Sunday, October 14, 2007

Adam Smith had "best practices" figured out 200 years ago

"The interest of the dealers, however, in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public.

To widen the market and to narrow the competition, is always the interest of the dealers. To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can serve only to enable the dealers, by raising their profits above what they would naturally be, to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens.

The proposal of any new law or regulation of commerce which comes from this order ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.

It comes from an order of men whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have upon many occasions, both deceived and oppressed it."

The above comes from ADAM SMITH (1776) over 230 years ago. From "THE WEALTH OF NATIONS"

As I continue to research how and why the investment industry is the way it is I am struck by the lines above by Adam Smith. They are so simple, and so obvious, and yet so far from how the financial system in Canada is operated.

I guess I am just upset and amazed at how far smart men will stray from known best practices when pushed or pulled by self interest. By my calculations (with help from Harvard, Osgood School of business, Georgia Tech, London Business School and others) Canada is being taken advantage of by between $30 billion and $60 billion each and every year due to financial people serving themselves. Not accidently serving themselves over the clients they promise to serve. "Knowingly" serving themselves first. Knowingly selling products and advice to clients which is false, misleading and not in the interests of the clients who are paying for the advice in good faith. The bargain they are getting in return is that they are being taken advantage of. Abused financially. That is what self regulation in Canada has given us, and it will not be corrected by one securities commission or one hundred. Correcting self dealing, self serving, self regulation requires taking away the priviledge of regulating themselves. It means no longer being able to "babysit" themselves, now that they have demonstrated they are not responsible enough. It means having independant oversight placed upon the industry.

Failure to follow known best practices. Failure to identify known conflicts of interest. This leads to a failure to place client interests first, and self regulation allows this to flourish time and time again. Witness the recent Asset Backed Commercial Paper crisis, which turned out so differently in Canada, than in other countries.

So the bog here will relate to best practices, as compared to not so good practices, and will try and look at a few examples to let you decide which category gets more business in Canada. Why am I bothering? Because this was my industry, my career, my passion. What is my motivation now? I tried for ten years to work within the industry to embrace best practices, and to encourage the industry to live up to its wish to be called a profession. I failed. I was punished for trying to place the interests of clients first. I am here to try and prove that it is still the right thing to do, to place clients interest first. That is my position, that is my bias. If I need a label placed on my mission it is that.

My first awakening that something was wrong, occured in the early 1990's. The Globe and Mail was writing about a mutual fund industry practice of sending the big seller's of funds off on free trips to exotic locations. From my position within the industry this was clearly a conflict of interest in the game of giving envestment advice. I thought that others would agree and want the bad practice revealed and removed. I was wrong. My manager at that time, was attending the Indy 500 each year, courtesy of Mackenzie mutual funds, and he told me that "anyone who talks about this is fired". Not only him, I learned later, that the entire company was on alert against letting the press find out about this practice, including internal telephone record monitoring of calls to the Globe and Mail etc. It was my first eye opener that told me the industry did not necessarily walk the talk they promise.

I began to campaign quietly within the company to separate the roles of "salesperson" from the role (and the title) of "investment advisor". This separation was not welcome. In fact, rather than help move toward any form of higher education requirement, and higher duty of care for the client, I found that my bank owned firm was moving in exactly the opposite direction. They had internal plans to keep the 1000 or so, "advisors" that they already had, but to also convert the 15,000 or so, bank employees who were acting as account mangers over to financial planners and investment advisors. They were "renaming" the entire workforce as professional advisors, without so much as meeting the educational or the experience requirements. In a self regulating industry this is not so much of a problem.

Today, we find from web site http://www.osc.gov.on.ca/ on the topic of "registration", that about 90 plus percent of people in Canada calling themselves investment advisors, are actually (and legally) registered with the government as "salespersons". This is an illegal and unlawful practice according to the law, as well as the self regulatory standards, not to mention that it misrepresents to the public (illegal to misrepresent under the competition act of Canada). None-the-less, it is accepted in an industry where self regulation allows it to occur.

This is example number one of 'knowingly" using poor industry practices when best practices are overlooked in favor of profits.