Why the Suitability Standard Is Not Suitable for Investors

October 31, 2018 | SeekAdvisor, Fiduciary, Bad Advice

Why the Suitability Standard Is Not Suitable for Investors

A 2018 Report issued by the CFA Institute found that 56% of Canadian retail investors don’t trust the financial services industry.

The business of financial advice has historically struggled from a PR perspective - and events since the turn of the millenium haven't helped.  The 2008 financial crisis - notably - did a lot of harm to investor confidence - especially in the US where several so called ‘blue chip’ Investment Dealers played a major hand in creating the disaster.  Meanwhile, back in Canada, not a lot has changed to strengthen the reputation of the industry or enhance investor protection since the Great Recession –

  • The barriers to becoming a licensed Financial Advisor remain appallingly low;
  • Over two thirds of Canadians are unaware of how much they pay their Advisors;
  • Insurance Agents continue to call themselves Financial Advisors and fill unsuspecting client’s retirement savings accounts with insurance products. 

I could go on…

One thing that hasn’t changed and should have long ago is the so-called ‘Suitability Standard’.  This is the requirement that your advisor provide you with investment recommendations that are suitable and alligned with your age, your means, your investment objectives and tolerance for risk.

Sounds reasonable, right?

But if you step back just a little to understand what is actually expected of advisors under this rule, suddenly it doesn’t seem so reasonable after all. Making recommendations which are suitable is all that is required. Financial Advisors are not required to act in your best interests they are only required to provide advice which could be characterized as 'adequate'.  Most advisors are not required to act as fiduciaries – where they have a legal obligation to act in your best interests.

Can you imagine if your doctor, accountant or lawyer wasn’t required to act in your best interests?   

So why isn’t this the case with the financial services industry? After all this is an industry responsible for managing billions of dollars of Canadians savings.

The reasons are simple. 

Investment dealers and regulators don’t want a statutory best interest standard.

A statutory best interest standard would negatively impact the industry in several ways  – increasing advisor and dealer liability, dramatically raising dealers oversight responsibilities, and damaging profit margins.

What frightens the industry most is the loss of a dealer’s ability to defend themselves when clients make claims after having suffered losses on their investments because of bad, conflicted advice.

Under the current regime all an advisor needs to do to defend themselves against a complaint is to prove their investment recommendations are suitable given the ‘know you client’ (KYC) information they’ve gathered.  It's not terribly difficult to show that an investment is suitable - it just needs to be 'adequate' for the client’s purposes.  Under a best interest standard, on the other hand, advisors would be far more accountable in demonstrating that their recommendations are the made without bias, conflict of interest, and client assets have not been used for the benefit of the advisor (i.e.: recommending an investment where the advisor will be paid more when a better or similar option exists).

Another common advisor defense against claims of loss is the concept of contributory negligence.  This is a concept that implies that the client has a least some responsibility for the activity in their investment accounts simply by deciding to invest.  This reasoning is common when a dealer defends one of their advisors against claims of loss "...hey, you agreed to the recommendation...".   If a best interest or fiduciary standard were adopted all investment decisions would be considered the responsibility of the advisor. 

The Suitability Standard is here to stay

On June 21, 2018 the Canadian Securities Administrators (the umbrella organization representing provincial regulators) dashed any hope of the adoption of a statutory best interest standard with this press release: Canadian Securities Regulators Align To Publish Harmonized Response To Concerns With The Client Registrant Relationship

After almost 15 years of research, consultation with industry stakeholders, investor advocates and the public, and countless roundtables, Canadian regulators have undeniably chosen a path where they are willfully turning their back on enhancing investors protection in favor of maintaining the status quo and the interests of the financial services industry.

In a 2017 interview that appeared in the Financial post here, CSA chair Louis Morisset reasoned:

“…a best interest standard could also let existing conflicts go unchecked because unique industry circumstances — such as dealers that sell only proprietary products — would make a uniform standard impractical.”

Morisset delicately acknowledges the thousands of ‘Financial Advisors’ (salespeople) who are only able to sell high cost mutual funds ‘manufactured’ by their dealers.  These product pushers include the collective salesforce at numerous Insurance Companies, the more than 13,000 advisors working in bank branches, and many more of the 80,000+ sales people regulated by the Mutual Fund Dealers Association (MFDA). 

What Morisset was telegraphing is clear - because operating model for much of the industry is predicated on offering conflicted and often mediocre advice, a statutory best interest standard is not just impractical, it’s impossible. 

Advisors who have adopted a Best Interest or Fiduciary Standard

“There are those who know and those who don’t.  All the advantages go to people who know.” Glorianne Stromberg, former Commissioner, Ontario Securities Commission

Regulators and large stakeholders such as the Banks are in no hurry to create a professional wealth management industry in Canada.  This leaves consumers to their own devices when locating an advisor who will either act in their best interests, or as a fiduciary.  From a consumer perspective, simply having an awareness of the rampant lack of professional standards in the financial services industry will put you in the captain’s seat when seeking financial advice. 

Who has a fiduciary duty? 

There is a small sliver of the financial services industry where advisors have a common law fiduciary duty to act in their client’s best interests – Portfolio Managers.

Anyone registered as a Portfolio Manager (PM) must act as a fiduciary.  The Ontario Securities Commission provides an excellent overview of what is required of a fiduciary here:

http://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20121025_33-403_fiduciary-duty.htm 

Because of the heighted legal liability associated with a fiduciary duty, investment dealers are generally cautious when approving an advisor for registration as a Portfolio Manager.  All Portfolio Managers are required to hold either the Chartered Financial Analyst (CFA) designation or the Chartered Investment Manager (CIM) designation.  Prior to approval they are vetted by a committee at their respective dealers and are subject to enhanced supervision. 

The Portfolio Manager title alone in not necessarily an antidote to bad advice.  Approval at large dealers is not always merit based. I recall sitting on a PM approval committee at a dealer and raising serious concerns about individuals seeking PM status - only to be overridden because they were ‘big producers'.   There have been several instances where clients suffered losses as a result of the misdeeds of a PM – notable scoundrels include Kris Sammy, Jay Noronha, Darryl Yasinowski and Scotia Bank.

What about advisors who act in your best interests?

Advisors not registered as PMs (Financial Advisors, Wealth Advisors, etc.) cannot claim to be fiduciaries.  No dealer would permit this.  Instead, it’s common for advisors to claim to act in their client’s best interests.  This is frequently nothing more than a sales tactic.  Identifying a Financial Advisor who truly adheres to a best interest standard isn’t easy.

The first step is knowing who and what firms to avoid when looking for financial advice.  This includes –

·       Insurance Agents calling themselves Financial Advisors.

·       “In-Branch” Financial Advisors working at any Canadian Chartered Bank.

·       Firms where advisors primarily sell proprietary products or offer a very limited selection of investments (a small “product shelf”) – this would include firms like Investors Group, SunLife Financial or Freedom 55 Financial.

·       Advisors who lack professional credentials and have just met the minimum proficiency standards to become ‘licensed to sell’ (see our blog post  How to Perform a Background Check on Your Financial Advisor)

When seeking our financial advice, ask the hared questions –

 

  • Are your investment recommendations free of conflicts of interest?
  • Are you able to offer me investments other than mutual funds?
  • What are your credentials?
  • Will you always act in my best interests in all circumstances?  Will you provide this to me in writing?

The Bottom Line

Consumers must act as their own advocates when seeking financial advice.  Regulators and the wider financial services industry are not committed to the highest principals of investor protection.  Instead they have demonstrated through their own actions that the interests of industry stakeholders will always come first and the consumer second. 

Finding a great advisor – one who will act in your best interests, always – isn’t easy, especially given Byzantine structure of the financial services industry in Canada and the institutionalized lack of professional standards.  This is why we created SeekAdvisor – to help you the consumer find a great advisor.  Before being profiled we want to ensure our members put you’re interests first, always.

 

Danny MacKay is the founder of SeekAdvisor, a former Bay Street Executive and Industry Insider turned Investor Advocate.