With CRM2 still ringing in the industry’s ears, the Canadian Securities Administrators have launched Consultation Paper 33-404 about best interest standards, conflicts of interest, embedded compensation, titles and other obligations of advisors, dealers and representatives towards their clients. With that in mind, what will investment advice look like in five years?
Increasing investment complexity has widened the gap between what the average investor understands and what the industry offers. In theory, this “information asymmetry” is balanced by disclosure (via prospectus), a knowledgeable advisor, and securities rules and regulations to make things fair.
But few investors read prospectuses, which are written by lawyers for other lawyers and meant to protect issuers. Advisors and planners, to the extent they are compensated by product providers via trailing commissions or selling concessions, may have a conflict of interest, leading to expanded regulation.
Aligning advisors’ interests with those of investors is most effective at protecting investors (see Chart 3). Some insist these interests are already aligned, but many industry practices rely on advisors’ goodwill, ethics and honesty. For whatever reason, securities regulators do not trust this approach. Consider that the Consolidated Ontario Securities Act, Regulations and Rules with Policy Statements, Blanket Orders and Notices has grown to 2,960 pages in 2016 from fewer than 270 in the late 1970s. Investors may be safer today, but by how much is debatable.
Status quo advocates insist investors will not be able to afford the important services of advisors and planners if commissions are banned, which will harm the general public. A 2016 University of Calgary whitepaper, “A Major Setback for Retirement Savings: Changing how Financial Advisers are Compensated Could Hurt Less-than-Wealthy Investors Most,” argued just that.
Indeed, the whitepaper found advisor numbers dropped in the U.K. and the Netherlands after commissions were banned — presumably, because clients couldn’t afford their hourly or contract services. In the U.K., advisors fell from over 40,000 in 2011 to 31,000 in 2014; the number of advisors dropped 20% in the Netherlands by 2014.
But while many point to this as an example of lowered advice access, that may not be the full story.
How many advisors retired rather than retrained? What is the possibility that expertise and professionalism have actually risen? Culling lower-performing players in any group leads to an improvement in the average of those remaining. Banning commissions may lead to such a cull.
Investment services are unbundling. In theory, consumers can better evaluate their savings and investments with more information. But the mere act of having an advisor isn’t enough to confer benefits (Edesess, Tsui, Fabbri and Peacock have argued that DALBAR studies are flawed). Instead, it’s having an unbiased, affordable advisor who integrates tax, estate and financial planning that can actually lead to being well informed.
Traditional players may dismiss the need for a best-interest standard, but the reality is simple. An aging population has not saved adequately for retirement, capital markets are far more complex, and the historical returns upon which financial plans have depended are not in sight. Clients need advisors who are looking out for them or online systems that can fill the gap.
Professional advisors continue to put client interests before their own and declare all conflicts. Conflicts of interest can be avoided by rebating any compensation arising to the client. Simple disclosure is not good enough because clients may feel guilty denying the advisor compensation, as found in the Journal of the American Medical Association study, “The unintended consequences of conflict of interest disclosure.”
Here are some principles to drive the discussion:
- Compensation drives behaviour, so encouraging advisor remuneration that promotes client interests first is preferred to disclosure alone.
- The most effective policies will change advisor rather than client behaviour.
- What gets measured gets attention, so if advisors and their firms are scored on costs, expertise and quality of products and service, participants will work to improve their own rankings.
- Simple, salient and timely disclosure is more effective than legalistic, voluminous and poorly timed discovery.
- The highest standards of conduct and duty should never be compromised. The obligation of an advisor is as a fiduciary: the same as for doctors and lawyers.
If you comment on 33-404, consider these points.