Canadian investors: cross your fingers!
September 20, 2016 by InvestingForMe
When it comes to your investments, do you think your advisor and their employer should be required to act in your best interests when they give you advice?
Most of us would answer yes, and in fact believe it’s their job to act in our best interest.
Well, unfortunately the idea of advisors working in your best interests is not exactly a requirement in Canada. There are no regulatory rules dictating an advisor must put your interests ahead of theirs or their employers. They’re only required to ensure their advice is suitable – the lowest possible regulatory standard.
How’s this possible?
First, some background stats
Before we go any further, let’s take a look at some statistics on Canadian investors. According to a study done for the Ontario Securities Commission’s (OSC) Investor Education Fund (IEF), we’ve got some interesting ways of doing business:
- The majority of Canadians use an advisor. In fact, 83% of Canadians with savings and investments have a relationship with an advisor, where the advisor makes investment recommendations about their money.
- Canadians are pretty ignorant about their advisors before they hand over their life savings. In fact, 66.7% of Canadians say they know little to nothing about the advisor when they hand over their savings.
- When it comes to choosing an advisor, Canadians are pretty lazy. One third get to an advisor through a referral, but the most common way to get an advisor is to have one assigned by a bank or financial institution. And, finally,
- Even though very little is known about the advisor, investors trust their assigned advisor, because they trust their financial institution to do what’s best for them.
It’s this 4th point about Canadians’ unconditional trust that is increasing demands for changes to the rules that govern advisors and their employers’ recommendations when dealing with Canadian investors and their investments. And it’s this same point that's costing investors some pretty big bucks.
“Advice that’s in your best interest” – Really? That depends!
What most Canadians don’t realize is that in the world of investments there are 3 basic regulatory standards that govern the investment recommendations given by advisors to their clients and as investors we need to be aware that our advisors don’t have to comply with all 3! Simply summarized from the highest to the lowest regulatory standard, these include:
- Fiduciary Standard: This is the highest standard, where, legally, the advisor and their employer are fiduciaries. Fiduciaries must ignore all considerations other than single-mindedly serving the interests of their customers in all matters related to the service provided. In other words, they must legally place their customers' interests ahead of their own. This is the highest legal and ethical standard in the investment world. There are no conflicts of interests. The client’s interests must always come before those of the advisor and their employer.
- Best-Interests Standard: Under this standard, the advisor and their employer
- Must do their job honestly, in good faith and in the best interests of their customer, and
- Must use common sense and demonstrate a degree of care, diligence and skill that a reasonably prudent person would exercise when making recommendations to a customer. (Although the Best-Interests Standard does not create a legal requirement to do so, regulators require the advisor to place the customer’s interest ahead of their and their employer’s.)
While most other jurisdictions around the world (United States, United Kingdom, Australia, European Union, etc.) have already moved away from the Suitability Standard and toward the Best-Interest and Fiduciary Standards, Canadian regulators continue their 12+ year debate whether or not to keep the Suitability Standard for Canadian advisors. So that means that while it sounds like advisors should put their investors’ best interests first, really there’s room here with this Suitability Standard for them to act differently, to make investment decisions based on what they think is suitable, but not necessarily in your sole Best-Interests.
I wish I knew why it’s taking Canadian regulators so long to upgrade the regulatory standards to eliminate the Suitability Standard. After all, when asked, industry players state that investment professionals already act in the best interests of their customers and that there’s no need for an upgrade to a Best-Interests or Fiduciary Standard.
If this is so and advisors already act in the best interests of their customers, then, to my mind, why not make it all legal, that is, upgrade the regulatory standard to what Canadians already assume they’re getting and what advisors say they're already doing. Why continue debating it for 12+ years?
To see the real effects of this loose regulation standard, let’s use a real-life example to help you to understand the differences these standards can make to your bottom line when an advisor works to each standard and the potential conflicts that can then surface with each.
Let’s say you have $50,000 to invest in the stock market. You want something that closely matches the performance of the TSX/S&P Composite Index. Oh, and you want hold the investment for at least 5 years.
Your advisor will know that the following types of options are available to you:
- Buy an established, indexed Exchange Traded Fund (ETF) that tracks the TSX/S&P Composite Index. Buying it at XYZ’s Discount Broker you’ll pay a commission of $6.95 and your annual investment costs (MER, TER, etc.) will be $30.00. Your total 5-year costs will be $36.95. Or,
- Buy McGillicutty’s, (imaginary) TSX/S&P Composite mutual fund. It invests in the same investments as the index and only has a small tracking error. There’s no cost to buy the fund and the annual investment costs will be 2.10% or $1,050.00. Your total 5-year costs will be $5,250.00. Or,
- Buy XYZ Bank's Composite Index mutual fund. It invests in the same investments as the index and only has a small tracking error. There’s no cost to buy it through your XYZ advisor. Your annual investment costs will be 2.26% or $1,130.00. Your total 5-year costs will be $5,650.00.
So, quite a difference in the 5-year cost of doing business, eh? How many investors would be aware of these different possible costs structures?
Note: Thankfully beginning July 2016, regulators now require advisors and their employers to provide investors with comprehensive information on both the performance of their investments and the costs associated with those investments, including all applicable fees and remuneration paid to advisors and their employers. This is an annual requirement.
Now, if your advisor is regulated to a Fiduciary or a Best-Interests Standard, they’re required to recommend buying option #1.
But, what if your XYZ advisor only has to meet the Suitability Standard? Hopefully, they're honest and still recommend option #1. But, you should know that under the current regulatory standard, all 3 options qualify as suitable for you!
So why would an advisor ever want to make you pay more?
Because the current Canadian advice standards allow our advisors to operate under the lowest standard (the Suitability Standard), many investors are unknowingly at the mercy of the morals of whomever we’ve hired to advise us. That potentially leaves us exposed to all kinds of questionable practices that can arise. Questionable because advisors often have added pressures from their and their employer's personal needs.
So, think about the possible conflicts in advice that can occur under the Suitability Standard in the following What if scenarios.
- What if, in the morning sales meeting, your advisor was told they were falling short of their XYZ Composite Index mutual fund sales targets? Pressure’s on to sell more!
- What if your XYZ advisor only has to sell another $50,000 of the bank's XYZ Composite Index mutual fund and they get a nice $500 sales bonus for the month?
These are the kind of details the average investor just doesn’t know about that might make your advisor make a different investment recommendation than you would think would be best.
From the advisor's point of view, there’s nothing really wrong with the XYZ Composite Index mutual fund! After all, it’s a suitable investment! But as we see from my earlier example, there are often much better investment options available, but unfortunately the average trusting Canadian investor is at the mercy of their advisor’s personal moral compass.
Conclusion: we all need to act
With over 120,000 registered advisors in Canada, the vast majority are hard working, dedicated and honest. I’m not worried about them. They already put their customer’s best interest first.
I’m worried about the dishonest, minority of advisors that are allowed to operate and profit from the low regulatory standards currently in operation in Canada.
It’s time to regulate advisors to a standard of conduct the majority of Canadians already believe they enjoy. It’s time Canada’s regulators did away with the Suitability Standard for advisors and their employers.
And as investors, until the governing standards are raised, we need to stop just crossing our fingers and trusting unconditionally that the advice we receive is in our Best-Interests. Read the fine print, ask for some costs comparisons, and let your advisor know that you’re also watching out for your best interests.
Want to know more about what can influence your advisor's recommendations?? Read the CSA Staff Notice 33-318 Review of Practices Firms Use to Compensate and Provide Incentives to their Representatives - December 2016