Mis-selling Mutual Funds/ Insurance/ ULIPs

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1 Mis-selling Mutual Funds/ Insurance/ ULIPs What is ULIP? A unit linked insurance plan (ULIP) is a product offered by insurance companies that gives investors the benefit of both insurance and investment under a single integrated plan. A part of the premium paid is utilized to provide insurance cover to the policy holder and the remaining portion is invested in various equity and debt instruments. Insurance constitutes a small part of the product value. The Fraud: Mis-selling practices by the sellers or agents The traditional ULIP policy is designed to be sold as a 15 year corpus building plan; however insurance agents sold ULIPs as three year money-doubling plan. The sellers do not inform the investors that they need to keep funding the policies every year for years to get benefits. The policies are designed in such a way that the first year commission goes as high as 40%, it goes down to 7.5% in year 2 and year 3 and then drops to 5% by year 4 and remains constant thereafter. Regulations allowed a lock-in of the money for three years after which the investors could stop paying the premium and surrender the policy. If the investor stopped paying the premium in the first few policy years, rules allowed insurance companies to return nothing. And even after the lock-in period got over, high surrender charges ensured that investors got very little money back if they stopped paying premiums. MINT, a business daily researched the aggregate loss to investors from misselling of insurance products amounted to Rs. 1.5 trillion during the period Regulatory Safeguards: SEBI: SEBI has notified mis-selling a fraudulent practice by adding the following clause into the Prevention of Fraudulent and Unfair trade practices Regulation. The clause reads: National Conference on Capital Market Frauds and Malpractices - Genesis, Resolution and Prevention 10 October 2013 (s) Mis-selling of units of 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 Making a false or misleading statement Concealing or omitting the material facts of the scheme, or Concealing the associated risk factors of the scheme Not taking reasonable care to ensure suitability of the scheme to the buyer Till date SEBI has banned fourteen major private insurance companies, from raising money from public for any Unit Linked Insurance Products. IRDA: The Insurance Regulatory and Development Authority (IRDA) has tightened regulations related to ULIP schemes w.e.f. September It has capped the commissions of agents and distributors. The minimum lock in term is extended from three to five years. The front end expenses to be distributed evenly over the lock-in period instead of just in the initial years. All policies must have a life insurance cover and minimum sum assured. The ULIP surrender charge is limited to Rs PHDCCI National Conference on Capital Market Frauds and Malpractices 1

2 CASE STUDIES AMFI: In January 2013, the Associate of Mutual Funds in India (AMFI) added fresh directives to protect investors from potential frauds, insisting on Know Your Distributor norms. It asked intermediaries to provide all documents of its investors in terms of Anti Money Laundering or Combating Financing of Terrorism requirements. To protect investors from any potential fraudulent activities the AMFI has also asked the intermediaries to ensure that the investor filled their own address and contact details in the mutual fund application form. The UTI Scam The UTI was incorporated in 1964 under the Unit Trust of India Act by the Government of India. The objective of UTI was to provide financial benefits to the lower and middle class income groups by investing their small savings in the capital markets during the rapid industrialization period in India. Among the different schemes of UTI, the US-64 scheme was the largest one, which had 2 crore of investors mainly from small savers category. The US-64 scheme was not covered under SEBI regulation. Over the years, the US-64 scheme changed from a debt based to equity based fund. Its investment details were kept secret and the chairman had arbitrary powers to personally decide an investments of upto Rs. 40 crores. Huge amounts of UTI s funds were channelled into the infamous Ketan Parekh K- 10 list of stocks, such as Himachal Futuristic, Zee Telefilms, Global Tele, DSQ etc. The UTI continued to buy these shares even when their market value began to crash in mid This is believed to have helped Ketan Parikh to prop up the share price of these stocks. UTI also invested in what turned out to be junk bonds - such as Pritish Nandy Communications (Rs. 1.5 crores), Jain Studios (Rs. 5 crores), Sanjay Khan s Numero Uno International (Rs. 7.5 crores.), Malavika Spindles (Rs. 188 crores) etc. In two months prior to the freezing of dealings in UTI s units, a sum of Rs crs was redeemed. Of this Rs 4000 crores was corporate investments. It is believed people in the know may have leaked information to big corporates, who withdrew their funds before its collapse. Further these units were repurchased by UTI at Rs per share when the actual NAV was around Rs As a result Small investors lost a further Rs crores to the big corporates. Regulatory actions related to the scam and restructuring in UTI: In July 2001, the board of trustees of the UTI decided to freeze transactions in US-64 scheme. The former UTI chairman PS Subramanyam and two executive directors MM Kapur and SK Basu and a stockbroker Rakesh Mehta, were arrested in connection with the scam. However, post the incident, several corrective measures were taken. The Government came out with a rescue package and change of management in Subsequently the UTI was bifurcated into two parts: UTI Mutual Fund (which runs a regular mutual fund) and Special Undertakings of UTI (SUUTI, to look at legacy investments and holdings in specific entities). In addition to these measures, to distance the government from running a mutual fund, the ownership was transferred to four institutions- SBI, LIC, BOB and PNB, each owning 25%. PHDCCI National Conference on Capital Market Frauds and Malpractices 2

3 A new board was constituted and management and systems strengthened. Currently UTI AMC is a successful mutual fund under SEBI regulations. It is the fifth largest mutual fund in the country. PHDCCI National Conference on Capital Market Frauds and Malpractices 3

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