Mis-selling

Mis-selling is not a customer-service failing. In Indian securities regulation it is listed alongside market manipulation and front running as a fraudulent and unfair trade practice, with the same investigation and enforcement consequences.

The definition has four limbs, and the fourth is the one that catches honest people. Three of them require the seller to have acted knowingly — a false or misleading statement, concealing material facts, concealing the associated risk. The fourth does not.

The fourth limb is a failure to take reasonable care to ensure the product is suitable for the buyer. You do not have to lie to commit it. You only have to sell something to someone it was never right for, without having checked.

The workbook's definition, taken from the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003, is this:

It appears as one item in the list of prohibited practices that also covers illegal mobilisation of funds through collective investment schemes, and sits in the same regulation as front running — the use of non-public information about an impending substantial order to trade ahead of it.

The enforcement machinery is the point. Where SEBI has reasonable grounds to believe a transaction is being dealt with in a manner detrimental to investors or the market in violation of these regulations, it can order an investigation into the affairs of the intermediary. On the investigating officer's report SEBI can initiate action for suspension or cancellation of registration, and under the SEBI Act a person indulging in fraudulent and unfair trade practices is liable to penalty. SEBI can also run parallel civil enforcement proceedings on the same set of facts.

A dealer at a broking firm has a 68-year-old client with a Rs 30 lakh retirement corpus, no other income, and a stated need to draw Rs 25,000 a month.

Six weeks later the position is closed out at a loss of Rs 7.4 lakh, nearly a quarter of the corpus.

Suppose the dealer disclosed the risk fully and honestly, and the client signed every page. Limb (iv) still stands on its own. A complete, truthful disclosure does not make an unsuitable sale a suitable one. That is the practical lesson of the definition, and the reason the fourth limb is drafted without the word "knowingly".

Chapter 2 (Market Participants in the Securities Market) lists mis-selling among the fraudulent and unfair trade practices under the PFUTP Regulations, 2003, and the chapter's sample questions test that family of practices directly — one asks which practice is "entering into a transaction in securities without the intention to perform it or without the intention to change the ownership of such securities", answer: fraudulent and unfair trade practice. The examinable content for mis-selling itself is the four-limb definition, and specifically which limbs require knowledge and which does not.

• Only three of the four limbs require the word "knowingly". The suitability limb does not. A question asking whether intent is required for mis-selling is testing exactly this.
• It covers services as well as securities — advisory, execution, portfolio services relating to the securities market are all in scope.
• "Directly or indirectly" is in the definition. A sale routed through an authorised person or a distributor is not outside it.
• Mis-selling is not front running and not insider trading. Front running is trading ahead of a client's substantial order on non-public information; insider trading concerns unpublished price sensitive information. All three sit in the same regulatory neighbourhood and the paper uses them as each other's distractors.
• Disclosure does not cure unsuitability. Full risk disclosure defeats limb (iii) and leaves limb (iv) untouched.
• The consequences run to suspension or cancellation of registration, penalty under the SEBI Act, and parallel civil proceedings on the same facts. It is not merely a compensation matter between broker and client.