The National Smarter Investor Study, which was published on November 3, 2015 by the BCSC,examined client-registrant relationships in Canada. The study found that, among other things, 90% of respondents described their existing level of trust in their investment representative as strong or very strong. This trust led some clients to ask fewer questions about how their representatives were compensated and to place less importance on reading their account statements because they were confident that their representative was taking care of their money. That's because they wrongly believe their advisor has put their interests first ,not realizing the suitability regime is in play.
One of the supposed cornerstones of the financial services industry is the rule that stipulates the sanctity of the so-called “suitability” of the transaction, the product and the portfolio recommendation.
You would have thought that something as important as a recommendation suiting the client’s financial needs and risk preferences, as well as the current risks in the market place, would be well defined. You would have thought that suitability would be etched in statute, in the courts, in common law, in financial services rules and regulations, in compliance departments rule books, in corporate quality control procedures, in the minds of everyone in the industry.
In
fact , it is not explicitly or specifically etched anywhere. There
are no rules that say what is and what is not suitable, there are no
principles that must be followed. The closest the Canadian financial
services industry has got to putting principles of suitability into
stone is the common garden “Know Your Client” (KYC) form. The
KYC form cannot safeguard the suitability of a transaction because it
cannot effectively relate the transaction to financial needs,
existing investments, risk preferences or current risk/return
relationships. All that really exists is the word itself amidst
vaguely worded paragraphs on the subject. Indeed, because current
thinking limits justification of suitability to the transaction there
is in reality no substance to what is and is not “suitable”.
More often, it really just boils down to not providing unsuitable
recommendations. Indeed ,the weak suitability criteria induce bad
advisor behaviours by contaminating the KYC process itself. KYC's are
modified to fit what the advisor wants to sell. See The
Know Your Client Process Needs an Overhaul
First let’s start with what goes into the suitability regime. It is typically a regime that requires that whoever is handling your investments puts you in products that are “suitable” for your objectives, financial situation , risk tolerance/capacity and even age. Of course, this doesn’t always happen. The classic example is of a advisor who shuffles conservative clients into resource stocks. This would be considered an unsuitable investment . We've seen people in their eighties sold 6-year DSC mutual funds .Older people typically need more fixed income, and less in the way of speculative securities.
Much research exists that shows that incentives skew advisor recommendations. The out of sight trailing commissions in mutual funds for example have been shown to cause advisors to recommend funds that are more expensive and end up being performance laggards. Investor advocates attribute the relatively slow growth of low cost index funds and ETF's in Canada to the suitability regime and the conflicts it permits. The suitability regime is the soil in which conflicts-of-interests grow like weeds .
The suitability regime breeds a culture that causes advisors to cross the foggy suitability line. The self-regulatory and industry organization investor complaint experience shows there is consistent and ongoing non-compliance with many of the current key regulatory requirements, with the unsuitability of investment recommendations being the primary basis for complaints to OBSI for the past five years, case assessment files for IIROC for the past three years and allegations in MFDA enforcement cases for the past three years. A large number of unsuitable investments remain undetected or ignored by regulators leaving investors with sub par return performance or even huge losses. For some investors those losses can be life altering.
While suitability offers investors some sort of protection, it falls short in some important ways. For starters, it doesn’t require brokers to find the best products, only ones that are ostensibly suitable for you. If an underwhelming house brand security lines up with the vague outlines of what is considered suitable they can still push it, even if it costs more to own, or underperforms peer securities. It doesn't even require selecting the lowest cost product that will meet your needs. Suitability is focused on the product and transaction while Best interests is focused on you.
In other words, mere suitability alone falls short of what the Best interests or fiduciary standard brings to the table. When your financial advisor works to the Best interests standard they have the obligation to put you in only the very best products they can, and to act in your own best interest, not their own. Advising under a Best interests standard takes a lot more work than becoming your typical “advisor”. They have to fulfill a certification process that requires them to uphold prudent investment guidelines and practices as delineated by regulators. The majority of most mainstream “advisors” do not meet this higher standard.
We believe when it comes to advising retail investors and their life savings, the individuals advising them should be held to the highest standard. The standard that meets this is the fiduciary one. What separates professionals in this business from sales people is standard that puts client interests first.
The retail investor has to have a clear understanding between the difference of a financial Professional and a salesperson posing as an advisor .If the mutual fund and investment dealers want to be viewed as trusted advisors then they must be held to a Best interests/ fiduciary standard ,the same standard as other professions such as an accountant or a lawyer. These firms should not be able to use disclosure and made up titles to acquire your trust. “Suitable investments “ may be causing you real harm via account churning , unduly high fee products , excessive leveraging and other tricks and deceptions.
For example , say you want to buy an automobile. You want something that gets at least 25 mph and costs no more than $20,000. OK, there are likely many models from many manufacturers that will fit those two requirements and, as such, are “suitable” for you. However, most consumers would want to drill down beyond those two attributes.
Which model has the best safety record? What is the fuel consumption ? Which has the best maintenance/repair performance? How does it stack up on emissions? Which holds its value best after three years? Do you live near a qualified mechanic who can repair your car when necessary and are parts readily available? These questions go beyond whether something merely satisfies your wants or desires–they go beyond the mere suitability of the initial results to your broad query–these additional questions will likely begin to determine what’s the “best” model for you to buy.
Now, it’s possible that there may not be a clear-cut winner. Maybe three models are all great choices and no one emerges as better than the others. Nonetheless, there is a huge difference between narrowing down the choices to among the best vs. what merely is suitable.
Financial Advisors are typically only required to find stocks, bonds, funds, etc. for retail investors that are merely “suitable”; whereas other financial professionals are required to undertake more diligent searches to consider what’s “best” for you. They must assess how it fits into your portfolio ,consistent with your KYC parameters. They need to consider product cost , tax implications ,features like liquidity and your loss capacity.
The wide spectrum of “suitable “choices complicates disputes for investors. Shrewd dealers are able to deflect liability in all but the most obvious cases of unsuitable advice. That is why they fear the Best interests standard.
A
key problem here for the average investor is -- Conflict-of-interest.
If an advisor finds a dozen or so stocks or funds that are merely
“suitable” for you, that registered person may feel pressured to
push one of those products because he or she gets paid a higher
commission or because their employer pressures them to move so-called
“house” product or that of a favored third party. That’s the
dirty little secret of Bay Street’s dealer community. Suitability enables conflicts to function under protective cover.
Does it make sense in this day and age that an individual can study for a few weeks and pass a registration examination that then effectively allows that person to provide advice to the public? Absolutely not.
In Canada. we have become entranced by the siren’s song of disclosure. It has been proven that disclosure ,while necessary ,is an ineffective retail investor protection.
It is important to understand regardless of whether an advisor is acting under Best interests or not it is impossible to remove all conflicts of interest, however the Best interests standard greatly increases the likelihood of reducing the abuse of these conflicts.
The Canadian Securities Administrators are currently looking into imposing a Best interests standard on advisors but it is years away and it faces stiff industry opposition. Until the issue is resolved it's CAVEAT EMPTOR.
Some videos to watch that will open your eyes are available at the Small Investor Protection Association website http://sipa.ca/contest/contestWinners.html https://www.youtube.com/watch?v=r0smCYvGVB8
If
you want to learn how mutual fund trailer commissions work visit
https://m.youtube.com/watch?list=PL6_kkUocOJXViw9ZM3Vpdh7TZnysmeIH-&v=T-uOKtiVa3M
a FAIR Canada production.
