ILAS The Investment that SFC Refused to Regulate

1. ILAS The Investment that SFC Refused to Regulate

2. ILAS: What Is It? • A mutual fund investment wrapped in a life insurance policy • Most policies have excessively complex, poorly disclosed, high fees, and they provide little life protection • Originated in the UK several decades ago as a means for reducing taxes. Most of the tax benefits no longer exist. • ILAS does not help Hong Kong citizens reduce taxes, so there's no apparent reason for a Hong Kong citizen to own one. • The types of ILAS policies sold in Hong Kong are now illegal in the UK. • ILAS policies such as Zurich Vista and Generali Vision are widely regarded as scams. (See The Great Expat Financial Planning Ripoff, by Hugh Stevenson).

3. ILAS Statistics • About 2.5 million policies sold in Hong Kong over the past 15 years • About 1.7 million policies in force right now • Insurers have collected over half a trillion HK dollars in premiums since 1997

4. Why Have ILAS Products Been Sold to So Many Hong Kongers? • Insurance companies pay extremely large commissions, much larger than fund companies • Commissions are not adequately disclosed in the way other investment products are (as required by SFC & HKMA) • The fee structure hides the massive upfront costs (by making costs appear to be spread out over several years) • Most people don't know they have better investment options • Gullible investors are lured in by “free” fund units • Investors are led to believe that their account value shows how much money they've earned (it doesn't)

5. Why Does the SFC Exist? • Section 4 of the SFO states that one of the regulatory objectives of the SFC is “to provide protection for members of the public investing in or holding financial products”. • Section 6 of the SFO states, “In performing its functions, the [SFC] shall, so far as reasonably practicable, act in a way which…is compatible with its regulatory objectives.” (Question: Has SFC fulfilled its regulatory objectives with regard to ILAS?)

6. Industry Asks to Be Regulated, but SFC Refuses to Regulate SFC issued a circular on 13 Aug 2009, which stated: "Some insurers, corporate insurance brokers and insurance intermediaries appear to be of the view that if they advise or make recommendations to policyholders concerning the selection by them of the underlying funds of ILAS (which invariably are securities), this must constitute advising on securities and must therefore give rise to an obligation to be licensed under the SFO. The SFC does not share this view." (Comment: Even if this did not constitute “advising on securities”, insurance intermediaries necessarily hold themselves out as “advising on securities”, which means they are required to be licensed under the SFO.)

7. Lawyer Criticizes SFC • In 2010, a lawyer, Timothy Loh, published an article criticizing SFC's “disturbing” guidance on ILAS. He warned sellers that they should consider getting an SFC license, in spite of SFC's actively discouraging them not to do so. • Carrying on a business in an SFC-regulated activity (or holding one's self out as doing so) without an SFC license is a criminal offense. • Loh claimed there was a “real possibility” that ILAS sellers who did not hold an SFC license could be found guilty of a criminal offense.

8. CIB Warns Brokers that They May Need an SFC License

9. PIBA Advises Brokers to Obtain an SFC License if They Sell Portfolio Bonds

10. German Court Ruled that ILAS Is an Investment (Not Insurance) According to an article published on 8 Aug 2012 by the law firm, Norton Rose Fulbright: “In a series of landmark decisions, the German Federal Court (BGH) held for the first time that unit-linked life assurance policies often qualify as investment products, and are therefore retroactively subject to much more stringent case law rules developed by German courts over recent years. As a result, a large life insurer is likely to be liable for hundreds of millions of euros…in mis-selling charges” (Could this happen in Hong Kong?)

11. ILAS: The Next Lehman Minibond The Lehman Minibond scandal was a public relations nightmare for SFC. During the midst of the scandal, SFC issued a circular denying that it was responsible for regulating ILAS sellers. Some insiders speculate that SFC was deliberately trying to distance itself from what it knew to be another, inevitable mega-scandal. As a result, investors were left to hang, so that SFC would be safe from criticism.

12. True or False? In its 2009 circular, SFC stated: "It is unlikely that an insurer or corporate insurance broker that is not carrying on a business in a regulated activity will be holding itself out as doing so." Fact: Insurance brokers openly advertise themselves as independent financial advisers (IFAs). Often, when they sell ILAS, their main selling point is not the ILAS product itself, but rather, their allegedly exceptional fund-picking skills and the long-term investment advisory service they promise to provide.

13. True or False? In its 2009 circular, SFC stated: "Any advice that might be given to a policyholder concerning the underlying securities is not, in fact, concerned with the acquisition or disposal of securities at all." Fact: Insurance companies are obligated to acquire the securities selected by policyholders.

14. True or False? In its 2009 circular, SFC stated: "ILAS are first and foremost insurance policies providing the policyholder with life cover, but which have an additional investment element. Life cover, as distinct from investment, would appear to be the dominant factor motivating a policyholder to acquire an ILAS product...it cannot be said that the purpose of acquiring an ILAS policy, or even the dominant purpose of doing so, is to secure a profit from fluctuations in the value of the underlying funds." Fact: Many ILAS policies provide no life cover. SFC authorizes all ILAS products and is fully aware of this.

15. True or False? In its 2009 circular, SFC stated: "It does not appear that financial gain is derived from advising or making recommendations concerning the underlying funds of ILAS. It is the sale of insurance products that generates the financial gains that are enjoyed by the insurers, corporate insurance brokers and insurance intermediaries." Fact: Insurance brokers sometimes earn more commissions from the underlying funds than from the ILAS products. (e.g., LM MPF) Fact: Consumers are often told that they are buying their brokers' allegedly superior fund picking skills, not just an insurance policy. Fact: Some ILAS policies explicitly remunerate brokers for giving investment advice. (e.g., Standard Life's Aspiration)

16. Does SFC's Code of Conduct Apply?Why or Why Not? • If an insurance broker holds an SFC license, does the broker need to follow SFC's Code of Conduct when giving investment advice such as this: “I have evaluated all available investment options, and in my opinion, I believe you should invest in mutual funds through an ILAS, rather than buy funds directly.” • SFC's Code of Conduct requires full commission disclosure. • Monthly payment ILAS products pay upfront commissions which are hundreds or even thousands of times larger than that paid by similar investment products (e.g., iFAST Central, MPF SVC). • ILAS products are more complex, harder to understand, far more expensive, and far more dangerous than most other investment products, due to their long lock-ins and massive exit penalties.

17. Unauthorized Advertisements In a circular issued on 4 June 2007, OCI stated: "It is incumbent upon authorized insurers and insurance intermediaries to ensure not only that the materials used for marketing and promoting ILAS to the public have been authorized by the SFC, but also that when communicating with prospective customers either verbally or in writing, they must not depart from the information contained therein. Failure to comply with this requirement might constitute a criminal offence under section 103 of the SFO."

18. Are These Illegal, Unauthorized Advertisements? • ILAS is a “fund platform”, a “tax wrapper”, a fund investment with free insurance • There's no credit risk • You can get your money back after the ICP • Fees are understated/misrepresented, potential returns are exaggerated • Promoting unauthorized funds via ILAS portfolio bonds • Claiming that you will earn money immediately even though the policy's cash value will be less (for up to a decade or more) than the amount of money you have contributed • Claiming that a special offer of extra “free” fund units will compensate you for the losses incurred by twisting policies

19. Dealing in Securities? • Schedule 5 of the SFO defines dealing in securities as: “inducing or attempting to induce another person to enter into or to offer to enter into an agreement…the purpose or pretended purpose of which is to secure a profit to any of the parties from the yield of securities or by reference to fluctuations in the value of securities.” • The value of an ILAS policy is determined by reference to fluctuations in the value of mutual funds, which are classified as securities. • Sub-paragraph (xi) excludes an individual from dealing in securities if he/she “issues any advertisement, invitation or document the issue of which has been authorized by the Commission under section 105 of this Ordinance” (meaning he/she doesn't need an SFC license). • Are ILAS sellers dealing in securities if they issue unauthorized advertisements (“ILAS is a fund platform”) or if they use the ILAS as a tool for distributing unauthorized funds that pay high commissions? • Does the sub-paragraph (xi) exclusion apply to sales of other investment products, such as mutual funds? For example, can I sell mutual funds without an SFC license if I issue SFC-authorized documents? Why or why not?

20. Portfolio Bonds & Unauthorized Funds • Insurance brokers use ILAS portfolio bonds to distribute offshore funds which have not been authorized by SFC. • The unauthorized funds pay very high commissions. According to SCMP, over 80 have collapsed or been suspended since 2008. Many have been exposed as frauds. • Portfolio bonds pay 6-8% commissions • Unauthorized funds pay commissions as high as 15% • Total commission is as high as 23%.

21. Unlicensed Activity? • On Feb. 9, the Insurance Commissioner clearly stated that she believed the marketing of unauthorized funds through ILAS portfolio bonds was SFC-regulated activity. Does SFC agree? • If yes, do the insurance brokers need a Type 1 or Type 4 SFC license? Do the insurance companies also need an SFC license? If insurance brokers marketed unauthorized funds to retail investors (non-professionals) via ILAS portfolio bonds, did the brokers violate Section 103 of the SFO, which prohibits marketing unauthorized funds to the public? Have insurance companies also violated Section 103, for example, by passing along unauthorized fund documents (e.g., the LM MPF Information Memorandum)?

22. Secret Fund Commissions • Some portfolio bond victims claim that their insurance broker denied receiving commissions for promoting the underlying unauthorized funds. Industry insiders have confirmed that this is common. • Insiders say that the fund commissions are received, but the commissions are paid to a different company, typically offshore, in order to evade corporate taxes and to hide evidence that they breached Section 114 of the SFO. • One insider believes the above activities involve criminal acts of fraud, bribery, and money laundering. Does the SFC agree?

23. GN 15: Ripoffs Are Banned

24. Why Is SFC Still Authorizing Ripoffs?

25. AXA's Pulsar II Minimum Contribution Period: Up to 4.5 years Account Maintenance Fee: 5.5% deducted from initial units Administration Charge: $600 HKD per year deducted from initial or accumulation units Account Service Fee: 1% deducted from initial and accumulation units Insurance Charge: A complicated formula which is to hard to summarize Death Benefit: Account value + 5% (life cover is less than the fees) Early Encashment Charge: A complicated formula, but can be as high as 65% of initial units Underlying Fund Active Management Fees: ~1 to 2%, but can be less or more.

26. Has SFC considered banning commissions?Why or why not? • The White House Council of Economic Advisers has argued that commission disclosure is not an adequate solution to the pervasive problem of mis-selling. Intermediaries still have an incentive to ignore their clients' interests and push whichever products pay the highest commission. • The UK and Australia have already banned product issuers from paying commissions to intermediaries. The EU will very soon. • The FCA recently reported that the UK's commission ban had no negative impact on consumers. “Product bias” has been reduced. Fees have been driven down.

27. In Conclusion... • Many ILAS policyholders were lied to, manipulated, and ripped off. These people want their money back. • Most ILAS salespeople were not licensed with SFC, and if they were, they did not follow SFC's Code of Conduct (by disclosing commissions). • If the SFC and/or a Hong Kong court decides that ILAS sellers are required to be SFC-licensed, it could potentially impact almost every ILAS that has ever been sold, possibly leading to compensation for hundreds of thousands of policyholders. • This could be the best chance for all ILAS victims to get justice. • Many ILAS victims are depending on the SFC to take responsible action, since they cannot afford to fight in court and are prohibited from joining together in a US-style class action lawsuit.