How to protect yourself from misleading financial promises

“Guarantee Mehnga Sauda Hai, Kimat Uski Pehchan,

Aisa Na ho Ki Guarantee,

Return Ki Le-Le Jaan.”

Translation: Guarantee a pricey deal, must assess its cost, see in lure of guarantee, the asset is not lost.

The word ‘guarantee’ right from “I promise to pay the bearer a sum of ‘X’ rupees.” to “get 100 per cent guaranteed return as high as ‘Y’ per cent.” infuses a great sense of comfort in the minds of people and are most likely to mislead. We will come to the details later. Let’s define the word guarantee first. It is a firm promise that something will be done or that something will happen.

In very simple terms, it’s an assurance that a condition will be fulfilled. And the beneficiaries of a guarantee have the legal recourse against the guarantor as per Indian Contract Act, 1872. This legality of contract gives comfort to the people.

Now let’s understand the fact that guarantee is a part of contract so it can’t be one sided act. There must be quid pro quo i.e. ‘something for something’. Guarantee is not an act of charity, it’s an act of reciprocity. So before relying upon a guarantee, one must assess the cost for which the guarantee is reciprocated.

Coming to the first paragraph, the promise by the RBI Governor on every Indian currency is so comforting that people put many things to stake to amass this without even understanding what it means. Do you know if you go to the Governor of RBI and give him a currency of Rs 500 and request him to fulfil the promise printed on that, he will give you another currency, Rs 500 or 5 currencies of Rs 100 or maybe 10 currencies of Rs 50 so on and so forth. The promise means nothing more and nothing less. And because RBI is banker to the government and government has sovereign power to print the currency, it will never default in its promise.

Now, let’s turn to an entity other than the government. In such case the fulfilment of promise will depend upon two things: 1. Capacity of the guarantor to fulfil the promise. 2. Intention of the guarantor to fulfil the promise.

The legality of the contract is useful for the aggrieved party if condition I is ok and condition two is not there. There is no question of guarantee being honoured in case condition ‘I’ is doubtful. Of course, the aggrieved party can initiate legal proceedings to bring the defaulters to book.

Without debating much into legality of it, please recall ‘Sahara Scam’, ‘CR Bhansali’ scam, JVG scam and other so many financial and leasing firms’ scams. Despite these being guaranteed schemes, the investors/ depositors couldn’t get their money back even after exhausting their legal options. Their only solace remains that culprits were brought to book.

The greed to make 'easy' money is so intense it sometimes overpowers their financial wisdom.

Against the above backdrop, my earnest request to common investors is that please never get swayed away by the guarantee rather try to know the credentials of the guarantor both in terms of capacity and intention.

One question may arise that how a common man with limited financial awareness or wherewithal are able to evaluate the capacity and intention of the guarantor. A valid question indeed! And as Aristotle (384-322BC) says, “Asking the right question is half the answer,” the first step starts with doubting the too attractive to be true kind of offers. Similarly, a mouth-watering guaranteed must be viewed skepticism. Sometimes an attractive-guaranteed-return may cost our principal. Please beware!

Being in the legal profession, I don’t have much knowledge about financial products, but I always smell-the-rat when I see exorbitant returns particularly in guaranteed kind of products. My benchmark for guaranteed products is always my bank ‘State Bank of India’s’ FD rate. If any debt or guaranteed products offers more than this, I try to understand the cost of guarantee either by my own understanding or by referring to some trusted financial experts.

Similarly, when it comes to equity investment, I benchmark my returns to broader Nifty-50 or Sensex and in case any fund outperforms these, I try to understand the reasons. If the reason is convincing enough to me by my own understanding, I invest if I have surplus money which I may not need in foreseeable future. Being influenced by verbosity of the sales professionals and understanding the logic are two different things. In case of confusion, restrict yourself to index fund or any large cap equity diversified equity schemes.

Then awareness is essential to get the optimal from investment horizon. The awareness also includes legal awareness. Investors must know that their money will be utilized in their interest or in the interest of all stakeholders.

Following checklist would be helpful:

1. Ask for proper regulatory approvals either from SEBI or RBI or IRDAI.

2. Do not issue cheques in the name of a third party.

3. Match performance with stated investment strategy.

We believe that greed exists on both sides of the fence. However, investors can avoid becoming victims of others' greed if they do a little due diligence on their own instead of blindly believing advisors or agents.

Further the investors must know their legal rights and laws related to investment which can be enforced at the time of need. Security and Exchange Board of India (SEBI) plays very important role in the Indian financial system by regulating the securities market, ensuring transparency, and protecting investors' interests. It also regulates the functioning of stockbrokers, sub-brokers, portfolio managers, and other intermediaries in the securities market.

(The writer is Executive Vice President, SBI Funds Management Limited)

(Translation & Synopsis by Sundaram, a practising Advocate based in N Delhi and an investo.)