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.

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

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 ” .

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