Fiduciary duty: will it make a difference?

I was passed along a 2010 report prepared by Joseph Groia of Groia & CO entitled “Extending a Fiduciary Duty to all Financial Advisors & Brokers: Will it make a difference?”: it argued that the imposition of such did not reflect the realities of the market place. It suggested on the other hand more investment in financial literacy, better disclosure (and pointed to the new erroneously named point of sale disclosure) and the removal of commission from product sales.

An important defining characteristic of a fiduciary type relationship is the extent to which the potential fiduciary concerned has discretion over decisions and processes.

In the simple transaction, parameter to parameter based suitability process of the Canadian retail advisory model, there is no presumed “advisor” discretion over the process: the relationship is a “simple” transaction relationship; the process is “transparent”; the client delivers the parameters; the “advisor” recommends suitable products within those parameters; the client “accepts” the recommendation after verifying parameter match and completing due diligence. In these laboratory conditions it is difficult to ascribe a fiduciary responsibility to this process. 

If only it were this simple, and it is in the realm of relevance and context that the Groia report misses the point: most client/”advisor” relationships are one where the “advisor” has a considerable amount of discretion with respect to the determination of the KYC parameters, to what they recommend, to how often they transact, to the strategy and the mix of assets and hence risk and return the client ends up with.  The process is wider in scope and complexity than the regulated process assumes.  Additionally, it is this type of “discretionary” relationship which the “advisor” is selling and which the investor accepts. 

When an eventual decision is made by the investor in these “wider” service relationships, it is often in the absence of the type of information needed to help them fully understand the nature of the recommendation, its integration within the portfolio and its interaction with their financial needs over time.  This lack of information over the actual suitability process and rationale/discipline for the strategy, security selection and portfolio structure planning and management that is effectively being provided, also obscures the decision making process and enhances the level of discretion taken by the “advisor”.   The information that would otherwise help reduce the level of discretion taken by the “advisor” in managing the investor’s financial needs and assets is just not there.  

The transaction based model presumes that the investor has an adequate suitability process through which they manage their transaction decisions – it has to rest on some fundamental does it not?  

In truth, most investors do not possess such a “working process” and this is substituted by the “advisors’” own processes.   Furthermore, because portfolio construction planning and management is a much more complex process than a stand alone transaction, most investors are only able to understand and accept the generics of a process: this means that disclosure of information necessary to help investors make decisions over outcomes derived from “advisor” processes is not sufficient a condition for the investor to effectively take control over the process.  In the realm of more sophisticated processes, the “advisor” will always be responsible for the integrity of the process.  

In other words the “advisory process” in which securities and products are recommended and positioned is a much more involved and complicated process than that assumed under the simple parameter to parameter transaction model.   A fiduciary type responsibility needs to be accorded to these types of relationships, for they possess the necessary level of discretion, and where there is such discretion and reliance, there is also the implication that the “advisor’s” actions place the needs of the client first and foremost.  Importantly, these are not decisions over which discretion has been accorded by virtue of convenience (make these decisions, I do not have the time!), but they are process derived decisions which the client is incapable of making on their own, and hence the client is both dependent on and vulnerable (where these processes are without integrity) to this discretion – note Lac minerals ltd. v. International corona resources ltd.

A greater focus on investor education will not solve the problems in the advisory segment, neither will the type of disclosure noted seen to date in mutual fund Fund Facts, nor the cessation of commissions on its own.  The latter point, however, is more likely to force a move towards fiduciary type services and its regulation as “advisors” are forced to justify their fees, either going the way of more efficient product/transaction distribution or advanced service differentiation. 

But, as I have argued before, trying to impose blanket wide fiduciary duty at the present moment in time is impractical – the industry is not ready for it – but there is an argument for allowing advisors and firms to deliver such and be regulated to such a higher standard accordingly.  At the same time, we need the true nature of the regulated transaction relationship and its responsibilities to be communicated to the client and to prevent those “advisors” operating in this segment from “selling” any other service.  

A fiduciary type responsibility should not be imposed on a simple client initiated transaction relationship, but should be applied to those services where there is considerable discretion and reliance on outcomes dependent on sophisticated services and processes and the integrity of those services and processes.    Change will not happen overnight and unless there is wholesale change in regulatory structure, culture, vision and the balance of power between industry and consumer rights, change will not happen at all. 

Again, a special “thank you” to Ken Kivenko for passing along these documents for discussion.

Leave a Reply