Brokers misleading investors about fiduciary duty: PIABA Report

The U.S. organization  , the  Public Investors Arbitration Bar Association ( PIABA) has issued a report highlighting how U.S. brokerages mislead investors as to the true nature of the dealer- client relationship.

They want Federal action to stop  U.S. Brokerage Firms misleading investors about their role as fiduciaries, which Firms deny to block arbitration claims.

"Investors believe they are doing business with individuals they can trust, because the brokers use titles which imply trust, their advertisements give the impression they can be trusted, and the brokers say they can be trusted to look out for the best interests of their clients.  A survey of the major brokerage firms show consistency in the advertising, in the tone they take on their websites, and the impression that they intend to leave on investors," said the report's other co-author, Christine Lazaro, director, Securities Arbitration Clinic at St. John's University School of Law.

"Yet when that trust is breached, a survey of answers filed in arbitrations demonstrate that these same firms disclaim liability when held to account in arbitration, and rely on case law to say no such duty exists. The public face of the firms is that they hold themselves to the highest standards, while the private face of the firms, in the arbitration forum where everything is non-public, is that they are mere order-takers," she says. https://piaba.org/system/files/pdfs/PIABA%20Fiduciary%20Study%20News%20Release.pdf 

A similar situation exists in Canada.Some examples of what has been dubbed The Grand Deception:

A survey of business titles by the Investment Industry Regulatory Organization of Canada (IIROC) found  that there is a wide array of business titles in use by licensed representatives both across firms and, in some cases, within the same firm. Some of the more commonly used business titles that were reported through the survey include: Advisor, Financial Advisor, Financial Assistant, Investment Advisor, Senior Investment Advisor, Financial Consultant, Personal Finance Consultant, Financial Planner, Certified Financial Planner, Wealth Advisor, Investment Associate, Private Client Principal, Private Client Associate, Retirement Specialist, Consultant to Seniors, Vice President, Senior Vice President, and Managing Director. IIROC concluded that many of these business titles do not, on their own, provide a meaningful description of the type of services and/or investment products that a licensed representative can offer to a client. Some of these business titles imply that the individual carries out an executive function within a firm, for example, Senior Vice President, where the individual is not, in fact, a corporate officer of the firm. IIROC also found that there is a wide array of financial designations that licensed representatives possess and may put forward, in addition to their business titles, in their dealings with clients. While some financial designations, including professional designations like the Chartered Accountant designation, require a specified number of years of work or hours of classroom study, passing an examination, and continuing education, the requirements for others are much less rigorous. In fact, some financial designations may be obtained after a weekend seminar or through online self-study, with a self-administered examination.These titles facilitate sales person gaining investors’ trust  and enabling the sales persons to sell products and implement strategies that are not in the investors’ best interests.

Another common example is the recommendation of proprietary mutual funds (which often bear the name of the brokerage firm). There are often similar, less expensive index funds or other mutual funds available with higher expected returns. A fiduciary couldn’t recommend proprietary funds if they weren’t the best option. A broker has no such constraints and can do so with impunity.

How about this declaration ? Your goals are unique, and BMO Nesbitt Burns Investment Advisors are here to help you develop a plan that's right for your needs. Working with us you can expect open,trusted and transparent advice...  https://www.bmo.com/nesbittburns  Sounds like you'll be provided advice that is in your Best interests, eh?

A number of OBSI recommendation cases cases further illustrate the two-faced  issue . Equity Associates refused to compensate a retired couple in the amount of $83,386. After the couple sold their home, their advisor invested the proceeds in unsuitable medium-risk and high-risk mutual funds.Richardson GMP refused to compensate several investors in the amounts of $232,500 and $66,366. They entrusted their retirement savings to an advisor who ignored their investment objectives and risk tolerance.Armstrong & Quaile refused to compensate a retired couple for $34,000 after their advisor urged them to borrow to invest. They sold their investments after a market decline to cover a debt they could not afford to service.Monarch Wealth Corp refused to compensate a young couple, new to Canada, in the amount of $30,628. They borrowed to invest after being told by their advisor they would not incur any losses.Despite the Ombudsman's comprehensive independent complaint investigation, the dealers refused to accept accountability or provide restitution.

Other excuses that dealers use when responding to a client complaint include:
1. Blaming the investor- greedy , didn't pay attention to forms signed
2. Falsely claiming that because the account is a discretionary one, no duty of care is required
3. Wrongly asserting that the responsibility for determining suitability rests with the client 
4. Incorrectly asserting that ,even though the investments are unsuitable, the dealer is not accountable because risks were disclosed to the client
5. Refusing to accept responsibility if "advisor " has sold products off the books of the dealer . Sometimes dealers are willfully blind if a " producer" is harvesting a client and when things turn ugly claim that they knew nothing about the egregious behavior and are not accountable.

A recent example of the latter practice involves a case involving FUNDEX  Investments Inc. http://www.obsi.ca/images/Documents/IR/refusal/fundex_investigaton_mr_and_mrs_s.pdf . In that case FUNDEX  argued that they had not approved sale of the exempt market product and the client must have  known they were not dealing with FUNDEX. The OBSI complaint investigator found otherwise and recommended full restitution. The dealer refused and the victims must now decide if they wish to proceed with civil litigation  or walk away with a hard lesson on who they can trust. From the FUNDEX website we note: " Since 1995, FundEX Investments Inc. has been providing independent financial advisors with an established, fixed fee business model that enables them to access a wide variety of quality investment products to best meet the needs of Canadian Investors."

Brokers and insurance companies are fighting hard to avoid becoming fiduciaries. They are currently held to the lower “suitability” standard. This means they can recommend investment products that may not be the best option available to help you reach your financial goals, as long as they are “suitable.” CAVEAT EMPTOR!

Research paper on Ponzi schemes: Cam McCormick University of Lethbridge

The Earl Jones scam is a particularly interesting read.

GET MAD, STAY MAD: EXPLORING STAKEHOLDER MOBILIZATION IN

THE INSTANCE OF CORPORATE FRAUD AND PONZI SCHEMES

Abstract:Using a multi-case study, three Ponzi schemes were investigated: Road2Gold, Bernie Madoff’s empire, and the Earl Jones affair. This grounded study used an inductive bottom-up methodology to observe and describe stakeholder mobilization in reaction to corporate fraud. This research on stakeholder behaviour in Ponzi schemes articulates new theory for describing stakeholder behaviour and possible determinants for successful mobilization to action. The data presented here point to a useful distinction in the stakeholders in a corporate fraud: reluctant and engaged stakeholders. Reluctant stakeholders seek only interest-based ends, whereas engaged stakeholders have additional identity and ideological goals shared by a mobilized group.

Read the paper here 

Checklist: Was your complaint handled fairly?

It's no secret- investment dealers hate to admit they provided bad financial advice. They will try very hard to avoid accountability for losses.

The industry has a longstanding over reliance on form documents such as disclosure forms, agreements, account statements and KYC forms, seeking to meet regulatory KYC and suitability obligations; however, more and more, courts and regulators are looking to the record of direct communications between the advisor and client to assess the degree to which the advisor's recommendations and the client's instructions were truly informed regarding risk and suitability issues. In some cases the 'paper' is not a barrier to the imposition of liability for losses sustained by the client.That should be your mindset as you assess the dealer's response letter.

You should assume the relationship between you and the complaint investigators is adversarial regardless of the soothing words of fairness and unbiased investigation. Some very smart seasoned people are reviewing your complaint to ensure the dealer is immunized from providing restitution. This Checklist should help you determine just how objective the investigation has been  Read the Checklist here.  

Related readings :

Calculation of Damages: Securities Fraud & Protection Resource Center http://www.securitieslaw.com/information/calculation-of-damages.asp

Resolving Investor Disputes : Is your Advisor to Blame?

http://www.robertson-devir.com/pdf/Is%20Your%20Advisor%20to%20Blame.pdf

Compensation for Retail Investors :The Social impact of Monetary Loss https://www.asic.gov.au/media/1343636/rep240-published-May-2011.pdf

INVESTOR ALERT : Return of Capital Mutual Funds

Return of Capital mutual funds have given rise to a significant numer of investor complaints and concerns.This ALERT explains the issues . Read the article here

The Suitability Standard in plain Language

The suitability standard for advice giving is the standard used by most dealer Representatives to make investment recommendations to you.It's important you understand how it works so you can assess your Rep's diligence in determining suitability.It will also be of use in the event you file a complaint.Read the article here

CRM2: Quick Guide for Retail Investors No. 2

Here’s Quick Guide # 2 for making the most of the Client Relationship Model Phase 2 disclosures.

NOTE: Fund Facts is a disclosure document for mutual funds. Dealers may charge fees not articulated in Fund Facts or set higher minimums for initial investments than defined in Fund Facts.While these fees will show up in CRM2 client statements , the cost for managing the mutual fund will not. Neither will the brokerage commissions incurred by the fund.These costs must be added to the CRM2 fee summation to get a complete picture of the fees you are paying.
Read the article here

CRM2 : Quick Guide for Retail Investors No. 3

This Guide will assist you in gatting maximum utility out of the disclosure provided by CRM2. Read the Guide here   Although the deadline set by regulators is July, 2016, many firms will be providing the fee and performance information earlier. Some can already provide it now.In any event, get up to speed on the information by reading some of the plain language references provided.

CRM2 : Quick Guide for retail Investors No. 1

This post describes Phase 2 of new securities regulations called The Client Relationship Model.This is information that retail investors should be aware of. Thanks to the Small Investor Protection Association www.sipa.ca for the information on trade confirmation slips and to the Investment Funds Institute of Canada www.ific.ca for the information on benchmarking.
Read article Other Guides to specific portions of CRM2 will be provided in the future. Stay tuned.

Expected Impact of CRM2 on retail investors

The robust Fair Dealing Model was killed off in 2004 and replaced with the Client Relationship Model whose basis is transparency not fiduciary duty.Ten years later (!) the countdown is on for a long overdue era of transparency for retail investors on the reporting of fees and account performance by the financial-services industry. Under CSA regulatory initiatives known as the Client Relationship Model, Phase 2 - or CRM2 -- various new disclosure requirements will be phased in over the next few years. Per the current schedule ( unless lobbyists obtain another delay), effective July 15, 2016, investment brokers and dealers will be required to provide two new annual documents. One is an account-performance report, summarizing the percentage investment pre-tax returns for the previous year, the past three-, five and ten-year periods, and since the account was opened (if it was longer than ten years ago) . This report will require reporting of money-weighted rates of return, customized according to when new money was deposited or taken out of the account.There is much research that shows that the equity risk premium is wiped out by fees, the impact of active management, buying and selling at suboptimal times and the use of volatile specialty funds that sport notoriously poor investor performance. CRM2 may help reduce this loss of return if investors apply the data to their decision making.

The other new required report, as of July 2016, will disclose fees and other charges. This report will itemize the cost of everything from embedded trailer commissions, to redemption fees, point-of-sale commissions/front-end loads, switch fees and RRSP administration fees, and provide an aggregate dollar figure for the 12-month period.The part of the mutual fund management fee charged directly by the fund company - and not passed along to the dealer in the form of trailers and other commissions - will not show up on the dealer compensation/fee statement. The dealer can only provide a precise accounting of items that are paid to it (whether paid by clients or a third party).Statements of securities held by a party other then the dealer or adviser (a.k.a client name accounts,off-book accounts) on which the Dealer receives continuing compensation will also be required.:

The technology has existed for years (possibly decades) to provide information to investors that would better assist them in understanding exactly how their investments are doing and exactly how much they are paying. The most elaborate financial plan available is useless if the investor doesn’t know whether or not they are on target to achieve their goals. If the detailed financial plans that many investors are provided with, with all of its colorful charts and graphs call for a specific rate of return in order for the investor to achieve their goals , if they cannot obtain their actual net of fees rate of return from year to year (or even more often), then the entire exercise is fruitless and a complete waste of time and paper.But that hasn't stopped dealers from claiming they are in the wealth management business or dealer representatives from calling themselves “advisors”.

The majority of retail investors in Canada are treated like mushrooms by the investment industry who does absolutely everything in their power to maintain the status quo and perpetuate the knowledge asymmetry that currently exists in order to maintain their unconscionable profitability at the expense of Canadian retail investors. Then the industry has the gall to suggest that the major issue that these obvious and logical reforms have not been implemented years ago is time and expense It is shameful that it has taken over a decade to alter the current state of ugly affairs in the Canadian Investment Industry . It's been irresponsible of industry to stonewall every reform initiative as an automatic reflex and for regulators to be passive observers - not merely because that introduces undue cost and risk on Canadians, but also because it thwarts the achievement of fair and efficient capital markets and adequate protection for retail investors, particularly seniors,retirees and other vulnerable investors.

Check out a sample of what the annual charges and compensation report (Appendix D) and investment performance report (Appendix E) might look like.

Assuming the CRM2 actually comes to be as regulators intended what will the impact be on investors?:

1. Sticker shock , possibly anger,when all the fees and charges are added up and presented in one place.The changes to the detail, timing and requirements for disclosure through CRM2 will change how Reps communicate with their clients, what they talk to them about, how often and when.
2. Return shock when the money-weighted return ( after fees) is presented in percent which can then be compared to a benchmark , a GIC or the target return based on the financial plan ( assuming a real one exists).
3. The Reps most likely to be grilled will be those who did little more over the course of the year than send holiday cards in December , invite clients to “Free Lunch “ seminars and solicit RRSP contributions in February.
4. Some investors will dump their current “advisors” on the grounds that they're not getting their money's worth in performance , communication or service.
5. Fees and expenses will become an integral element of suitability criteria
6. Greater transparency may prompt dissatisfied investors to seek lower-cost approaches to investing. Among them are fee-based advisors who employ low-fee indexing strategies. Other alternatives include technology-driven advice substitutes -- known as robo-advice -- offered through online discount brokers. Others may join an investment club, maintain an advised account and an online account and/or become Do-It-Yourselfers .
7. The media , bloggers , investor advocates and maybe even regulators will write insightful articles on how to use the new information provided for more informed decision making.
8. Regulators will be forced to act on at Rep proficiency and a Best interests standard as horror stories surface in the media and courts.The value of the true financial planner will be revealed.
9. Many investors may ask Reps why low MER mutual funds, low fee ETF's , low-cost index mutual funds or hybrid mutual funds that invests in ETFs aren't being recommended or why a price break isn't offered on large accounts.
10. Overall, the savings and retirement nest eggs could result in more money for investors ( if they read , understand and use the information ) and less complaints about dealer/ Rep abuse- the rudimentary beginnings of professional advice giving. Robust Regulatory enforcement is critical to making CRM2 a success..

It's not all roses however. There is a real danger that unscrupulous Reps will steer people into more expensive insurance products ( segregated funds)/ exempt securities , recommend unnecessary fee-based accounts ( “reverse churning”) or just raise fees hoping that Canadians passivity will prevail.Minimum account sizes may be invoked or minimum annual fees made part of the account agreement.There is a possibility that some dealers will list so many fees that instead of opening eyes, they will glaze them.Some Reps may take some material out of the mal-disclosure Handbook and downplay the value of the added transparency.Some dealers may decide to charge for mail delivery of confirmation slips or even account statements as the telecom firms have done.Investors will have to be alert.Unless investors take ownership of their investments, the expected benefits of enhanced disclosure may be lost.

CRM2 shines a much needed light on the relationship between a salesperson ( “advisor” ) and the investing client. CRM2 may open people's eyes and potentially empower them but it won't mean they are dealing with a fiduciary. Dealer Reps who are just salespersons and don't provide good value for money ; savvy clients might drive them into thinking about getting a different day job. CRM2 may also prompt reforms by banking and insurance regulators to get off their butts and better protect financial consumers.NOTE:Although CRM2 is a net step forward , the cracks in the suitability-KYC system are being papered over and a real opportunity to reform the system has gone. It is a crying shame that FDM was killed stillborn. We are set to go into the next market downturn with an inappropriate advice system and who knows what we will unearth .


ADDENDUM Some thoughts on disclosure effectiveness

Regulators and many in the industry believe that annual fee disclosure and performance reporting will allow retail investors to make better investment decisions and assess their dealer representative. Research however suggests this dream may not be accomplished. For instance ,when executive compensation disclosure was mandated ,the result was an increase in CEO compensation.One never knows for sure of unintended consequences.The mutual fund " Simplified prospectus" is another example of a enticingly good disclosure idea that went South and has since been supplemented with Fund Facts, a streamlined two page plain language disclosure document.

Disclosure effectiveness is linked to the level of investor engagement, the investor's financial literacy/numeracy , the amount of information to absorb and the investor's dependence on his/her Rep ( and the level of trust).The usefulness of disclosure is also dependent on the nature of the disclosure, how it is presented , when it is presented and the investor's ability to compare to reference data. Rest assured that Bay Street will not readily relinquish billions of dollars in fees via better disclosure without a well orchestrated counterattack

Here's some research on disclosure  for you to peruse:

The unintended consequences of conflict of interest disclosure

http://www.cmu.edu/dietrich/sds/docs/loewenstein/UnintendedConsq.pdf The research found that people generally don't discount advice from conflicted dealer Reps as much as they should, even when the Rep's conflicts- of- interest are disclosed. The more startling findings, however, are that disclosure can have a variety of perverse effects and make the situation worse .

Duties of Disclosure

http://www.lawgazette.com.sg/2003-6/June03-feature.htm

How does simplified disclosure affect individual fund choices?

http://www.finrafoundation.org/web/groups/foundation/@foundation/documents/foundation/p121994.pdf Research suggests that simplified disclosure does not improve investment decision quality / responsiveness to fees but does speed up decision process.

Worthless warnings: Testing the effectiveness of disclaimers in mutual fund advertisements

"More than $11 trillion is invested in mutual funds in the United States. Mutual fund investors flock to funds with high past returns, despite there being little, if any, relationship between high past returns and high future returns. Because fund management fees are based on the amount of assets invested in their funds, however, fund companies regularly advertise the returns of their high-performing funds. The SEC [ the U.S. Securities regulator ] requires these advertisements to contain a disclaimer warning that past returns don’t guarantee future returns and that investors could lose money in the funds. This article presents the results of an experiment that finds that this SEC-mandated disclaimer is completely ineffective. The disclaimer neither reduces investors’ propensity to invest in advertised funds nor diminishes their expectations regarding the funds’ future returns. The experiment also suggests, however, that a stronger disclaimer – one that informs investors that high fund returns generally don’t persist – would be much more effective...."

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1586530 Canadian regulators use the same worthless warnings as well.

The effect of fee disclosure on mutual fund selection

http://www.hertig.ethz.ch/LF_Fall_2012/Papers/Fisch_Fee_Disclosure_Draft_June.pdf?abstract_id=2101315

Mandatory Disclosure and the protection of investors(1984)

http://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=9807&context=journal_articles

Financial reporting disclosure: investor Perspectives on transparency , trust and volume: CFA Institute

http://www.cfainstitute.org/ethics/Documents/investor-perspectives-on-disclosures.pdf

Reading the Fine Print: The Devil is in the Details - The Art of Retirement

http://theartofretirement.org/2014/12/reading-the-fine-print/

Kenmar comments on IIROC CRM2 consultation

http://www.iiroc.ca/Documents/2014/ed6c9071-12d6-4fb1-88dd-2c1193c92ef0_en.pdf

Will dealers and dealer Reps really accept that transparency demands a willingness to present the facts in an unadulterated state? Will the industry be willing to be upfront with the most critical information or will there be wordsmithing and game playing? Will Reps call a “commission” a “fee” so that the fact that the Rep's compensation is tied to sales will mask the true nature of the advisory relationship provided? Will investors be shifted into inappropriate fee-based accounts thereby converting "commissions"  into "fees"? That sort of doublespeak runs contrary to the spirit and intent of CRM2. The CRM2 information must be presented prominently to ensure it’s really drawn to the client’s attention (or will its value be maligned/downplayed)? CRM2 does not specify a defined disclosure format -will dealers merely make the data “accessible”/ embed it in a mountain of details using a small font size and industry jargon? To the extent that the financial services industry remains a reluctant participant in  providing transparency, it is to that extent that the full benefits of CRM2 will be subject to sabotage.

Regulators should closely monitor the implementation and conduct a full assessment after say, 18 months.Changes to the regulations should be made based on the observations and assessment.

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.