Small Investors Pushing For Greater Protection

Peter Muggeridge | September 26th, 2016

The investment advice industry gets a wake-up call as small investors push for greater protection.

CASE #1 A mutual fund dealer encourages his 40-something client to purchase an expensive product, not telling her that he’ll earn a higher commission for selling it. While this fund doesn’t perform any better than its cheaper competitors, over the course of time it costs the buyer thousands of dollars more in management fees.

CASE #2 An older couple is charmed by a persuasive advisor who convinces them to adopt a higher-risk strategy despite the fact it makes no sense for their age and stage in life. The markets dip, and they lose half their savings.

CASE #3 An 80-year-old woman gives her financial advisor blank cheques to invest her retirement savings. She soon discovers he’s been funnelling her money directly into his own company. Humiliated and broke, she’s forced to return to work so she can pay her bills.

In each of these real-life scenarios, the financial advisor has clearly failed to act in his client’s best interest. He has pocketed their money, given them bad advice or steered them into risky schemes, causing huge financial loss for the investors at a time they can least afford it.

But in only one case did the advisor actually break any laws.

That would be #3, a clear-cut case of fraud. And while #1 (pushing a client into unsuitably high-cost investments) and #2 (exposing a client to inappropriate higher-risk investment strategies) may seem highly unethical, they aren’t strictly illegal under the fuzzy regulations governing the investment industry.

So what does constitute illegal practice from your investment advisor? Well, it’s complicated, and the lack of clarity governing the advice industry has become a huge bone of contention for small investors.

It should be noted that the vast majority of advisors, who go by a myriad of mysterious titles (see sidebar below), do act in their client’s best interest. They’re required to go through the Know Your Client form, in which they build a detailed account of their clients’ financial situation, needs, goals and risk tolerance.

But many groups, including CARP, the Canadian Foundation for Advancement of Investor Rights (FAIR) and the Small Investor Protection Association (SIPA), say this isn’t enough to protect small investors, especially seniors who are particularly vulnerable. “Unlike younger people, many older investors just don’t have the time, the tools or the income to recover lost savings,” says Wade Poziomka, CARP’s director of policy and litigation.

Next: Your future financial security

Multi-ethnic businessmen holding laptops in police line up

Putting money into the market is always unnerving, particularly when your future financial security depends on getting it right. And with enrolment in public or private pension plans dwindling, coupled with the endless run of low interest rates, there’s a paucity of safe investments that offer decent returns. So, many feel they have no choice but to invest their money in the stock market.

Because many of us don’t have the financial literacy to navigate this course alone, we seek the services of an advisor we trust will act in our best interests. Our lack of expertise puts us in a vulnerable relationship with our advisor. “Invariably, the advisor is going to have the upper hand in the relationship,” says Neil Gross, executive director at FAIR. “We go to our advisors thinking they’re going to tell us what product is best for us and what strategy is in our best interest,” says Poziomka. But unlike our lawyer or a doctor—they aren’t bound by law or oath to put our interests first.

That means that if the advisor can earn more commission by steering a client into a higher-cost investment – even if there’s a similar cheaper product on the market – there’s nothing really stopping him. Moreover, Gross adds, most salespeople who work for fund manufacturers or for banks that have their own in-house funds aren’t really independent. “They’re making a recommendation to a client, but at the same time they’re being paid by the manufacturer to push its specific product. That creates a whole host of problems.” Which begs the conflict-of-interest question: are they salespeople or advisors?

Obviously, the practice of up-selling well-heeled clients doesn’t qualify as the crime of the century, especially for those who don’t have a stake in the market. But when we’re saving for retirement, there’s no reason we should be giving the industry more than it already takes in. Here’s the impact an extra one per cent in annual fees can have on your investment portfolio.

That’s more than $80,000 out of your retirement fund and into the pockets of the advisors and the firms they represent. And no crime has been committed.

And even when there is criminal activity, the odds of catching the perpetrators or recouping losses are not in the investor’s favour. “Almost everyone who makes a claim directly [to the firm] will be turned away at the door or offered nuisance money to go away,” says Harold Geller, of the Ottawa-based law firm McBride Bond Christian LLP, which pursues cases on behalf of clients who have suffered losses due to negligence of their advisors. “While the dealer’s response to the complaint prior to litigation is stacked against clients, the courts are very favourable to a good claim,” says Geller.

Next: File a complaint through the Canadian Securities Administrator

When the initial complaint fails, the victim’s next step is to file a complaint through one of the Canadian Securities Administrator’s enforcement bodies. The CSA is an umbrella organization of provincial and territorial securities regulators who oversee the industry. The provincial regulators confer power on three bodies to regulate the conduct of advisors: the Investment Industry Regulatory Organization of Canada (IIROC), the Mutual Fund Dealers Association of Canada (MFDA) and the Chambre de la sécurité financière (CSF) in Quebec.

Many victims say this fragmented system isn’t working. For starters, both IIROC and the MFDA are self-regulatory bodies—they’re funded by the industry they’re meant to police. Those who have unsuccessfully filed claims through these enforcement bodies become embittered by what appears to be an incapability or unwillingness to go hard after the advisors.

Small investors often wonder if anyone has their back. Poziomka, puts this into stark reality, saying that “last year, IIROC received 1,341 complaints, and yet only referred 124 complaints for investigation.”

Even when investigations are opened and fines imposed, advisors seldom pay up. In its 2015 Enforcement Report, IIROC characterized collecting fines as “challenging.” And the MFDA admits that, in 2015, it imposed fines of $5,389,650, of which only $843,982 (16 per cent) has been collected. Both IIROC and the MFDA say their collection powers need to be enhanced to go after advisors who dodge fines by leaving the industry. “We have requested statutory fine collection powers from the provincial regulators on several occasions but have not received them,” contends Ian Strulovitch, director, public affairs at the MFDA.

The abysmal collection record prompted the Small Investor Protection Association (SIPA) report – Unpaid Fines: A National Disgrace. Suggesting that there are close to a billion dollars in outstanding fines, the SIPA report concludes that this failure to collect “contributes to a breakdown of trust in the system” and “reduced investor protection.”

“If you have a low investigative rate, a poor record on collecting fines and limited enforcement powers, it’s no wonder people complain that these organizations are ineffective,” says Poziomka. “Even so, they’re prosecuting more cases than they did 20 or 30 years ago” says Gross, in defence of the regulators.

The Ombudsman for Banking Services and Investments (OBSI) is another avenue where investors can take their complaints. But while OBSI has a good record as an investor advocate it has restrictions on the kinds of cases it can take on and has no power to enforce its rulings.

When justice can’t be found through any of these enforcement bodies, the frustrated victims must turn to the courts as a last-ditch measure. “Any good lawyer with enough interest and time can learn how to successfully pursue a case of this type for their clients,” says Geller. But fighting your case through the legal system can be a lengthy, complex and costly process, only viable to those who have the financial wherewithal.

Next: A national regulator overseeing the entire industry?

All this points to a fragmented and ineffectual enforcement system that’s not doing a great job protecting investors. And it’s leaving too many feeling helpless, suspicious or seething with anger.
The tide, however, seems to be turning. As pressure to level the playing field builds from groups like CARP, SIPA and FAIR, provincial regulators have begun thrashing out ways to improve investor protection. The Canadian Securities Administrators has begun consultations on how to best implement improvements to investor protection.

One idea that’s often discussed is the creation of a national regulator overseeing the entire industry. Gross feels investor would benefit from “a single, better-co-ordinated set of regulations, standards and enforcement capabilities.”

It’s a worthy goal but could take years to come to fruition. Until then, almost everyone (save the investment industry) feels that we need a law that guarantees that investors’ needs come first.

Known as regulatory best-interest standard, it would be similar to the fiduciary duty a lawyer has with his client.

But there’s been pushback from the industry, particularly on the regulatory best-interest standard, which, Gross says, “could present significant challenges to some of their business models.” While the MFDA is neutral on increased regulation, it is monitoring the CSA consultation process and will make sure its “rules are materially harmonized with any new CSA requirements,” says Strulovitch.

In the meantime, he says the MFDA will “continue to actively focus our activities on improving the investor experience and protecting investors.”

Ultimately, we need to draw a clear distinction between what is sound financial advice and what is inappropriate. And we need a strong national regulatory body that’s armed with sufficient powers to enforce this

“Canada has some of the strongest financial institutions and the weakest regulations,” noted Larry Elford a former financial advisor said in a recent talk to Southern Alberta Council on Public Affairs.
It will take bold action and foresight for the investment industry to change the way it does business.

But for the many whose entire life savings depend on the integrity of the this system, change is necessary, and it’s long overdue.

A version of this article appeared in the September 2016 issue with the headline, “Who’s Got Your Back?,” p. 67-72.