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Insurers are in the business of judging risk and the problems intermediaries now face gaining PI cover suggest the regulatory burdens of giving advice outweigh the potential rewards.

The greatest problem is the continuous series of reviews and investigations into potential mis-selling. As equity markets continue to tumble, the PI insurers see a danger that more of such investigations may emerge.

This highlights an essential problem for the financial services: what is the dividing line between mis-selling and restrospective disappointment with the performance of a product?

The FSA appears confident it can judge the difference, however, and is currently looking to define mis-selling as part of its response to the Sandler Review. It also sees it as a way of helping to reduce the problems that have kept potential PI providers out of the market.

It is specifically the fall-out from the pensions review that has prompted the FSA to look to define mis-selling.

The regulator has said its power to conduct reviews has been severely limited with the passing of the Financial Services and Markets Act 2000.

The Act specifies that although it is for the FSA to report to the Treasury on the proposed use of this power, it is the Treasury that must decide whether parliamentary approval for a review should be sought.

This requirement for parliamentary approval from both houses is a powerful safeguard against unwarranted use of this power, according to the FSA. It has not been sufficient to waylay insurers' concerns, however.

Aifa is already working on a definition of mis-selling it would like to see the regulator adopt. Achieving this would go a long way to helping intermediaries, the Association believes. At the moment most advisers spend a lot of time justifying their advice with the intention of mitigating any possibility of future potential mis-selling claims, rather than providing simple guidance for their clients, Aifa noted.

In a letter to the FSA late last year, the trade body suggested what it would like to see included in any forthcoming guidance on mis-selling.

Tracey Mullins, director of public affairs at Aifa, said the association wants to see some indication that mis-selling is a serious charge, more than a simple administration mistake in the sales process.

Mis-selling, as a definition, should have more to do with wilfulness, incompetence or dishonesty, all of which would lead to consumer detriment, she said.

This would go a long way to dispelling the fear among intermediaries that the regulators will pounce on any failure to comply with every detail of every rule, according to Aifa.

A level of paranoia has entered the industry, with many advisers struggling to comply to the letter with the law at all times, making the advice process longer as they are looking over their shoulders all of the time, she noted. There has been some indication from the FSA that Aifa's suggestions have been taken into consideration, Mullins added. Howard Davies, chairman of the FSA, has indicated mis-selling has to take notice of information available at the time of sale and should not be a view on the sale with hindsight.

The other issue with mis-selling is the overuse of the term, especially in today's investment climate.

Mullins said: 'Mis-selling is not just a handy catch-all phrase but some view it as a way to encompass everything, such as instances when the value of the investment has not lived up to expectations.

'The industry feels it needs some guidance from the FSA because of what has happened over the past few years. Intermediaries feel the FSA can pounce on any product at any given time and review the way in which it is sold. The problems with PI cover have been the result of this perception.'

Simon Ellis, managing director at Henderson Global Investors, believes consumers just want honesty and one way to mitigate mis-selling claims would be for advisers to admit ignorance occasionally.

He said: 'Sometimes people sell something they do not understand fully because they think they will lose the sale if they admit it. But no one can know everything and if the client understands that then they can accept the risks involved.'

While Ellis believes a true definition of mis-selling should come from the lawyers as a guiding principle he suggested: 'Mis-selling is when someone is sold a product where the material facts known to the person selling are not fully disclosed, including what they don't know.'

Ian Chimes, managing director of Credit Suisse Asset Management (UK), said there has been genuine cases of mis-selling over the years but differentiation is needed between these and cases of where clients are just looking for someone to blame for the loss in the value of their investments.

'The litigation culture of the US has slowly been working its way over here over 20 years to the point today where someone loses money and then searches for someone to blame,' said Chimes. 'The industry and the regulators need to reinforce the message there is risk in investments and that risk cannot be underwritten by the product providers or advisers selling them.'

Seen from this perspective the key issue is to understand the risk/reward trade off in financial assets and not to base it on experience of the recent bull market, which provided plenty of reward without revealing much risk. The experience of the past three years has shown just what happens when the bull market is reversed and reward disappears.

Nick Wells, communications director at Artemis feels many clients do not truly understand risk and find their preferences change the moment markets fall. Wells does not believe defining mis-selling will really change anything unless investors receive more education first.

Unjustified optimism about equities has certainly not been the preserve of the end investor. Providers have, through product innovations that failed to work, added to the perception of mis-selling in the market.

Chimes noted that going forward providers will be sure to stress test such vehicles more aggressively. Products such as precipice bonds were most likely tested based on 15% falls in the relevant stock market indices in the past, whereas today and in the future, these are more likely to be tested on falls of 75%, he said.

'Of course there is a cost to this so participation on the upside will be less,' Chimes noted. 'We are moving towards average pedestrian returns being the core for investments. If a product becomes too racy and the market drops, someone is going to start looking to be compensated for that. There will be a concentration instead on balanced and steady returns and products that are more speculative will be isolated and covered with health warnings.'

Ellis believes groups and intermediaries alike should be clear to consumers when they do not fully understand the product they are recommending. In the case of splits, people have claimed it was impossible to know the effect of such prolonged negative equity markets having not experienced them before but then the product should have been tested at the extremes on the downside, not just the up, he said.

'A low market was a possibility that should have been looked at,' Ellis said.

A solid definition of mis-selling will not stifle innovation in the investment market, Wells said, but new vehicles are likely to become more targeted at experienced investors.

As intermediaries become more concerned about mis-selling the investment houses are already claiming they have the solution; namely multi-manager products.

'Intermediaries have had to change the way in which they deal with clients and I think outsourcing will play an increasingly important part going forward,' said Wells of Artemis, which has a funds of funds operation.

The regulator is not just confident it can come up with a definition of mis-selling, it believes it can go further and come up with a group of products that will be almost impossible to mis-sell. This is Ron Sandler's proposed suite of stakeholder vehicles, which will be able to be sold with no or, at most, generic advice. However, the issue of responsibility for any mis-selling remains. In the original Sandler document issued last summer it noted product providers were most likely to be ultimately responsible for any mis-selling of the proposed range.

Under Sandler's recommendations providers would be free to market them without adhering to the bulk of the FSA's conduct of business rules with regards to suitability and the requirement to know the customer.

If product warnings are not properly delivered, the basic principle would be that the product provider would be responsible for the way in which the product was sold, Sandler argued.

In practice, Sandler said, the providers of these products would almost certainly wish to protect themselves from the consequences of a distributor's actions and would require indemnities from distributors for any errors or omissions by them.

some of the main products identified as being mis-sold over the past 20 years

Casual Dress Prabal Multicolor Sweetheart Print Gurung Home Income Plans: Mid 1980s through early 1990s Retired homeowners were encouraged to remortgage and invest the funds into an investment vehicle, the risks of which were not clear. When the investments went sour, the regulators stepped in and investigated a number of companies involved in this area of the market

Personal Pensions: started in 1988 through to the early 1990s Sold to people who should have joined or stayed in occupational schemes and lost the benefit of employer contributions. Some deferred pensions were transferred to personal pensions without the correct analysis of loss of benefit.

FSAVCs: Late 1980s through to late 1990s. Review by the FSA was started in 2000. When a pension scheme member was sold a FSAVC when they could have been better off in an in-house AVC.

Mortgage Endowments: Difficult to pinpoint time frame as this issue is still ongoing. While the regulator has admitted there was no systematic mis-selling of these products, individual mis-selling has been identified. Sold (mainly by banks and building societies) without giving consumers the choice of repayment option. Some also sold with ˜guarantees' implicit (to pay off mortgage plus provide bonus). Risk of not meeting target not explained to consumer.

Print Dress Gurung Sweetheart Casual Prabal Multicolor Possible mis-selling issues

Precipice bonds The FSA has said investors in precipice bonds, which link to stock market indices and offer guaranteed capital returns, have suffered significant losses. Although falling markets have been a factor, there is also clear evidence that there has been mismanagement and mis-selling, according to the regulator. A lot of these were direct offerings.

Dress Multicolor Gurung Print Prabal Sweetheart Casual Zeros and other split capital investments: Split capital trusts with high levels of bank debt and exposure to other highly geared closed end funds have fallen sharply in the last two years. The collapse of the sector plus the fact that zeros had been marketed by some providers as a low risk investment, caused much concern amid investors and the regulator leading to several investigations into the matter. Much of the criticism aimed at these products arises from the operation of the so called ˜magic circle' which lead to high exposure in other, geared, split capitals. The Treasury Select Committee looking into the matter has issued preliminary findings stating there is substantial evidence the magic circle operated in a manner harmful to shareholders and recommended product providers do something to compensate investors.

Income Drawdown products: The issue with these products concerns where people were sold the plans without its risks being properly explained. People bought into the products because of low annuity rates but the subsequent falls in the equity market has caused the overall value of the plans to be poorer than if the member had bought an annuity.

Property investment vehicle: The FSA has started a project looking into the sale of property investment vehicles, although this is not a review. The FSA plans to look at the risk to retail consumers from investing in property funds, examining the extent to which financial advisers understand and properly advise on this type of investment.

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