Acting in your best interest
You may have assumed that the Financial Advisor you've relied on always had your best interests at heart. But is that in fact the case? And to what extent are they so obligated?
Taking control of your financial future is a wonderful thing. Having realistic expectations for future growth, selecting the proper investments, understanding the purpose of each holding in your portfolio (rather than chasing what worked yesterday), and preventing oft-repeated investor behaviour from eroding that financial future is essential. For myriad reasons, however, the need to protect and grow one’s wealth in conjunction with a professional, rather than on one’s own, is a necessity. The question is, how do you choose the right Advisor? How do you assess credibility, ethics, track record, and process? Recently, there has been a flurry of activity, both the in US and in Canada, around regulating the conduct of professional Advisors, with the goal of increasing investor protection. Scandals from Madoff to First Leaside show that there is a need for this, and we are very happy to see it, as it will lead to the betterment of our entire industry. As our clients and friends, it is important that you understand what changes are being proposed, how we made the decision years ago to conduct ourselves using the absolute highest standard of ethical and moral values, and how we distinguished ourselves in that respect. Let’s discuss:
In the USA: The US Department of Labor (DOL) recently issued the “Fiduciary Rule” (i), which requires Advisors who advise on retirement assets (IRAs, 401Ks, etc.) to govern themselves by the standard of a Fiduciary (as defined under ERISA) (ii). Previously, most advisors were only held to the lower “Suitability Standard”; the distinction between the two is very important for clients to understand. The Suitability Standard only requires that an investment product or security be "suitable" for a client. While this, too, mandates making recommendations that are consistent with the best interests of the client, an Advisor has no specified duty to act in the client's best interest over his or her own. For example, under the suitability standard, an advisor would be able to pick a fund that paid the highest embedded commission as long as the fees weren't "excessive”. The Fiduciary Standard takes the Suitability Standard a step further and stipulates that an advisor must place his or her interests below that of the client, and display a duty of loyalty, prudence, and care. A fiduciary must avoid conflicts of interest and is prohibited from taking unfair advantage of a client's trust. Under the Fiduciary Standard, an Advisor is obligated—not just ethically and morally—but legally—to act in the best interest of the client above all else. President Obama touts this as a tremendous step forward in terms of protecting investors (iii). However, the final version of the Rule that was handed down is a watered-down, conciliatory, collection of half-measures (iv) that blunted the teeth of many of the originally intended concepts (v), among them, restrictions on proprietary products, and an immediate effective date. It also only applies to retirement accounts; a significant limitation. However, the creation of the Fiduciary Rule is unquestionably a step forward (vi) if not entirely based on its prima facie merits, than at least for bringing the conversation to the forefront and making investors aware of some very important issues.
Here at Home: For several years, our regulators North of the border have been hard at work creating a similar requirements, known here as the “Best Interest Standard”(vii). The Ontario Securities Commission, through the creation of its Investor Advisory Panel (viii), has (finally), last month, issued its report not only detailing the need for a “Best Interest Standard”, but committing itself to the creation thereof (ix). A major focus is going to be preventing conflicts of interest, including embedded compensation. Trailer fees, deferred sales charges (DSC), and other heretofore “hidden” forms of advisor compensation may be eliminated outright, or, at least forcibly disclosed to clients up-front. The standard builds on the policy goals of regulators to educate investors (which is a goal we share with them). Firms may be required to disclose whether they are offering proprietary products only or a mix of proprietary and non-proprietary products. Mutual fund dealers may need to disclose that they do not consider a full range of investment products. Know-Your-Client (KYC) and Advisor proficiency requirements may both be tightened. Understanding if your Advisor is choosing investments manufactured by their own firm (or if they are incented to do so) versus considering an entirely open range of solutions, is something investors would be wise to do. Our suspicion is that, whatever form the legislation in Canada ultimately takes, like in the US, it will be an improvement over the status quo, but ultimately, won’t take the place of an investor needing to conduct their own thorough due diligence when hiring an Advisor and understanding exactly what conflicts, or potential conflicts, could exist in the mind of their Advisor.
What is an investor to do? Understanding how their Advisor is compensated, their investment selection process, the importance of open-architecture (the ability to select investments outside of those created by their own firm), as well as the ethics, integrity, and qualifications of their Advisor should be absolutely top-of-mind for any investor, and, at the end of the day, while legislation will help, it is no substitute for knowing exactly whom you are retaining as your Advisor. People tend to act according to the manner in which they are incented, so make sure your Advisor’s interests are fully aligned with yours and that it is your best interest that is at the core of everything they do: The perfect place to start is with The Statement of Investor Rights, created by the CFA institute. We believe that you have these rights, and we do everything in our power to help you exercise them. This piece, Realize Your Rights, also created by the CFA Institute, gives you a usable list of Questions to Ask Your Financial Advisor. While the questions should serve merely as springboards to broader discourse, it is a great start. Anyone you work with (or are considering working with) should be able to provide satisfactory answers to the questions in the Realize Your Rights piece as well as the ones linked below. We certainly can.
How We Distinguish Ourselves:
At The Kaufman Group, we are way ahead of the curve. Long before the Fiduciary Rule, the Best Interest Standard, or CRM2 (x) became topical, we chose to take the highest possible road and conduct ourselves according to the strictest of ethical standards. We take our responsibilities to our clients very seriously, and are committed to demonstrating that on an ongoing basis. Here’s how:
1. We receive no compensation from anyone but our clients. Because we are paid only by our clients, we remove even the potential for conflict of interest. Any funds in which we invest are F-class, meaning that, by definition, there is no embedded, trailer, deferred, hidden, or any type of compensation paid to us whatsoever. Further, we charge no commission on transactions—i.e. to buy or sell. Instead, we charge our clients a flat percentage fee (deductible for non-registered accounts) that covers everything we do. Our only incentive is to help our clients grow their wealth. The very few exceptions to this process are outlined below (*). Our clients know exactly what they are paying, as all costs are plainly disclosed. We issue a receipt for our fees every year and highlight our fees on ongoing progress reports. Nothing hidden; zero surprises. We have done this for many years, long before the industry began to explore mandating it.
2. We invest with the best available managers in the world because they are proven experts in their particular area of expertise. While we are licensed Portfolio Managers, we don’t have the hubris to suggest that we are the best stock pickers for your portfolio. So too, we don’t choose managers that happen to work at the same firm as us, and we don’t constrain ourselves to only Canadian managers. We strive to find the best possible components for our client portfolios, and are entirely open in our architecture, meaning we have the freedom, flexibility, and open platform to do what is right for our clients.
3. When we manage our clients’ portfolios on a discretionary basis, we operate as Fiduciaries, which is the highest standard of care in either equity or law. Everything we do is free from conflict of interest—either real or perceived; present or potential. Our firm is the only one in Canada certified by The Centre for Fiduciary Excellence (CEFEX), which mandates adherence to best practices as prescribed by the Employee Retirement Income Security Act (ERISA), the Uniform Prudent Investor Act (UPIA), the Uniform Prudent Management of Institutional Funds Act (UPMIFA), and the Uniform Management of Public Employee Retirement Systems Act (MPERS) (xi).
4. As a Chartered Alternative Investment Analyst (CAIA®), I am bound by a strict code of ethics (xii). That ethical standard is identical to the Chartered Financial Analyst (CFA®) code of ethics and comprised of the same material (xiii), known as the strictest code of ethics in the industry.
5. I am presently a candidate for the Accredited Investment Fiduciary (AIF®) designation (known in Canada as the Accredited Investment Fiduciary Professional—AIFP®) Advisors with the AIF® designation have committed themselves to be being held to the higher Fiduciary Standard when it comes to providing investment advice. Administered by The Center for Fiduciary Studies and fi360, based in Pennsylvania and Toronto, the Accredited Investment Fiduciary (AIF®) professional designation is the industry's first and only designation that demonstrates knowledge and competency in the area of fiduciary responsibility, and communicates a commitment to standards of investment fiduciary excellence. Holders of the AIF® mark have successfully completed a specialized program on investment fiduciary standards and subsequently passed a comprehensive examination (xiv).
*The exception to this rule pertains to “new issues”—corporate finance underwritten stock issuance (IPO’s and such). If clients wish to participate in these share offerings, commissions are paid by the company issuing stock to our firm, of which part is shared with us. This specific activity is driven by client requests, and all commissions are disclosed in advance. Finally, when a client purchases an insurance policy, commission is paid by the insurance company to our insurance group, of which a portion is shared with us; all of which is disclosed plainly, in advance, to the client before making any decision to proceed.
At The Kaufman Group, we work with a select number of Canadian families. We accept new clients solely by referral, growing our practice by doing right and doing well for our clients. We would welcome an opportunity to discuss these important subjects with you, and invite your questions and comments.
[i]US Department of Labor. “Federal Register” vol. 81 no.68 http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=28806 [ii] US Department of Labor. “Meeting Your Fiduciary Responsibilities.” https://www.dol.gov/ebsa/publications/fiduciaryresponsibility.html [iii] The White House; Office of the Press Secretary. “Fact Sheet: Middle Class Economics: Strengthening Retirement Security by Cracking Down on Conflicts of Interest in Retirement Savings.” https://www.whitehouse.gov/the-press-office/2016/04/06/fact-sheet-middle-class-economics-strengthening-retirement-security [iv]Fortune Magazine. “Wall Street Dodged a bullet on the Retirement Fiduciary Rule.” http://fortune.com/2016/04/06/retirement-savings-fiduciary-rule/ [v]US Department of Labor. “Chart Illustrating Changes from Department of Labor’s 2015 Conflict of Interest Proposal to Final.” https://www.dol.gov/ebsa/pdf/conflict-of-interest-chart.pdf [vi]Forbes Magazine. “DOL Issues Final Fiduciary Rule, Does it Fall Short?” http://www.forbes.com/sites/ashleaebeling/2016/04/07/dol-issues-final-fiduciary-rule-does-it-fall-short/#13fa3077548e [vii] Ontario Securities Commission (OSC). “Securities Law & Instruments – 33.403” http://www.osc.gov.on.ca/en/37838.htm [viii] Ontario Securities Commission (OSC). “Investors – Investor Advisor Panel.” http://www.osc.gov.on.ca/en/Investors_advisory-panel_index.htm [ix] Ontario Securities Commission (OSC). “2015 Annual Report of the Ontario Securities Commission Investor Advisory Panel April 2016.” http://www.osc.gov.on.ca/documents/en/Investors/iap_20150420_2015-annual-rpt.pdf [x] Ontario Securities Commission (OSC). “Industry: Cost Disclosure, Performance Reporting and Client Statements.” http://www.osc.gov.on.ca/en/Dealers_crm2-faq-planning-tips.htm [xi] Richardson GMP Ltd. “Richardson GMP Embraces Fiduciary Excellence.” http://www.richardsongmp.com/become-a-client/client-experience/fiduciary-excellence [xii] Chartered Alternative Investment Analyst (CAIA). “Code of Ethics.” https://www.caia.org/sites/default/files/documents/policy/CAIA%20Code%20of%20Ethics9-22-2014.pdf [xiii] CFA Institute “Standards of Practice Handbooks” 2014 no. 11 http://www.cfapubs.org/doi/pdf/10.2469/ccb.v2014.n4.1 [xiv] Fi360. “Center for Fiduciary Studies.” http://www.fi360.com/center-for-fiduciary-studies