Authbridge

Wealth management firms are beginning to see clients losing trust in them following the Citibank fraud where a rogue employee managing the portfolios of some well-heeled investors took them for a ride after promising them monthly returns of 3% (or annual returns of 36%).

There have been previous instances of banks and wealth management firms working more for their own benefit than the clients’, but the business has remained largely unregulated because it is widely seen as one where the investors are rich, smart, and can take care of themselves.

The size of the Citi fraud—around Rs.300 crore—and the profile of some of the people who lost money (promoters of the Hero group; the founder of venture capital company Helion) may force a rethink, say experts and wealth managers.

“There is an urgent need to regulate the industry. At present, it is completely unregulated. There is no clear definition of what is the liability of a wealth manager,” said Rajesh Saluja, chief executive and managing partner, ASK Wealth Advisors Ltd.

Wealth management firms sell insurance, mutual funds, equities, fixed income and structured hybrid products, but are not regulated by market, insurance or banking regulators. They also offer alternative investment products such as art and wine. Yet, there is no clear definition of what constitutes wealth, and who can become a wealth manager.

“There are no set benchmarks as to what is the training an advisor needs to undergo to be able to offer meaningful advice,” added Saluja who said that both mutual fund lobby Association of Mutual Funds of India, or Amfi, and the Financial Planning Services Board have considered taking the industry under their wings in the past. “Nothing happened.”

The ownership of the firms, as one would expect from an unregulated business, is diverse. Some wealth management firms are owned by brokerages, others by banks, and still others by individuals. And some firms are mere advisors, and do not handle the client’s money.

Hong Kong and Shanghai Banking Corp. Ltd, Kotak Mahindra Bank Ltd and Citibank Inc. have the largest wealth management divisions among banks while DSP Merill Lynch Ltd, Religare Macquarie Pvt. Wealth and IIFL Pvt. Wealth are wealth management divisions of brokerages. Each firm has a different benchmark for wealth and sells a different suite of products. Nor is there an industry standard on commissions.

While some local banks offer wealth management services for portfolios as low as Rs.500,000, some foreign banks will not touch a portfolio worth anything less than $1 million (about Rs.4.5 crore). There is usually a relationship between the size of portfolio and quality of advisers available, said a senior HR consultant, who did not want to be identified. According to him, relationship managers at foreign banks, who are MBAs with an experience of 5-7 years command a package of Rs.15-20 lakh. The package goes up to Rs.18-30 lakh with work experience. “Relationship managers at domestic banks and brokers could be earning a tad lower,” he said.

Certified financial planners start at a smaller package, but experienced ones take home pay on par with the MBAs, he added.

Regulatory officials express their inability to regulate the business. While a Sebi (Securities and Exchange Board of India) official says wealth management of banks cannot be regulated by the capital market regulator as it falls under the banking regulator, the Reserve Bank of India’s position is that the Citi case seems to be a one-off instance and not a systemic issue.

“The incident does not have anything to do with power of attorney norms under the portfolio management services (PMS) guidelines of Sebi,” said a Sebi official who did not want to be identified. “It is linked to private banking transactions which come under RBI’s purview.”

The official added that Sebi has, in the past two years, not received any complaints from clients of PMS schemes regarding misuse of the power of attorney (where the client signs over the right to invest on his or her behalf to the portfolio manager).

An RBI official who did not want to be identified said there doesn’t seem to be scope for the central bank to get involved.

And an investor said the Citi fraud is one of those things that could not have been prevented.

“If an individual breaks the system, you can take steps to control it, but cannot stop it. Fraudsters are so ingenious that they come up with something new, and regulation often has to play the catch up game,” said Seshadri Bharathan, a broker and a Citi wealth client himself.

It is likely that investors will become more vigilant after this incident, said the Sebi official.

“We believe the high networth investors should always do a little due diligence before shelling out money for any scheme in the market. It is very easy today as most of the information are readily available on the website. If they have the slightest doubt about any investment or a scheme, they should privately seek a reply from regulators, and Sebi is sufficiently prompt to respond to their queries.”

Bharathan said the general faith among rich clients has been shaken after the Citi fraud. “People are now double checking everything.”

Saluja of ASK Wealth admitted there is concern among the investors. “Clients are curious about what has happened and how the fraud has been perpetrated. They want to ensure their money is safe. And there is a little bit of concern about the practices followed by the wealth managers.”

According to Bharathan, another factor in frauds such as the one perpetrated by the Citi employee is the relationship between wealth managers and their clients. Some managers become very close to their clients who often treat them as trusted friends. This trust translates into letters of instruction that they issue to wealth managers because many of them are busy with their day jobs and do not wish to either be bothered by having to sign off on investment decisions, or miss a great opportunity because they are otherwise occupied or travelling.

An executive at a foreign bank said one way to address this issue is strong and regular compliance and audits. “If the audits are not regular, or if the relationship manager is convinced he can hoodwink it, he will be encouraged to become adventurous,” added this official who did not want to be identified.

Other executives in the wealth management business claim clients of bank-owned wealth management companies are more vulnerable to fraud. Such clients usually invest in debt and fixed return schemes, and their focus is more on their day jobs than their portfolios, they add. In contrast, clients of brokerages are more involved because they track the stock markets.

Banks also have custody of the money and, hence, the risk of fraud is higher than with those firms that merely dispense advise, said Sandip Sabharwal, chief executive officer, portfolio management services, Prabhudas Lilladher Pvt. Ltd.

“When a bank is directly linked to wealth management services, the risks are higher and the regulations should be strict enough to control any third party transfer,” said the head of wealth management at a large foreign financial services firm, who spoke on condition of anonymity. Such transfers are the core of the Citi fraud.

“Fraud occurs when three factors come into play—perceived pressure, rationalization and opportunity. In the case of Citibank, we know of two,” said Ajay Trehan, chief executive of AuthBridge Research Services, a risk management consultancy.