What would you call a mutual fund distributor who sells 150 schemes to the same person? Or an insurance agent who sells a policy to someone, knowing full well he cannot afford the premiums?
Piran Doctor, a chartered accountant, says it is not mis-selling but plain fraud. Doctor was asked to buy an insurance policy, which would serve as collateral against his loan account. "The rate on the current account of the foreign bank was quite attractive at nine per cent and way below the market rate of 13 per cent."
However, when he received the policy papers, they were a complete mess. "My height is six feet, four inches but the form said I was five feet and six inches. There were several such mistakes." Later, he discovered his personal details were deliberately stated wrongly, so that he would not have to go for a medical test. His premium: Rs 1 lakh per annum for 10 years.
When he went back to the non-banking financial firm (NBFC, which supposedly had a tie-up with the foreign bank), he was told that since the 15-day free-look period was not over, he would be given a fresh policy. But it never came.
After a point, the insurance company officials stopped taking his calls. The free-look period had also expired by then. He discovered much later that the foreign bank had no tie-up with the NBFC either.
Doctor has since taken the legal route and created a group for people cheated in a similar fashion. From Doctor's experience, one thing is clear: while financial regulators such as the Reserve Bank of India, Securities and Exchange Board of India and the Insurance and Regulatory Development Authority might be taking some corrective steps, the malaise of financial fraud has become deep-rooted.
Sanjay Sinha, founder of Citrus Advisors, says mis-selling occurs because the seller does not have enough knowledge of the products. In addition, there is no recognition for good advice. "In good times, many intermediaries made easy money. Though things are tighter now, many are still intoxicated with those numbers. The result is mis-selling," he says.
According to another former head of a mutual fund house, the line between mis-selling and fraud is very thin. He says there are innumerable cases where mutual fund distributors have sold products to risk-averse people by showing historical data. "By showing 30-35 per cent returns in the past years, they convince these investors that they will earn at least 15-20 per cent even in bad times," he says.
He recounts a case where a retired person was convinced to invest a large amount in an equity-linked savings scheme. When markets crashed, he could not even cut his losses because his money was locked-in for three years. "For a retired person, liquidity is essential. The distributor who sold him a product despite knowing his age and financial situation was hurting him," he adds.
No wonder, financial planners say you don't really need every mutual fund, insurance, or savings product sold to you. True, some of these might not cost you much. But some others that are mis-sold can damage your financial situation considerably.
If not judiciously bought, insurance products can hurt your wallets really badly. You should only buy insurance to protect your financial life from unwelcome surprises and to cover your family's needs when you might not be around. Insurance agents might not have your actual needs in mind when they hard-sell an insurance product to you. All they might be thinking of is their own fat commission and you could be saddled with a product on which you have to pay unnecessary premiums.
So, your first step is to see whether the product being sold to you will really save you taxes as claimed. Remember, ideally, insurance should not be bought to save taxes, but to protect your family. Next, examine in detail what kind of cover the insurance offers you. Is it regular income such as an annuity product? Or does it provide a lump sum to your family in case of an eventuality?
If it is a cover you need and your existing insurance policies are not covering your requirement adequately, then look at how much cover you will get and at what cost. See the lowest premiums on the product. Essentially, it is most important to see the exclusions under which the claims will not be paid, and whether you are out of those exclusions.
Ashvin Parekh, national leader (global financial services) at Ernst & Young, says that all the stakeholders, distributors, and manufacturers mis-sell to their customers/investors. The intermediaries will seldom evaluate or make the customer understand the underlying risk associated with the product he buys.
Parekh blames customers as well. "Customers also become impulsive to buy and sometimes lose their balance between fear and greed." The first step is to take preventive measures and know what the insurance agent is pitching you, and try and gauge whether you really need the product. You should make it a point to take a second opinion for your investment needs, like what you do when a doctor recommends a surgery for your ailment.
Are regulators doing enough ?
The present nature of financial products' distribution model is commission-based, where advice given is often bundled with sale (distribution) of the relevant product. This, along with multiple regulators having different regulatory standards, has caused sale of toxic products, with commissions up to 40%. In other words, it would take many good years for the investor to just get the principal back on these products.
While aggressive vigilance would yield some results, deeper reform would be two-fold. First, a change in the mindset of some regulators to cap commissions, at say 5%. This would prevent a race to the bottom by distributors racing to sell the most toxic products. Second, to mandate segregating the advisory business from the distribution business, the first step of which has been taken by Sebi passing the Investment Advisers Regulations this year.
Founder, Finsec Law Advisors and former executive director, Sebi
At the heart of the issue is the motivation for the distributor to sell honestly the correct product, after understanding the risk and reward requirements of the customer. The intermediaries will either be motivated by the commission or the sales target.
The regulators try and act as custodians of the customers' interest. This, in itself, becomes challenging, with far too many customer segments, products and market dynamism to take into consideration. The end state is far too obvious. The regulator will never be ahead of the curve in this game. He will, at best, attempt to create frameworks to capture the elements of protection. Customers also become impulsive to buy and sometimes lose their balance between fear and greed.
Also, there is enough evidence to establish that regulators going beyond the balance on investor protection could eventually spoil or kill the market. Quite funny as it may sound, only an adequate dose of anti mis-selling regulations will work.