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Misselling Implications and Concerns

How and why does financial mis-selling occur? Critically discuss the question making reference to different perspectives and theories. Outline and describe two real world cases of mis-selling [as provided on the module blackboard site or from your own research] and indicate how and why financial mis-selling has developed in these cases.

The concept of Misselling is very important in today’s financial sector. Misrepresenting the service or product to complete the sales is called Misselling. It is considered illegal in many countries. Misselling is used by various financial firms for many years. It is the sale of the financial product or investment by unsuitable, false information or misleading advice. Infulence of misspelling is strong on the sales. Deceptive practices and corporate culture is associated with financial misselling. Financial Misselling may be ignorant, aggressive or ineffectual sales tactics (Inderst and Ottaviani, 2009). It is a failure to advise appropriately to customers and are strategies which are used to sell the products to the customers which they do not require. In this report, we have tried to explain the various perspective of financial misspelling. Two real life cases of misselling and how financial misspelling developed in these two cases are described in this report.

Misselling is an unsuitable advice given to the customer in which the risk are not properly explained to them which results in buying a product that is not right for them. Like, for example, a customer wanted to buy a computer, and he told the sales person that he want the computer to watch the DVDs. The sales person recommended a computer model to him, and he took that computer home and later found that the model does not have the DVD drive. It does not mean that the computer is wrong, but the problem is that it is not as per requirement which means that the model was mis-sold by the salesperson to the customer.  Financial misselling may be of two types: Material suitability and Material misrepresentation. Material Misrepresentation means giving incomplete or misleading information to the customer about the product or service and makes it appear like something which is not true whereas suitability misselling means selling unsuitable service or product to the customers (Arthur, 2006). The salesperson who advises the investor to buy the financial product should recommend the product which suits them, and he should properly explain what are the risk involved in it, what the product can’t do and can do (Georgosouli, 2011). If the salesperson fails to do so, then the customer may be allowed to claim compensation for the same. Financial services may be sold to the customers in a manner which is clear, fair and not misleading. It should treat the customers fairly. Few key points about financial misspelling which should be kept in mind are: Customer can make a complaint against financial misselling even if they do not lose money (Carlin, 2009). If the requirement of the product does not suit them and it is a risky investment then also they can make the complaint against the financial misselling. But a complaint can only be made if they were not informed about the risk involved in the investment. The circumstances about which the customer is neither aware nor they desired than the customer is at financial disadvantaged. The minimum standard and commitments that the organization is bound to provide to the consumers are called the corporate codes. The corporate code typically includes the following: A commitment to the employees and the company towards general ethical standards, have values such as trust, integrity, honesty, working towards the interest of the consumers  and the stakeholders, complying the regulatory requirements and the laws, fair competition, respecting the environment and the social responsibility. . There exist distinct views about misselling: Misselling is considered as a moral risk. It arises from regulatory judgment and misguided paternalism (Carlin and Manso, 2010).

Causes of Financial Misselling

There exist various causes for misselling activities: Customers are not made aware of the risk involved with a particular product and the problems associated with it which lead to inappropriate and expensive services. Customers often fail to identify the quality of the product they have purchased. HR practices that are followed in the organization like sales persons are employed without their integrity check. The sales person’s recruited belongs to their family or friends. The practices of higher commission for higher sales are encouraged. Encouraging the customers to repurchase the product they do not require (Ericson and Doyle, 2006). The companies are aware of the fact that confused and miss informed customer end up making poor purchase decision which leads the company to earn high profits. Conflicts of interest may also lead to misselling. An individual may desire and pursue his interest above the interest of others. Organizational structure and the actions arising due to such structure can also lead to the conflict of interest (Wierzbicka, 2016). A financial advisor or suppliers have more knowledge about the financial services which can lead the financial advisor to mislead the consumers. The sales persons are more exposed to the ethical practices because they work in unsupervised settings; they are responsible primarily to generate revenue which can sometimes be very stressful (Gray, 2004). Short-term objectives are the basis for their evaluation, and they are paid by commission. Lack of transparency leads to misselling. These all reasons lead the salesperson to work unethically. It involves resource misallocation throughout the society. The economy can work efficiently only if the resources are allocated to services people require. Inappropriate sales have led to the financial crisis in the USA in the year 2007-2010. By purchasing inappropriate services, the customer tends to pay more and will not be able to support themselves and their family in retirement. This financial distress causes mental illness and can lead to job loss and marital breakdown. If the firm sells inappropriate products to the customers than it can lose the trust of the customers which can hamper the reputation of the firm. Product managers use complex pricing and marketing strategies to make more profit and to baffle the investors (Plosser, 2008).The levels of fines and punishments have increased substantially in the recent years. It has reached to the level of 138.59 billion pounds for the year 2012-2014 in the USA. Whereas in the UK it was 247.20 billion pounds between the period of 2002-2015 (Huberman And Jiang, 2006).

Steps taken to avoid misselling

 The investment advisors must follow the law, codes of conduct and legislation of consumer’s protections. If he does not follow the rules as framed by the law than he may have to face the penalty for the same (Ferran, 2012). To avoid misspelling the financial advisor must act with due care, skills and diligence which are to the best interest of the market and the clients. They should assess the client’s financial situation and investment objectives. The advisors should know their client and should assess the appropriateness of the product for the customers. Should make the client aware of the risks attached to a particular product (Hill And Kozup, 2007). Should develop a reasonable and prompt system to handle the complaints of the clients. Properly document the appropriateness and suitability of the product for the client, ensure properly that the staff is aware of the codes and the rules of the business and provide proper training to the staff.By providing better information and Libertarian paternalism, misselling can be avoided. The advisors need to act in the favor and the interest of the investors and should be trustworthy. The investors should develop the ability of decision making. The public agency or government must develop regulation to keep a watch on the activities which affects the public. To control market failures, regulations needs to be undertaken. There are many market failures that exist like excessive profits, anticompetitive behavior, scarcity, monopolies, etc.  The two theories towards the approaches to regulation are public interest and private interest. The theory of public interest helps to avoid the conflicts of interest and helps in preventing the risk taking (Leyshon and Thrift, 2007). The theory of private interest means that private welfare and individual improvement plays an important role in the regulation process. The key concern in the process of regulation is Distributional Justice and paternalism. Due to various misspelling scandals which took place in the UK and around the world Steps have been taken to improve and enhance the financial literacy of the consumers. The increase in “Customer empowerment” and “Responsibilization” is the primary reason for the change to happen. Having the skills, knowledge, and confidence to take financial decisions responsibly is called financial literacy. It is an ability to evaluate and understand the information and take decisions after having knowledge of the financial consequences. The three elements that define financial capabilities are skills, understanding, and knowledge, Attitude and confidence. The people who are financially capable can take good financial decisions (Stango and Zinman, 2009). They can manage and understand their debts and credits. They can measure the returns and risks which are involved in the investment and savings options. They have wider social, ethical, political dimensions for their finances.

Royal & Sun Alliance Life and Pensions Ltd and Royal & Sun Alliance Linked Insurances Ltd

Royal & Sun Alliance Life & Pensions Ltd and Royal & Sun Alliance Linked Insurances Ltd is a part of  Royal & Sun Alliance Group which consist of a substantial part of United Kingdom Life operation. RSA has been penalized by FSA for breaching the rules and regulations as framed by PIA Rules, SIB principles, and LAUTRO Rules while selling its Home Plan mortgage endowment policies. During July 1998 to June 1999, it was found that RSA”s advisors had failed miserably to provide suitable recommendations to its customers of mortgage endowment. In certain cases, it was found that its monitoring was insufficient and was not able to exercise due care to provide suitable recommendations. They have related the policy of mortgage endowment as a tool for repayment of the mortgage. The documents for finding the risk of the investor were not proper of the RSA. RSA has failed to monitor its processes adequately. As the nature and size of RSA were big, therefore many customers were exposed towards the possibility of risk and loss. Advisors are required and obliged to recommend and advice only those policies to the customers which best suit their requirement after identifying the attitude of the customers towards risks involved in the policy of mortgage endowment. It is important that the customer is aware of the risk involved in the policy, and if they are not prepared to accept the risk, then the product is not suitable for them. The advisors have failed to provide their best advice towards RSA’s home plan policies. As RSA is responsible for its advisors and the failure of the advisors to recommend the best policy that suits the customer’s requirement, it is the failure of RSA as well. The procedures followed by the advisors for making recommendations were lacking in RSA. The documentations to find out the fact that is customer’s attitude towards risk were inadequate. RSA’s Bag note does not provide proper guidance about the procedure of fact findings. The training provided to the advisors was not sufficient and was given insufficient details to identify the customers for whom the policy will be unsuitable. The risk category followed by RSA was not proper as it does not enable the checkers to identify the risk adverse customers from the documents alone. RSA failed to monitor the employees, investment staff and the appointed representatives by the procedure established by the PIA Rules. Timely actions were not taken on the misselling made towards the sale of short- term contracts. FFQC failed to check the short-term contract sales. Some samples were checked by the enforcement which recommended that some sales were made for less period than the recommended period, and no evidence exist that the customer wants the policy for less than the recommended period. With the help of the documentation alone, the risk checkers could not find out the risk adverse customers. The high penalty was imposed by the regulatory authority so that the contraventions are not committed to further by the firm. While determining the financial penalty, FSA has taken into consideration the seriousness of the contravention and the misconduct. In this particular case, the internal procedures of RSA have serious flaws and the procedure followed by RSA to determine the attitude of the customer was not proper. For determining the penalty FSA needs to consider all the relevant facts of the case like the seriousness of the misconduct, the loss caused to the customers due to misselling. Due to this misconduct, a financial penalty of 9, 50,000 pound was imposed on RSA. The penalty was required to be paid in full by RSA. The penalty was required to be paid on or before 8th April 2003. If the penalty was not paid to FSA on time than FSA can recover the amount as an amount outstanding due to FSA.

Pacific Continental Securities (UK) Ltd

The second case is of Pacific Continental Securities (UK) Ltd. PCS was incorporated in February 2001. It was a stockbroking firm. It provides specialized advice to retail customers. It deals in the trading of” AIM” (Alternative Investment Market). For generating more customers PCS used the strategy of financial promotions and mail shots. It provided free research reports. Once consent has been received from the customer than a research report was sent to the customers and they were telephoned to open a trading account. The customers were mainly contacted through telephone and the senior advisor’s advice the customers about the shares they should purchase. The company has received a decision notice on 23rd December 2008 from FSA under section 205 of the FSMA. FSA has issued a public censure as against the company. The FSA has issued a public censure on the company for the breaches conducted by the firm on the principle of business which is in connection with arranging and advising on the sales of high- risk securities to the customers between the periods of April 2005 to June 2007. PCS has failed to perform its business with integrity which is considered as a breach of the principle 1; it has failed to take reasonable care to control and organize its business effectively and responsibly taking into account the adequate system of risk management which is considered as a breach of principle 3. It has failed to give due regards towards the interest of its consumers and to treat them fairly which is the breach of principle 6. And it failed to deal in a cooperative and open way with the FSA which is the breach of principle 13. The breaches mentioned above relates to the failures of the PCS when arranging and advising to the customers towards the purchase of securities with high risk. During the period mentioned above the expected standards of PCS fell below the level of the regulatory system. PCS has recklessly and deliberately operated its business to misled its consumers, and it permitted its representative or advisors to engage themselves in inappropriate practices of selling despite being aware of its failings. It had failed to comply adequate monitoring system. It has not treated its customers fairly and conducted trading which is more than the requirement of the customers trading limits. It was not co-operating with FSA during the investigation process and had failed to cooperate and open with the FSA.  The failings of PSA were serious. PSA knowingly used the unacceptable sales methods and practices. It provided inappropriate, misleading and incomplete information to its customers which lead to a risk to the customers.  Customers were encouraged to purchase the securities about which they were uncertain and hesitated. In spite of the customers telling the advisor that they do not sufficient amount to invest in PCS, the advisors make multiple calls to the customers. There were many issues in the report provided to the BOD of PCS which includes misleading advice about the prices and trend of the securities, lack of arithmetical ability, calling the customers in unsuitable situations, Lack of knowledge about gearing and ratios and unstructured presentations. The issues which are mentioned above were repeated in many of the compliance reports also. This lead to a penalty of 20,00,000 pound on PSA which is considered a very important reason which leads to its liquidation.

Conclusion

The pressure on selling the products makes advisors less interested in bothering about the risk that customers can have because of misspelling. In today’s climate, it is very likely that misselling claims will continue to rise. The firm who are providing investment advice should review their risk management and internal procedure. Changing this mindset is a major challenge and earning commission should not be the only motto. Because of these instances, there have been calls in the UK to ban the products by selling on commission. Tight control must be imposed to reduce misspelling in the financial industry. It is the responsibility of the seller to not to provide misleading information to the buyers. However, it can be seen around the world that the brokers and bankers sell the products which are best for them in spite of selling the products which best suits the buyers. The number of cases of misselling is increasing. As the customers and bankers are chasing over higher returns, such cases have increased drastically.Customers should also develop awareness about the products they are purchasing to avoid misselling and purchase the products that best suits their requirement. By developing the financial literacy, corporate codes, regulation and whistle- blowing financial misselling can be avoided.

References

Arthur, T. (2006). More Pensions Mis-Selling Ahead: By Government Of Course. Economic Affairs, 26(4), pp.72-74.

Carlin, B. (2009). Strategic price complexity in retail financial markets☆. Journal of Financial Economics, 91(3), pp.278-287.

Carlin, B. and Manso, G. (2010). Obfuscation, Learning, and the Evolution of Investor Sophistication. Rev. Financ. Stud., 24(3), pp.754-785.

Ericson, R. and Doyle, A. (2006). The Institutionalization of Deceptive Sales in Life Insurance: Five Sources of Moral Risk. British Journal of Criminology, 46(6), pp.993-1010.

Ferran, E. (2012). Regulatory Lessons from the Payment Protection Insurance Mis-selling Scandal in the UK. European Business Organization Law Review, 13(02), pp.247-270.

Financial Structure and Monetary Policy Channels. (2002). Journal of Financial Intermediation, 11(4), p.486.

Georgosouli, A. (2011). The FSA's ‘Treating Customers Fairly’ (TCF) Initiative: What is So Good About It and Why It May Not Work. Journal of Law and Society, 38(3), pp.405-427.

Gray, J. (2004). The Legislative Basis of Systemic Review and Compensation for the Mis-Selling of Retail Financial Services and Products. Statute Law Review, 25(3), pp.196-208.

Hill, R. and Kozup, J. (2007). Consumer Experiences with Predatory Lending Practices. Journal of Consumer Affairs, 41(1), pp.29-46.

Huberman, G. and Jiang, W. (2006). Offering versus Choice in 401(k) Plans: Equity Exposure and Number of Funds. The Journal of Finance, 61(2), pp.763-801.

Inderst, R. (2010). Misselling (financial) products: The limits for internal compliance. Economics Letters, 106(1), pp.35-37.

Inderst, R. and Ottaviani, M. (2009). Misselling through Agents. American Economic Review, 99(3), pp.883-908.

Leyshon, A. and Thrift, N. (2007). The Capitalization of Almost Everything: The Future of Finance and Capitalism. Theory, Culture & Society, 24(7-8), pp.97-115.

Martin, C. and Milas, C. (2013). Financial crises and monetary policy: Evidence from the UK. Journal of Financial Stability, 9(4), pp.654-661.

Perry, V. and Motley, C. (2009). Where's the Fine Print?: Advertising and the Mortgage Market Crisis. California Management Review, 52(1), pp.29-44.

Plosser, C. (2008). Financial Econometrics, Financial Innovation, and Financial Stability. Journal of Financial Econometrics, 7(1), pp.3-11.

Schwartz, J., Luce, M. and Ariely, D. (2011). Are Consumers Too Trusting? The Effects of Relationships with Expert Advisers. Journal of Marketing Research, 48(SPL), pp.S163-S174.

Smith, R. (2011). Investigating financial aspects of dog‐fighting in the UK. Journal of Financial Crime, 18(4), pp.336-346.

Stango, V. and Zinman, J. (2009). What Do Consumers Really Pay on Their Checking and Credit Card Accounts? Explicit, Implicit, and Avoidable Costs.American Economic Review, 99(2), pp.424-429.

Taek Yi, H., Dubinsky, A. and Un Lim, C. (2012). Determinants of telemarketer misselling in life insurance services. Journal of Services Marketing, 26(6), pp.403-418.

Westland, J. (2015). The information content of financial survey response data.Financial Innovation, 1(1).

Wierzbicka, E. (2016). Misselling BarierÄ… Rozwoju UbezpieczeÅ„ W Polsce. Zeszyty Naukowe Wyższej SzkoÅ‚y Humanitas ZarzÄ…dzanie, 17(2), pp.315-327.

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