Double charging/dipping on fee based transaction accounts in Canadian Retail Financial Services

Double dipping is where “advisors” and/or their firms charge investors, with fee based transaction accounts, a fee on their accounts at the same time as taking commissions and other transaction returns on the underlying investments.  Since these accounts are meant to swap payment of transaction remuneration on securities held within the accounts for a simple annual fee that favours those with high levels of transactions, knowingly taking commissions and other transaction returns on investments held within these accounts would be a fraudulent act.

Double dipping appears to be a systemic issue in Canada with TD, CIBC, HSBC and Scotia all having been found wanting in this respect.   Canada’s regulators have, for some reason, decided to treat these breaches of firms’ and registrant obligations and regulations as uncontested settlements with no admission or denial of the charges, and have to date seemingly relied on self reporting of issues.

Continue reading

Comments on Advocis’ Consumer VOICE Survey 2015 – Part 1

It is frustrating to see so much energy expended on trying to argue what should be, so clearly, an indefensible position: that commissions are such an essential part of the provision of professional financial advice that their removal would destroy the value, rational and delivery of advice itself.     

Advocis’s Consumer Voice Survey 2015, “Investor Insights on the Financial Advice Industry” makes some bold statements about the risks to the provision of advice in the event of a ban on commissions and reports on what I believe to be a heavily biased survey of “consumer views” on the value of advice, conflicts of interest and the impact of commissions on financial advice.  I will delve further into this report in a subsequent post.

Continue reading

Regulators have been attempting to live with the addiction for too long: end it in the best interests of all.

ADVOCIS talk with gusto about the need for change and the importance of advice, but when it comes down to the most obvious of all the required changes, removing the conflict that stands in the way of best interests’ advice, they appear blindly intoxicated by the charms of the conflict itself. What would Socrates have said about an organisation that placed commissions at the centre of its reason for being?

The Second of two research pieces commissioned by the CSA, a report titled “A Dissection of Mutual Fund Fees, Flows, and Performance ” prepared by Professor Cumming of York University-Schulich School of Business, as part of its review of “how embedded compensation could give rise to actual or perceived conflicts of interest”, is now out.  

The report is the first of its kind to analyse Canadian mutual fund flows, mutual fund fee structures and performance.   The international body of work in this area is large and it is no surprise that the Cumming’s report conclusions largely reflected this much wider body of work. 

The report confirms that mutual fund flows are impacted by embedded commissions, that where embedded commissions exist flows are much less influenced by past performance and that even performance (at the gross return level) is negatively impacted by progressively higher embedded commissions.  So yes, at a purely impersonal data level, embedded commissions give rise to actual conflicts in fund distribution: these conflicts are highlighted by the sensitivity of flows to compensation as opposed to performance.

No surprise then that the trade body representing financial/investment advisors in Canada, Advocis, cautions against reading too much into the report:

“any decisions with respect to product sales or offerings in the market place must ensure that advice is broadened not restricted”

“it appears that the report does not consider the monetary value of the financial advice provided to client”.

Advocis is a staunch supporter of commissions which they say are integral to the advice industry in Canada: commissions they say allow advisors to service the smaller investor and their removal will restrict the availability of advice for the smaller investor and should not be entertained.  

Advocis is also coincidentally championing an upgrade to financial advice in Canada, promoting higher standards of professionalism and enhanced training as keys to improving financial advice and consumer protection.  In its recent submission to  the “Expert Committee to Consider Financial Advisory and Financial Planning Policy Alternatives”, it made the following observations:

“We identify and describe four major problems with Ontario’s existing regulatory framework at the level of retail financial services:

1. anyone can call him- or herself a financial advisor and offer financial advice, including planning;

2. existing regulation focuses on product sales, at the expense of proper regulatory oversight on the critical financial relationship between the advisor and the client;

3. there is no firm, clear, and universal requirement for advisors to stay up-to-date in their core areas of knowledge; and

4. there is no effective, industry-wide disciplinary process”

“Regulatory reform in Ontario’s financial advice sector cannot and will not succeed unless the foundational nature and importance of advice is formally recognized at the outset of any reform effort.”

“the various inadequacies of the current regulatory scheme result in unnecessary and avoidable consumer exposure to fraudsters and advisor incompetence;”

“the needs of consumers and advisors have outgrown the existing, largely product-based model which currently regulates Ontario’s financial services industry; and,

“Ontario’s current web of regulatory structures and relationships produce unnecessary complexity for all stakeholders — and needless confusion for consumers.”

The consideration of the impact of commissions on financial advice and the need for higher standards and professionalism is a global phenomenon.   Most other international regulators that have overhauled their financial advice system have recognised that conflicts of interest impact the advice that investors receive and that removing these conflicts are an integral part of upgrading the advice and regulatory landscape.   The transition has been towards a best interest standard investment process that puts the client and advice at the heart of the process. 

Logically, Advocis’ submission to the “Expert Committee to Consider Financial Advisory and Financial Planning Policy Alternatives” covers much the same ground, with the exception that it wishes to retain conflicts of interest.  This is a non sequitur.

They talk with gusto about the need for change and the importance of advice, but when it comes down to the most obvious of all the required changes, removing the conflict that stands in the way of providing advice that is in the client’s best interest, they appear blindly intoxicated by the charms of the conflict itself.  What would Socrates have said about an organisation that placed commissions at the centre of its reason for being?

But, the history of the world is littered with the consequence of the hold of the status quo, yet somehow we do eventually manage to move forward and gradually change the human outcome. 

Regulation in this country is perverse and, yes, only removing commissions from mutual funds is a dumb solution.  Wholesale regulatory change is needed and that is the rub: does Canada have the guts to make the necessary changes? 

Regulators have been attempting to live with the addiction for too long: end it in the best interests of all.

Compromised by its many biases the Brondesbury report completely misses the point about fees!

From one critical perspective this report appears to blame consumers of advice for the outcomes of a business model compromised by transaction remuneration.  Little is said of the inadequacies of suitability standards and their regulation or of the failings of investment processes focussed on the transaction.  Lacking such balance the report appears to advocate for the transaction model and thus is pared of its credibility!

If you had stopped reading the Brondesbury report into Mutual Fund Fees at the first summary conclusion on page 6, you might have walked away thinking the report was in favour of fees for the right reasons:

“Evidence on the impact of compensation is conclusive enough to justify the development of new compensation policies.”

If you had read on you should be left in some doubt as to how much of a marginal benefit a move to fees would have on investor outcomes.  The report appears to build an argument that suggests investor behavioural biases are the most important vitiating impact on outcomes and that advisors are merely responding to their transaction requests.    

Continue reading

The Brondesbury Report & Cultural Bias in the Regulation of Canadian Retail Financial Services…

I am going to delve into the Brondesbury report shortly, but first we need to step back and look at the frame we are in, because neither the Brondesbury report nor the CSA have fully explained this.

The CSA have unfortunately addressed mutual fund fee issues separately from the wider problems in the Canadian financial services industry and, most notably, separate from that of best interest standards.  There may well be a reason for this!

Aside from the investment counselling/discretionary client portfolio management segment of the industry, whose standards and responsibilities appear, to all intents and purposes, to be ignored as valid reference points in current deliberation, the frame we are looking at is the one that holds the advisory segment. 

The advisory segment is still regulated on a transaction by transaction basis with responsibility for the transaction effectively lodged with the individual investor.  This is a simple parameter to parameter model that aligns risk preferences and investment objectives, adjusted for some nebulous assessment of investment experience (often arbitrarily assigned), to a product recommendation.  The product recommendation passes through the parameters.   In the Securities Act, for instance, the provision of a transaction recommendation within an advisory registration capacity is not technically considered to be advice.

The KYC is not a portfolio/optimisation process.  In fact, if you were to hand a KYC to an investment professional they would have to bypass it to a more sophisticated investment process to construct, plan and manage an asset allocation and security selection that matched a given investor’s risk preferences/asset liability profile. 

The current culture assumes that investors come with requests on a transaction by transaction basis, that the KYC process is effective and sufficient and because of its simplicity is therefore simply understood.  An investor in this frame should be able to own the transaction with the advisor only responsible for the product advice and not the management, or the construction or the planning.  If we refer to the careful delineation in the Securities Act, the investor is not actually being advised. 

In this frame “the culture” assumes that it is the investor’s own behavioural biases that drive mis-selling and that the advisor must accommodate these biases or risk losing business: I phrase this with reference to comments that I will, in a later post, draw from the Brondesbury report.

I have a number of issues with this framing of the KYC process and so, it would seem, did the OSC way back in the late 1990s and the early 2000s –note the FAIR DEALING MODEL and earlier Financial Planning Project initiatives: 

In 1999, the Canadian Securities Administrators committee on financial planning proficiency standards identified conflicts of interest in financial planning advice as a more significant concern than representatives’ proficiency. The CSA committee undertook to pursue this area as the second phase of the Financial Planning Project. Around the same time, OSC Chair David Brown determined that changes in the social and economic environment, and in the business structures and objectives of the securities industry, warranted a fundamental re-examination of the regulations governing the delivery of financial advice to retail investors. He recognized that our regulations are still product-based, as they have been for decades, even though the industry has moved to an advice based business model. In early 2000, the OSC launched the committee that has led to this Concept Paper.

The promise of service has long since exceeded that of the simple transaction. It has long since extended to the provision of advice that relates to overall financial needs and financial assets.  The process needed to manage these needs and assets is more sophisticated/complex than that provided by the KYC parameter model.

Today the KYC remains as the barometer of the suitability of product advice and the assessment of the suitability of advice.  In order to deliver the promises that the industry is effectively making the investor today you would need to move your focus of attention to a more complex and integrated service process.  In truth investors should be paying for the process and not the transaction.  Unfortunately the industry remains mired in a culture that rewards the transaction and not the process, and hence focus has remained on the transaction and transaction remuneration. 

If we are to deliver on the service promises being made we need to develop our processes and thereby raise our standards of advice.  By removing remuneration from the transaction and aligning it to the process, i.e. a fee for service process and advice, we change the industry from one focussed on transactions delivered by a rudimentary process to one focussed on advice delivered by modern technology and knowledge that better matches the promise.   At the moment advisors can effectively promise best interests yet remain regulated on the transaction.  This risks a disconnect between the processes needed to deliver the wider promise and those needed to satisfy minimum standards.

The Brondesbury report, along with many others, is stuck in the transaction mindset: 

It believes in a world where investors initiate and are able take control of their investment decisions, where the KYC is simple and effective in delivering investment solutions, where advisors are not promising a higher standard of advice and are hostage to investor behavioural biases and where advisors are not responsible for educating the investor over their process and disciplines.  It believes in a world where the cost to the investor of delivering the transaction solution is of equivalent value to the investor and where there is no other promise than the transaction and no other alternative spectrum of advice.  The report ignores the fact that today’s promises exceed the boundaries of KYC suitability and require more advanced processes that naturally differ from those required to deliver stand alone product recommendations.

The Brondesbury report is looking at the problem through the rear view mirror, replete with longstanding cultural biases that have impeded the development not only of higher professional standards but more efficient and cost effective wealth management solutions.  This is a very complex area. I will address some of the wider issues as I explore the Brondesbury report in subsequent posts. 

———-

I discuss issues with the current parameter to parameter suitability model in my submission to the CSA on Best Interest Standards in Appendix A.  Also in this document are a number of excerpts from many of my blogs on best interests and the KYC process. 

Also worth reading is “Fiduciary Obligations of Broker-Dealers and Investment Advisers” by Arthur B Laby. 

Are Canadian regulators ring fencing consumer investing behavioural biases in favour of transaction returns?

“we suspect that much of what we see as impact of compensation is just investors failing to make rational decisions.” P53 of the Brondesbury Report on Mutual Fund Fees.

I am in the midst of reviewing the CSA commissioned Brondesbury Report on Mutual Fund Fees and am ploughing through the reference material which supposedly underpins its conclusions.  Amongst the many nuggets I have unearthed is the following taken from “Investors’ Optimism: A Hidden Source of High Markups in the Mutual Fund Industry” :

Previous works have identified investors’ optimism bias towards equities issued in their domestic market. In particular, academic research on mutual funds has focused on investor’s lack of financial literacy. …These empirical findings of investor’s deviation from rationality are in line with our model’s emphasis on investor’s limited financial knowledge of the mutual fund industry.

Investors’ optimism bias can be closely related to their lack of knowledge of the fund market, leading them to choose sub-optimal benchmarks such as bank savings instead of low-cost index funds or ETFs. Besides, investors’ optimism bias is probably influenced and reinforced by the marketing practices of mutual funds, which promote the sale of fund shares.

The reference to sub-optimal benchmarks is both noteworthy and ironic because both the new Point of Sale disclosure documentation for mutual funds and the performance reporting requirements laid down in the CRM2 lack mandated performance benchmarks. 

Interestingly the Canadian Securities Administrators had earlier proposed a GIC or cash based benchmark for Point of Sale mutual fund disclosure documentation, but baulked at the last minute for a number of reasons. 

So why were Canadian regulators looking to implement “sub optimal benchmarks”?  Were they ring fencing consumer behavioural biases in the interests of transaction remuneration or were they themselves acting in ignorance?  We may never know but the point is an interesting one and much more so given the deeper contextual focus in the  Brondesbury report on investor behavioural biases (chapter 5):

“Behavioral biases of investors are not easy to overcome. Behavioral biases affect advisor behaviour (just as advisors affect investor behaviour), investor choices of investment, and ultimately, investor outcomes”

“Time is a precious commodity to most advisors. There is only so much time an advisor can afford to spend to overcome the behavioral biases of investors, regardless of how they are compensated”

Investor behaviour biases lead to sub-optimal returns and these biases can be confused with compensation impacts

Behavioral biases of investors are not easy to overcome and they are a key factor in sub-optimal returns on investment. This poses a real limitation of the conclusions we can draw from the research literature, when we look solely at clients of commission-based advisors.

If there is no comparison between different forms of compensation, one can easily be misled into believing that sub-optimal behaviour is the result of the advisor’s recommendations and not, at least in part, the behavior and attitudes of the investor.

There are two issues related to behavioral biases that must be mentioned here. The first is the question of who is responsible for overcoming the behavioral biases of individual investors. While helping clients to do so may be something that a top-notch advisor will choose to do, we are not aware of any rule or principle that points to de-biasing as an advisor or a firm responsibility, regardless of compensation scheme unless a failure to do so impacts ‘investment suitability’ in some way.

“we suspect that much of what we see as impact of compensation is just investors failing to make rational decisions.” P53 of the Brondesbury Report on Mutual Fund Fees.

This quick post introduces some of my concerns with the Brondesbury report and my belief that many of its conclusions and analysis remain mired in a transaction mindset that continues to beset regulation of advice in Canada.   Regulators and, it would seem, some esteemed others appear mired in a perplexing behavioural bias towards “what does and does not represent investment advice”. 

Keynote Address by Bill Rice, Chair Alberta Securities Commission -December 3, 2013

I am just going through this key note address.   I will be blogging about this in greater depth, but I thought it would be useful to note some interesting statistics and one key observation:

Use of the word advisor/adviser – 0 times

Use of the word salesperson – 5 times

Use of the word intermediaries – 7 times.

It seems to me that the heart of the matter, as far as this key note address is concerned, is the differing view over the roles of advisors and the representation of that role.   Bill Rice views the role as one of salesperson and intermediary.   If the role was clearly one of pure intermediation, then I would agree with him, but it is not. 

This speech betrays an alarming level of ignorance, within the corridors of our country’s regulators, as to what is happening in the financial services industry. 

A few quick thoughts re the CSA’s Status Report on mutual fund fees…

Status report?  The only part I can see dealing with the status (after a quick skim of the document) is the following:

”CSA staff continue to consider and discuss the information gathered through our consultative process with a view to determining next steps.”

Which raises the question, “are they only considering information gathered through the consultation process?”.  I hope not. 

Continue reading

The ice is melting….and sun is not yet full out!

As Ken Kivenko pointed out to me, Invesco, Blackrock and Mackenzie and have managed to get agreement to push through lower cost DIY funds.  I think this is some achievement and credit should go to the OSC, Invesco (who have led the charge on this particular item) Blackrock and Mackenzie, and of course everyone else who has been putting pressure on the regulators and the industry to change to more accountable and responsible and professional advice based business practises.

But instead of stopping here, the message is clear, the industry can change and change with an alacrity that puts the post FDM process to shame.   Regulators should take note, if the mere threat of best interests can create what is in truth a vast sea change in fund distribution, just think what the planned implementation of Best Interest standards could be capable of doing!

We now know the industry can turn on a dime and while a move towards best interests will by no means be as easy, for a race that has built the pyramids eons ago, that which is intrinsically at the forefront of any renaissance, a simple change in attitude should be a breeze. 

Misdirected criticisms prove need for more reform in financial services

In recent comments in the National Post Ed Waitzer attempts to deflect criticism of his earlier article Regulate outcomes, not rules but fails to address the message of that article, which was ““It is now time to stand back and review the landscape and consider the impacts of the many new rules that have been put in place”.  This is also the argument of those who oppose the introduction of best interest standards and the removal of transaction based remuneration. 

Continue reading

Surfing on the edge of a razor blade….another post in the Russian Roulette series.

For the retail investor, leveraged investment with high cost investment products is a bit like surfing on the edge of a razor blade: you either have an exhilarating ride of a lifetime or you end up crashing with all the ugly consequences.

What we should be aware of are that costs and timing are important, and so is the sophistication of the strategy, though neither are really given due consideration at the retail level.  As it is, recommending high cost, long term, leveraged strategies is like placing those investors on fast sledges at the top of mountains with no ability to break or manoeuvre.  

Importantly the ups and downs of the leveraged strategy are not symmetrical with the returns of the market so you can effectively bin the vast majority of risk disclosure.

Continue reading

Russian Roulette: leverage and seeing through the marketing message…

How on earth are investors meant to be able to assess the risks and returns on borrowing to invest strategies when they are not provided with the hard data on which to assess the risks of their decision and when everything they read suggests only the unsophisticated are unable to appreciate the incredible benefits of leverage?

Continue reading

A short message: we have a regulatory bubble that needs bursting….

The real identity is lost: the ends and means of the regulation of the transaction have long ceased to be relevant to the retail end user. It is absurd. We have a regulatory bubble that needs bursting.

What are the biggest threats to regulatory change?  Are they the arguments brought forward by the industry that state that small investors will no longer be served and that advisors will switch to looser regulatory regimes (insurance).

Continue reading

Why are benchmarks important in mutual fund point of sale documents?

In response to a recent blog on benchmarks and behavioural economics I have been asked to comment on the importance of benchmarks in point of sale documents.  The following is the detail supporting that response, and (at the end of the post) a set of answers to a number of questions:

Continue reading

A green light for low ethical standards or has “best interest standards” been given the go ahead?

Leaders lead and set standards and examples.  Yet, with the Canadian mutual fund point of sale document we have, inter alia, a) something which has been allowed to be sent after the transaction and b) something in which information critical to making informed decisions has been taken out of the frame or dumbed down so as to be worthless.

Continue reading

OSC Dialogue 2013 – In order to nudge, you need to know where you are going. But does the OSC?

Where is the imperative for the OSC to clearly define exactly what it is and what it stands for? And, of course, where exactly does the OSC want to nudge investors?

I know the Canadian press will not pick up on these points, but I think it is important that they be brought to the public’s attention. I was listening to a recording of the behavioural discussion at the recent OSC 2013 Dialogue.  What interested me was a rather long question by Rhonda Goldberg, Director Investment Funds at the OSC:

Continue reading

Is it really all about transparency?

The following is a quote taken from a recent Preet Banerjee article from the online Money Sense.ca website.

“But it should be noted that advisers can achieve transparency in a commission model simply by being transparent. If they take the time to break down the costs and embedded compensation that commissioned products carry, they fulfill the ultimate expectation of consumer advocates: providing investors with informed choice.”

Unfortunately this is about as far from the ultimate expectation of consumer advocates as the earth is from the centre of the Milky Way, and Preet’s logic is as about as mind boggling as the inestimable distance between the two.

Continue reading

At this rate, propaganda may be the OSC’s only effective plan….

Investor beware, in the absence of concrete regulatory change, the OSC may have to rely on gradually introducing an idea of investor confidence into your mind.

The OSC has just published its 2013/2014 statement of priorities.  It is bland, uninspiring and fails to make a firm commitment, either way, on the key issues of our day.  The OSC, once again, is preferring the warm fuzziness of further discussion and consultation to the realities of conflict and commitment.

Blithely ignorant of the increasing body of research that raises considerable doubt over the efficacy of disclosure, the OSC continues to rely heavily on this out dated remedy. 

Continue reading

Investor confidence, regulation and saving…

Regulators’ views of capital market efficiency are framed on the past, a past where high costs and crude suitability standards did not ostensibly materially impact saving’s ability to fund both consumption and capital investment dynamics. To make the transition we need lower transaction and structural costs and more sophisticated processes. This is a dynamic which will make an impact on savings, asset prices and returns, and possible fundamentally impact consumer confidence.

Continue reading

The reality vortex! How to turn a mutual fund into a loaf of bread…

From a recent Morningstar article about some Invesco research into fees and costs:

“A test audience was asked which it would least enjoying paying: fees, commissions, charges, or costs. Respondents were 9 times more likely to say fees rather than costs.”

I am not really sure what Invesco is trying to pull here.  Really!  But I am drawn to the absurd and this is absurd.

Continue reading

Strange but true…Advocis in the battle against commissions banning…

An e-mail appears to be doing the rounds from Advocis HQ about the evils of banning commissions.  Normally I would not comment publicly on e mails, but this is an issue that is currently in the public domain and arguments that are being used to further the defense of the commission culture are part of that domain and need to be rebutted.

Continue reading

If you get rid of commissions will the cost of advice really skyrocket? Will smaller investors be left out in the cold?

What would you rather do, create an environment which will address the key issues of our day, or retain one that ignores them?

Ask an industry representative about getting rid of commissions and they will talk to you about the alienation of the small investor; “smaller investors will no longer be able to access advice”, they say,” in other countries x% of advisors have already left the industry and millions of people can no longer get advice”.  I of course refer to a recent National Post Comment article by Greg Pollock titled “Ban commissions on mutual funds, decrease access

Continue reading