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Our investment advisers’ moral compasses are still being aligned

Keith Ambachtsheer is director emeritus of the International Centre for Pension Management at the Rotman School of Management, University of Toronto, and president of KPA Advisory Services.

Edward J. Waitzer is Jarislowsky Dimma Mooney chair and director of the Hennick Centre for Business and Law, Osgoode Hall Law School and Schulich School of Business, and senior partner at Stikeman Elliott LLP.

In 1994, the Ontario Securities Commission asked one of its commissioners to undertake a review of regulatory issues facing what was then a rapidly growing investment fund industry. Commissioner Glorianne Stromberg's report, released in January, 1995, highlighted inherent conflicts of interest with respect to the structuring and management of investment funds and the distribution of securities generally – all resulting in the interests of consumers not being placed first. She also noted the inadequacy of the training and proficiency of many of those who sell and manage investment funds. Her proposals addressed these conflicts of interests and proficiency gaps.

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More than 20 years later, the Canadian Securities Administrators is still studying these issues. Many in the industry continue to argue that it is the client's responsibility to do their homework. Should caveat emptor apply when buyers think they are hiring a professional to help them do the shopping?

With the passage of time, the significance of the issues highlighted in Ms. Stromberg's report now have systemic implications. For one, a strong financial-services sector depends on public trust. This has been seriously eroded and is unlikely to be restored (or a sound regulatory framework built) unless investors are entitled to expect that the financial professionals they rely upon are proficient and will be held accountable to a uniform best-interest standard. As importantly, the lack of workplace pension coverage for the majority of Canadian workers, coupled with the ongoing transfer of wealth from savers to the financial sector through high investment fees, have become challenges to the adequacy of retirement income savings. We continue to kick the can down the road.

The notion that financial professionals must act in the best interests of their clients and make full disclosure, particularly regarding conflicts of interest, is long overdue. The need for such core principles have been recognized in most other mature market economies. The suggestion by some Canadian securities regulators is that incremental rules, in the absence of strong foundational principles, may be sufficient. The result, if this approach is taken, will defer practical solutions and raise expectations, which will be disappointed.

We must also look beyond principles that seek to provide a strong moral compass for the industry and focus on ensuring the proficiency of investment "professionals." If accountants, actuaries and lawyers need to go through rigorous certification processes to practise their profession, why not investment advisers and managers? The stakes, for clients, are often higher, as a recent study concluded.

The study compared the investment behaviour and results of a large sample of Canadian mutual-fund investors with those of the investment advisers who serve them. The researchers found that while conflicts of interest impact the behaviour of some advisers, there is a bigger problem. In most cases, there was a strong correlation between how advisers advised their clients and how they invested themselves. In fact, on average, their investment results were worse than those of their clients. The researchers concluded that, in too many cases, advisers are drawn into the industry with the, misguided, strong belief that the combination of high-fee funds and high turnover will improve performance. This suggests that most investment advisers know no more about successful investing than their clients do.

Finally, it should not be surprising that countries with the strongest best-interest standards for financial advisers also have the strongest rules regarding workplace pension-plan participation. While fiduciary principles-driven funds will easily generate twice the pension per dollar of contribution than the average mutual-fund option, more than three-quarters of Canadian private-sector workers do not participate in a pension plan other than the Canada Pension Plan. The recent agreement to enhance CPP benefits has moved Canada's retirement savings yardstick in the right direction, but will not fully bridge this looming retirement savings gap. Canada's financial-services regulators and industry should play a constructive role by raising the bar on fiduciary conduct and designing and offering cost-effective workplace pension plans for 21st-century realities.

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