5.3 Due Diligence Process by AMCs for Distributors

Why AMCs Are Made Responsible for Distributors

SEBI regulates AMCs directly. It does not register mutual fund distributors — AMFI does that through the ARN. That creates a supervisory gap: the layer closest to the investor, where mis-selling actually happens, sits furthest from the regulator.

SEBI's answer is to place the obligation on the entity it does regulate. AMCs must conduct due diligence on distributors and are accountable for whom they empanel. The commercial incentive runs the other way — a large distributor brings assets — so the requirement is deliberately mandatory rather than advisory.

Which Distributors Are Covered

Due diligence is required for distributors that meet any one of the prescribed thresholds. The thresholds are framed around scale and reach, on the reasoning that a large distributor's practices affect many investors:

• Presence in multiple locations, indicating a branch or franchise network
• Assets under advisory above a prescribed level
• Commission received above a prescribed level, aggregated across the industry or from a single AMC
• Number of investors serviced above a prescribed level

A small individual distributor operating alone is generally outside the formal due-diligence net, though ordinary empanelment checks — valid ARN, KYD compliance, PAN, bank details — apply to everyone.

AMFI publishes the aggregated data on distributor commissions and assets that allows AMCs to identify who crosses the thresholds.

What the Process Examines

The review goes well beyond confirming that the ARN is valid.

Two areas carry the most weight in practice. Churn — repeatedly switching investors between schemes to generate fresh commission — is the classic detriment, and it is visible in transaction data as a pattern of short holding periods. Product-mix concentration in high-commission categories is the other, because it suggests recommendations follow the commission rather than the investor's need.

Who Is Accountable

The obligation rests on the AMC, and the trustees are required to oversee that it is carried out. Due diligence is not a one-off exercise at empanelment; it is periodic, and findings must be recorded.

Outcomes range across a spectrum: continued empanelment; empanelment with conditions such as enhanced monitoring or training requirements; restriction to certain products; suspension; or termination. Where conduct suggests a breach of the AMFI Code of Conduct, the matter can also be referred to AMFI, which administers the ARN.

What This Means for a Distributor

The practical implications are concrete and worth internalising early in a distribution career:

• Your transaction pattern is visible. Switch activity, holding periods and the category mix of your book are all data the AMC can examine.
• Complaints matter even when resolved. A pattern of complaints of the same type is evidence about process, regardless of individual outcomes.
• Documentation is your defence. A recorded risk profile and a written basis for each recommendation is what distinguishes a defensible recommendation from an accusation of steering.
• Empanelment is conditional and reviewable. It is not a permanent entitlement acquired once.

Where Due Diligence Sits Among the Other Controls

It helps to see this requirement as one layer among several, because the exam sometimes asks which mechanism addresses which risk.

Certification tests knowledge once. The Code sets a standard. Due diligence is the only control that looks at what a distributor has actually been doing over time, using real transaction and complaint data rather than a declaration. That is why it is aimed at scale: examining every ARN holder this way would be impossible, while examining the largest networks reaches most investors.

A Note on Records

Because due diligence is periodic and evidence-based, the records an AMC can draw on are the records that exist. A distributor whose files contain dated risk profiles, written recommendation rationales and acknowledged commission disclosures can explain an unusual transaction pattern — a cluster of switches following a genuine change in a client's circumstances, for example. A distributor with no such records cannot, and an unexplained pattern is assessed on the data alone.

This sub-topic appears twice in the NISM curriculum — once in the regulatory unit and again in the distribution unit — which is a reliable signal of examination importance. The regulatory framing is that SEBI reaches the distribution layer through the AMC; the distribution framing is that empanelment carries ongoing conduct obligations. Both describe the same process.