Four Questions Investors Deserve Answered

As part of my continuing research into the financial services industry, I come up with a few questions that I hope can be posed to the Ontario Securities Commission at an upcoming town hall meeting they are hosting to try and improve conditions. I am encouraged by any and all attempts to do so, and I will try and update you as to any answers, or non-answers received to the following:


1. Why are transactions that are considered fraudulent or bordering on fraud in the United States allowed to continue as "standard industry practice" here in Canada? Specifically the practice of advisors recommending the highest compensating mutual fund class (the DSC class) to clients, despite there being lower cost alternative choices in the identical fund product that clients would be better served with.

see washinton post article [1]
see US court cases [2]
see IFIC and MFDA stats on Cdn fund sales practices [3]



2. Why are investment salespeople who are officially registered as "registered representatives", or as "salespeople", at the Securities Commission, allowed to represent themselves to the public as "investment advisors", indicating a different level of fiduciary duty to the public, when the Securities Act is clear on which titles are allowed and which are not?


3. Why are investment firms allowed to promise and advertise a high level of public trust, or as one firm's code of ethics states, "trust through integrity in everything we do", and then claim no responsibility to a 90 year old client who is mistreated by an advisor. The advisor was subsequently terminated by the firm, but still the firm denied any responsibility to the client. How is it that they are allowed to get away with this level of misrepresentation? [4]


4. Why are Canada's investment dealers allowed to, "buy silence" on matters, sometimes of a criminal nature, sometimes fraudulent, by offering to exchange money for silence from the victims of commercial crime. Is allowing the cover-up up of fraud in the spirit and intent of the Securities Act, or are steps being taken to disallow this type of criminal cover-up?








[1]



washingtonpost.com

Citigroup, Others Pay Fines Over Mutual Funds
By Brooke A. MastersWashington Post Staff WriterWednesday, March 23, 2005; 5:29 PM
In their continuing effort to clean up mutual fund sales, federal and industry regulators yesterday fined three large brokerage firms and a fund company a total of $81 million for improper sales practices and required them to make restitution to tens of thousands of investors.
The regulatory actions covered alleged abuses in two areas but shared a common theme: investors were steered into fund purchases that benefited their brokers, often at the investors' expense. The Securities and Exchange Commission and the industry regulator NASD have been investigating both issues for more than 18 months as part of a wide-ranging probe of the $7 trillion mutual fund industry.
Citigroup, JPMorgan Chase and American Express Financial Advisers paid a total of $21.25 million to the NASD, formerly known as the National Association of Securities Dealers, to settle allegations that they collected excess commissions from more than 50,000 households by selling high-fee "class B" mutual fund shares when the investors could have bought another class of the same funds for less. In addition to the fines, all three firms will convert the shares into the class that pays lower ongoing fees, and reimburse customers who have already sold the shares for the extra fees they paid.
Citigroup also paid $20 million to the SEC to settle similar allegations plus an additional charge that they took secret "shelf-space" payments from more than 70 mutual fund companies to recommend their products.
One fund company, Putnam Investments, agreed yesterday to pay a $40 million penalty for failing to tell its board and investors that it was rewarding brokerage firms for pushing Putnam products. That money will be put back into the Putnam funds for distribution to shareholders, the SEC said.
As is customary in securities industry settlements, the firms neither admitted nor denied wrongdoing.
Regulators have been investigating sales of class B shares since 2003 because of concerns that many investors did not understand how this kind of share worked. Unlike more common Class A shares, where investors pay a commission or "load" up front, Class B shares carry a "back end" load that must be paid when the investor sells. This arrangement, which is legal, allows investors to put off paying the commission, or avoid it entirely if they hold the shares for 6 years or longer.
Problems arose because some fund companies discount or waive commissions for Class A shares when the investment is large enough, usually $50,000 or more, but don't do so for Class B shares. According to allegations in the settlements, brokers sold Class B shares and failed to tell customers that Class A shares would be cheaper.
This is the largest Class B case the NASD has ever brought, said its enforcement chief Barry Goldsmith.
More cases are imminent, but most of the problems stem from past sales rather than ongoing abuses, the regulators said. Citigroup's Smith Barney brokerage unit now automatically flags class B transactions to double check whether investors would do better buying another class of shares, said spokeswoman Kim Atwater
"Since we've focused on this issue, we've seen positive changes at other firms in how these products are sold," said Goldsmith. "Practices have improved."
The SEC is trying to eliminate the problem of under-the-table payments by mutual funds to brokers by banning the most common method of payment, a practice known as "directed brokerage." Fund companies may no longer steer stock and bond transactions to particular brokerage firms in exchange for having their funds promoted by the brokers to their retail customers. Putnam paid directed brokerage fees, and Citigroup received them, the regulators said.
Investors who were harmed by B share sales practices do not have to take action to receive reimbursement. Under the settlements, brokerage firms must bear the costs of identifying and contacting investors, regulators said.
"The Commission's enforcement focus in the B Share area has improved the industry's self-policing," said Ari Gabinet, regional director of the SEC's Philadelphia office which spearheaded the investigation.
© 2005 The Washington Post Company





[2]
Jacob Zamansky, a securities lawyer in New York, represented the Huffs in their case against Prudential Securities (NEW YORK TIMES April 18, 2004, A BROKERS EMPTY PROMISE, A RETIREE's SHATTERED DREAM", by Gretchen Morgenson, view at www.regulators.itgo.com/PI/903.htm

"All the investors were placed in fee-based accounts, with annual charges of at least 1% going to the brokerage firm."

"Major Wall Street firms have targeted and preyed on unsophisticated 'buy and hold' Ohio investors, placing them in inapropriate fee-based accounts that generat huge annual revenue streams for the brokers," Mr. Zamansky said. "They put their own financial interest ahead of their customers'."


In a recent notice to members, the NASD warned that "it could be a violation of industry rules to put a customer in a fee-based account that costs more than an alternative".


"US brokers censured and fined for pushing DCS mutual funds"
By James Langton, Investment Executive, Thursday, April 19, 2001

"fines for improperly recommending deferred sales charge funds over front end load funds"
"which would have been more cost effective"
"The sales commissions would have been less than half this amount had they sold Class A shares"

NASD news release dated Wednesday, April 18, 2001, at www.nasdr.com/news/pr2001/ne_section01_026.html

"unsuitable recommendations of class B shares to customers..............when it would have been more cost effective for those customers to purchase Class A shares"

NASD INVESTOR ALERT, "Class B Mutual fund Shares: Do They Make the Grade?"
Speaks to DSC mutual funds. "The only differences among these classes is how much you will pay in expenses and how much your broker will be paid for selling you the fund." www.nasd.com/Investor/Alerts/alert_classb_funds.htm





[3]
When comparing two otherwise identical mutual funds, except for the compensation paid to advisor, a popular Deferred Service Charge (DSC) fund, which pays 5% to the advisor without disclosure on client confirmation or client statement, has grown over SEVENTY TIMES as large as an identical fund that has no hidden commission structure. This growth was achieved despite a higher management cost to the client, and a multi-year penalty to the client to exit the fund. (Source, Ontario Securities Commission Fair Dealing Model proposals, appendix F, "Compensation Bias", page 12)


Mutual fund industry association statistics (MFDA, IFIC) point out that approximately 80% of advisor assisted mutual fund sales in Canada have taken place using the higher pay to advisor, DSC choice, rather than using other less costly choices available since commissions became fully deregulated.




[4]
See Ontario Court Norah Cosgrove vs. RBC