When overseas investing goes wrong, who answers?

You must have come across the story of a disaster that befell some investors who bought American stocks through an Indian app. In mid-October, nearly 30 investors reportedly found that their holdings in large, well-known US companies had been sold off and the proceeds immediately invested in a thinly traded Chinese ‘insurance technology’ company whose stock was worth about a dollar. The stock subsequently fell about 60%. According to the investors, the aggregate loss is about ₹100 crore. The platform has not put a number on it, and at this point it’s hard to say.

I won't get into what went wrong, because nothing has been established yet. The platform suggests the accounts may have been targeted using information exposed in another company's data breach. The US broker, according to news reports, says the unauthorised access came through the Indian app's interface. An FIR has been filed in Bengaluru naming the Indian and American entities. But my column is not about this incident (if it was indeed a hack). What interests me is that a dispute of this kind was almost inevitable.

Think of the layers between an Indian investor and, say, a share of Apple bought through such an app. There is the app and the Indian company operating it, an introducing entity that brings in the customer, a US broker that executes the trades and a custodian that holds the shares. To the investor, it is just the friendly screen of one app. Behind it, however, are several companies across two countries, each with its own contracts, laws, regulators, jurisdictions and lawyers. When something goes wrong, everyone has a reasonable-sounding explanation, as the platform and broker are doing now. The Indian investor, meanwhile, has no obvious recourse beyond filing an FIR.

In theory, investors know this. The platforms' terms and disclosures do spell it out. In fact, one such document sent to me bluntly stated that, in the event of a dispute, the investor would have no access to any investor grievance redressal or arbitration mechanism in India. The customer's recourse, it said, was directly with the US broker. Domestic investors take such protections for granted. They deal with stock exchanges that have grievance redressal mechanisms, an Indian regulator and brokers subject to these safeguards. If something goes wrong, the legal system they must turn to is close at hand. Those who send money abroad give up much of this protection, almost certainly without reading the terms and conditions.

It’s been a long-standing theme in my columns that in all aspects of investing, complexity only serves the seller. Each layer in the chain is good for the businesses that make up that chain but a risk to the investor, who has to trust more companies.

This episode also shows that lower trading friction is a double-edged sword. The investors who have been ripped off say they received no alert or verification prompt before their large-cap holdings were sold off and an unknown stock bought. One says his $3.1 million portfolio was sold within two minutes. Apps advertise low friction as a convenience, and that’s true for small actions. But for a seven-figure sale that wipes out a major part of the portfolio and is plainly unusual, surely there should be some confirmation. I mean, a broker is a broker, not a vending machine. The stories still have to be verified, but the system design lesson is obvious: a system that makes it easy for you to do things also makes it easy for someone else to do something in your name.

Beyond all this, the larger question is: why do so many people end up using this route? I think the answer is something I have written about extensively in recent weeks: the best, the safest, the most well-regulated route for investing abroad has been shut for some time now.

Since 2008, Indian mutual funds that invest abroad have been subject to an industry-wide limit of just $7 billion, forcing AMCs to stop taking fresh investments. Meanwhile, the $250,000-a-year LRS (Liberalised Remittance Scheme) route, which people use when investing through these apps, remains wide open.

The government needs to rework the mutual fund route to create a viable, well-regulated channel for Indians who want to invest abroad.

Until then, anyone investing abroad through an app should ask one question before signing up—and ask it of every layer in the chain: if something goes wrong, who do I complain to?
Dhirendra Kumar is founder and chief executive officer of Value Research, an independent investment advisory firm. Views are personal