August 16, 2019 | Find an Advisor, Fiduciary, Financial Advice, Advisor Background Check
A visitor to SeekAdvisor recently asked about the Dealers who many of our profiled advisors work for…
“Hey SeekAdvisor…I don’t recognize the names of most of the firms that the advisors on your site work for. Are they safe?”
Absolutely they are. In fact, on SeekAdvisor we only profile advisors who are Independent. In many cases, Independent Advisors don’t work for Dealers who’s name you would immediately recognize. But that’s okay (and perhaps better) and in this post I’ll explain why.
First - it's important to understand who 'isn’t' Independent Financial Advisor?
Most registered Financial Advisors in Canada aren’t Independent.
Instead they work for large financial institutions under brands that most people would recognize. Non-independent advisors include:
· Anyone who works at for a bank or credit union.
· Anyone who works for a company that sells proprietary products – such as Investors Group (now IG Wealth Management) or Freedom 55 Financial.
Financial Advisors working for large, big brand name firms can’t generally offer advice which is completely independent. When I say independent, it’s important to understand that their advice isn’t free of conflicts of interest.
Most Non-Independent Financial Advisors are burdened with serving the interests of the organizations they work for first, and their clients second.
At the highest level, profitability of the firm is the priority. This is obvious. Banks, for example must demonstrate to their shareholders the profitability of their various businesses – including wealth management. Here are a few ways these firms achieve this objective with the help of their advisors, and to the detriment of their clients:
1. Distribution of Proprietary Products – Proprietary products are financial products that are ‘manufactured’ by the same Dealer, or a company affiliated with your advisor’s dealer. From a Dealer perspective, sales of proprietary products are much more profitable than non-proprietary products because 100% of the profits are retained in-house. As a result, Financial Advisors (and their Managers) at Non-Independent dealers are frequently offered monetary incentives to recommend these products over other products that may be better suited to their clients.
According to CSA Staff Notice 33-318 (Review of Practices Firms Use to Compensate and Provide Incentives to their Representatives):
“These practices create a serious conflict of interest. These practices create an incentive for representatives and the firm to drive sales of proprietary products in order to maximize the firm’s profits, which can result in inappropriate advice and inferior client outcomes.”
2. Distribution of Initial Public Offerings (“IPO’s”) – One of the primary sources of revenue for Investment Dealers is the distribution of Initial Public Offerings. These deals are structured by Investment Bankers at a Firm who acts as the “lead advisor” to the company issuing the IPO. The shares are subsequently distributed through a “syndicate” consisting of many different Investment Dealers. These deals are very lucrative for both Dealers who are part of the syndicate and their Advisors – offering Financial Advisors anywhere between 3% and 5% fee based on the dollar value placed in client accounts. Imagine an Advisor allocating $3,000,000.00 worth of shares to client accounts and grossing $150,000.00 for their efforts. During my time in the industry I saw many windfalls of a similar size. IPOs are frequently positioned to clients as an exciting opportunity to get in on the ‘ground’ floor of a new company – and the financial incentive to recommend them to clients is clear. IPOs have historically performed quite poorly, especially when compared to the broad market. In this study researchers concluded:
“The average return estimated during the three years following Canadian IPOs is abnormally low, statistically significant and in the vicinity of -20% to -40% for all IPOs…”.
3. The Compensation Grid: The so called “Grid” applies to all Financial Advisors working at Banks and other large institutions that could be categorized as ‘Independent Dealers’. But it’s important for investors to understand how these employee advisors are paid by their firm and how this can lead to advice that’s conflicted. The comp grid is simply a performance-based compensation system. The more gross revenue an advisor brings into their firm, the more they are paid. For example (and these are accurate representations of most dealer grids) – the lowest grid level might be $300,000.00 – where an Advisor who grosses this amount over a year might be paid out 25% of this amount. The top grid level might be $750,000.00 and the Advisor will be paid 50% of this amount, plus additional bonuses and rewards. Between the top and bottom grid levels there might be 3 or 4 others with incrementally higher payouts. Clearly this incentivises Advisors to grow their business and reach the next grid level. It may also incentivise Advisors to recommend products that offer the Advisor higher compensation but may not be in their client’s best interests. A quote from this notice by the Investment Industry Regulatory Organization of Canada sums up this concern quite nicely:
“…when it came to compensation-related conflicts, most firms sampled lacked a meaningful process to identify, deal with, monitor and supervise compensation-related conflicts. For example, most firms did not have mechanisms in place to identify advisors who recommend products that yield higher fees and bonuses, when there are other suitable but less expensive alternatives available. They also did not have a process in place for implementing additional monitoring of advisors approaching compensation thresholds based on the amount of revenue generated.”
How Regulators are Conflicted in their Duty to Protect Consumers
Along with several other drivers of revenue, conflicts continue to persist at non-independent financial institutions. Since they are fundamental to the operating model and profitability of these firms, they are unlikely to go away any time soon.
For their part, regulatory authorities such as IIROC and the MFDA (Mutual Fund Dealers Association) are clearly aware of issues that plague the industry but do little to protect consumers in a meaningful way. Instead regulators are in many ways conflicted themselves. According to IIROC the are funded “…on a cost recovery basis, charging dealer firms an annual fee based on the firm’s capital, number of registrants, trading activity and revenues.” If you dig a little deeper you will see that they actually take a percentage of the principal amount of each New Issue (IPO) or any subsequent distribution of securities. So yes - the regulators themselves benefit from the distribution of IPOs and other distributions.
Who Are Independent Advisors?
It isn’t uncommon for many Advisors to refer to themselves as ‘Independent’. They’ll often use the term as a badge of honour, suggesting that they aren’t beholden to a head office dictating how they run their business.
But not all Advisors are truly ‘Independent’ – instead there is a spectrum or hierarchy of independence.
Investment Council/Portfolio Managers – aka: ICPMs. Advisors in this category are registered as Portfolio Managers and have a fiduciary duty to act in their clients best interests. ICPMs are regulated by provincial securities commissions such as the OSC (Ontario Securities Commission). They are typically small in terms of Advisors and support staff, occupying a single office or just a couple of locations. ICPMs are fee only – they are not allowed to accept compensation that isn’t totally transparent and disclosed to their clients. They are not owned by larger dealers and do not sell ‘products’.
Fee Only Financial Planners. These Advisors typically work for themselves as sole proprietors. They are not registered with a regulator and are not licensed to recommend investments. Instead Fee Only Financial Planners are in the business of financial planning – which is a broad term which might include retirement planning, budgeting and estate planning. This group of Advisors are compensated on either an hourly or project basis.
Independent Advisors at Independent Dealers. Advisors working at so-called Independent Dealers are not always truly ‘independent’. The only claim that these Advisors have on their independence is that they aren’t operating under a bank – but their firms have a revenue model is in many ways identical to a bank. Advisors at these firms might be compensated according to a ‘grid’ and they may participate in IPO’s and other forms of tied selling – with a potential bias to selling inhouse, proprietary products. Some independent dealers have both an employee model as well as a Principal/Agent Model. Advisors operating under a Principal/Agent Model could be considered more independent than Employees as they’re responsible for their own expenses, and their compensation grid isn’t always tiered according to how much revenue they generate.
Are Independent Advisors Safe?
Returning to the original inquiry – by ‘safe’ its fair to assume that this means “…is my money safe?”
Yes! Your money will be as safe with an Independent Advisor as it would be with any Advisor working at a big bank owned dealer, but there are a few caveats.
First, you’ll want to make sure that your Advisor is registered with a Regulator. As part of a background check you can confirm an Advisors registration by checking Canadian Securities Administrators website.
If the Advisor is a Fee Only Financial Planner – their name will not appear in the registration database. This is okay because you will never (or you should ever!) transfer asset for them to invest for you or write a cheque to them for investment purposes. They only provide financial planning services. The only payment they can receive is for their services or advice.
Registered Advisors and Portfolio Managers who manage your money use the services of a clearing corporation for the safe keeping of your money. Advisors at large independent dealers such as Canaccord Genuity or Raymond James are ‘self clearing’ which means they have their back office for the administration of accounts.
Smaller independent firms such as RT Mosaic or Huxton Black use the services of Clearing Corporations such as National Bank Independent Network (NBIN) or Fidelity Clearing. Both firms administer billions of dollars on behalf of independent advisors and their clients. These services include trade execution, issuing client statements, account transfers, tax reporting, etc. You can see the list of NBINs services here. The services of a custodian ensure that all your money is held in safekeeping with all the necessary checks and balances.
As with any advisor you should never write a cheque for deposit in the Advisors name. Cheques should always be written to their dealer (for large independent firms) or the firm that provides their clearing services.
The most egregious examples of financial fraud in Canadian history have occurred when clients have written cheques directly to their ‘trusted advisor’. Some of the stand out perpetrators of these crimes include Earl Jones and the more recent case of Daniel Reeve.
5 Benefits of Working With an Independent Advisor
1. Transparent Fee Structure – Truly independent Advisors charge a flat fee based on the assets they manage. They cannot accept ‘hidden’ fees or commissions from the sale of products. All fees for their services are reported to you.
2. No Sales Quotas – Independent Advisors aren’t beholden to a management team who encourages the sale of products which may not be in your best interests.
3. Fiduciary Duty – Many Independent Advisors are registered as Portfolio Managers who have a legal duty to always act in your best interests.
4. Flexibility – Independent Advisors are not limited to a small product shelf from a specific family of mutual funds or proprietary funds. Instead they can offer investment solutions from a broad universe.
5. Liquidity – Unlike Insurance Agents, and other sales people who position themselves as Financial Advisors, Independent Advisors will not recommend illiquid investments such as Segregated Funds or Deferred Sales Charge funds that you won’t be able to liquidate without facing harsh monetary penalties.
Misguided Consumer Priorities
Most Canadians choose to work with Advisors at large name brand firms. This is probably because they believe that their money is ‘safer’ when their Advisor works under these brands. While it is true that it is ‘safe’, the controls in place are no more robust than those with Independent Advisors.
A more important consideration when choosing an Independent Advisor over a Non-Independent Advisor is alignment of interests. Knowing that an Advisor is truly able to act in your best interests, without bias is an important step in selecting a truly professional Advisor.