Mis-selling of AT-1 bonds is only the tip of the iceberg
PremiumMis-selling issues and sharp sales practices have gained attention from many regulators
On 12 April, Sebi imposed penalties against Yes Bank and its officials for mis-selling additional tier-1 (AT-1) bonds to retail investors. While the order has been stayed by the Securities Appellate Tribunal, the events have shone a spotlight on the issues of investor protection and fair dealing.
The details in Sebi’s order are troubling. Over 97% of individual investors in the AT-1 bonds were existing customers of Yes Bank, and one-fifth of them prematurely closed their fixed deposits to invest in these bonds. There are indications that at least some of these were older customers with a low risk appetite. But the main issue is that the customers were not made aware of the risks associated with the AT-1 bonds, because the private wealth team knowingly excluded them in the verbal sales pitch. According to a deposition from a relationship manager, the application forms, including the documents pertaining to risk disclosures, were signed by customers at the settlement stage of the transactions, after they were already influenced to purchase the bonds.
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The mis-selling of AT-1 bonds is only the tip of the iceberg. It became an issue because the bonds failed, and investors suffered significant losses. Investors in India are routinely sold investment products that are not appropriate for them, whether these are annuities, Ulips, high-risk funds and even derivative products. Victims are not limited to individuals but can be trusts, cooperative banks and other customers who don’t have the ability to evaluate their investments. It is not clear how much of it is wilful mis-selling and how much due to the lack of knowledge of the sales agents and relationship managers responsible for the selling.
Mis-selling issues and sharp sales practices have gained attention from regulators globally. In the US, Wells Fargo settled with the SEC on allegations that it opened checking accounts for customers without their consent. In 2019, the Hayne Royal Commission study found significant problems in Australia’s financial industry, including advisers failing to act in the best interest of their clients, conflicted remuneration structures that lead to poor outcomes for clients.
Beyond legal arguments, let’s talk about what constitutes mis-selling, based on the Yes Bank case. If the product risk disclosures are available in the public domain (say exchange websites) and the customers are tech literate, does it absolve the responsibility of the salesperson from making adequate disclosure? If that were true, there is no reason for regulators to insist on product disclosures and risk profiling at the time of a sale. Even if there are no regulations, the principles of fair dealing demand that customers are made aware of the risks in plain language. Secondly, if the salesperson is not incentivized directly from the sale, and potentially doesn’t have the incentive to mis-sell, does it absolve his/her responsibility for duty of care to clients? No, the clients don’t know or care about how the salesperson is compensated. When they make their decisions based on the information shared by the salesperson, they trust the person to provide full and accurate information and have their interests at heart. Thirdly, does a high financial capacity of the client indicate that they don’t need the same duty of care? No, if there is one lesson from financial crises, it is that the rich and informed investors don’t always make better decisions than others.
Who is responsible for this state of affairs and what can be done to reduce the incidence of mis-selling? The current disclosure and communication requirements have been nothing more than a box-checking exercise, and the industry should aspire to a principles-based, fiduciary duty standard. In practice, it means salespeople putting the customers’ interests above their own and their firm’s interests. Had that been the case, they wouldn’t have influenced their customers to break their FDs to invest in risky bonds. Secondly, there needs to be relevant and ongoing ethics training for staff to ensure that they are aware of expected ethical behaviour and are given the tools to manage ethical challenges.
Organizational culture drives behaviour, which in turn drives how employees treat customers. Regulators can help by focusing on individual accountability through clear identification and ownership of roles and responsibilities within business functions and units. For example, the Monetary Authority of Singapore published guidelines on individual accountability and conduct for financial institutions last year, which aims to strengthen oversight over material risk personnel and reinforce conduct standards among all employees.
Mis-selling raises concerns about professionalism, erodes trust and leads to poorer outcomes for everyone. Leaders at investment firms need to take ownership of the problem. What Sebi has done in the Yes Bank case is welcome, but for it to have a lasting impact, we need to prevent instances of mis-selling at the source instead of punishing the occasional wrongdoer.
Vidhu Shekhar is country head, India, CFA Institute.
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