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expert's podium

S. Kelly Rodgers is president of Rodgers Investment Consulting

by Janet McFarland on the potential for tougher rules for financial advisers raises some interesting questions. While I strongly support tougher enforcement and higher standards within the investment industry, I wonder just how it might work.

In Britain, the practice of an adviser receiving commissions for the sale of products from the company offering products will be banned in 2012. In Canada there is much talk of applying a 'fiduciary standard of care' to advisers. Which is better? Which has some chance of working?


Before we can answer that question, we must first examine what we mean by a 'fiduciary standard of care'. I am not a lawyer, so my explanation may be criticized by those trained in the law but it is a plain English definition that I have been told by lawyers is fair.

A Fiduciary must put the interests of those to whom they owe a duty ahead of their own and a Fiduciary must avoid conflicts of interest.

The current standard for an adviser is that they must recommend only products that are suitable. A Fiduciary would be required to recommend the most suitable products.

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Let's examine this distinction. Hypothetical investor, we will call him Jim, goes to see his Manulife adviser. Manulife has recently introduced a group of funds managed by Mawer Investment Management, a very highly regarded firm. Jim has seen the many press reports on the quality of the Mawer funds and management team and thinks the Manulife Mawer Balanced fund would be an appropriate.

Current Standard of Care

Manulife adviser: "Jim, this is an excellent fund from an excellent company and I agree this is appropriate for your objectives. While our version of the fund is new, the original fund has been given a five-star rating by Morningstar. You can purchase this fund on a front end load basis or a rear end load basis. If the former, I will receive a higher trailer fee and you will pay an upfront commission, which we will negotiate. If the later, I will receive a lower trailer fee but the company will pay me a commission and you will be locked in for a number of years. Which option makes the most sense to you?"

Fiduciary Standard of Care

Manulife adviser: "Jim, this is an excellent fund from an excellent company and I agree this is appropriate for your objectives. While our version of the fund is new, the original fund has been given a five-star rating by Morningstar. There are a number of ways you can make this purchase. As a Fiduciary, I have to avoid conflicts and act in your best interest so I will explain all of the options.

"You can purchase our version of the fund and the MER will be 2.45 per cent annually. I will be paid a service fee, called a trailer. I will also get a commission at the time of purchase, which we will negotiate or you can chose the deferred sales charge method.

"Now, since I am a Fiduciary and must act in your best interest, I should also tell you that you can purchase the original version of this fund directly from Mawer. You call their 1-800 number or purchase through a discount broker for a small commission. The MER when you purchase this way is 1.03 per cent annually, less than half of the MER for our version. They will not pay me a service fee out of the MER, so you and I will have to negotiate what is a fair payment for my time and advice.

"Saving 1.40 per cent annually in MER expenses will allow you money to grow much faster, and over the next 20 years, this will make a very significant difference in your wealth. We can figure out how much of a difference by going to the Ontario Securities Commission website and using their MER calculator.

"So Jim, would you like to purchase the Mawer Balanced fund with a 2.45 per cent MER or the one with the 1.03 per cent MER? For every $100,000 you invest in this fund, the difference in the annual expenses will be $1030 every year that you own it. "

There are many other firms and products where this type of conversation could take place and readers should not think the issue only applies to Manulife. Investors Group and Industrial Alliance also have products that can be purchased much more cheaply directly from the managers. And for readers who think this is only a problem for insurance company products, many of the investment firms participating in managed account programs offered by investment dealers can be accessed directly by clients for much lower fees.

As you can see from this hypothetical conversation, I believe it is highly unlikely that advisers will adhere to a fiduciary standard of care as long as the industry maintains its current structure.

My concern would be that the current fiduciary standard would be weakened and lessened in its interpretation. Instead of 'you must put the client's interest ahead of your own' it would become 'you must make recommendations that are the best for the client, within the context of the products you have to sell' (even if those products are not the best) which is the current standard.

Given the current structure of the investment industry and the overwhelming number of advisers who are little more than distributors (salespeople) I cannot see how a true fiduciary standard is practical.

Simpler Approaches

Perhaps some simpler approaches that would not require a complete industry restructuring and could be implemented immediately would be useful.

We could start with reversing the recent change in categories of registration. Canada has eliminated, with the stroke of a pen, salespeople in the investment industry. They changed the name of the registration category from Salesperson to Dealing Representative. Investment and Mutual Fund Dealers have also assisted. Never did you see a business card that said Salesperson. They have titles like, Financial Planner, Investment adviser, Account Executive and Vice president, if they are a really good salesperson.

Most of us understand what salesperson means. How many people outside of the investment industry know that the rest of these titles mean the person is a commissioned salesperson.

The second thing that could be done is to require IIROC, the regulator for the Investment Dealers, to actually publish on their website the registration of all advisers. Currently this must come from the Provincial Securities Commissions and the OSC site is excellent for this, but it does not contain much detail on IIROC registrants, such as whether they are registered for options or when they joined the industry.

The third thing would be to disclose the components of the pricing. What is the client paying for the investment management and what are they paying for the sales commissions and service fees? An investor cannot assess the value of the advice received if they do not know the cost of that advice.

The fourth thing would be for each of the provincial securities commissions to engage more actively in the regulation and oversight of the investment dealers and mutual fund dealers and rely less on 'self regulation'.

And finally we could begin to move to a system like Britain is moving to by banning commissions. If advisers want to be treated like investment professionals, then they should begin to act like investment professionals, not sales professionals. If they want to be treated like sales professionals, then they should acknowledge that they are sales people and not try to hide it.