SEBI To Keep Sight on Mis-selling in Mutual Funds

March 28, 2024 Mutual Fund

After the stress test diktat for small cap funds and mid cap mutual funds, the capital market regulators, SEBI has its eyes on mis-selling in mutual funds. This is because in an industry that is in the race to garner AUM (through distribution and sales channels) — so that a hefty fund management fee is earned — often the interest of investors is taken for granted.

There have been instances where senior citizens, who generally are risk averse, are mis-sold or pushed very-high risk small cap funds and mid cap funds. In certain cases, positioning debt mutual funds as an alternative to bank fixed deposits, senior citizens are recommended credit risk funds and long-term debt funds, paying no heed to the suitability of these products.

Similarly, solution-oriented Retirement Funds, which have a lock-in period of 5 years and are okay for someone in the wealth accumulation phase, have been provided to investors who are very close to retiring. Even newbies or first-time investors in mutual funds, who may have a risk appetite, are sold inappropriate schemes. Moreover, quite a few investors are asked to churn their mutual fund portfolio every few months.

In short, a lot of naive investors are taken for a ride. The key reason for this is that, often the recommendations are espoused by distributors, agents or banks who put their interest at the fore (as per commissions earned) rather than of investors. The truth of the matter is that investing in mutual funds through banks is a bad choice. It may offer you convenience and service, but not quality need-based advice.

Most of the banks claim their recommendations are funds handpicked by their expert mutual funds research team. But do you think, the banks will be interested in distributing schemes if they earned zero or low commissions? The fact is that a third-party product such as mutual funds earns handsome commissions for banks.

An analysis of the commission disclosure made by AMFI, reveals that among the top 20 mutual fund distributors, a majority of them are banks. To reflect positively on the bottom line, banks aim to report a consistent rise in their fee income. Given this, don’t buy the glib talk of the relationship managers at banks who seldom care which investment product will be the best suited for you, the investor. They are busy meeting their sales targets and earning better incentives.

[Read: Should You Trust a Bank for Investment Advice?]

For unbiased and independent investment advice, it would be worthwhile reaching out to a SEBI-registered investment adviser who, after assessing the investor’s risk profile, age, broader investment objective, financial goal/s, and the time in hand to achieve those envisioned goals, draw a need-based investment plan (to be followed) and recommend a variety of investment products –not just mutual funds. To render such service, registered investment advisers levy a fee and do not earn commissions from the investment products recommended.

SEBI’s move up to curb mis-selling in mutual funds is in the larger interest and well-being of investors. The regulator is expected to focus on certain categories and sub-categories of mutual funds that have witnessed a stupendous inflow in the recent past. According to media reports, the regulator has already raised queries to certain fund houses seeking explanations for transactions in certain cases. According to the industry personnel, transactions between April 2022 to December 2023 would be on the radar. Nevertheless, the regulator in its capacity could ask for specific transactions as well if it believes there could be instances of mis-selling.

According to SEBI, mis-selling is the sale of mutual fund scheme units directly or indirectly by persons by making false and misleading statements. Likewise, omitting, concealing material facts and suppressing crucial information such as the risk involved in the investment product, luring investors with returns, and/or not ensuring the appropriateness of the investment product is also mis-selling. However, if the buyer/investor of the investment product is well-informed about all these facets and provided with investment solutions that align with his/her age, risk profile, investment objective and time horizon and yet opts in for an inapt investment product, then that cannot be construed as mis-selling.

The question therefore remains: how is SEBI going to exactly determine whether there has truly been mis-selling in mutual funds? In reality, mis-selling is notoriously difficult to pinpoint.

Therefore, the SEBI compliance and disclosures for mutual fund distributors/agents/brokers, including banks should also go up —just as the way it is currently for registered investment advisers. After all, even mutual fund distributors, agents, brokers, and banks also have a fiduciary role to keep investors’ interests paramount. Disclosure of commissions received or receivable, while it is a part of AMFI’s current code of conduct, must be followed. Moreover, all other features of AMFI’s code of conduct need to be followed in letter and spirit.

“To give real service you must add something which cannot be bought or measured with money, and that is sincerity and integrity.” — Douglas Adams.

Mutual fund distributors, agents, brokers, and banks ought to show integrity, shape the culture of transparency and openness, and offer sensible investment solutions rather than merely push financial products that earn better commissions. In other words, they should be ‘Financial Guardians’ to their client.

SEBI’s vigil on mis-selling in mutual funds, in time to come, would be a big boon for investors. Potentially with investor education, SEBI’s vigil would also shape up the mutual fund industry with registered investment advisers offering independent and unbiased advice.

Happy Investing!

Note: This write-up is for information purposes and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Mutual Fund Investments are subject to market risks, read all scheme-related documents carefully before investing.

This article first appeared on PersonalFN here