CIRCUIT BREAKER. Needed, a crackdown on mis-selling

The National Spot Exchange (NSEL) scandal is, as Alice would say, getting curiouser and curiouser. The Economic Offences Wing this week rounded up key staffers at India’s top brokers for mis-selling. Investors on the exchange claim that, in punting on paired contracts on NSEL, they were unaware of the nature of the underlying contracts. They went by the ‘risk-free’ double-digit returns promised by their brokers.

For brokers who peddled NSEL products, the law will no doubt take its course. But if mis-selling of commodity contracts is a serious enough offence to merit the arrest and interrogation of brokers, how come mis-selling of other financial products is routinely swept under the carpet?

Forget adventurous investors who actually hunt for double-digit returns in paddy, castorseed or wool. Often, it is risk-averse investors who seek the safe harbour of regulated products, who are made victims to mis-selling.

Consider the insurance industry first. Try asking any insurance agent for a pure-term policy. Chances are that he will try his utmost to sell you an endowment plan, money-back plan or any one of the other investment-cum-insurance products that, despite their fanciful description, fetch you neither a reasonable return nor sufficient insurance.

You could have bought that pure-term cover online at a fraction of the cost. But the agent is much happier, thank you, selling you a traditional plan because he gets as much as 30-35 per cent as his cut, on the first year’s premium.

Tantalising SMSes promising you a ‘pension of ₹30,000 a month and ₹60 lakh benefit’ on a saving of ‘just ₹3,000 a month’ are quite commonplace (I received one this morning). When you follow up, you usually find strings attached, including the small fact that you actually need to die to benefit from that ₹60 lakh.

There are several low-interest loan offers peddled to unsuspecting borrowers over phone. On pursuing them, you find that the loan comes bundled with an insurance plan, which requires you to commit to hefty annual premiums even as you struggle with the EMIs.

Anecdotal evidence on insurance mis-selling is backed by data from regulator Irda’s grievance management site too. It shows life insurers dealt with as many as 2.11 lakh complaints about unfair business practices in 2013-14. Not only has the number doubled in three years, complaints on unfair practices amounted to nine times those received about insurance claims. Yet, far from tightening the screws on distributors, Irda is now proposing to do away with the licensing requirement for insurance agents!

Most Indian investors who don’t care for market-linked returns, look to their banker for cast-iron products. But they aren’t safe from mis-selling at their bank either. Quite apart from your “relationship manager” continually bombarding you with savings products (a euphemism for traditional insurance plans) and new fund offers (NFOs), most banks seem to treat your personal information like graffiti.

How else do you explain all sorts of call centre staffers cold-calling you with generous offers for credit cards, personal loans, balance transfers and ideas to convert your credit card balances into EMIs? This is a fertile ground not just for mis-selling, but for outright fraud too.

The low-interest personal loan often turns to be very expensive when you know the mode of calculating interest. Balance transfers at a promotional rate may mask a high upfront fee for processing.

On loans or cards, if you accept an offer, the staffer seeks all kinds of confirmatory details over the phone, so that your transaction can processed in double-quick time. This has proved a godsend for phishers, who are now on to the same modus operandi.

Despite all these goings-on, financial regulators think that while other financial intermediaries indulge in mis-selling, banks can do no wrong, because they value client relationships, and provide only the most-suitable advice. Wrong. The advent of non-branch banking and the furious churn in bank staff often leads to them caring more about meeting their aggressive cross-selling targets than about evaluating a customer’s suitability for ULIPs or mutual funds.

Until a year ago, mutual funds were financial products, where mis-selling was relatively rare. After all, how could anyone mis-sell a product whose track record is there for anyone to see? (It was abysmal too, in the case of equity funds). Even if agents or banks were tempted to mis-sell funds, Sebi’s ban on upfront commissions and the 2.5 per cent cap on the fund’s annual expenses made sure that no one was particularly keen to do so.

But with this bull market pushing the returns on some equity funds into three digits, some companies came up with the brilliant idea of closed-end NFOs. So that honeymoon is now officially over. With investors keen to join the equity party at this late date, a flash-flood of NFOs has hit the market. Industry leading asset management companies have played right along by offering upfront commissions of 5-7 per cent on these NFOs.

Yes, the commission is paid for by the fund. But that doesn’t prevent distributors from mis-selling them to entirely unsuitable classes of investors. Therefore, we know of 80-year-olds who have been sold micro-cap funds or first-timers who have bought banking or infra funds. While Sebi has largely been wringing its hands from the sidelines, the industry body has recently circulated a proposal to cap upfront commissions.

Mis-selling in financial products may be rampant today. But the above instances also show the way on the regulatory fixes to tackle it.

One, mis-selling thrives on opaque and complex products. Therefore, the first step is to make it mandatory for financial products to disclose their track record. It is only when an investor cannot check product returns for himself that he relies on the word-of-mouth assurances from an intermediary.

If you had asked the man on the street to invest in equities last year, he would have refused, because everyone knew equities made no returns for six years. He is unable to say the same about a traditional insurance plan because he is unable to decipher the jargon (fund value, death benefit, loyalty additions) that goes with it.

Two, abolish upfront incentives and migrate financial products to a trail fee pegged to the value of the investor’s portfolio. This way, distributors will gain nothing by churning clients or recommending new products ever so often. Instead, their interests will be best served by staying with the investor and sharing in his returns (or losses).

Three, evolve a common registry for financial intermediaries (across products) and educate investors that they must insist on the registration number before they begin transacting with any agent. This will pin responsibility for tall promises and make grievance redressal easier. Finally, insist on stiff penalties on firms flouting any of the above norms. These measures should do more to curtail mis-selling than all the pious statements being made by regulators.

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