Tuesday, December 23, 2014

User Guide for Fund Facts

The Kenmar Associates team has prepared a User Guide for Fund Facts that should allow you to obtain the most value from this disclosure document.

The attached Guide is written in plain language and broken down by sections in Fund Facts for ease of use.While current regulations require pre-sale delivery of Fund facts only in May 2016, many firms will start providing it now. In any event, you can ask your dealer for it now- it’s your money. Get the Kenmar Guide here.

Checklist : Diligent Supervision of Off Book and Outside Business Activities

This checklist is intended to help identify diligent supervisory practices used to detect Off Book and Outside Business Activities by  "advisors".We sincerely hope it will help in the successful prosecution of investment dealers who say “ I had no idea” by identifying prudent practices that should be in place to prevent investor abuse. For seniors and retirees this abuse can be life-altering.There is no room for wilful blindness in today's advice giving industry.

We hope regulators and SRO’s will apply the Checklist in their deliberations as well. Too often the dealer Representative  is called to account and the investment dealer gets away with “ I had no idea” yet took no pro-active steps steps to get an idea. Read the article here

Tuesday, December 16, 2014

Comments unbecoming of a “wealth management industry”

Comments unbecoming of a “wealth management industry”

Despite fierce industry opposition ,a determined group of regulators has finally made the delivery of Fund Facts mandatory BEFORE the investor is required to make an investment decision. Imagine that!The industry should be embarassed and ashamed at its anti-investor stance over these many years.

One has only to review the comments that were made during the prolonged consultation on the pre-sale delivery of Fund Facts to realize just how big the gap is between sales and advice at the most senior levels of the mutual fund industry ( referring to itself as being in the wealth management industry) . The most basic act of advice is for a professional advisor to explain the product and why it is being recommended for inclusion in a portfolio. For investor advocates, this is so fundamental to advice giving that it is a no-brainer. Yet as you gaze upon some of the comments regulators had to wrestle with, you quickly realize the source of the many problems in the fund industry and the fierce opposition to a Best interests standard is ... top management. Given the intense industry stonewalling ,it is no wonder it took over 10 years to bring in this most fundamental reform related to being in the investment advice business ( The comments actual apply more to an industry in the sales and marketing business ).

Take a look at the rationale used to delay , bypass or kill pre-trade disclosure of Fund Facts:

A few commenters said that, given the substantial anticipated costs and the lack of a detailed cost-benefit analysis, they are unable to agree with the CSA's perspective on the benefits and costs of implementing pre-sale delivery of the Fund Facts.

A commenter noted the "specific" costs of implementing the pre-sale delivery of Fund Facts are:the administrative, production and delivery costs of sending the Fund Facts separately, instead of with the trade confirmation;the operational costs of creating and running a process to ensure for timely pre-trade delivery of Fund Facts and the costs of sufficiently documenting investor receipt of Fun Facts

It was suggested that a trial program be conducted among a sample of dealer representatives to see if the costs associated with pre-sale delivery of the Fund Facts can be justified in terms of its utility for investors.

Some commenters said that moving from post-sale to pre-sale delivery of Fund Facts is a significant change that shifts the delivery obligation from a dealer back office operation to the front line sales force. Therefore, the pre-sale delivery requirement will affect independent dealer representatives and small firms in a disproportionate manner.

Furthermore, a number of independent mutual fund companies are dependent on third party distributors, who seldom have face-to-face meetings with investors and often rely on telephone conversations or other means of communication.

Several commenters expressed the view that pre-sale delivery of Fund facts would slow down the sales process.

Some commenters that it is important to make a distinction between investors who rely on a dealer representative's recommendation and those who rely on their own research and judgment. We were told pre-sale delivery of the Fund Facts will only delay an investor from executing an investment decision they have already made.

Some commenters said that the requirements to qualify for the pre-sale delivery exception are unduly narrow and are likely to frustrate some investors, especially experienced and knowledgeable investors who do not want orders delayed pending delivery of the Fund Facts. These investors should be allowed to expressly waive pre-sale delivery of the Fund Facts in favour of post-sale delivery.

The pre-sale requirement will be less onerous for bank-owned distributors, who meet with investors at a local branch, facilitating in-person pre-sale delivery of Fund Facts.

Some commenters also noted that pre-sale delivery will impact a dealer representative's product shelf because it will be more difficult for smaller and independent dealers to distribute a wide selection of mutual funds. To ensure pre-sale delivery of the Fund Facts and to complete transactions on a timely basis, dealer representatives may be forced to narrow their "product shelf." Over time, this may affect the level of competitiveness of the mutual funds industry.

One commenter noted that an unsatisfactory transition period would pose serious human resource challenges, leading to delays, as well as customer experience and compliance concerns.

Industry commenters were generally unanimous in recommending a switch-over date that avoids the months of November through April since resources at that time of year would be heavily engaged with RRSP season [ sales ] activity, year-end trading and financial reporting. Therefore, an early summer change-over period would be preferable since it would be the least disruptive from an operational standpoint.

For telephone sales, one commenter told us that pre-sale delivery of the Fund Facts has the potential to create a negative investor experience. In such circumstances, it was suggested that dealers should be permitted to inform the clients that they can receive the Fund Facts within two days of the purchase rather than the onus being in on the investor to initiate the request

One commenter also suggested that dealer representatives be permitted to ask their clients for annual instructions or standing instructions in a manner analogous to the continuous disclosure process in National Instrument 81-106 --Investment Fund Continuous Disclosure. Alternatively, the opt out could be in the form of a declaration (e.g., a clause in the account agreement subject to annual renewal in writing) or an acknowledgement upon the purchase of a mutual fund that the investor will be responsible for getting the most recent copy for the Fund Facts prior to any new trade instructions to the dealer representative.

One commenter noted that the verbal disclosure would take approximately six minutes without taking into account additional time that might be needed to answer any questions the investor may have. This would be even more so when an investor purchases several funds at the same time. Moreover, in the case of investor-initiated trades, especially by seasoned investors, this mandatory verbal disclosure will amount to an annoyance and delay and fee-only dealer representatives will have to charge the investor.

One commenter also expressed concern that the limited number of third party service providers to facilitate implementation could place industry members at financial risk as they will negotiate contracts with a "virtual monopoly", which may result in a "concentration risk in outsourcing".

One commenter noted that the pre-sale delivery of the Fund Facts is proceeding without assurances that investors will realize costs savings. Operational savings from the cessation of prospectus distribution to investors may lead to material profits for fund companies, while the dealer representatives pay for the bulk of pre-sale delivery costs.

Some commenters lauded the removal of the previously proposed requirement to bring the Fund Facts to "the attention" of the purchaser, which was viewed as an unclear requirement that could have potentially added unnecessary costs and confusion for dealer representatives and investors.

We could go on ,but the evidence is clear. A sales mindset and culture is in place trying to masquerade as a professional wealth management/ advisory business. Until this changes, investors will be at risk .That is precisly why investor advocates are demanding increased “advisor” ( the misleading title used by the industry to portray dealer representatives) proficiency and a fiduciary standard. It's now up to regulators to bring in needed reforms or investors to implement Caveat Emptor and ignore all the industry hype about the value of advice.

Let us all hope that 2015 will see some leaders emerge and transform the industry to a trusted one – one that is sorely needed by most retail investors.

Friday, December 12, 2014

Supervision on vacation , compliance out of sight

                                                                                                                                     December , 2014
Supervision on vacation , compliance out of sight

Following a disciplinary hearing held on September 22 – 24, 2014, in Calgary, Alberta, a Hearing Panel of the Investment Industry Regulatory Organization of Canada (IIROC) found that Grant Patrick Matthews made unsuitable recommendations in the accounts of four Deele Financial Markets Inc. ( a Calgary based dealer ) clients, engaged in discretionary trading in the accounts of two clients, and engaged in excessive trading (churning) in the accounts of three clients. The Hearing Panel also found that allegations of failure to know his clients, with respect to the four clients, and discretionary trading, in the accounts of one client, had not been proven.
The Hearing Panel’s decision dated November 21, 2014, is available at: http://docs.iiroc.ca/DisplayDocument.aspx?DocumentID=E3CCCA84688043EBB50218E0C0801C75&Language=en .

Specifically, the Hearing Panel found that Mr. Matthews committed the following violations:
a) Between approximately January 2009 and May 2012, Mr. Matthews failed to use due diligence to ensure that recommendations were suitable for four clients, based on factors including the client’s financial situation, investment knowledge, investment objectives and risk tolerance, contrary to IIROC Dealer Member Rule 1300.1(q);
b) Between approximately June 2010 and May 2012, Mr. Matthews engaged in discretionary trading with respect to the accounts of one client, without being authorized and approved as having discretionary authority, contrary to Dealer Member Rule 1300.4;IIROC Notice 14-0289 Enforcement Notice/News Release – In the Matter of Grant Patrick Matthews – Discipline decision - Liability
c) In December 2008, Mr. Matthews engaged in discretionary trading with respect to the accounts of one client, without being authorized and approved as having discretionary authority, contrary to Dealer Member Rule 1300.4; and
d) Between January 2009 and March 2011, Mr. Matthews engaged in improper practices by excessively trading in (churning) the accounts of three clients, for the sole purpose of generating additional commissions, contrary to Dealer Member Rules

These are fine regulator-speak words but let's take a closer look at what really happened to one of the clients in more detail , client EF. Source : http://www.iiroc.ca/Documents/2014/5e35ee7b-0a06-4618-a4f3-b90971a9ef33_en.pdf

Know your Client (KYC): Client - EF is a 69 year old retired widow. She has a high school education, and was a homemaker for much of her working life. She also worked at one time as a franchisee operator of a lottery booth. Her late husband, RF, worked as a custodian at a local high school before he retired. Prior to that, he managed a gas stationer generally left the household financial affairs and investment decisions to her husband.11. A March 2004 New Client Account Form (“NCAF”) for EF’s RRSP account stated that EF earned $40,000 per year from the lottery booth, and RF earned $32,000 per year as a custodian. Their stated liquid assets were $100,000, and their fixed assets were listed as $300,000. The stated [ emphasis ours] investment objectives [ emphasis ours] were 50% long term growth, 50% short term speculative, [ are these are clear and proper objectives for a retiree?] and her stated risk tolerance parameters were 50% medium and 50% high. At the time, EF was 60 years old and her investment knowledge was listed as “fair” [ whatever that means but we can be confident she didn't understand the leveraged ETF's mechanics] . Her husband died in May 2010. Following her husband’s death, in June 2010, EF, met with Matthews to sign estate documentation and discuss his future handling of her accounts. She was then 67 years old. Do you think this is a well defined set of “objectives” for a person in this financial situation? Do you think this is robust KYC or a setup for a fee grab?

She completed an NCAF to open her TFSA account, which stated that she was retired,
with a modest income of $32,000 per year. The investment objectives were 25% income/50%
long term growth/25% short term speculative, and the risk tolerance parameters were
changed to 33% low/33% medium/33% high [ whatever that means]. The stated assets remained the same, as did the description of her investment knowledge as “fair”. Given the available information, her risk capacity , the ability to absorb losses, was low . Losses in a TFSA cannot be offset against capital gains. The word “ fair” is meaningless and it appears to be a slick way to justify the risky trading strategy in her TFSA account by portraying her as more knowledgeable than she really is..

Following her husband’s death, EF completed an NCAF for the TFSA, but not for her other accounts. There are no account updates between June, 2010, and EF’s transfer of her accounts to another firm in May, 2012 [ for us, this suggests a compliance systems problem] IIROC notes that for the period of June 2010 onward, the stated investment objectives and risk tolerance parameters were too aggressive for EF, who was then a retired and recently widowed senior, with limited assets and income. IIROC says Matthews failed to learn and remain informed of the essential facts relative to EF as the stated investment objectives and risk tolerance parameters in her accounts were inconsistent with her true financial situation, investment knowledge, investment objectives and risk tolerance. In our view that is being disingenuous. We say Mathews deliberately set it up so he would have a paper trail to show his actions were consistent with a knowingly defective KYC document. He didn't fail, he succeeded at deception.We also ask, where the heck was the supervisor or Branch manager to prevent this obvious information travesty? And why does the IIROC investigation report play word games?

Suitability :EF's investing knowledge was very limited so naturally IIROC has concluded EF relied upon and followed Matthews’ recommendations for the investments in her accounts. “This was particularly evident during the time period of June 2010 onward, following her husband’s death” IIROC notes. Did the Branch manager not notice the change in pattern? In general, the nature of the trading in the RRSP account [ her retirement fund] was focused on frequent trades in medium to high risk securities. The medium risk securities were primarily resource issuers trading on the TSX, and the high risk securities were primarily commodity-based leveraged exchanged traded funds (“LETF”) , a complex speculative product that works on the basis of daily returns. There were no low risk holdings according to IIROC yet the dealer's systems did not detect this wholly unsuitable portfolio construction.. From May 2010 to April 2012, the average hold period for all securities was approximately 5 months. The average hold period was just 38 days for positions in which gains or losses were actually realized. In addition, although there were some purchases made in the accounts of dividend-paying securities, in many cases the securities were not held long enough to be eligible to actually receive the dividends. By now, you'd think someone at the dealer would have woken up to the fact this poor retiree was being gamed. No such luck.

Between Jan. 2009 and Oct. 2010, there were an incredible 66 LETF transactions, which resulted in losses of $14,999 (including $7,805 in commissions). The majority of the LETF positions were held for short time periods, on average 2.74 days. However, there were 5 LETF trades which were held for a much longer period, an average of 178 days, and resulted in losses of $17,485. Between June 2010 and May 2012, the total value of EF’s accounts declined from $115,478 to $106,159, reflecting a loss of 8%. This included the payment of commissions of $13,378. During the same time period, the S&P TSX Composite Index increased by 5.29% for a differential of 13.5 %. During this time period, the performance of her holdings was very volatile in comparison to the overall market performance. The total value of her accounts ranged between approximately $160,000 to $100,000. Such volatility is a sure sign that account risk was high The dealer Reps recommendations were not suitable for this client in light of her age, employment status, investment knowledge , experience and true circumstances but inexplicably they continued for a considerable time without dealer intervention except to cash brokerage commission cheques.

Discretionary Trading : The nasty “advisor” behaviour doesn't stop with unsuitable investments. . During the period from June 2010 (after her husband’s death) to May 2012, Matthews made 113 trades ( about 1 trade per week!) in EF’s retirement and savings accouterments tells us that EF says that she instructed Matthews to “take care of her”, and that she “left everything up to him”. She wanted him to continue the type of trading activity that he had carried out with RF, as she had limited investment knowledge. Gimme a break . During the material time, Mr. Matthews executed many trades in EF’s accounts without confirming the details of the trades with EF prior to their execution. The hapless widow's retirement account savings were not designated as discretionary by Leede but they happened anyways. Leede’s supervision and systems failed to pick up on this in your face financial assault.

What do we learn form this case ?

Clearly , Risk tolerance does not match the trading patterns. It should have been 100% speculative risk. Anything else is a compliance breach. Investment knowledge is “fair”. An attentive supervisor should not ever set up a speculative account for an investor with “fair” investment knowledge. And of course Objectives did not match risk . Despite the obvious, this exploitation carried on in plain view for a prolonged period of time.

The first lesson learned is therefore quite clear. The most basic systems and processes were not in place at Leede . Nearly everything that could be wrong , was wrong. The real culprit here is Leede Financial . We do know the abusive practices by this individual impacted 4 other investors possibly many more at that Branch. IIROC tell us it is standard practice for IIROC Investigation teams to consider the issue of supervision whenever they are conducting an investigation of a dealer Rep, and to investigate where there are indications of a failure to supervise. However, given the confidential nature of their investigations, they cannot confirm whether or not they have or had an active investigation ongoing, unless and until any such matter proceeds to disciplinary action, in which case it then becomes public record when a Notice of hearing is issued. They assert that it is general practice to prosecute cases involving a failure to supervise by way of a separate Notice of Hearing before a separate Hearing panel.

Here's some 2013 IIROC Enforcement statistics for 2013 that we think speak for themselves.:
There were 1690 complaints of which 280 originated from the public
There were 203 complaints involving unsuitable investments and 88 involving unauthorized trading
There were just 63 prosecutions of individuals by IIROC of which 19 involved suitability ,1 involved discretionary trading and just 4 involved supervision
There were only 12 prosecutions of dealers of which a mere 5 involved supervision ( this is for the entire year for all of Canada)
Fines imposed on individuals amounted to $4,382,500; only 10.5% of the penalties assessed against individual registrants were collected.
Fines imposed on dealers amounted to $2,220,000 ,about half that imposed on individuals; 98.1% of the penalties assessed against dealers were collected
What do these numbers suggest to you?

In the Mathews case we say that management was asleep or willfully blind at such horrific and highly visible and prolonged financial assault. This cannot and should not ever happen in the wealth management industry especially to multiple victims over such a extended period of time. The advocacy community, including a number of former and current Reps, is of the firm conviction that SRO's are spending too much time on disciplining Reps ( and not collecting fines) and not going after the root cause : Deficient supervision / compliance systems and a broken KYC system. The great Quality Control expert Edward Deming coined the rule: 85-97% of problems are the responsibility of management. We are convinced this is correct .This is why for every Rep prosecution we expect at least one corresponding supervisory prosecution and with much higher penalties and sanctions. A few strong high profile examples would change dealer behaviour real fast.

We argue that suspected supervisory breakdowns should have at least as high investigation priority than Rep prosecutions and should carry larger fines. This is further supported by the fact that Reps are usually fired but Branch managers often remain on to be negligent again in the future.

Hopefully, 2015 will see a lot more timely prosecutions of dealers for breakdowns in supervision , compliance and KYC deficiencies/adulteration.

The other BIG lesson . CAVEAT EMPTOR ! You are not dealing with “advisors” that are required to act in your Best interests.

Kenmar SRO surveillance Team

Monday, December 8, 2014

ALERT: The trouble with fee-based accounts

ALERT : Improper use of fee-based accounts                                                         December, 2014  

We have received a flood of queries and complaints regarding advisors' actively promoting fee- based accounts rather than commission –based accounts. It looks like an epidemic that we hope regulators pro-actively address. Some of the increased conversion activity may be due to proposed regulatory iniatives to prohibit embedded sales commissions/trailers in products.Ironically, unless there is robust supervision , regulatory oversight and self-protection, you may end up paying more as a result.

Commission- and fee-based accounts each involve different advantages and disadvantages for clients, and these basic advantages and disadvantages should be clearly understood before signing up for an account type.

In a commission-based account, you are charged a commission each time a trade is executed. For you, the advantage of this arrangement is that the service(s) received in exchange for the commission paid is concrete and specific-a given trade, which is typically based on a specific recommendation by the dealer representative. Moreover, when the client’s account is inactive-either because no recommendation has been made or because the advisor has recommended a long-term hold on a security-the client incurs no trading commission . Most canadians are Buy-and -Hold so fee-based accounts may not make sense for the majority.

In several cases ,client investments were converted into expensive proprietary products ( incurring early redemption fees on their mutual funds along the way ) and then their accounts moved into fee-based accounts where they were gouged on the fixed rate by paying thousands per year more than what they would have paid had they simply held the Baskets and Private Pools in ordinary non fee-based accounts. In another case , a retiree who made just two trades paid account fees which amounted to more than 10 % of her annual account income of $11,000. The unsavoury practice of placing a client who trades infrequently in a fee-based, rather than a commission-based, account is known as “reverse churning”.  In one extreme case, a 89-year old widower was charged $31,000 for just 4 trades over 2 years!

In contrast, fee-based accounts charge a set percentage of account value or, in rarer cases, a flat fee, for an ongoing service, regardless of the number of trades that occur in the account over the specified period. In principle ,the advantages that fee-based accounts potentially include:

(1)fostering a greater alignment of interests between the dealer Rep and the client, under the assumption that, if the Rep's compensation is based on a percentage of the value of the assets in the client’s account, it is in the best interest of both the client and the advisor to maximize the value of those assets;

(2)reducing the likelihood of certain harmful sales practices, such as churning or making recommendations unduly influenced by compensation, since such practices will not increase the dealer Rep’s compensation, but may expose them to liability and regulatory risk;

(3)increased transparency of the cost of services and advice provided to the client insofar as fee-based charges make it less opaque to clients that they are compensating their Representive for services, including those that do not necessarily result in trades (e.g. a recommendation to continue holding a security or maintain assets in cash ). In a commission-based account, clients may be led to assume that these services ( if provided ) are provided for free, even though they may be embedded into the product fee structure; and
  (4) enhanced predictability of fees/charges ( for dealer and client) but not necessarily lower fees for  clients.

Unfortunately, principles and dealer Rep fee revenue goals too often collide.

The type of complaints we are receiving center on pressure to convert to a fee-based account without proper rationale. Those who transact most may be better off in a fee- based account, and those who transact little may be better off in a commission- based account. A number of complaints also surround the question of whether cash,/GIC's should be exempt from the fee.Read and understand the terms of the account agreement before signing.

The fee- based account is really a volume transaction discount, strategically priced at a level that ensures both dealer Rep and dealer earn a good return from their clients who decide to proceed with this option. Such a recurring revenue model is perfect for dealers. While one of its stated potential advantages is that it removes the temptation to churn an account, there is plenty of room to take advantage of the investor: clients who transact little and therefore have a minimal commission trail can be plunked into a fee- based account and thereby increase dealer Rep and firm revenue at the expense of clients. We have also seen IPO's appearing in retail accounts where embedded sales commissions are not only attractive to dealers but actually, in the case of closed-end funds, harmful to investors.

If you are encouraged to unnecessarily leverage your investments, the apparent advantage of lower dealer /Rep transaction fees is negated by increased fees on higher account asset balances and more investment risk for you. Using margin is an increasing danger to be on the alert for as fee-based accounts multiply.

Another common complaint is from clients, especially the elderly, with a basic bond portfolio who are being charged a fee between 1% and 2.25%, a rate that is higher than the interest rate on a majority of the bonds in the client’s portfolio. While this action is not outright illegal, it is highly unethical. A bond is meant to be an income-producing vehicle used to pay a certain interest return for a designated period of time. At bond maturity, the client receives his money.However, when the portfolio is static, meaning the Rep researched the bonds, sold them to you for a good reason, and earned a commission initially, there is no reason to charge an annual fee . To charge an annual fee for managing a portfolio of bonds, when all that the client needs are his mailed interest cheques, amounts to financial abuse.

Several complaints concern investors who hold both a commission and a fee-based account . In those cases,, the Rep charged the client a commission on the purchase of a security and subsequently charged an additional fee by transferring that security into a fee-based account.

Given the attractiveness of fee-based accounts for dealers/Reps, such an account might reduce the probability of say, Rep recommendations that involve a low-cost ETF portfolio requiring only once a year rebalancing. You need to be alert – in fact, ask why ETF's are not utilized in your commission -based account before even considering conversion to a fee-based account.

Investment dealers love a steady revenue stream and a lot of the products and services they provide are designed to deliver this. One example is the unduly popular wrap account, where a mutual fund company takes a few of its proprietary funds and wraps them together in a single portfolio-in-a-box product. Wraps are brilliantly promoted, but not nearly as good as building a portfolio by selecting the best, economical funds from a variety of companies instead of just one. In effect, a wrap does all the security selections and asset allocation freeing up the Rep to hunt for new clients.

Fee-based accounts make some sense for clients who trade actively and rely on the guidance of a professional advisor who might provide a wide range of services that might include estate and tax planning as well as investment recommendations. The important questions to ask are: “Are these services actually provided?” and “Does frequent trading actually lead to better returns?”. There is significant research evidence that it does not. Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell..” - Warren Buffett

The best-suited clients for fee-based accounts are ones who are active investors and have a solid knowledge of what they’re doing. Unsophisticated investors more intent on collecting income than portfolio growth are the least suited to account conversion.

A large number of complaints involve A class mutual funds in a fee-based account. Effectively the dealer/Rep is receiving the trailer commission on top of the account fee ( double-dipping) .In November, TD Bank subsidiaries were required to repay overcharged mutual fund clients The

subsidiaries were required to pay about $13.5 million to some current and former clients to compensate them for more than a decade of excess mutual fund fees as part of a settlement deal approved by the Ontario Securities Commission (OSC). The OSC was told that failures in the firms’ internal controls and supervisory systems lead to fee calculation errors in some accounts. In other instances, clients were not advised that they qualified for mutual funds with lower MERs, or management expense ratios.Apparently no one figured this out over a period of 10 years. Lesson : Check your account to ensure you're not getting hosed.For a fee-based account ,you should be sold F class funds which have the trailer commissions stripped out of the MER.

In the December edition of the OSC's Investment Funds Practitioner, the regulator indicates that it is problematic for an investment fund series that is intended for fee-based accounts to include embedded trailer commissions. "This type of dual compensation structure is inconsistent with a critical attribute of the fee-based series, namely the negotiation of the dealer's compensation, which is intended to provide investors with heightened transparency of the cost of the dealer's services and a clear expectation of the services to be rendered in exchange for the negotiated fee," it says.

Bottom line : Costs count. In short, fee-based accounts may not be the best fit for certain clients if annual fees end up costing more than the trading commissions that would have accrued in accounts that show little to no activity.Think twice about opening a fee-based account then think again every time you see a charge. Experienced investors who manage their own portfolios can cut their costs dramatically. A portfolio of index exchange-traded funds (or index mutual funds) should cost no more than 0.4 % annually, including commissions to buy and sell.If you buy stocks and bonds directly via a discount broker you can save even more. .CAVEAT EMPTOR

Saturday, November 22, 2014

The Folklore of Finance : How Beliefs and behaviors Sabotage Success in the Investment Management Industry

In  “The folklore of finance: Beliefs that contribute to investors’ failure” Paul Sullivan discusses a new study The Folklore of Finance : How Beliefs and behaviors Sabotage Success in the Investment Management Industry  indicating that “the way individual and professional investors made investment decisions was so skewed that achieving both high returns and long-term objectives was nearly impossible”. What the study found is that due to “’the folklore of finance’…people were overconfident in their investing ability, unable to focus on their stated long-term goals when distracted by short-term noise in the markets, and had come to distrust their advisers and lose interest in receiving professional investing help.”  The study also found that the prognosis is poor for changes to investor current behavior exemplified by: “futile quest for alpha”, short-term orientation instead of focus on “setting a financial goal and meeting it”. If your advisor is not calling you regularly to discuss how you are doing against your long term goals, perhaps you should be looking for a new advisor. Thanks to Peter benedek at

http://retirementaction.com/2014/11/21/hot-off-the-web-november-24-2014/  The Full Study is available at http://www.statestreet.com/centerforappliedresearch/doc/folklore/paper.pdf In effect, the financial services industry faces a crisis of faith that may lead to more Do it Yourselfers that can be counter to investors' long term interests.The financial services industry needs to develop a new Folklore of Finance that reinforces the values to achieve true success beyond the profitability of industry participants.

Saturday, November 8, 2014

There's disclosure and then there's mal-disclosure

Disclosure is intended to foster robust communication and understanding between the dealer representative and the investor.It permits an understanding of the risks, fees and suitability of an advisor recommendation so an informed investment decision can be made . Emailing a copy of Fund Facts is technically a disclosure under a transaction business model but providing complex documents to retail investors without engaging them is not disclosure in a client -advisor relationship model.Sending it AFTER the purchase decision has been made adds to the nonsense. But even if an effective mandated disclosure regime is implemented ,dealer Reps have a variety of techniques to subvert disclosure should they wish to do so.Unfortunately , some do. This article sheds some light on the murky world of  investor mal-disclosure processes . Read the article   Be AWARE.

Outside Business Activities can Impair your Financial Health

This article explains why working side deals with your advisor may not be the smartest move. Lots of potential bear traps. Read the article here 

Friday, November 7, 2014

Complaint handling for Seniors in need of major reform

Complaint investigators have not tailored their protocols to match the unique challenge of complaints from the elderly. Most haven't made the cultural shift to comply with CRM and IIAC's list of Best practices in dealing with seniors. The mindset change from a transaction business to an advice business is not encapsulated into operations or complaint investigation methodologies /assessments. Complaint investigators need to realize that the risks clients face saving for retirement are different than the risks they face during retirement. Building a plan to distribute a nest egg in a manner that mitigates the unique risks the client will face during the retirement years is absolutely necessary yet most complaint investigators do not consider this in complaints received from seniors and retirees. Dealing fairly, honestly and in good faith with clients includes the handling of complaints. Further, a number of civil cases have demonstrated that new standards of care are expected within Canadian society and complaint investigations should take them into account.

Once Securities Commissions and the MFDA/IIROC  improve their processes it can be an example for investment dealers to follow. This article describes the practices and behaviours that need to be changed. Read it here 

Tuesday, November 4, 2014

The Great KYC Deception....a relationship not in your favour

Kenmar Associates                    Financial Literacy Month                                        November , 2014

Investment KYC Deception, investors deceived, "set-up" from the account opening..a relationship not in their favour

Here's our contribution for this year's Financial Literacy Month. How millions of investors, Canadian and American are deceived, and "set-up" from the very account opening into a relationship which might not be in their favour. Unlike industry participants and their lobbyists, we concentrate on Investor Protection via Streetproofing-making retail investors street savvy.

The KYC (Know You Client/Customer Application Form) is designed and completed in a manner to be used against your investment interests by salespeople and dealers, and used against you a second time if and when you complain against them.

It is one of your first acts when you visit investment sellers, and this video by seasoned investor advocate Larry Elford ,shows how the dealer is years and years ahead of your experience in the matter, and how they take advantage of this to set the stage…..for themselves. Not every broker/dealer does this of course, but the percentage is in the majority, so your odds of going through the process described in the video are quite high.Enjoy the Video.

Investment KYC Deception   Click here 

Keep in mind that even if you have the MOST TRUSTWORTHY man or woman on your side, the dealer who sponsors their sales license should be approached from a Caveat Emptor perspective.Until a Best interests regime is implemented , that's the safest approach.

Stay tuned for more Streetproofing educational materials.

Rules of Prudence for Individual Investors

Rules of Prudence for individual investors
A plain English set of  common sense rules that could save you a lot of money and anguish. 

Saturday, November 1, 2014

Mandatory and Voluntary Disclosure Leads Advisors to Avoid Conflicts of Interest

Abstract Professionals face conflicts of interest when they have a personal interest in giving biased advice. Mandatory disclosure—informing consumers of the conflict—is a widely adopted strategy in numerous professions, such as medicine, finance, and accounting. Prior research has shown, however, that such disclosures have little impact on consumer behavior, and can backfire by leading advisors to give even more biased advice. We present results from three experiments with real monetary stakes. These results show that, although disclosure has generally been found to be ineffective for dealing with unavoidable conflicts of interest, it can be beneficial when providers have the ability to avoid conflicts. Mandatory and voluntary disclosure can deter advisors from accepting conflicts of interest so that they have nothing to disclose except the absence of conflicts. We propose that people are averse to being viewed as biased, and that policies designed to activate reputational and ethical concerns will motivate advisors to avoid conflicts of interest. To read the full Paper click here 

Monday, October 27, 2014

The role of securities regulators in “educating ” financial Consumers

The role of securities regulators in “educating ” financial Consumers                   October, 2014

October is Investor Education Month in Canada so it's a good time to discuss the role of regulators in educating financial consumers. We support financial literacy for Canadians but have warned against depending on it as a tool against consumers making big mistakes and industry abuses. Laws and Codes , a Best interests standard and robust enforcement are needed to protect consumers - financial education and disclosure alone can't do the job.A Best interest standard and "merit regulation" would benefit investors far more than "investor education" which no matter how good it is, does not narrow most investors' competency/capability gap.

That being said, actions need to be taken until financial advice is delivered on a professional basis.

The MFDA prepares some excellent guidance materials for the dealers it regulates. It should do the same for its most important stakeholder - the mutual fund investor - materials that will explain their rights , how the MFDA protects them and where the bear traps are. We call this type of education Street proofing -getting investors primed to engage with Bay Street- improving awareness. If well done, it would increase the level of engagement that regulators have with Main Street and help prevent at least some complaints and potentially increase client satisfaction. It would help create a cadre of oonstructively critical and inquisitive investors determined to better understand the advice given and the nature of their investments.

Recently ,the Mutual Fund Dealers Association of Canada (MFDA) announced the launch of an investor education section on its website. In the new section, investors can find information about mutual funds, including information about fees and Fund Facts documents, as well as information on checking a salesperson's ( advisor's ) registration and disciplinary history, the MFDA /IPC investor insurance scheme , OBSI and advice on avoiding fraud and financial harm. Links to investor education resources from members of the Canadian Securities Administrators are adroitly used as well as other regulators and international organizations. Including the SIPA and FAIR Canada websites would be helpful too. Investors who are seniors / retirees can also review the seniors' section of the MFDA website which contains information about the assistance that the MFDA can provide to seniors, as well as a library of links to on-line resources directed towards Canadian seniors.A good MFDA communication plan should ensure it will be accesssed by many information hungry mutual fund investors.

This initial effort by the MFDA is welcomed but much more can and needs to be done. There are a number of areas that we think deserve special attention from the MFDA. These are primarily areas where we are receiving a lot of requests for additional information or where there have been a significant number of complaints. These include but are not limited to : Outside business activities, the risks of leverage, dealing with advisors that are dually registered ,"Free Lunch" Investment Seminars -Avoiding the Heartburn of a Hard Sell , Guide to filing a robust complaint , peeling back the DSC onion, completing a NAAF to prevent problems,What the heck is KYC and why it is important? , How mutual fund salespersons are paid , Understanding the impact of conflicts-of -interest, Understanding the difference between Best interests and Suitability, Understanding and using the Fund Facts Risk disclosure , Using the Account Statement for better investing outcomes, The difference between Suitable and Unsuitable investments and the meaning of “advisor “ titles and credentials ( could link to Glossary on IIROC website) . A forthright presentation in text and/or smart phone APPS of these tough issues will help reduce investor abuse / undue losses and improve investor outcomes.

Better design of forms would allow a certain amount of education to be embedded in the form itself.For instance, there have been numerous suggestions to make the New Account Application Form more meaningful and for Risk Profiling approaches to be documented and standardized.Online forms could be made “ intelligent ” and interactive . Such an approach is consistent with Just in Time delivery of information and education.

We would also like to see the MFDA ( and IIROC) issue timely ALERTS informing investors of specific issues and hazards prevalent at the time. This could include warnings about deceptive advertising ( a great example can be found at http://www.fca.org.uk/consumers/protect-yourself/misleading-adverts ), Betting the Ranch: Risking Your Home to Buy Securities , The signing of blank forms, explaining Return of Capital mutual funds, Alternative Funds Are Not Your Typical Mutual Funds , The risks and dangers of making financial side deals with your salesperson , Using the MFDA Whistle blower program, How to effectively use Fee disclosure and Performance reporting , Watch out for Misleading Titles and Designations , How to read the Fund Prospectus etc. ALERTS should also inform investors of ongoing Consultations and new or pending regulations/ rules of interest to retail investors. Investors would subscribe and have the ALERT sent directly to their email inbox. This kind of real time investor protection is vitally needed in today's fast paced investment world.

Investor education can also be effected by the use of Case Studies ( narrative and /or video) which showcase people's experiences with different investments and dealers. Such studies make investing issues real to main Street. It is well known that for retail investors , personal stories are more effective in conveying messages than dry facts. Given the wealth of data locked up in MFDA investigations and Enforcement Cases ,the MFDA should use Case studies to inform investors what can go wrong and how to protect against advisor /dealer malfeasance. Street proofing investors is a core element of investor protection.

Finally, a comprehensive Glossary of all the commonly found terms in the mutual fund industry would be extremely useful. A good example would be the one provided by Morningstar Canada. A simple link would do the job.

All documents , ALERTS and Warnings should be written in plain language and available in both English and French.

A similar set of ideas apply to IIROC but these would include additional topics uniquely relevant to the brokerage industry. Similarly, Securities Commissions could fill in the gaps for the Exempt market , in particular, Equity crowdfunding. By working collabartively with SRO's a robust Street proofing educational regime can be esttablished at reduced cost.

Financial literacy topics such as portfolio construction , risk minimization ,the calculation of performance return , asset allocation, tax optimization, The relationship between risk and return, The Grass Isn’t Always Greener-Chasing Return in a Challenging Investment Environment , Structured products , Financial tools and calculators etc. should , with a few exceptions, be left to professional educators that are independent of both the industry and securities regulators.They have much greater leeway to be constructively critical of regulations, regulators, industry participants , industry sales practices and behaviours.

Of course , if investment advisors were professionals working to a Best interests standard , much of this Street proofing education would be redundant . There would be no need for CAVEAT EMPTOR


     1. Investor Enquiries and Complaints Archive: Kenmar Associates
  1. IOSCO REPORT ON INVESTOR EDUCATION INITIATIVES RELATING TO INVESTMENT SERVICES http://www.lautorite.qc.ca/files//pdf/education-financiere/IOSCOPD404.pdf
  2. Improve consumer protection by SROs: C.D. Howe Institute research report
  3. Marketing of mutual funds (2005) Ken Kivenko http://venablepark.com/articles/analyze_fund_ads_for_clues.pdf
  4. How to know when your advisor is behaving badly - The Globe and Mail http://www.theglobeandmail.com/globe-investor/investor-education/how-to-know-when-your-adviser-is-behaving-badly/article18593654/#dashboard/follows/


Friday, October 24, 2014

Advisor's Alpha :Good for your Practice and your Clients ( Vanguard 2013)

Outperforming the broad market has historically been very difficult, both in absolute terms and in tax- and risk-adjusted frameworks. Where adding value is the goal, advisors may be better served by changing their performance benchmark from the market’s return to the returns that investors might achieve on their own, without professional guidance. A financial advisor has a greater probability of adding value, or Alpha, through relationship  oriented services, such as providing cogent wealth management and financial planning strategies, discipline and guidance, rather than by attempting to outperform  the market.Read the Paper

d research May 2012

Tuesday, October 21, 2014

On the stability of Risk Tolerance

It is widely believed that (financial) risk tolerance is highly unstable and particularly subject to market conditions. However, through a series of independent studies there is now strong evidence that this view is incorrect. The most recent study clearly demonstrates the stability of risk tolerance across the 2003 to 2009 market rises and falls through detailed analysis of test/retest data, involving two tests of the same individuals, the first during the 2003-7 bull market and the second in the subsequent bear market. The study confirms the anecdotal evidence from FinaMetrica subscribers that clients' risk tolerance scores remained remarkably stable through the most turbulent market conditions in living memory. Many advisors and others involved in financial advisory services will now need to change their views about the nature of risk tolerance, how it should be assessed and its role in the financial advising process - all of which will be discussed under Consequences for Advice. However, before considering the consequences we should review the evidence for the stability of risk tolerance and before that we should examine why the contrary view is so widespread.Read the Research paper here

Monday, October 13, 2014

All you ever wanted to know about Disclosure...and MORE

A core tenet in contemporary securities regulation is that public disclosure will level the playing field by reducing information asymmetries. It's tempting to think that just by spelling out the features and risks on a piece of paper, let investors read it and everything's OK — the investor now can make an informed investment decision.. The reality is that the disclosure process is far more complex . Effective disclosure depends on how clearly written the disclosure is , the completeness of the disclosure, the investors' willingness to read it , the investor's understanding of the disclosure , the investor's financial and contractual literacy , the investor's vulnerability level, when the disclosure takes place and a number of other factors.Even the method of delivery ,font size and location can impact the effectiveness of disclosure.In the case of retail investors, we have concluded that disclosure is a necessary but insufficient tool for investor protection.In this blog we discuss a few key aspects of disclosure for the retail investor.

Take a look at our Comment letter on Point- Of- Sale disclosure to the Bank of International Settlements.It's a great primer on disclosure as it appies to investing. It's written in plain language so very easy to follow.http://www.bis.org/publ/joint32/kenmar.pdf

For over a decade, Kenmar Associates has advocated for the delivery of Fund Facts prior to the
decision to purchase mutual funds. For whatever reasons, such an obvious requirement has been
opposed by industry participants and lobbyists. This makes absolutely no sense if there is to be an
informed investment decision. It is inconceivable that an industry which constantly claims the value of investment advice should not insist that dealer representatives provide a copy of FF's to clients before the purchase decision is made. Providing FF two business days after the investment decision has been made is a nonsense disclosure . Here's what we told regulators http://www.osc.gov.on.ca/documents/en/Securities-Category8-Comments/com_20140411_81-101_kenmar-associates.pdf

Disclosure isn't just about product characteristics and features.One of the complaints often heard about the investment industry is lack of disclosure about compensation. It is up to clients to ask their financial advisor how they are compensated, and even then it might be difficult to verify if the advisor is telling the truth. Independent research has demonstrated that compensation has a huge impact on the investment recommendations by advisors ( non-fiduciaries). It would seem that more disclosure is the obvious answer, but according to one academic study it might not make much of a difference in the actions of clients and might make the advisors even more biased.George Loewenstein et al from Carnegie Mellon University wanted to evaluate the effects of conflict of interests disclosure from advisors, on the decision making of their clients. The study entitled “TheDirt On Coming Clean:Perverse Effects of Disclosing Conflicts of Interest“ had a surprising result .- disclosing the conflict- of- interest actually increased the bias even more.Lowenstein argues that “moral licensing” is one of the reasons this happens. Basically this theory says that an advisor with an undisclosed conflict- of-interest will feel guilty enough about it that they will try to “do the right thing” to some degree. By disclosing the conflict- of-interest, it allows the advisor to do whatever they want since they have admitted the conflict and therefore don’t have to feel guilty about it anymore. Be aware.

Regulators recognize that sales communications play an important role in the business of investment fund issuers, and as such,expect such communications to provide “clear, accurate and balanced messages, particularly when directed at retail investors.Such materials, if improperly written, can undo the positive intent of mandated disclosures.Sales communications should be in plain language and avoid the use of industry jargon, defined terms or acronyms and generally be easy to understand by retail investors. Information, including warnings, disclaimers and qualifications, must be given sufficient prominence in order to be consistent with the content of the document.Sales communications should not include statements that are vague or exaggerated or that cannot otherwise be verified. Regulators expect fund companies and dealers to include specific information in sales communication documentss if a distribution or yield is quantified in such document, including the basis of the calculation, the percentage of total distributions comprising reinvested units, how the yield was calculated, the time period covered by the distributions, the key assumptions and the impact changes to such key assumptions may have on the target distribution or yield. Lastly, They also expect that return of capital distributions should not be presented in a way to suggest that they represent investment returns.A lot of expectations but unfortunately little monitoring and regulatory enforcement.

It is all well and fine to disclose the MER of a mutual fund but unless the investor can assess the long-term impact on fees, the disclosure has limited value.Similarly ,if performance is provided without comparison to a benchmark , the average retail investor may derive little from the disclosure. Some disclosure documents are so complex and filled with elaborate terms and conditions that it should come as no surprise that retail investors find it difficult to make informed decisions.This is one reason why we have promoted the idea that investment advisors should be proficient and be required to act as fiduciaries.

We will soon be commenting on the fee and performance disclosures required by the Client Relationship Model part 2.Until CRM2 disclosure focussed on the prospectus and continuous disclosure obligations. With CRM2 ,regulators awoke to the fact that dealers had been able to promote a transaction business as an advice business but without the associated disclosures and standards. Once registered as salespersons, stockbrokers and salespersons  became dealer representatives and business titles changed to advisor and other misleading tiitles which calmed invesrors. .Hence the sudden need for the disclosure of fees , account performance , conflicts- of -interest and client relationships and an increrased regulatory scrutiny of  "advisor " titles and designations.

We have also commented in the past on " Free lunch" seminars, financial pornography , presentations at retirement homes, Fund company webinars , "advsor" use of social media and other " off book" disclosure mechanisms that are loosely covered by securities laws and rules.All of these sorts of  sales communications ( i.e. disclosures of information  designed to promote sales) can be hazardous to your financial wealth. Take a read about what one abused investor has to say about “un-disclosure ” .http://www.investoradvocates.ca/viewtopic.php?f=1&t=180&p=3786#p3786

Sunday, October 12, 2014

Broker Incentives and Mutual Fund Market Segmentation

Broker Incentives and Mutual Fund Market Segmentation Diane Del GuercioJonathan ReuterPaula A. Tkac NBER Working Paper No. 16312 Issued in August 2010 NBER Program(s):AP   IO 

We study the impact of investor heterogeneity on mutual fund market segmentation. To motivate our empirical analysis, we make two assumptions. First, some investors inherently value broker services. Second, because brokers are only compensated when they sell mutual funds, they have little incentive to recommend funds available at lower cost elsewhere. The need for mutual fund families to internalize broker incentives leads us to predict that the market for mutual funds will be highly segmented, with families targeting either do-it-yourself investors or investors who value broker services, but not both. Using novel distribution channel data, we find strong empirical support for this prediction; only 3.3% of families serve both market segments. We also predict and find strong evidence that mutual funds targeting performance-sensitive, do-it-yourself investors will invest more in portfolio management. Our findings have important implications for the expected relation between mutual fund fees and returns, tests of fund manager ability, and the puzzle of active management. Furthermore, they suggest that changing the way investors compensate brokers will change the nature of competition in the mutual fund industry. Read the paper 

Thursday, October 9, 2014

The importance of Risk Profiling

The #1 cause of client complaints is unsuitable investments. The # cause of unsuitable investments is a poor risk assessment of the client risk profile.The article discusses the elements of risk and how to take risk into account when designing an investment portfolio.Read the article

Monday, October 6, 2014

IFIC funded study points the way to reform-our Observations

IFIC sponsored a Study by  The Conference Board of Canada (CB0C) Boosting Retirement Readiness and the Economy Through Financial Advice CBoC is recognized as a professional research house with the highest level of intellectual integrity.. CBoC openly acknowledge that “advisors” do not produce enough extra returns to cover their fees . CBoC argue that the real benefit of having an advisor may not be investment advice at all. It may have more to do with engendering beneficial savings behaviour among clients. They concluded that if more people used investment advisors, they would save more money, and the country would benefit over the long term .As is well known ,“advisors” seek out clients who already have significant investable savings and tend to drop clients who fail to invest enough money over time because these clients don’t generate enough fees .If one reads between the lines, CBoC is saying that account underperformance is significant and the main benefit of advice is an increase in savings rate i.e. a babysitting role. This implies that if lower cost products were recommended , better returns would be obtained AND even more savings would accrue. However, the current Canadian business model where “advisors” sell more expensive ,underperforming actively-managed mutual funds leads to high costs and minimal unbiased advice. This supports a reformed business model where investors pay advisors' separately for tailored advice rather than having the mutual fund company pay for the advice contingent on selling their product..This way ,investors can feel more assured that the recommendations made are in their best interests and if not, they can engage another advisor or become a DIYrs if they feel they are sufficiently competent to control their own financial destiny. This will lead to increasing the number of professional advisors and enhanced financial outcomes for over 10 million Canadians. IFIC deserve credit for engaging CBoC and letting the chips fall where they may.Read our Observations