Just days ago, Subrata Roy, founder of the Sahara Group, passed away at the age of 75. Roy’s legacy, however, is marred by the Sahara India financial scandal — a dark chapter where the group, disregarding regulatory norms, engaged in issuance of financial instruments. The repercussions were severe, particularly for investors from the lowest economic strata who, often without an understanding of the products, found themselves badly affected.

In a country where over 70 per cent of the population struggles with financial literacy (per S&P study), the saga of mis-selling has deep roots. Instances abound where investors were deceived through false, misleading, or incomplete information about financial products, leading them to make decisions contrary to their best interests.

While pyramid/Ponzi schemes have been famous for duping investors, mis-selling has taken various other forms — from Unit Linked Insurance Plans (ULIPs) disguised as mutual funds, to the sale of Additional Tier 1 (AT1) bonds to conservative investors without full disclosure of risks.  Furthermore, dividend plans of mutual funds have been sold by misrepresenting payouts, building unrealistic income expectations for unsuspecting investors.

Despite efforts by regulators and financial institutions to protect investors by enforcing rules and regulations to prevent and penalise mis-selling practices, the problem persists. In light of this, here are five essential strategies to shield yourself from becoming a victim of financial mis-selling.

#1 Beware of High-Pressure Sales Tactics

High-pressure sales tactics involve using aggressive and manipulative techniques to influence gullible individuals to make quick decisions without fully understanding the risks or implications of a financial investment. These tactics push individuals into products that are not suitable for them.

Creating False Urgency and Scarcity: Mis-sellers create a sense of urgency by emphasising that the investment opportunity is limited and may not be available if the individual doesn’t act immediately. This urgency can lead individuals to make impulsive decisions.

Taking a leaf out of the consumer durable product playbook, the seller/agent might claim that a special discount or bonus is available only for the next 24 hours if you invest ‘NOW’. In the case of many unregulated fintech products, there have been instances where mis-sellers claimed the investment opportunity would be closed soon. Countdown timers on websites or in promotional materials also convey a sense of fake urgency.

Emotional Manipulation: Mis-selling is mostly psychological. Heavy use of crafty words is essential. High-pressure sales often involve playing on emotions, such as fear of missing out (FOMO) on potential gains. By evoking strong emotions, sellers aim to override rational decision-making and prompt individuals to take immediate action.

They will make you think about the dreams you’ve always had — luxurious vacations, a beautiful home, financial freedom. And, then pitch that this investment is your ticket to turning dreams into reality. If the so-called advisor knows you well, they may use personal stories and refer to people in common circles to seal the deal. In the case of YES Bank AT-1 bonds, many senior citizens were sold bonds as a ‘high-yield but super-safe product on par with FDs’ by the branch relationship managers.

Continuous Follow-Up and Persistence: Mis-sellers engage in persistent follow-ups, applying continuous pressure on the individual to make a decision. This persistence often acts as a catalyst.

For example, thanks to the ubiquitous mobile phone, you are just a call away. Once or twice you may disconnect the phone or even scream ‘not interested’. Unfazed by all this, tele callers do continuous follow-ups, making investors feel obligated to reciprocate. Continuous follow-up increases familiarity too.

Overstating Potential Returns: Mis-sellers exaggerate the potential returns of an investment while downplaying associated risks. By focusing on the upside, they create an illusion of a ‘low-risk, high-reward’ opportunity.

For instance, often only those investment returns of a product are shown where the returns are highest. To do this, they may use online links/newspaper/magazine clippings of old articles. Mis-sellers of small-cap funds aggressively highlight 2009, 2014, and 2021 calendar year gains, and then extrapolate the same over 10-20 year periods!   

Creating a Sense of Trust: High-pressure tactics often involve building a quick rapport or trust with the individual to make them more susceptible to the sales pitch.

For instance, many mis-sellers are known to give unusual amounts of personalised attention to create a sense of a close and trustworthy relationship. This can make it more difficult for the individual to question the legitimacy of the offer or even understand the hidden agenda. There have been cases where customers have withdrawn long-term money to invest in short-term offerings when showered with enough personalised attention!

Pseudo-financial planning games also work well. Some agents have used their relationship with senior citizens by selling them market-linked debentures (MLDs) with unfavourable terms. Since seniors live alone and desire attention from younger people, mis-sellers have tasted success by presenting a superficial financial plan for ‘uncle/aunty’. Playing on trustworthy stereotypes — such as a friendly demeanour, authoritative tone, or even dressing in a manner that implies professionalism — goes a long way in impressing gullible investors.

Use of Complex Jargon: When individuals feel they don’t fully understand the technical language being used, they may be more likely to succumb to pressure out of fear of appearing uninformed. When complex jargon is used alongside time pressure, individuals may feel they don’t have sufficient time to fully understand the intricacies of the investment, leading them to rely more on the sellers’ guidance, which is exactly what they want!

Complex language can be used to make investments seem more sophisticated and exclusive, potentially pressuring individuals into decisions without fully understanding the intricacies involved. In the case of cryptocurrency investment, jargon such as decentralised blockchain technology, deflationary consensus algorithm, etc. has been used to net investors. As you can see, this doesn’t have the same effect as simply saying put your money into this new digital currency system that uses advanced technology to ensure security and reliability.

#2 Never Ignore Fees, Charges

When considering financial investments, one crucial aspect that should never be ignored is the transparency and disclosure of fees, costs, and charges associated with the product. A lack of clarity in this area can raise red flags and may indicate potential issues with the investment.

Investors should be wary if there is a complete absence of clear information regarding fees, costs, and charges associated with the investment. A lack of transparency in this regard can lead to unpleasant surprises and hinder the ability to make informed decisions.

For instance, there have been many examples previously (pre-2010) where ULIPs have been sold without mentioning high premium allocation charges or PAC (10-20 per cent). It is only after a few years that such ULIP investors discovered how hefty PAC eat into their investments. Of course, the insurance watchdog brought rules that prevented ULIPs from charging such exorbitant PAC.

Another red flag is when agents or advisors fail to disclose the commissions they will earn from promoting a specific financial product. Honest and transparent professionals should openly discuss the compensation they receive, ensuring investors are fully aware of potential conflicts of interest.

If agents or advisors avoid or deflect questions about fees, costs, or charges, it may indicate an attempt to keep investors in the dark. Investors should insist on clear, straightforward answers and be wary of those who seem hesitant or unwilling to provide such information. For instance, while mutual fund agent commissions usually vary from 0.50 per cent to 1.00 per cent of the AUM, endowment plans/money-back plans in insurance offer much more handsome commissions — a reason why agents push such plans more than pure term policies. Policies with renewal pay more commission (in percentage) than single-premium policies.

#3 Look for regulatory oversight  

Lack of information about regulatory oversight is another red flag. Investors should inquire about the regulatory body overseeing the financial product and verify its legitimacy. Do not fall for official-looking documents or logos; verify independently. Reliable investments are typically regulated by reputable authorities, and clear information about this regulatory oversight should be readily available.

Of late, some fintech platforms have been marketing agriculture/farm investment projects by pooling money from many investors with promised returns of 10-15 per cent. Such collective investment schemes, which ordinarily should take approval from SEBI, haven’t done so. Earlier, many bond aggregator platforms without any regulation sold different types of bonds, including unlisted ones. SEBI had to step in and bring online bond platform provider norms to regulate this space.

A robust financial product should have a transparent redressal or recourse mechanism in place. Investors should be cautious if there is ambiguity or lack of information regarding how grievances or disputes will be addressed. A well-defined process for complaint resolution is a hallmark of a trustworthy investment.

#4 Ask Pointed Questions

When entering the realm of financial investments, investors must ask pointed questions to ensure a thorough understanding of the product and mitigate potential risks.

Understanding Risks: Investors should inquire about potential risks associated with the investment. What are the factors that could adversely affect the performance of the investment? Seeking a comprehensive understanding of risks enables investors to make informed decisions aligned with their risk tolerance. For instance, when many investors greedily bought high-yield credit/debt mutual funds pre-Covid from Franklin Templeton MF, they never realised the true meaning of illiquidity, high-yield credit, etc. Only when a crippling market dislocation, fed by the onset of the Covid pandemic, sucked out liquidity from the funds’ underlying holdings did they start realising the risk. 

Clarification on Terms and Conditions: Investors must seek clarity on all terms and conditions, including those presented in fine print. Asking specific questions about contractual obligations, penalties, and any hidden clauses ensures that investors are fully aware of the terms governing their investment.

TnC is often an ignored document. Many avoid reading such documents due to small font sizes. But, as the adage goes, the devil is in the details. Be it a bank product, mutual fund product, or insurance offering, official documents carry important information, which is often overlooked.

Knowing the conditions under which an investment can be exited, and the potential associated costs, allows investors to plan their financial strategies effectively.

Assess Investment Performance History: Instead of relying on short-term or selectively chosen data, investors should ask for the investment’s performance history over a meaningful period. Requesting performance data beyond a single year provides a more accurate depiction of how the investment has fared under various market conditions.

For example, many investment offerings today come with ‘presentations’. In such documents, back-tested data for chosen strategies are shown to prove how wonderful such options would be if someone invested in them 15-20 years back. Back-testing is not real data. Such back-tested returns often involve tweaking a strategy to fit historical data perfectly, a practice known as overfitting or curve fitting. This can create a strategy that works well in the past but fails to perform in real-world conditions or future market scenarios. When someone overtly emphasises such data to convince you of an investment, that’s a major red flag.

Written Information Over Verbal Assurances: Verbal assurances may not provide a sufficient foundation for understanding the intricacies of an investment. Investors should request written information, including prospectuses, offer documents, and any relevant literature. Written documentation offers a concrete reference point and reduces the likelihood of misunderstandings.

For instance, many investors a few years back were mis-sold dividend plans of hybrid funds. Investors hoped for the simultaneous generation of stable, regular dividend income, along with capital appreciation of the original investment. But when markets fell, paying such regular dividends was not possible. Plus, a market correction reduces the corpus on which the dividend is paid. Additionally, changes in dividend taxation rules (dividends from equity-oriented funds were tax-free until March 31, 2018) also made this route less attractive.

#5 Check Credentials of Advisors

When seeking financial advice, verifying the credentials of advisors is a fundamental step to safeguard your investments.

Avoid Bank Relationship Managers: While banks provide a range of financial services, their Relationship Managers (RMs) may have sales targets that could influence their recommendations. As a rule, it’s advisable to exercise caution and seek advice from independent professionals rather than those tied to specific financial institutions.

Use SEBI Registered Investment Advisors: When it comes to investment advice, prioritise engaging with advisors registered with the Securities and Exchange Board of India (SEBI). SEBI-registered investment advisors (click here to see list: https://tinyurl.com/sebiria) adhere to regulatory standards, providing a level of assurance regarding their qualifications and ethical practices. Fee-only advisors are compensated solely by their clients, reducing potential conflicts and aligning their interests with yours.

Caution in Insurance Advisory: In the realm of insurance, the landscape can be intricate. Be wary of eloquent agents and prioritise consulting advisors well-known for giving accurate advice. Additionally, consider talking directly to the clients of these agents to gain insights into their actual experiences.

Seek feedback on products specifically from registered advisors rather than distributors or agents. Directly approach individuals who have sought advice from the advisor in question to gain an unbiased understanding of their experiences. Platforms like bl.portfolio can be valuable resources for obtaining genuine feedback.

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