Advisors Behaving Badly

I like to think that most investment advisors seek to do what they think is best for their clients. However, there are advisors who do the wrong thing, sometimes out of ignorance, sometimes due to poor supervision, and sometimes because they are predators, only in it for themselves.


Investment advisors who meet the average “retail” investor in Canada are likely licensed by one of two bodies, the Mutual Fund Dealers Association of Canada (MFDA) or the Investment Industry Regulatory Organization of Canada (IIROC). As the name indicates, MFDA licensees are authorized to sell mutual funds. IIROC licensees are authorized to sell a wider variety of investment products, including individual stocks, bonds, Exchange-Traded Funds (ETFs) or other exchange-traded products. Many also sell mutual funds.






In the following you will read several brief descriptions of advisor misconduct that resulted in fines, suspensions, or terminations of employment in the investment industry. Sources for these examples are from the enforcement sections of the websites of the MFDA and IIROC.


Pre-Signed Account Forms

An advisor, wishing to save a client time filling out tedious paperwork, says he just needs the client’s signature and that he, the advisor, will take care of the details. Ostensibly done for the benefit of the client, this is bad behaviour because an unscrupulous advisor can fill in details that are not necessarily consistent with what the client wants. For example, all investing involves a degree of risk. These risks can range from the virtually risk-free money market mutual fund to a very risky concentrated selection of emerging market stocks from only one country.  Most of the mainstream mutual fund companies pay a trailing (ongoing) commission to the advisor (and the advisor’s firm) who recommends one of their funds. Being able to sell a high-fee fund is better financially for the advisor than is a low-fee fund.


Lesson for Clients

Do not sign any documents in advance. If a dispute later arises over the actions taken by your advisor, you don’t want to have your signature used against you.


Unsuitable Investment Recommendations

An advisor neglected consideration of a retired widow’s circumstances when making investment recommendations. This long-term client had limited investment knowledge, used her investment assets to supplement her income, and relied on her advisor for recommendations. The bad behaviour began following the advisor’s move to a new firm shortly after the client retired. Over the subsequent five years, the client’s accounts lost 23% of their value while during the same period, the S&P/TSX Composite Index (broadly representative of the Canadian stock market) went up by nearly 24%. The client wanted low-risk, income-producing assets suitable for a retiree, while the advisor put a significant proportion of her assets into high-risk investments. Furthermore, the client’s margin account was in a debit balance for nearly two of the five years in dispute. In other words, the advisor was borrowing against the value of her account to invest. This further compounded the risk.


Lesson for Clients

Don’t trust your advisors? This is a tough one, because the advisor did not have a disciplinary record prior to this, was cooperative, and fully accepted responsibility. There were no red flags.


There is a saying that goes something like, “No one cares for your money more than you do.” Even if you have limited knowledge of investing, you still have to understand enough to recognize when your advisor is going outside the limits you agreed to. “Buyer beware” is too often still applicable.


Look for an advisor who understands your circumstances and goals, focuses on asset allocation rather than picking individual stocks, knows the risks you face and understands the way insurance may help to mitigate that risk, and only then suggests the appropriate products to invest in, all the while paying attention to the tax implications of the investments that are chosen. That’s a whole lot more than, “I recommend you invest in these four mutual funds.”


Borrowing Money from a Client

In this case, an advisor borrowed money from two clients, requested a loan from a third, and in the case of a fourth client, processed a redemption and deposited the amount in an account owned by relatives without disclosing this to the client. This last instance amounts to discretionary trading without permission and theft.


If we ignore the last one for the time being, the problem here is one of a conflict of interest. Instead of engaging in investment recommendations made in the interest of the client the advisor is now a debtor of the client, which changes the nature of the relationship.


As for the theft, this was eventually repaid with interest, but that does not change the fact that the advisor took advantage of her access to her client’s account to “borrow” money without the knowledge of the client.


Lesson for Clients

People involved in the financial services industry need to have their own financial houses in order. Bankruptcy can bar someone from holding an investment advisory licence. Nothing in the judgement indicated that the advisor was about to go bankrupt but borrowing money from a client is surely a sign of trouble. In the findings, the advisor stated that she lacked the means to pay the fine that was levied. If your advisor solicits a loan from you, review your accounts carefully and consider looking for someone else to manage your investments.


Evading Supervision of Unsuitable Leveraged Investment Recommendations

One of the most important undertakings when taking on a new client is to gain a full understanding of that client. The New Client Application Form (NCAF) helps an advisor gain this understanding by going through a KYC (Know Your Client) process. Among other things, an advisor needs to understand a client’s knowledge of investing. In this case, the client, a woman in her 60s, had limited investment knowledge. Nevertheless, the documentation indicated that her knowledge was good. It is not stated explicitly in the finding, but it appears that the advisor had an investment plan that she would be unable to implement for a client of limited knowledge.


The advisor went on to open several accounts, funded largely by the commuted value of the client’s pension plan. In addition, the client borrowed additional money to deposit into her investment accounts, using her home as security. This money went into a margin account. Deposits were invested in Deferred Sales Charge (DSC) mutual funds.


Multiple margin calls were made on the client’s account. The advisor arranged to cover these margin calls by selling and withdrawing (deregistering) funds from the client’s LIF (Life Income Fund), which held the commuted proceeds of her pension. This resulted in taxes from the withdrawals and fees from selling the DSC funds.


The advisor did the same with an acquaintance of this particular client. Eventually, both clients closed their accounts.


To summarize, the advisor used a double leverage strategy. First, the clients borrowed money using a line of credit secured by the value of their homes. Second, these funds were deposited into margin accounts, which allowed the advisor to borrow against the deposited funds to extend the amounts invested. Given the clients’ limited understanding of, and experience in, investing, and their limited tolerance for risk in light of their need to use income from their investments to support their living expenses, this strategy was wholly unsuitable.


Furthermore, the advisor did not document that the funds deposited into the clients’ margin accounts were also from borrowed funds. Knowledge of this detail would have helped the advisor’s supervisor to gain a better understanding of the risks the clients were taking on.


Finally, the advisor communicated with these clients using a personal email address, contrary to her firm’s policies and good practice. This further hampered the ability of the advisor’s supervisor to review the correspondence between the advisor and her clients to see if any red flags were raised.


Lesson for Clients

Investing is risky. You could lose money. Borrowing to invest makes investing even more risky. Yes, the opportunity for outsized returns is there, but leverage works both ways. Positively, your wins are magnified, but so are your losses when the returns are negative. I wouldn’t say never borrow to invest but think about it long and carefully before you do. This advisor told her clients that borrowing to invest was a “no brainer.” When an advisor fails to explain the risks involved, that is a red flag.


Pay attention to the correspondence you get from your investment advisor. Investment advice is heavily regulated, with significant compliance and supervision required. Watch out for actions an advisor might take to avoid supervision like using a personal email address or otherwise not documenting your interactions.


This case showcases the importance of asking questions of your advisor. Despite regulations, unscrupulous advisors continue to operate in the industry, either thinking that they somehow “know better,” or even worse, that they view their clients as opportunities for them to make money, regardless of whether it makes any money for the clients.


Conflicts of Interest

These are just a few examples of bad behaviour. Some advisors have engaged in such egregious behaviour, their character so thoroughly unsuited to the role, that they have been permanently barred from working in the investment industry.


If there is a consistent thread that runs through these cases, I think it is conflict of interest. If you are an investor, you may have received notices from your investment firm about conflicts of interest. These declarations came about as a regulatory requirement. Note that these are conflicts that are inherent within the respective firms.


Investment advisors also have conflicts of interest. Probably the most important one is the recommendation of one product versus another because there is a difference in compensation to the advisor, not because one product is objectively judged to be superior to the other.


Investment product A pays the advisor more than investment product B, but investment product B has a better long-term track record than investment product A. What would you expect an advisor to do? One likes to think that the advisor will act in the client’s best interest, but that is not always so, as these cases make clear.


And as a final note, just because an advisor discloses conflicts of interest, do not think that this means that the issues are resolved. A self-interested advisor is going to view that disclosure as clearing the path for continuing self-interested behaviour. A client is probably best advised to regularly review the actions of the advisor to see whose interest is actually being served.


This is the 108th blog post for Russ Writes.


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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.


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