Misleading an investor to invest in a fund with low returns or unduly high risk, which is not necessary for him/her to assume to realise a financial goal, amounts to misselling.
Mutual fund (MF) is an excellent investment instrument to realise financial goals, provided appropriate funds are used to meet separate short-term and long-term financial goals, so that the goals may be achieved conveniently by taking minimum risks depending on financial needs and resources of the investors.
For example, for a wealthy investor with high and regular income, there may not be any need to invest in high-risk equity funds to realise the long-term goals, but an investor with low income, there may be no option but to take the risky route to accumulate fund for a long-term goal.
But misleading an investor to invest in a fund with low returns or unduly high risk, which is not necessary for him/her to assume to realise a financial goal, amounts to misselling.
The lure of getting higher commission often leads a financial advisor or distributor to misrepresent facts about a mutual fund scheme to mislead an investor to invest in a fund that is not suitable to meet his/her financial objectives.
To indulge advisors/distributors in misselling a product, Asset Management Companies (AMCs) used to offer high upfront commission, which is paid on the fresh sale of a fund, along with attractive trail commission, which is paid on the fund value during the investment period.
However, the practice of misselling also depends on category of advisors/distributors. While employees of organisations involved in selling investment products tend to get more involved in misselling as they hop their jobs and would not be held accountable for misselling in an older organisation, individual advisors/distributors tend to put clients’ interest on top as they need to maintain personal relationships with the clients, who would introduce other people only if they are satisfied with the services of the advisor/distributor.
In fact, despite differences and anger against some AMCs for contacting their clients directly to push direct plans and with other issues, individual advisors/distributors were unanimous in saying that they would provide clients MF schemes of such AMCs if their schemes best suited the financial interests of the clients.
To curb the menace of misselling, market regulator Securities and Exchange Board of India (SEBI) has barred the Registered Investment Advisors (RIAs) from selling regular MF plans, that provide commission, to end the conflict of interest and to make misselling unattractive, the regulator has asked the AMCs to end providing upfront commission and has also rationalised the trail commission to reduce total expense ratio of the funds.
While the instant incentive of upfront commission was the root cause of misselling, trail commission compels the distributors to sell good funds as the quantum of the trail commission depends on fund value during the course of investment. So, a better fund would generate better return, resulting in higher fund value and higher trail commission.
Moreover, rationalisation of trail commission also narrows down the differences in trail commission offered by different funds, so only goods funds would now provide distributors good commission and would discourage them from selling bad funds.