"CODE OF SILENCE"
Is It Time To Change Investment Advisor Behaviour, Bank Behavior?
Larry Elford, CFP, CIM, FCSI, Associate Portfolio Manager, (retired)

There have always been written or unwritten rules dictating silence within the ranks of the investment industry. Employees experience threats of termination if they say anything that may embarrass the industry or the firm. But this raises a quandary: What does an industry member do when he or she witnesses client abuse or code of ethics violations? What if management ignores, or worse, sanctions the behaviour? What happens when the very people you are required to report to are part of the problem?

Management compensation in the industry is partially determined by sales or revenues, which puts the industry in the position of walking the line between, acting as professionals to benefit the client and acting as salespersons to maximize revenues. These are two different horses, and both cannot be ridden at the same time by the same rider. The industry code of silence is one of the largest impediments preventing the industry from becoming truly professional. It grew out of the days when investment dealers called themselves "stockbrokers", buying and selling shares. While many feel and act as if they are professional, the code of silence allows a few to act as financial predators hiding inside a business that runs on trust.

Today, the investment industry in Canada advertises the duty of care and trust to benefit the client. Are they delivering this duty to clients? When things go wrong, they are often hidden by the industry’s code of silence, or by confidentiality agreements purchased with clients’ own funds. These allow the industry to talk the talk of trusted professionals possessing high levels of honesty and integrity while walking the walk of commission based salespeople. Need examples? They’re easy to find.

Example #1: Free mutual fund trips. When Globe & Mail reporter Bud Jorgensen began writing articles about advisors sent on holiday junkets by mutual fund companies in the '90's, my manager announced that anyone who spoke to the press on the topic would be fired. At the time, he was about to enjoy his free annual trip to the Indy 500 courtesy of a fund company. After our entire industry was embarrassed by this kind of greed, the practice changed.

Example #2 - Double dipping. When advisors sell a fee-based account, clients are supposed to avoid commissions on subsequent transactions. I have witnessed several cases, however, where advisors have reversed the process for their own benefit. By investing a client's assets into a commission based account and later advising them to move to the new asset-based or fee-based account sets no compliance bells ringing. If the move results in no change except adding a new fee on top of the commissions already paid, the client has been double-dipped. It is unethical, but since it doubles an advisor’s revenue and thus his income, it happens over and over.

Example #3 - "No duty of care owed to clients". Industry literature talks about the duty of care owed to the client, claiming, "Client interest comes first". It also specifies a clear duty of care and a fiduciary responsibility to a "professional standard". When 90-year-old Norah Cosgrove took her bank owned investment dealer to small claims court in Ontario for a $10,000 problem, however, the dealer’s statement of defence was that, "At no time were the defendants acting in a fiduciary capacity", and "The plaintiff was responsible for directing the course of investments in her account". To a 90-year-old client, they were claiming no duty, nor any responsibility. She was totally on her own. That is not what their advertising leads investors to believe. The largest and most supposedly trusted financial institution in the nation claimed they owed no duty of care for this type of account - exactly the same type of investment account held by the majority of Canadian investors. Will this defence be submitted if others run into a problem?

Example #4: Gag orders to cover up abuse or crime. When an investment firm is finally pushed into acknowledging wrong behaviour (usually after years and many thousands of dollars in legal fees), they often offer to award the client cash to make the problem "go away". Part of this settlement process involves a confidentiality agreement requiring the client to promise never to reveal the facts of the case. Does this mean corporations in the financial/investment field can cover fraud or criminal acts by buying silence with the client's own money? It surely appears that way.

There was no disclosure when a 90-year-old Kelowna man lost his home to his trusted investment advisor, who helped the gentleman into an assisted living facility. Family members later found that the elderly client’s home was transferred into the advisor's name at less than market value, without benefit of appraisal and at a zero interest rate. In order to get his home back, the client had to sign a release saying, "for value received...........". What value did the client receive for signing this document Answer: He received his OWN HOME back. For further evidence of the internal code of silence, consider that the IDA (Investment Dealers Association of Canada) was notified of this and were met with non-co-operation by the firm involved. The company’s code of ethics, by the way, states that, "every transaction or activity we are involved in must stand the test of complete and open public scrutiny".



Example #5: Hidden mutual fund commissions. Rather than the clear disclosure that the industry requires, much of the compensation paid to advisors by mutual funds remains hidden behind a legal prospectus. This might explain why a popular Deferred Service Charge (DSC) fund, which pays 5% to the advisor (without commission disclosure on client purchase confirmation or on client statement), has grown over SEVENTY TIMES as large as the otherwise identical fund that has no hidden commission structure[1]This growth was achieved despite a higher management cost to the client, and a hidden penalty to the client to exit the fund. Which fund choice does your advisor suggest to you the DSC version, or non-DSC? Why? In whose interest? Where is the disclosure that the industry rules require?

Example #6: employees forbidden to reveal commission-free funds. Although against both the spirit and intent of the Competition Act of Canada[2], as well as the written company policies, neither policy was followed at my company. Furthermore, I was told that the actual policy followed is not to inform the public that they can purchase mutual funds without commission. Since commissions were officially deregulated in about 1987, can you point to a single industry advertisement in which bank owned investment dealers showed the options available when purchasing a mutual fund?
Conditions will improve when legislators and judges forbid gag orders, codes of silence, and written or unwritten sanctions against people who speak out in the public interest. With almost daily revelations of investment scandals, corruption, and other evidence of corporate, "psychopathic" behaviour among some members of the industry, it is time to eliminate the dark corners that hide these abuses.
Until then, the claim that financial advisors qualify for the term “professional” will remain a painful and unfunny joke.

[1] . (Source, Ontario Securities Commission Fair Dealing Model proposals, appendix F, "Compensation Bias", page 12)

[2] Competition Act-Misleading Advertising and Deceptive Marketing Practices at www.ig.gc.ca

Some findings based on my twenty years in the Canadian Financial Services Industry.
Executive Summary:
1. Bank and Investment Industry rules get followed disparately, selectively and haphazardly, depending upon whether the rule is in the industry interest or in the public interest.
2. Self-regulation allows the industry to be self-arresting, self-judging, and self-punishing, and has resulted in the selfish interests of the industry to abuse the public interest and the public trust.
3. Industry, “codes of silence”, written or unwritten, allow indiscretions to remain hidden or covered up.
4. Abuse, fraud and inappropriate financial treatment of clients are also covered up with cash settlements rather than disclosed, discussed, deterred.
5. Until industry interests, people and players are separated from the role of industry referees, the game will always be stacked against the public interest, and trust in our financial services industry will continue to decline.
6. The industry is allowed to act like a bully, or to live up to the "wild west", comments of one Bank of Canada governor due to the sheer size they possess, the strength, and the freedom to make and enforce their own rules.

I have little faith in the process until it is built on a more sound foundation. To quote but one self appointed self regulatory industry association, “ The Mutual Fund Dealers Association of Canada is the self-regulatory organization for Canadian mutual fund dealers. The MFDA regulates the operations, standards of practice and business conduct of its 183 members and their approximately 70,000 representatives with a mandate to protect investors and the public interest.”

When I read this two concepts jump out at me. One is that this is a self regulatory body, and two that it’s stated mandate is to protect investors and the public interest. In my opinion if we follow the money trail of how they were started, funded, and by whom, as well as the public track record of how well or how poorly investors and the public interest has been treated, I can make no other conclusion that this and similar self appointed, self regulatory organizations are flawed from foundation.
When legislation changes regarding who is allowed to guard the financial henhouse in Canada, and prevents those wealthy foxes from volunteering for the role or appointing themselves, I believe we will make some progress toward the public interest. Until then the personal nest eggs of Canada’s public are at risk of abuse by financial predators.

It would appear that of the thousands of rules the industry is subject to, most are likely to be unused for years, many are ignored, and some are pulled out to punish or be enforced only haphazardly or arbitrarily depending on the good or bad graces of the persons involved.

To be more exact, if the rule is intended to protect the public, and/or save them money, the rule is less likely to be enforced since ignoring violations of these rules are of benefit to firms and managers who are supposed to spot the violations (remember, we are “self regulating”). Much like having a referee on your own team, the calls are going to go your way more often. If the rule, however is to protect the industry or the firm, it is more likely to be enforced or even used in ways against employees who need bringing “into line”. It smacks of disparate treatment depending on who the rule is to benefit.


Larry Elford, CFP, CIM, FCSI, Associate Portfolio Manager (retired 2004)
521 Fairmont Blvd S
Lethbridge, Alberta
T1K 7G3