Wednesday, May 25, 2005

Here is what is wrong with Brown's speech

(see "What is wrong with this speech article previous for OSC chair David Brown's action on Portus)

In it, he dodges responsibility for hedge funds, by saying they do not fall under OSC jurisdiction. Despite the illegality of unsuitable investments under the Securities Act. Despite the number of improprieties it took to get this investment marketed to thousands of Canadian clients, he appears ready, willing and able to do...................nothing.

He told the Toronto CFA Society that advisors should be held accountable for any inappropriate investments made by clients they referred to the firm. Yet while he talks the talk, and collects the highest paycheque in the land as the top securities regulator in Canada, it seems as if the punishment he is metting out to advisors making innapropriate and perhaps self serving advice to clients is to do............................nothing. Perhaps a stern speech. A bit of a talking to.

I found this line funny: "Many advisors have said the focus on referral fees has been unfair, saying that if they were simply "in it for the money" they could have earned more by selling their client a DSC fund. "

Funny in that 80% of all mutual funds sold in Canada (by advisors) are sold to clients under the DSC option. Are they giving investment advice, or are they "in it for the money"?

See warnings about selling the highest compensating class of mutual funds at the NASD (National Association of Securities Dealers in the US) web site for possible clarity on this issue. http://www.nasd.com

Once again I ask the question: Why are investment practices that are immoral and illegal in the United States, considered, "standard industry practice", in Canada?
The problems are so widespread and so systemic, that the poor regulators are unable to even take the first steps in Canada. they just show up, take the $000,000 pay each year, misinform the public that they are protected, and then move on to leave the system no better off for average Canadians. Very misleading.

Pointing out that hedge funds are not regulated by the OSC, Brown urged all investors who are interested in such products to, "be sure they understand what they are getting into". Ouch! What a stern talking to. I am sure that bold action like this will change the world. This sounds to me like telling criminals to "be sure and remember to register your weapons".

This inaction is of no use and little value. Forgive me my bitter tone, but without serious action, we may have just witnessed another multi-billion dollar consumer rip off successfully done in Canadian style, under the view of the country's top securities cops. And off they ride into the sunset..............to do more good work.

What is wrong with this speech?

Brown: You can't sell what you can't understand
Steven Lamb
(May 10, 2005) In one of his last addresses to the investment community before leaving his position as OSC chair, David Brown told the Toronto CFA Society that advisors should be held accountable for any inappropriate investments made by clients they referred to the firm.
"There may well be some issues to address in relation to the manufacturers of some of these investment products. But the responsibilities of the intermediaries involved are clear," said Brown. "They are professionals with a duty to understand the products involved and the risks entailed."
While refusing to answer any specific questions regarding the investigation into Portus, Brown concedes that the OSC is more focused on the advisors who sell complex products, than on the manufacturers of those products.
Some question whether there are gaps in the current regulations which allowed Portus to be sold to inappropriate clients in the first place. Brown disagrees, saying the "know your client" rule places the onus on advisors to understand the products to which they direct their clients. If they don't understand the product, they cannot possibly consider it to be suitable.
"In fact, the complexity of the foreign intermediaries involved in the international aspects of the transactions — and the lack of regulatory compliance by Portus — has made it difficult for investigators to understand this product after months of forensic accounting," Brown admitted. "You can't apply any particular investment recommendation to the client's needs, unless you have an understanding of the risk attributes of the investment."

Much of the furor over Portus is that as a hedge fund investment, it should only have been available to accredited investors. When asked if the industry has been able to sidestep such rules, Brown said it was too early to tell and he had seen no evidence of this.
"We're working with the two SRO's — the IDA and the MFDA — to make sure that our rules are adequate," he said. "We are quite prepared to look at our own rules and make sure they are explained well enough, but we also want to make sure they are being complied with by those who are out making these investment recommendations.
"What everybody involved in the recommendation of complex financial products needs to do is to reassess their understanding of the product, reassess their commitment to investors, to make sure that products are suitable for them and to make sure they are motivated with the best interests of their investors in mind."
Many advisors have said the focus on referral fees has been unfair, saying that if they were simply "in it for the money" they could have earned more by selling their client a DSC fund.
But Brown says the regulator is really interested in finding out how Portus products found their way into so many portfolios so quickly.
"The fees that were being paid were comparable to fees that are being paid on the sale of mutual funds, but these were fees being paid for referrals and we need to understand whether that indeed was a factor in such a broad penetration of this product in such a short period of time."
While advisors were comfortable collecting a similar payout as they would have with a mutual fund, they are accepting none of the responsibility that would have accompanied the transaction had it been a fund sale.
"When formerly elite investment instruments become more widely available, the industry has to take a good, hard look at them to determine their suitability for the average investor," Brown said. "We also have to make sure that the industry is clear on its responsibilities."
Pointing out that hedge funds are not regulated by the OSC, Brown urged all investors who are interested in such products to be sure they understand what they are getting into and how the product matches their own risk parameters.
"I'm asking all those involved in the distribution chain to ask themselves whether they are comfortable, whether they understand the products they are selling," he said. "It is really a call to the industry — to us as the regulators, to the SROs who are responsible for setting the education standards — to stay current."
Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

Putting Client First. Marketing spin, or fact?

The Professional Financial Advisor
Toronto-based Financial Advisor John De Goey offers thoughts about fee-based advice, holistic planning and capital markets.
Corporate Mandate
By John De Goey Tuesday, May 24, 2005
A man (even if that man is a corporation) cannot serve two masters. Either he is serving shareholders or he is serving clients. Both are noble. Both are justifiable. But both cannot be served simultaneously.
I just finished reading Joel Bakan’s book “The Corporation”, which I received as a Christmas present. As a UBC corporate law professor, Bakan’s basic thesis is that since corporations are legally considered to be people, what kind of a personality type might reasonably apply to a corporation? The rationale put forward shows pretty convincing evidence that if corporations were in fact human, they would be seen by society as irresponsible psychopaths who lack empathy and are incapable of feeling remorse.
Corporations were brought into existence to make money. That is their overarching purpose. Senior executives, therefore, have a legal obligation to “maximize shareholder value” at the expense of all else. In fact, the law forbids all other actions and motives. When side-effects (something economists call “externalities”) do harm to society, corporations look for ways to avoid the blame. Think of the long history of harm done by corporations through time: Bhopal, Exxon Valdez, Thalidomide, Enron. The list goes on and the market timing scandal that pitted the interests of shareholders against those of unitholders is likely to go down as another fine example in a long line of externalities.
It is with this in mind that I reflected upon the re-assuring tone and content of all the web sites, newsletters and mission statements that so many investment firms (both those who create investment products and those who recommend them) show to their clients. Almost without fail, there will be a reference to the phrase “the client comes first”. Clients, always on the lookout for decent, high-integrity companies to work with, are presumably made to feel all warm and fuzzy when they read this- and to hand over their life’s savings as an expression of their unfailing trust in these reassuring words.
A man (even if that man is a corporation) cannot serve two masters. Either he is serving shareholders or he is serving clients. Both are noble. Both are justifiable. But both cannot be served simultaneously. In the majority of cases, the more money a firm makes, the higher the cost borne by clients. Conversely, the more prices are cut to benefit clients, the more shareholders will feel the pain. Profits derived from price changes, for instance, are a zero sum game. Whenever one party is doing well, it is as sure as the night follows the day that this comes at the expense of the other party.
What I found try astounding in the book is that one of the world’s re-eminent economists, Milton Friedman is of the opinion that corporate profit is a moral imperative. Friedman believes that corporate responsibility is both illegal and immoral if it compromises profits. He believes it is both illegal and immoral to put the client’s interests first.
Quite apart from the severe consequences if Friedman is right (jail time for installing SO2 scrubbers?), this could also lead to somewhat humourous situations. Imagine having a shareholder showing up at a corporate AGM brandishing a mission statement saying “It says here that you’re putting the clients’ interests first- what the hell is that about, Mr. CEO? If you don’t start charging as much as the market will bear and sending me the money in the form of higher dividends by the end of the next quarter, I’ll get you ousted.”
The simple lesson is that things are seldom as they appear. It is obviously disingenuous of corporations to suggest that they are simultaneously pursuing both agendas to the point where both sets of stakeholders’interests first. No one can have it both ways.
Even if CEOs said something like “we aim to balance the legitimate interests of all our stakeholders”, I would buy in, although Friedman likely would not. My view on the obvious disconnect is that the ubiquitous bumpf about putting clients first is really just another cynical attempt to get people to give you their money. Corporations don’t really mean it. Friedman says they would be breaking the law if they did.