The financial and economic turmoil of the past four months has put heightened scrutiny on how the financial industry treats average investors in Canada.
In times of extraordinary volatility, questionable practices and products such as unsuitable investment loans, leveraged exchange-trade funds and mutual funds with penalties for investors who sell, tend to exact their greatest toll.
“You only see the rocks when the tide goes out,” said Ermanno Pascutto, executive director at the Canadian Foundation for Advancement of Investor Rights, or FAIR Canada.
Earlier this month, an Ontario government task force released a sweeping set of potential regulatory reforms, including several proposals designed to protect individual investors. They include limits on the sale of mutual funds with deferred sales charges (DSCs), and an overhaul of the dispute resolution process, which investor advocates have long complained is tilted in favour of the financial industry over individual investors.
The Globe and Mail spoke to Mr. Pascutto about the proposals and how the pandemic has hit the retail investing community in Canada.
How has the pandemic affected investor protections in Canada?
We don’t see regulators as having done much to deal with COVID-19 issues for retail investors. They have taken timely, effective action for the financial industry and for listed companies. I compliment them for how quickly they moved to get agreement among the 13 provincial and territorial regulators on these things, and I think they’re all positive. We would have liked to see more from a retail investor protection perspective. For instance, we raised the issue of the sale of leveraged investment products with the Canadian Securities Administrators immediately before the market crashed. I have been strongly of the view, for more than a decade, that investment loans to purchase high-fee investment products is a dumb strategy. I can’t see any real justification for it.
How common is it for retail investors to borrow money to invest in Canada?
We’ve been pushing for the regulators to find out the extent of the problem. We would like to see some concrete action. How many people were put into investment loans and lost a lot of money in February and March? How many of them had margin calls and were forced to sell? And how is this going to impact the system?
Are investors generally encouraged to take on debt?
Investment loans are great for the adviser because it boosts their assets under management and their commissions. We should put the onus on the firm to show that there’s some justification for it from the perspective of suitability. If you are advising clients to borrow money to buy high-fee mutual funds or segregated funds, you should have to document how this is suitable for the client.
What about leveraged exchange-traded funds, which use derivatives to magnify returns. Are those appropriate for smaller investors?
For over a decade, we’ve been talking about the dangers of leveraged, inverse and commodity ETFs. We don’t think it should be called an ETF if it’s based on futures contracts or derivatives. And even the world’s largest ETF providers have recently written to regulators pushing for a name change. ... I’m optimistic regulators may tackle the issue this time.
You recently called on the financial industry to waive redemption fees on funds with deferred sales charges. Why did that take on such urgency?
We’ve had a historically huge increase in unemployment in Canada. A lot of that affected middle- and lower- income people. For people facing the loss of income, one way to address that is by taking money out of their savings. But when they go to access their savings, they find there are fees to take your own money out. A lot of advisers like DSC mutual funds because they have a big payoff upfront.
Do you support the task force’s recommendations on limiting the sale of DSCs?
I think that’s as good as we can get, if the Ontario government is not prepared to support a complete ban on the sale of DSCs. It’s still odd, because the rest of the country is banning them. But I think this a good result. I think most financial institutions are going to walk away from DSCs, if they haven’t already.
Another proposal is to give the Ombudsman for Banking Services and Investments the authority to make binding rulings on compensation for investors who have been harmed. Is this in line with what you’ve been pushing for?
We’re pleased with that. The problems with complaint handling have been around for a very, very long time. The system is far too difficult for the average retail investor. I think the majority of people just give up. Even if they get to OBSI, and OBSI finds in their favour, OBSI has no power to require compensation. I’m optimistic this will lead to binding decision-making power, at least in Ontario. But it’s hard to get agreement among 13 regulators – some of them have different priorities and they’re dealing with a very powerful investment industry.
Do you think OBSI will be busy in the months ahead?
You're very likely to see a deluge of complaints to OBSI later this year. Back in 2009, OBSI was completely overwhelmed with complaints. And it took them years to catch up.
What kinds of complaints?
Most of them would be over the lack of suitability for people who were put into very high-risk investments, or they were convinced to borrow money to invest. For most people, leverage works as long as the markets are going up. But as soon as it turns down in a significant way, people start to find they’ve lost half of their savings.
This interview has been edited and condensed.