This article appears in the November 2021 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.
Elke Rubach struggles to remember a busier period than her time at a bank-owned brokerage in the wake of the global financial crisis, when her position in the company’s compliance department put her on the front lines during the last major wave of advisor negligence lawsuits.
“I was the only client-complaint contact at the time, so it was lots of fun,” said Toronto-based Rubach, who has since founded her own advisory firm, Rubach Wealth. “Nobody complains when things are going well, but in 2008, when it all went south, the calls were coming in thick and fast.”
Darren Coleman, senior vice-president and portfolio manager, private client group at Coleman Wealth, Raymond James in Toronto, understands why market crashes like those in 1929, 1987 and 2008 generate such a strong response, as some investors’ excessively risky portfolio positions are exposed in spectacular style.
“These are huge international events where it seems like your money vaporizes. Nobody wants them to happen again,” he said.
Still, Coleman said the retreat from risk often prompted by these calamities could be sowing the seeds of the next crisis in advisor-client relations, which he predicts will arrive in much stealthier fashion.
“Clients are conditioned to think about the risk to capital, but the trouble is that retirement is about income, not capital,” he explained. “Next, we are going to see cases where people complain that their advisors never exposed them to enough risk, because they were worried about a crash when they should have been worried about loss of purchasing power.”
“By the time you realize the portfolio was too conservative, it may be too late to do anything about it,” Coleman added.
Formerly, many retirees could seek refuge in low-risk fixed income investments because they were able to count on rich pensions to cover the bulk of their retirement needs. However, demographic trends mean Canadians are more reliant than ever on their personal investments for retirement.
According to Statistics Canada, by the end of 2019 — the most recent year for which data is available — just 37.1% of employed Canadians had a workplace pension, down from a mid-1970s peak of around 46%. Even those with coverage are likely worse off than previous generations, thanks to the large-scale flight from defined-benefit plans in the private sector.
Compounding the pension gap problem are forecasts projecting lower real returns in the longer term, as well as growing fears about inflation.
The recent Quebec Superior Court case of Fattal c. Scotia Capital Inc. offered a glimpse at the future of advisor negligence lawsuits, after Sam Fattal — a Montreal businessman — sued his former financial advisor. Fattal alleged that the unduly conservative portfolio devised for his family cost them around $10 million in lost profits over two decades.
According to Justice Martin Sheehan’s April decision, Fattal’s bookkeeper raised the alarm in 2015 after a sharp drop in the portfolio’s value. This prompted one of Fattal’s sons to review the accounts. The son believed financial objectives geared entirely to income generation were inappropriate, considering the family had no need for additional revenue.
However, the judge ruled in favour of the financial advisor after reviewing know-your-client documents signed by Fattal in 2014 and 2015. While it was true the family — whose net worth exceeded $50 million by the time of the trial — could afford to be more aggressive with their investments, that was not their desire, the judge wrote.
“The Court concludes that the Fattals had a low risk tolerance and that a financial objective which was aimed at income generation and preservation of capital corresponded to both their wishes and their temperament,” the decision stated.
Still, when it came to the plaintiffs’ complaints about the portfolio’s overexposure to preferred shares, Justice Sheehan found the family was entitled to damages. They had invested heavily in the hybrid securities as an alternative to bonds after yields plummeted in the wake of the 2008 financial crisis. Between 2012 and 2017, the decision said preferred shares accounted for approximately 60% to 70% of the Fattal portfolio.
“This overconcentration in preferred shares created a lack of diversification and increased the risk to unacceptable levels. It also conflicts with Scotia’s internal guidance,” which called for a portion between 20% and 50% of the portfolio’s total fixed-income allocation for preferreds, the judge wrote.
Comparing the portfolio’s actual performance with a model version in line with the firm’s guidelines, Justice Sheehan determined the Fattals were due close to $365,000 in damages.
Michael Lesage, a Toronto litigator, said the relatively low damage award can be explained by the advisor’s accurate assessment of his client’s risk tolerance.
“At the end of the day, I think the evidence was quite clear that the father wanted to be invested very conservatively, and he largely was,” Lesage said. “But it should also serve as a reminder to brokers that they may be liable if they fail to follow their internal policies and procedures. Even though the liability was pretty miniscule here, that might not prove to be true the next time around.”
At Ottawa’s MBC Law, partner Margot Pomerleau said the case should be a wake-up call for advisors who believe a conservative approach will steer them clear of legal trouble.
“Their focus needs to be more on the suitability of investments, rather than strict rules about risk, because there are investors who can take more risks, and others who ought to take less,” said Pomerleau, who manages the firm’s financial loss litigation team. “In lots of cases, advisors are not getting the right information on investors’ objectives to be able to match them to a suitable portfolio, based on their age, time horizon and risk tolerance.”
Advisors shouldn’t be scared to simplify their message when breaking down concepts like inflation, interest and risk for clients, she added.
“The average investor has no clue about any of this,” Pomerleau explained. “They really have to be spoon-fed every little bit of information.”
According to Coleman, comparative retirement-income forecasts can nudge some conservative clients to take on more risk in their portfolios. However, the effect may be limited on investors who discount the effect of inflation by thinking in terms of today’s dollars when assessing their future income needs.
For those who need an extra push, he uses analogies and relatable examples to hammer home the risk of inflation. “What did your first house cost? What did your first job pay you? What are those things worth now?” Coleman said. “I tell clients it’s not about protecting their dollars, but what a dollar buys.”
Whether advisor-client relations deteriorate because of allegations of excessive or insufficient risk, Rubach said the root of the problem is always the same.
“What you see in every case are misunderstandings and poor communication,” she said. “A well-intentioned advisor might assume the client understood what was explained to them, when in reality, they didn’t.”
In her own practice, Rubach avoids industry jargon and encourages clients to broaden the conversation about their investments among a wider circle of contacts.
“Triple check that not only your client understands what’s going on, but also their family,” she said. “I’m not trying to promote paralysis. Honestly, I’m on a quest for common sense.”
Detailed note-taking on interactions with clients offers a measure of legal protection to advisors, but for those seeking to avoid court altogether, there’s no substitute for deep personal knowledge of the people they are serving, according to Rubach.
“I don’t believe in rules of thumb. Everyone has a different life, and every client should have a different plan adapted to them,” she said. “You can’t just have a conversation once a year; that’s a transaction, not a relationship. It may work in many cases, but I don’t think it’s doing the job right.”
Product manufacturers tackle the retirement savings gap
As pension coverage among Canadian workers drops, financial product manufacturers are looking to fill the retirement savings gap.
In the past year, Purpose Investments Inc. unveiled a mutual fund designed to provide lifetime income to retirees, while Vanguard Investments Canada Inc. released a retirement-focused ETF that targets a payout of 4% per year, plus the possibility of capital appreciation. Both were welcomed by certified financial planner Alexandra Macqueen.
“Fewer Canadian employers are offering a traditional defined-benefit pension plan, but that doesn’t mean there are any fewer retirees who want a secure and stable income in retirement,” said Macqueen, co-author of Pensionize Your Nest Egg. “Hopefully the marketplace can continue to provide solutions.”
Purpose’s Longevity Investment Fund mimics a pension plan, with monthly lifetime distributions beginning as investors turn 65. The fund aims for an initial 6.15% annual lifetime income payment that escalates as retirees age. When investors die or exit the plan, only their unpaid capital is redeemed, with returns left in the pool for the benefit of other members.
The offering is a fresh take on the “tontine,” Macqueen said, an investment plan with roots in 17th-century France.
“This one is structured to allow some liquidity, but it’s essentially the same idea. Over time, the returns are shared among a smaller group of survivors,” she explains.
Meanwhile, at the federal level, one of the Liberal government’s final acts in the last Parliament paved the way for advanced life deferred annuities and variable payment life annuities.
ALDAs allow registered retirement account holders to put some of their savings toward an annuity deferred until age 85, rather than forcing them to start at 71, while VPLAs provide varying payments depending on the performance of the underlying annuities fund.
“We’re all living much longer, but as a society, we’re not doing a great job of putting aside huge amounts of capital,” Macqueen said. “The market is coming up with solutions to help, and I’m looking forward to seeing the product shelf expand in the coming years.”