Commission Conflict and Gross-IRR Comparison
An investor with Rs 3 crore to allocate is comparing two Category II funds. Fund A has a target gross IRR of 15%, a 2% upfront distributor commission and a 20% performance fee. Fund B has a target gross IRR of 12%, a 0.75% upfront commission and a 15% performance fee with a hurdle. The distributor prepares a one-page comparison that shows only gross target IRR and past three-year returns. The distributor verbally tells the investor that Fund A is clearly better and that the commission does not influence the advice. The investor asks for the commission in writing and for net-of-fee scenarios, but the distributor says those details are in the PPM and not needed for a decision. The distributor’s firm has a revenue-sharing arrangement with Fund A’s manager that pays an extra 0.5% if the distributor crosses Rs 25 crore of commitments in the quarter. The distributor is Rs 4 crore short of that target.
1. Identify the conduct issues in the distributor’s recommendation and explain how they should be addressed before subscription.
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The recommendation is affected by a clear conflict of interest. Fund A pays a materially higher upfront commission and the firm receives an extra 0.5% if the distributor hits a quarterly target; the distributor is close to that target. Saying that commission does not influence the advice while withholding the revenue-sharing arrangement is misleading. The comparison is also incomplete because it uses gross target IRR and past returns without showing fees, hurdle, risk, liquidity and net outcomes. Target IRR is not a promise, and past performance does not establish future returns. Before subscription, the distributor should disclose in writing the upfront commission, any revenue share or target-linked incentive, and the capacity in which it is acting. It should provide a net-of-fee comparison and a balanced risk disclosure, then assess suitability independently of the target. If the distributor cannot give objective advice because of the incentive, it should escalate or decline the recommendation. The investor should be given time to review the PPM and ask questions without pressure.
2. How should the comparison be presented to the investor?
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The comparison should start with the investor’s objectives, risk tolerance, liquidity needs and time horizon. It should then show, for each fund, the gross and net return scenarios after management fees, performance fees, hurdle and distributor commission, with the assumptions stated. The distributor should explain that target IRR is a projection, not a guaranteed outcome, and that actual returns depend on exits, valuations and market conditions. It should compare investment strategy, sector concentration, leverage, valuation policy, tenure, redemption restrictions and key-person risk, not just a single return number. Past returns should be shown with their period, basis and limitations. The written disclosure should state the commission and any revenue-sharing arrangement with Fund A’s manager, and should explain that the distributor may receive more from Fund A. The investor should sign an acknowledgement of the conflict disclosure. The distributor should retain the comparison, the suitability rationale and the investor’s questions and responses.