OBSI Name and Shame

I would like to refer readers to the recent OBSI name and shame press release.  It concerns Richardson GMP, a firm that has been accorded a Fiduciary Certification on its discretionary mandates.

The OBSI reports are sparse and it is difficult to discern just what the securities at issue are, but I would hazard a guess that they are in the asset backed/collateralised loan/mortgage backed area given that the problems arose during 2007 and 2008 and looked to relate to once highly rated paper.

I can see why many firms would not want to reimburse investors for normal market losses, and in most instances, where a portfolio is properly structured, I would agree with them.  But it looks as if structure and transparency over structure were found lacking and I do wonder why Richardson took the risk to their good faith message in this particular instance.  I fear perhaps the lawyer’s hand and not pragmatic business logic.   But then again there is too little information here to really go on.  

However, what concerns me in the “power of ten realm” is that we are at heady market valuations and who knows how many shaky foundations are set to be levelled in the months and years ahead.

FAIR Canada & IIROC Request for Comments re Client Relationship Model – Phase 2, Performance Reporting and Fee/Charge Disclosure

I would refer people to FAIR Canada’s submission on CRM phase II.  It makes some good points re the following:

A) discount brokerage disclosure,

B) definition of trailing commission,

c) points re the clients not directly paying trailer fees and such charges being for services rendered,

d) short term trading fees and deferred charges, and

e) re requirements to report on investments not defined as securities in legislation.

My submission to the CSA re Risk Classification disclosure

Re: CSA Notice 81-324 and Request for Comment – Proposed CSA Mutual Fund Risk Classification Methodology for Use in Fund Facts

The part must relate to the whole and the whole to the part and the both must know of it:

The CSA in their consultation paper fail to explain how the risk classification methodology proposed for use in the point of sale documents is to be used by investors to make informed decisions, and how advisors are to use the same to determine suitability.

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IIROC’s guidance for leveraged investment

I can see that IIROC have put some real work into this and have largely done as much as they can given the constraints they are operating under: they cannot rule against leveraged investment or unilaterally move outside of a transaction remuneration regime; this is the main securities regulator’s job, if not a government level responsibility.    

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Principle based versus rule based regulation and the hidden benefits of a best interests standard.

Regulation and investor protection begins at home, not at the regulatory level or with the courts.

There is a lot of confusion amongst the regulated that a move towards a best interests standard will lead to more rules.  This is incorrect.  They will lead to more principles and fewer rules, less conflict and better outcomes, greater self regulation and higher levels of investor protection and much reduced regulatory intrusion.  But not overnight!

The ability to deliver best interests standards depends on well structured processes that depend on a well defined set of decision rules.  Strong processes need only be regulated by principles, as the processes contain all the rules.   The trick is to make these processes transparent and accountable to a standard (best interests).  

Regulation + process = leverage. 

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Fostering a culture of compliance, an alignment of regulation and incentives, through best interests standards.

Whether he realises it or not, Bill Rice has unwittingly argued for the introduction of best interests standards as a solution to the regulatory burden.

I wanted to make a further comment on a topic that spins nicely off Bill Rice’s Keynote speech, that applies to everyone who opposes the introduction of a best interests standard. 

“It is important to securities regulators that intermediaries are as effective as possible and, in that regard, that they be as skilled and experienced as possible, and are motivated by incentives to do as good a job as possible.”

That topic is compliance and the benefits of encouraging a culture of compliance.  At the moment the focus is on balancing the opposites of advice based service requirements and transaction based remuneration.   Compliance and incentives are in conflict and the hammer and the nail will always be needed to keep the two together. 

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Best interest standards…not a recent movement

As per Bill Rice’s recent keynote speech (to the IIROC – CLS Compliance Conference 2013), there is a mistaken assumption that the global movement towards best interest standards has occurred as a result of the most recent financial crisis, and that because Canada emerged relatively unscathed (although I would argue that Canada’s consumer debt dynamics would suggest otherwise) that best interest standards are an ill conceived knee jerk reaction to problems which do not exist in the Canada.

In point of fact, regulation in the UK has been focussed on issues of best interest standards for a much longer period of time. 

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The essential role of securities regulation…

Recognising and protecting the implied contract, to act in one’s best interests, between consumers of financial services and advisors should lead to more market efficient outcomes, should better maintain the integrity of the market place and raise the confidence of consumers in the advice they receive and the markets and securities in which they invest.

I wanted to address a central theme in Bill Rice’s recent address. This theme is the apparent regulatory focus on intermediaries (noted throughout his speech) to the exclusion of consumers.  

The following is taken from “The Essential Role of Securities Regulation, Duke Law Journal February 2006”.

“Any serious examination of the role and function of securities regulation must sidestep the widespread, yet misguided, belief that securities regulation aims at protecting the common investor….…The law of securities regulation may be divided into three broad categories: disclosure duties, restrictions on fraud and manipulation, and restrictions on insider trading.

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Euphemism: regulators still clinging to the past, still unwilling to face the fundamental problem?

Quite frankly I am gobsmacked, but at the same time eternally grateful to the many gifts this communication will provide the public debate on best interest standards.  I of course refer again to the Keynote Address by Bill Rice, Chair Alberta Securities Commission, on December 3, 2013 to the IIROC – CLS Compliance Conference 2013.

In this address he made a number of points that I think are worth pointing out and rebutting:

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Financial intermediation…

Just doing some research on financial intermediation and came across this interesting paper:

Finance vs. Wal-Mart: Why are Financial Services so Expensive? Thomas Philippon, New York University

“The finance industry of 1900 was just as able as the finance industry of 2000 to produce bonds and stocks, and it was certainly doing it more cheaply. But the recent levels of trading activities are at least three times larger than at any time in previous history. Trading costs have decreased (Hasbrouck (2009)), but the costs of active fund management are large. French (2008) estimates that investors spend 0.67% of asset value trying (in vain, by definition) to beat the market.

In the absence of evidence that increased trading led to either better prices or better risk sharing, we would have to conclude that the finance industry’s share of GDP is about 2 percentage points higher than it needs to be and this would represent an annual misallocation of resources of about $280 billions for the U.S. alone.”

And also:

Has the U.S. Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation Thomas Philippon May 2012

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. 

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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. 

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Russian Roulette– further information

Here are some other links (FAIR, SIPA, Ken Kivenko) and other miscellaneous leverage references.  Please note that not all links relate to views that I would support: many are intended to show some of the dubious aspects of the promotion of leverage, so be warned.

I have had a response from FAIR Canada to one of my posts on leverage and note an excerpt from that response and links to a number of their documents below:

FAIR Canada

“Leverage continues to be a growing problem in our view.  In our letter to the CSA, we thought it was important to point out the linkages between the financial institutions lending the money to pursue these strategies (B2B Trust  being a prime example, but not the only one by any means) and the advisors who seek to gain through increased assets under management and/or greater embedded commissions and how this interaction buts consumers at risk:”

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Russian Roulette– more data

Leverage strategies using high cost retail investment products expose investors to significant risks, especially at fair to high market valuations.   Even very low cost strategies are exposed to significant risk as the market and economic cycle matures strongly suggesting that leverage is more strategic than a long term asset allocation play.  

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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.

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Russian Roulette: why is borrowing to invest so ingrained in Canadian culture?

I am not talking about the obvious “commission incentive” here for advisors.  No, I am talking about the laissez fair attitude (almost a belief in a divine right) towards the risks of inappropriate leverage and the easy assumption, including the apparent complicity of regulators, that a mere insufficient disclosure of risks using unrealistic assumptions (if any) is enough to provide due warning to/inform a client when the accompanying sales practises are ignored by regulators. 

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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?

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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).

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