaries; 11. regulating investment of funds by insurance companies; 12. regulating maintenance of margin of solvency; 13. adjudication of disputes between insurers and intermediaries or insurance intermediaries; 14. supervising the functioning of the Tariff Advisory Committee; 15. specifying the percentage of premium income of the insurer to finance schemes for promoting and regulating professional organisations referred to in clause (f); 16. specifying the percentage of life insurance business and general insurance business to be undertaken by the insurer in the rural or social sector; and 17. exercising such other powers as may be prescribed from time to time, 299

Mutual Funds Different investment avenues are available to investors. Mutual funds also offer good investment opportunities to the investors. Like all investments, they also carry certain risks. The investors should compare the risks and expected yields after adjustment of tax on various instruments while taking investment decisions. The investors may seek advice from experts and consultants including agents and distributors of mutual funds schemes while making investment decisions. With an objective to make the investors aware of functioning of mutual funds, an attempt has been made to provide information in question-answer format which may help the investors in taking investment decisions. Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document. Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unit holders. The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public. History of Mutual Funds in India and role of SEBI in mutual funds industry Unit Trust of India was the first mutual fund set up in India in the year 1963. In early 1990s, Government allowed public sector banks and institutions to set up mutual funds. In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are – to protect the interest of investors in securities and to promote the development of and to regulate the securities market. As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the mutual funds from time to time to protect the interests of investors. All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the mutual funds sponsored by these entities are of similar type. A mutual fund is set up in the form of a trust, which has sponsor, trustees, Asset Management Company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of 300