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Mutual Fund Mis-Selling is now Fraud: SEBI

SEBI has made misselling a fraudulent practice by adding a clause into the "Prevention of Fraudulent and Unfair Trade Practices" Regulations, via a notification:

(s)  mis-selling of units of a mutual fund scheme;
Explanation.- For the purpose of this clause, "mis-selling" means sale of units of a        
mutual fund scheme by any person, directly or indirectly, by─ 
(i) making a false or misleading statement, or 
(ii) concealing or omitting material facts of the scheme, or
(iii)concealing the associated risk factors of the scheme, or
(iv) not taking reasonable care to ensure suitability of the scheme to the buyer.

At first glance this appears to be a far reaching addition because you can hardly prove (or disprove) such an allegation when it occurs. Did the agent conceal a material aspect of a scheme? How can you prove it if he said he did reveal it?

The last bit (ensuring suitability of the buyer) seems even more subjective, but I suppose it could be on a "reasonable effort" basis where you can only get rapped in a very extreme case.

Having gone through the rest of the "fraudulent" practices, it seems we do have a framework of subjectivity. For example:

(b) dealing in a security not intended to effect transfer of beneficial ownership but
intended to operate only as a device to inflate, depress or cause fluctuations in
the price of such security for wrongful gain or avoidance of loss;

You could easily state that most intraday "strategies" of a large size will qualify. However I believe the framework is subjective because it needs to be so: given the range of appeals available (SAT, courts) it is better to have a law that is broad and subjective, rather than create a tight and restricted rule which the big and bad jokers will easily find a way around.

So overall, I don’t find it such a bad deal to not have a strict definition of what misselling is. What I would like to see, however, is that SEBI investigates cases, and has HUGE penalties on extreme forms of fraud of any sort, including jail time.

Today, fraudsters get away with small fines and a small period of a ban on trading. That should not be the case. If we want to deter other people from a crime, the punishment should be huge and visible. That means when they catch the big frauds, those people need to go to prison. We need to see people banned for life from the markets. We need to see fines that are so heavy they will leave the fraudsters with nothing – I mean, for a fraud of Rs. 100 cr. we should see fines of Rs. 500 cr. as punitive damages.

In this respect, if a bank is found to be selling equity mutual funds to old women who come in looking for a deposit, I think the bank should be fined a minimum of Rs. 10 cr. as a deterrent. Banks seem to have the most serious offences of misselling agents who pose as "relationship managers".

Misselling may be provable only in an extreme case, and with respect to mutual fund selling I think it’s difficult to prove either side. Online players need to be careful; they must provide all information available (risk factors etc.) and have some defence available to state that they tried to provide "suitable" products for a buyer. For others, agents have to be careful to reveal such information pro-actively.

I don’t believe this regulation changes much: misselling in mutual funds has been cut down since SEBI removed entry loads and the new offer frenzy died. But I would welcome something similar in insurance and banking.

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