Between a rock and a hard place: in the absence of best interests the conflicts are growing….

The OSC’s mandate is “to provide protection to investors from unfair, improper or fraudulent practises, and to foster fair and efficient capital markets and confidence in capital markets.”.

Yet, it and the CSA have yet to make a definitive stance on the introduction of best interests standards, the very same standard that I believe is key to levelling the playing field between potentially fair and unfair outcomes.  Two recent pieces of news have led me to reiterate the importance of higher standards governing the provision of advice to investors:

The first is the most recent financial ombudsman (OBSI) name and shame case: an investment advisor recommended leverage to a 74 year old woman at the top of the market in 2000, and used a pension fund (RRIF) that was being used to support her financial needs as a repayment vehicle.   The funds raised (some 150,000, or close to 50% of her investible assets) from the leverage were also apparently invested in higher risk equity vehicles.   Now the details of the elderly lady’s withdrawals are not totally clear, but what is clear is that the withdrawal requirements from the RRIF portfolio, plus the costs of paying back the loan, put her at great financial risk

The advice, in my opinion, was irreconcilable with the client’s financial position.  Yet, complaints to the firm and the MFDA yielded nothing and the Ombudsman, in order to justify restitution, had to first prove that the client was little more than a financial illiterate.  Under current rules and regulations investors are deemed responsible for transactions, irrespective of whether the advice is responsible or not, with advisors only required to make sure that transactions that are recommended can be vaguely justified by the loose fitting parameters of the know your client form. 

Best interest standards might well have prevented this advice being given in the first place.  Unfortunately, the scale of the problem was only uncovered by the lady’s children and it is unclear how many other people may be likewise effected.   Such outcomes are clearly unfair, yet they are outcomes that are not only propagated but encouraged by current regulatory standards. 

What is best for the client is not the point, it is what can pass through the rules that matters.

The second item of news was the news that, according to an article, TD’s Full Service Investment brokerage are revamping advisor compensation structures.  These changes which are intended to increase productivity and raise profitability would reduce payments to advisors bringing in revenue below a certain level and increase incentives for those producing more.   I would presume this means getting rid of small clients, or increasing transactions, or increasing margins on transactions, or focussing effort on gathering new clients and away from managing existing clients.

the full-service brokerage unit of TD Waterhouse, will cut compensation for advisors who bring in between $375,000 and $399,999 in annual commissions and fees, according to a compensation document obtained by  Starting next year, those advisors will be paid 20% for all transaction fees or ticket charges they bring in. Currently, they receive 30% to 44% of the ticket charges they generate, with maximum payout given to higher ticket charges

But what interests me are the stresses that this may place on a system that is already compromised in terms of its representation of service, a representation that conflicts with the regulated contract.    There is nothing wrong in a company looking to increase their sales, or their margins, but there is something wrong if a company pretends to be acting in their clients’ best interests when it operates within a framework that cannot possibly deliver on that promise.

For the market as a whole, the only way you can increase productivity and profitability without negatively impacting service is through improvements to and increased sophistication of process (technological and organisational).  Otherwise it is a race to the bottom. 

While I can see lots of room to improve portfolio construction, planning and management techniques and processes, few of these would involve increasing transactions or returns from transactions, in fact quite the opposite.   Many investors are likely transacting too much and paying too much, and if advisors are forced to increase their revenue streams, and their revenue streams are comprised of commission, they are likely to be transacting more.

Furthermore, there is no client buy in to this state of affairs.  While many do think their advisors are acting in their best interests, and many firms are flying on the coat tails of this perception, the reality is far different.   Best interests standards would place a limit on how far firms could push the extraction of “value” without communication (agreed extra fees) justification (performance benchmarking) and accountability (actually being responsible for the impact of inappropriate advice).  

Under current regulation, what is best for the client is unfortunately not what matters: what can pass through the rules does though and this is my concern.  As the market competes to raise margins and returns on a transaction bedrock, the conflicts of interests that pervade transaction led business models are likely to intensify and further weaken the integrity of the system.

A best interests regime would find many conflicts of interest inherent in this supposed business plan of TD’s, although we have to take’s word for what this “document” comprises.  And so the industry appears to be acting without compunction when it comes to conflicts of interests while our regulators have yet to define their own position with respect to best interests.


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