Financial Services Mis-selling

Instructor: John K Ashton

ABP: 4904

Name: Alisha Sajjal

ID: 500432605
MBA in International Business
abp747@bangor.ac.uk

FINANCIAL MIS-SELLING ASSIGNMENT

Table of Contents
Executive Summary................................................................................................... 2
1.

Introduction....................................................................................................... 3

2.

Scope of the study................................................................................................ 3

3.

How and why does financial mis-selling occurs..........................................................3

4.

Outline and description of two real world cases of mis-selling......................................6

5.

a)

Enfield Credit Union vs Davy Stockbrokers (2008).................................................6

b)

Chang Tse Wen vs Deutsche Bank (2012)..............................................................8

Conclusion and Recommendations..........................................................................9

FINANCIAL MIS-SELLING ASSIGNMENT

Executive Summary
Financial miss-selling is often resorted to in order to increase the revenue and sales base of
the company and commission and similarly links benefits for the sales person totally
undermining the investor benefits and sentiments. The hows of the mis-selling usually occur
through the modus operandi of omission or misrepresentation of material facts and non
-suitability of the product or service sold to the customers needs. The why of the financial
miss-selling is attributed to reasons like regulatory demands and expectations that are not in
tune with the organization goals and objectives which may force the firm to resort to financial
mis-selling. The other attributable reasons aligned with academic literature available in this
regard are both consumer specific as well as organization and executive specific. In deciding
the case for mis-selling, the regulatory authorities will normally take a decision on the basis
of the suitability of the recommendation and risk needs to be reasonably explained for
dismissing the allegation of financial mis-selling. Financial mis-selling can be reduced with
help of an emerging term right selling, more focus on customer preferences, increasing
transparency and establishing proper codes of conduct.

FINANCIAL MIS-SELLING ASSIGNMENT

1. Introduction
Financial mis-selling occurs when a salesperson adopts an ethically and morally questionable
practice and misrepresents or misleads the investor or a prospective investor about the nature
of the product or service that he purports to sell (Harrison & Estelami, 2014). This
misrepresentation could take the form of hiding certain important information or description
of the financial product that would affect investor decision or result in customer buying the
wrong product (Beyer, Meza, & Reyniers, 2013). The Bank of England defined mis-selling as
a risk to financial stability (Morse, 2016, p. 5).
On contrary Atkinson, et al. (2010) linked financial mis-selling with increase in revenue
generation and similarly with employment benefits and commissions for sales staff however
it still mentions that its a way of undermining the investor benefits and sentiments.
Moreover, it includes an element of illegality, induced purchases not suited to the investors
needs and a bent towards the miss-sellers profit (Morse, 2016). To illustrate the phenomenon;
when an investor without any dependents and thereby no resultant need for life insurance is
induced and misguided by a salesperson to urgently invest in a life insurance policy so as to
protect his assets and investments; a classic case of financial miss-selling occurs (Halan, et
al., 2014).
2. Scope of the study
This paper focuses on defining and explaining what is financial mis-selling in Introduction.
Section discussed below (third) elaborates on how and why this mis-selling occurs. Forth
section will reflect two financial mis-selling cases followed by the detailed reasoning that
how and why this happened. Last but not least the fifth section will provide the conclusion
and recommendations suggesting ways of eliminating financial mis-selling issues.
3. How and why does financial mis-selling occurs
The hows of the mis-selling usually occur through the modus operandi of omission or
misrepresentation of material facts that relates to deliberately dressing the product to mislead
customers (Ericson and Doyle, 2006). Opposing it, Suitability mis-selling is when an
unsuitable product or service is provided to the customer as explained in the insurance
example1 and the customer is lured to do so by the sales person (Georgosouli, 2011).
Additionally, Erturk (2016) explained that due to lack of knowledge and experience level of
the customer financial mis-selling occurs.
1 Mentioned at the end of the Introduction section.
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On the other hand, Carlin and Manso (2010) relates mis-selling cause to conflict of interests
among people and structures and bank manipulations in advising customers. The classic
examples of mis-selling in the UK are those of the Lloyds Banking Group. Regulations in
the form of severe repercussions and compensation have been introduced so as to keep a
check on this practise. The mis-selling of payment protection insurance (PPI) with 400,000
unresolved cases resulted in 23.8 billion of PPI-related compensation till date to the
aggrieved parties. Endowment and self-certification mortgages are other scandals within the
gamut of this practise (Comply Advantage, 2016). Moreover according to Financial
Ombudsman services, in 2015 firms controlled 16.5 million complaints against PPI cases.
List of mis-selling among different financial products apart from PPI is shown in Figure 1,
total number of complaints to firms in figure 2 and amount of fines in figure 3 of Appendix.
The why of the financial miss-selling is attributed to reasons like regulatory demands and
expectations that are not in tune with the organization goals and objectives which may force
the firm to resort to mis-selling (Ferran, 2011). Further, given the variety and complexity in
pricing of the financial products and services, firms resort to product differentiation thereby
increasing the choice base of the customer. This results in the confused customers making
sub-optimal decisions. It also relates to information overload which increases the fear of poor
decisions (Ericson and Doyle, 2006). Carlin (2009) terms this phenomenon as obfuscation
wherein a ploy is made to add friction to the consumer rational decision making wisdom.
According to Bhattacharya, et al., (2016) the complexity perception in spite of similar
functions in the financial sector whether in terms of return or security is deliberately created
so as to impress the prospective customer with the better product or service tag; sometimes
even resorting to mis -selling. Financial sales often involve an element of advice from the
sales person; firms often take advantage of this element and present information to investors
not resulting in an optimal decision or these firms have a tendency to behave in a way so as to
take advantage of these observed anomalies (Ferran, 2012). Since the advisor is equipped
with a better knowledge of the nature of the financial products and services dealt with by his
organization that he purports to represent; it becomes easier to mislead customers and take
advantage of the knowledge gap thereby. This acts like an incentive for inflating the
perceived value of the financial product or service, especially in cases where the sale is
directly linked to the commission component of the advisor (Inderst and Ottaviani 2009).

FINANCIAL MIS-SELLING ASSIGNMENT

Kaur & Bansal (2016) pointed out that the dilemma faced by the sales staff of the financial
services concerns are often characterized by unsupervised settings with absolutely no
guidance or mentorship. Their job is directly linked to generating the revenues and their
evaluations and incentives are driven by short term performance goals. This induced them to
indulge in the mis-selling practise. Other benefits like promotions and recognition also
motivate the employees to succumb these actions. Added to it, Erturk ( 2016) mentioned that
legal regulation are mere ethical standards which are easily over ridden by the pressure and
demands of the top management with a bent towards achieving or exceeding the profit
numbers.
Due to the imposed consumer loyalty in the financial services sector. Evidence in this regard
based on survey results indicate that customers to not prefer switching brands in this market.
A BERR (2000) survey attributed the reasons of loyalty to the familiarity and trust. The firm
in such a scenario induces switching by resorting to mis-selling tactics influenced by the
Klemperer Switching model (Ranganathan, Seo, & Babad, 2006). The model is basically a
multiple time period model wherein in the first time period, products are competitively priced
so as to capture market share. However, in the subsequent time periods, as a comfortable
customer base is in the process of becoming and the switching costs, tend to increase the
product pricing; the rates are increased. The existing customers will however expect a lower
deposit rate. Banks then resort to mis-selling due to the nature of financial services
advertising and the marketing function are normally associated with revenue and profits for
the financial products sold by the firm (Georgosouli, 2011).
Drawing in from The Marketing Revolution theory, the marketing function operates
independently of the risk management and operation function which results in inevitable
conflicts due to the difference in the goals of each department. This lack of coordination is
also often cited as one of the reasons for the marketing executives to resort to the mis-selling
practice (Keith, 1960). Linking the commission of the marketing executives on the basis of
their performance acts as an incentive for them to resort to financial mis-selling. Other
reasons for the adoption of this practice is the fact that the layman customer is not aware that
he has been potentially misguided and place total reliance on the sales person without
comprehending what they have bought (Hill and Kosup ,2007).
The nature of financial services is prone to fear and uncertain benefits which make them
complex and prospective customers tend to fear the poverty, loss of assets in this scenario.
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Executives take advantage of the fear factor to further boost up sales through advertising
(Kaur & Bansal, 2016). Stango & Zinman (2009) also relates insurance and pension policies
to one of the major cause of misleading customers.
The customer level causes of financial mis-selling may be attributed to Irrational Heuristics
approach from Hahnemann and Tversky where the customer decision making is majorly
affected by framing the product and service to make it more attractive; the regret and loss
aversive nature emotionally tangle the customer to get mis-lead by the information
(Gigerenzer, Hertwig, & Pachur, 2011).
On the regulatory front, the financialized world where indebtedness is prominent (38% in EU
to be precise) (EC 2009); abusive and predatory lending stressing on credit scoring, value of
security, high interest rates and fees clubbed with an aggressive marketing may have urged to
resort to mis-selling. The modern financial world is characterized by the declining role of the
state. Even after earning more than previous generations, people are in an insatiable desire for
growth and money (Stegman,2007). Consumers are urged through marketing and other
gimmicks to spend more and are recognized accordingly (Huberman and Jiang, 2006).
Marketing gimmicks and efforts to create hype for a product in customers mind also
encourage misleading the customer through mis-selling (Schwartz et al., 2011). Increasing
globalization also has led to increase in borrowings and mis-selling. In 2007, the European
Union borrowed more than 1 trillion Euro (Carlin, 2009). The household debt phenomenon
has increased in relation to income as depicted in the graph (Appendix Figure 4).

FINANCIAL MIS-SELLING ASSIGNMENT

4. Outline and description of two real world cases of mis-selling

a) Enfield Credit Union vs Davy Stockbrokers (2008)

the decision, such a scenario was used by Davys at their advantage. Mis-selling here
involved breach of contract, misrepresentation and breach of fiduciary duty as well as
statutory duty.
By manipulating the union, given the variety and complexity in pricing of the financial
products and services, Davys took advantage of this fact thereby increasing the choice base
of the customer resulting in sub-optimal decisions. This happened due to information
overload which increased the fear of poor decisions (Loerwald & Retzmann, 2010). The
complexity perception in spite of similar functions in the financial sector whether in terms of
return or security was deliberately created so as to impress the union with the better product
or service tag resorting to mis-selling.
The sale involved an element of advice from the sales person; Davy took advantage of this
element and presented information to the Union not resulting in an optimal decision and
behaved in a way so as to take advantage of these observed anomalies. Since the advisor was
equipped with a better knowledge of the nature of the financial products and services dealt
with by his organization that he purported to represent; it became easier to mislead the
customer and take advantage of the knowledge gap thereby (Erturk, 2016). This also acted
like an incentive for inflating the perceived value of the financial product or service,
especially since the sale was directly linked to the commission component of the advisor.

FINANCIAL MIS-SELLING ASSIGNMENT

Due to the nature of financial services advertising; the function is normally associated with
revenue and profits for the financial products sold by the firm. According to Keith (1960) The
Marketing Revolution theory, the marketing function operated independently of the risk
management and operation function which resulted in inevitable conflicts due to the
difference in the goals of each department. The risk management perspective judged the
marketing function on the basis of sales volume generated ignoring the quality aspect while
the marketing function judged the Risk management on the basis of rigid parameters imposed
and wasted marketing efforts. Linking the commission of the marketing executives on the
basis of their performance further acted as an incentive for them to resort to mis-selling.
Where investment products tend to misrepresent information or fact that is untrue due to
which the customer is induced to enter into the contract like this case; mis-selling is proved
(Inderst and Ottaviani 2009). As Gigerenzer, et al., (2011) mentioned that the customer level
causes of financial mis-selling may be attributed to Irrational Heuristics approach from
Hahnemann and Tversky where the Union decision making was majorly affected by framing
the product. The regret and loss aversive nature of the Union whereby they presume the
recent past to represent future combined with the endowment effect in a desire to make profit.
On the regulatory front, increased borrowings; abusive and predatory lending stressing on
credit scoring and preference for value of security clubbed with an aggressive marketing may
have urged Davy to resort to mis-selling. It was observed while studying the case with
allegations of financial mis-selling that the reasons are increasingly attributed to the nature of
the product complexity and a desire for higher returns by the firms as well as the investors.
Thus in my opinion as well the
b) Chang Tse Wen vs Deutsche Bank (2012)
In this Singapore based case, it was held that where a bank has a pre-contractual duty of
advice to his client; the duty cannot be negated by any standard documentation claiming nonreliance or non-advisory clause. Wen won the case and was able to refund US$49 million as
the customer had clarified at the pre-contractual stage that he had limited knowledge and
experience and intended to rely on the banks advice. It was held that duty of care was
extended to the customer thereby in spite of the fact that the agreement was not documented.
This was held even though the customer had signed the Standard Service Agreement
containing standard own judgement and non-reliance clauses. It was also held against the
bank that a breach of duty had taken place and no evidential estoppel of the standard
agreement against the customer could be used by the bank. Where the executive had
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expressly denied and informed the customer about the own judgement clause, the ruling
would have been in favour of the bank. Also, the doctrine of contractual estoppel in cases
where the customer had little or no financial experience and the bank committed to advise
him in the pre contractual stage itself is not tenable. Moreover the bank further invested in
unilateral trading for which Mr. Wen never asked for thus breach of duty of care was
approved against bank (Morgan Lewis, 2013).
How and why of the case
An element of advice from the sales person was there and the bank took advantage of this
element and presented information to investors not resulting in an optimal decision and the
bank had a tendency to behave in a way so as to take advantage of these observed anomalies.
Where investment products tend to complex information or fact and customer is induced to
enter into the contract; mis-selling is proved (Morse, 2016). Breach of duty of care was
approved regardless of no written clause relevant to this found in documentation. Wen
claimed that in an initial meeting he claimed that he is inexperience and trusted bank on
important matters then why the bank does not informed him about the risks involved.
According to Harrison & Estelami (2014) it is the duty of the seller to inform the customer
about all potential risks. However in this case although Bank took care of all the
documentation but was unable to keep the trust of the customer Mr. Wen by not caring about
the investments resulting in huge losses.
The Pressure or opportunity theory claims that the business environment create pressure for
violation of regulations and provides an impetus for these violations to remain undetected.
The theory further argues that illegitimate practices are resorted to for personal gains where
employees are compared to amoral rational calculators who calculate the cost and benefits
of the rules to their own advantage. The corporate culture supports these practices and they
become a way of life (Inderst and Ottaviani, 2009).This also reflect this case where bank took
advantage of it and invested Wans money in places which were not most suitable.
Three allegations were put forward on bank including breach of duty, breach of contract and
misrepresentation. However due to written documentation he was able to succeed in only
one, breach of duty of care. In my opinion also on one end bank is right that no such
documentation was put forward in the start of the contract that the bank will take the loss
however this is the reason that claims put forward by Mr. Wan were not approved. However
he won under the breach of care context which every investment company and Bank must

FINANCIAL MIS-SELLING ASSIGNMENT

take care of. The Bank duty is not only limited to the contract legalities but to maintain trust
of its customers thus leading to Mr. Wan succeeding in the case.
5. Conclusion and Recommendations
The customer level causes of financial mis-selling may be attributed to framing the product or
service to make it appear attractive; the regret and loss aversive nature of the customer
whereby they presume the recent past to represent future combined with the endowment
effect in a desire to make profit which may sometimes result in a bias towards the wrong
decision and lack of knowledge giving an edge to the practice of mis-selling (Halan, et al.,
2014). On the regulatory front, firms wants to maximise their profits and customer base and
the banks resort to abusive and predatory lending, preference for customers with higher value
of security, high interest rates and fees clubbed with an aggressive marketing strategy which
promote unfair means (McGovern and Moon, 2007).
In terms of recommendations, Forseth, et al., (2015) explained, financial mis-selling when
rectified leads to an emerging term called right-selling. He mentioned that blame games
must be eliminated and fare selling practices to be followed. Further Ferran (2012) stated that
more transparency and focus on quality must be followed by businesses. Proper codes of
guidance and rule and regulations must be monitored and it is considered as incapability of
the system if these mis-selling cannot be rectified (Macartney, 2009). Consumer suitability
should be consider in limelight. However according to Loerwald & Retzmann (2010), it
cannot be ignored that selling pressure always prevails leading to a threat of financial misselling. It is recommended that the regulatory set up be made more stringent and steps be
taken by the regulatory authorities to make the customer more aware of the pros and cons of
investing in financial products through the medium of advertising and other marketing tools.

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