Pushing boundaries while supporting the status quo: the CSA’s proposals for cost and performance disclosure.

The CSA’s updated proposalsto improve disclosure of “advisor” remuneration and to institute a simple statement of client account performance were released on June 14 2012.

The proposals suggested a format for disclosure of “advisor”/firm transaction based remuneration and rudimentary formats for reporting holdings, transactions and more importantly gains and losses on an investor’s accounts.

There are a number of issues here:

The first is the continuing conflict between the “regulated service” and the crude transparency intended by existing regulation and the current proposals: the advisory segment of the industry is predominantly a transaction based business engine designed to shift securities and product at as high a margin as possible, whereas the investor is looking, inter alia, for advice, management and competitive returns. The two objectives are incompatible and the statements only highlight that state of affairs.

The second is that consumers are deemed responsible for the investment decision in advisory based services while regulation is tightening the noose around consumer responsibility for the transaction: the new Point of Sale document for mutual funds has tightened the noose at the point of sale and IIROC CRM initiatives (of which the current CSA proposal is effectively a component) are formalising the transaction led, parameter to parameter (the most basic of basic) suitability process.

These enhancements to regulation have been formalising the burden of investor responsibility without informing the investor of the true nature of the regulated relationship.   And no, the IIROC CRM project does not inform the investor of the true nature of the relationship.  

As previously discussed in other blog posts and numerous other documents, the regulated relationship is not the relationship which most consumers consider themselves to be in, for a large number of reasons. As such, it is also likely that the performance reporting proposed by the CSA also fails to reflect the non regulated but contracted service.  

There is of course the risk that performance reporting, without the necessary disclosure of the true relationship, could further cement consumer misunderstanding.

Nevertheless, in a transaction based relationship where the consumer is responsible for the decision and where the suitability process is a very simple parameter to parameter process, with limited advisor responsibility, the issue of performance is very important.

Without information on the performance of investments, information on the risk of investments, information on the risk, performance and profile of the portfolio, then consumers who have opted to take responsibility for the asset allocation, security selection and effectively the risk/return management of their assets will be unable to make effective transaction decisions, or to mitigate their own decision risks.   The performance reports only provide a net increase/decrease in capital after adjusting for deposits and withdrawals and fails to inform the investor.

Educational initiatives in Canada also appear aimed at enforcing investor responsibility in the decision making process.   But there is no evidence of any real regulatory intent to inform the consumer of the true parameters impacting their decisions. 

In this context, the performance reporting proposals provided by the OSC are not capable of providing sufficient information to allow investors to make informed transaction and portfolio decisions over time. 

The point of sale document fails to provide a comparable benchmark against which funds need to be assessed, and the proposed performance reporting document fails likewise. Comparing performance against a GIC investment, as proposed is not going to inform investors about the risks and returns of their investments, their suitability and costs and their ability to meet their long term financial goals.  A true performance analysis would most likely question the value of their current wealth management relationships.  

Unfortunately, it is here where we come to an impasse within the current regulatory regime: where you have simple parameter to parameter suitability processes and where the investor is deemed to be making the transaction decision and initiation, there is no fundamental rationale for providing a comprehensive analysis of risk and performance. Why is this? Because the advisor is not recommending (advising) a portfolio strategy and is not responsible for processes which manage the risk and return of this strategy over time, for this would imply discretion, which would imply a different investment relationship.  The service is not the provision of competitive returns and risk management but the sale of securities and investment products within a constrained suitability decision making process. 

The industry, rightly or wrongly has a strong argument against the implementation of performance reporting procedures which are outside their remit. Hence, why we have probably arrived at a very weak performance analysis that merely provides a weak dollar weighted rate of return against a lowball cash benchmark. 

The CSA proposals are status quo fomented and I fail to see how they can help to enhance investor protection.  They are in reality designed primarily to give the impression of proper regulatory oversight while maintaining a minimum standard, parameter to parameter business and regulatory model which fails most investors.   This is the CSA covering its own backside while dutifully enforcing an unfair regulatory model.

There are of course positives to the proposals: the statement disclosing transaction based remuneration is welcome, but it needs to be clearer about where these fees are coming from; they may be coming from third parties, but ultimately the payments are coming from investors’ capital invested in these products and I would like to see this made clearer. It is not total charges and compensation received, but total charges and compensation paid by the investor. These are deductions from capital and returns on capital, which is the point.

In conclusion, the proposals a) do not provide the type of information that is needed for investors to make informed investment decisions, b) lack a supporting educational initiative designed to inform investors about the factors they need to consider when assessing the performance of their investments and hence whether they should really be seeking a different relationship, and c) ignores the real relationships and service representations that many, if not most, investors are exposed to.    

In the end, proper performance analysis spells the death knell of high cost transaction based business models, and it is a fine art keeping the investor reined to the chassis of this model without shedding too much light on its realities.  “We will let you look at the engine, but only if we blindfold you first.”

The CSA is doing nothing more than extending the life of a business model which should no longer be in force while paying lip service to the goals of investor protection.   “Hopefully”, it may say, “we can please both sides without rocking the boat too much”, the regulatory boat that is.

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