There has rarely been a case that so neatly illustrates everything that is wrong with the way financial products are sold to consumers in Hong Kong. People who put money into what they thought were low-risk, protected with-profits investments and who now face diminished returns - and even losses - may be wondering what went wrong. The answer lies in a dysfunctional system with poor oversight and a commission-generating fee structure that places financial advisers in conflict with their client's best interests. Although products such as with-profits policies are investment not insurance products, they are issued by insurance companies. While the underlying assets may be equities, under Hong Kong regulations, the products do not necessarily have to be authorised or regulated by the Securities and Futures Commission (SFC). Clerical Medical International (CMI) had its with-profits products authorised by the SFC while Scottish Mutual International (SMI) did not. On the distribution side, several investment products including with-profits funds and long-term savings plans may be sold by insurance agents and brokers as well as SFC-authorised investment advisers. These insurance intermediaries are required to register with an industry body and pass simple exams covering insurance and investment-linked assurance products. After that, regulations allow them to sell several investment products, some involving 30-year financial commitments or heavy leveraging. Many of these financial advisers favour these products because of the huge up-front commissions attached. And because Hong Kong, unlike Britain or Australia, does not require disclosure of commissions, the client will never know how much incentive the commission is providing. Investors in with-profits policies, for example, would not have known their adviser was earning a 7 per cent commission on a normal investment or up to 24 per cent on a geared one. Undisclosed commissions on long-term savings products provide even more incentive. Up-front commission on a long-term savings plan can exceed HK$200,000, depending on the term. Not bad for the hour's or so work it took to convince the customer this was the best product. Then there is the regulatory side. Despite the cross-selling of financial products by insurance companies, banks and brokers and investment advisers, Hong Kong has separate regulators for each industry, patching the regulatory gaps with largely ineffective memoranda of understanding. Any hapless investor prying into the regulatory system is fobbed off with an impenetrable if technically correct description of how these Byzantine arrangements operate. It can be puzzling for investors who feel they have been mis-led or mis-sold a product to know where to turn. In this case, SMI's website tells investors its with-profits product is regulated by the Office of the Commissioner of Insurance, a body with no hands-on regulatory powers or resources. It also tells them to direct complaints to the Insurance Claims Complaints Bureau, which, when approached about the matter, denied it had any regulatory oversight of investment-related products. Despite problems that have repeatedly been brought to light by the Consumer Council, the insurance industry remains self-regulated with no independent regulator. The rules are not as black and white as all this and there are many things that certain providers and intermediaries can and cannot do when it comes to different products. But both have become good at covering themselves through an array of disclaimers which the client signs before any purchase. There are disclaimers to say that an insurance sales person did not recommend individual funds and others to confirm the client fully understood the product and the risks. There is little recourse for clients that sign things without reading them, but financial advice too often comes in the form of an aggressive sales pitch which accentuates the positive and ignores risks. As well as illustrating the usual array of issues with the sale of investment products provided by insurance companies, the SMI with-profits funds goes one step further. Investors in SMI's Dublin With Profits Funds would have been pleased to learn that they would receive an annual bonus, while investors in the SMI With Profits Series I Funds had theirs cancelled for a second year. This was despite the fact that the fund that would receive a bonus had performed worse than the one that would not. One investor with money in both funds noted this anomaly could have something to do with the fact that the first fund could only charge its annual management fee when annual bonuses were paid out while the other got its 1.4 per cent management charge irrespective of bonus payments. With most financial products, however badly the investors fare, the providers get their management fees and the distributors their commission. As a high degree of fee transparency is not required in Hong Kong, the investor rarely knows how much of his investment goes towards fees. These undisclosed commissions raise questions whether investors were properly informed about the risks of the product or the potential costs of early surrender. 'It has now reached the time when people are realising they are up s**** creek without a paddle,' one industry source says. 'They're sitting on two to three billion dollars of business and probably at least a billion is leveraged. We're talking about the middle class of Hong Kong ... and they are out for blood.' lotte.pang@qedglobal.com