Mis-selling- The Achilles Heel of Financial services Industry

In general Mis-selling can be defined as “The ethically questionable practice of a sales person misrepresenting or misleading a buyer about the characteristics of a product or service.” In the financial service industry this could include the sales person not disclosing certain facts about an investment which could change the judgment of investor.

Although mis-selling has been prevalent in the system across various sectors, more so into financial sectors, it has been making headlines of late due to its increased volume and regulator’s being clueless regarding proper mechanism to control the menace.

Sebi mulls fresh checks on mis-selling of MFs- Dec. 22, ’14.

 Insurance companies have sought relaxation in the hefty penalties proposed in the insurance bill for ‘mis-selling’ and demanded that they should not be held liable for any ‘act of omission’ by their agents.

Securities & Exchange Board of India (SEBI) has brought mis-selling of mutual funds under the ambit of Fraudulent Trade Practices. SEBI has defined Mis-selling as the sale of units of a mutual fund scheme by any person, directly or indirectly, by-

(A)Making a false or misleading statement, or

(B)  Concealing or omitting material facts of the scheme, or

(C)Concealing the associated risk factors of the scheme, or

(D)Not taking reasonable care to ensure suitability of the scheme to the     buyer.

It means the person who advises you to buy must recommend something suitable for your needs, and explain properly what it can or can’t do. They should make sure you know the risk.

Key things to remember about financial mis-selling:-

(1)It’s not about whether you lost money or not: Even if you didn’t lose out, if the product is not right for you- perhaps it’s a riskier investment than what you wanted- you can still make a complaint about financial mis-selling.

(2)You can’t complain just because an investment performed badly: some investments are risky, and if you take a gamble you have to accept that you might lose. But you can complain if you were not told about the risk.

“Caveat emptor” or “Buyers beware” defense is no longer available to sellers, but this is the most effective mantra for an investor to protect himself from being  mis-sold. Most of the times products are mis-bought rather than mis-sold in retail financial market. It is found from some extensive studies by FCA (Financial Conduct Authority-UK) that people fall into some common mind traps/ behavioral biases related to three main areas: 1) Preferences, or what we want; 2) Beliefs, or what we think are the facts; and 3) Decision-making- we use decision making shortcuts while assessing available information.

The study reckons that people are particularly prone to making errors about financial products and services. This is because:

• Many products are very complex. This leads people to simplify decisions, like focusing only on headline rates.
• Products can involve trade-offs between the present and the future, so often people make decisions against their long-term interests and smart sales persons exploit this bias to the fullest.
• Decisions can require assessing risk and uncertainty, and most people are bad or terrible at statistics.
• Decisions can be emotional. Stress, anxiety, fear of losses and regret can drive them rather than costs and benefits.
• Customers also become impulsive to buy and sometimes lose their balance between fear and greed.
• You can’t learn from past mistakes in some cases. Retirement planning or taking out a mortgage is done once or infrequently, and consequences are revealed only after a long delay.

The FCA study says that firms play a crucial role in shaping consumer choices. Product design, marketing and the sales process can make the effects of people’s biases worse and cause more problems.

(Source: FCA,http://www.thisismoney.co.uk/money/news/article-2307384/FCA)

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. SEBI has taken a very good step in this regard by passing the Investment Advisers Regulation 2013. Rising competition and insatiable hunger of manufacturers as well as intermediaries to capture and retain market share is also one of the reason behind mis-selling.

Sometimes mis-selling occurs because the seller doesn’t have enough knowledge of the products. Looking after the customer in the right way and hitting sales targets seem to be diametrically opposed to one another.

Not only is it the responsibility of the seller not to mis-sell, but the vast majority of buyers do not and won’t ever have sufficient knowledge and understanding to defend themselves against unscrupulous financial advisers and institutions. For the fortunate few who are adequately informed, they can at least to some degree ensure that what they are sold is an intrinsically good investment and suitable for them. In general experienced investors can look after themselves up to a point.  In addition, there is very low recognition for good advice.

We need clarity of analysis to find the root cause of the problem and in the process the industry must be compelled to get its integrity act together, once and for all in the process of ascertaining the expectations of the investor whose interest should be protected within the ambit of the regulations. In turn, it is the onus on the part of the investors to scrupulously adhere to the specifics of the road-map of achieving the goal and apply due diligence in an ideal manner which may radiate the ways for prospective investors.