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In the U.S., the controversial fee-based account has dwindled in popularity, but Canada’s still moving full steam ahead with the non-commission advisory model. Just because our financial industry is still promoting the account, however, doesn’t mean we’re not faced with the same problems that derailed the option down south.

At Advisor Group’s Compliance Matters Summit on Tuesday, Nigel Campbell, a partner at Blake, Cassels & Graydon in Toronto, said the financial community needs to pay closer attention to the problems surrounding fee-based accounts, especially after how they’ve been abused in the States. “The fee-based issue is perhaps a future landmine for the dealer community here in Canada,” he says. “Everybody should be tuning in now. As is typical in our country, we learn lessons from the United States and, provided we pay attention and learn them early, we can perhaps offset any problems.”

What happened in America is that fee-based accounts, which were introduced in 1995 as an alternative to commission-based trading, ended up being misused by some advisors who charged clients huge fees, despite not executing many trades and giving little advice.

As an example, in 2007, UBS Financial Services was fined $23.3 million in connection with fee-based account abuses. In one case, the company charged a 91-year-old more than $35,000 for just four trades over two years — that’s about $8,800 per trade. This was $33,000 more than what the client would have paid in a traditional brokerage account.

There hasn’t been any trouble on this level in Canada, but that doesn’t mean it can’t happen. “It has all the qualities of a perfect storm,” says Campbell. “You have significant issues you’ve been warned about, coupled with the ability to garner substantial fines. That’s a bad combination when it comes to regulators.”

“When [the fee-based account] first got started years ago, it was not intended to create issues; it was intended to solve issues,” adds Bill Haldane, CCO at BMO Nesbitt Burns. “There cannot be a fee that turns an otherwise dormant asset into an active revenue-generating asset, which in its simplest form causes a great deal of the issues that [we’ve seen] over the last little while.”

Because of the potential for abuse, fee-based accounts aren’t for everybody. The best-suited clients are ones who are active investors and have a good knowledge of what they’re doing. It’s imperative for advisors to know their clients well; they otherwise risk possible regulatory sanctions if anything improper happens.

Campbell says investment advisors’ basic obligations are acting in the best interest of their clients and avoiding conflicts of interest.

One way to prevent any potential problems with fee-based accounts is to accentuate all the contact points with the client. Campbell explains that “provided you bring value, describe the nature of the account to the client who can understand the description and bring these other values — such as research, ongoing advice, particular attention, increased contact, meetings — then there’s an easier explanation for why a particular investor is suited to this.”

Jeff Kehoe, the Investment Dealers Association’s director of enforcement litigation, says the best measure of whether or not a client should open a fee-based account is appropriateness. “If you have someone who only makes one or two trades a year, it might not be appropriate,” he explains.

However, if the advisor has explained everything to his or her client, and the fees are transparent, and the client still decides to open an account, then it’s “not something the IDA will interfere with,” he says.

Kehoe also points out that advisors can expect “increasing attention” from the IDA in regards to fee-based accounts, especially when it comes to elder abuse. “It’s coming to an audit near you,” he says. “But if you act appropriately and demonstrate [why the account was opened] there will not be the $23 million regulatory action by the IDA.”

While Kehoe says he’s going to crack down, Campbell questions why the IDA hasn’t been clearer with fee-based account regulation. “What struck me is there’s not a lot of real clarity from the IDA at this stage,” he says. “It’s almost as though they’re aware of the UBS thing, but on the other hand, where is the clarity going to come from? Will there be a notice to members? What is the nature of disclosure the IDA is looking for?”

“I wish I had a better answer for you,” responds Kehoe, adding that while he knows it’s an issue, the regulator has been “distracted” the past six months with other business. “As a result, the street priorities are still priorities.”

One group among which complaints are arising is the elderly and, more specifically, their families and estates. Campbell has noticed an increase in lawsuits brought by families concerned about mistreatment. Often these complaints are delayed, as it takes relatives time to figure out that there’s a problem. “It goes back to this predominant question of value for money,” he says.

But providing value for the dollar isn’t specific to any age group. In fact, it’s what advisors should be thinking about all the time. “Are you hosing the client?” asks Campbell. “It really comes down to that. That’s the ultimate test, and it’s not more complicated than that. If you can provide the value your client wants, you have very little to worry about.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(04/16/08)

Bryan Borzykowski