By Mark Barnicutt on February 8, 2010
This year, I celebrate my 20th year in the wealth management business. Although short in duration relative to some of my business partners, it’s sufficiently long to have experienced both good and bad market conditions. Unfortunately, in the bear market phase of every cycle, there are always sad stories about investor wealth that has been destroyed. I firmly believe that the accumulation of wealth for most people is primarily driven by the need for comfort, independence and their desire to pursue their goals and aspirations. This applies equally to both private and institutional wealth.
As the accumulation of such wealth requires hard work, patience and perseverance, investors should not have to accumulate their wealth twice! The needless destruction of wealth has always been something that causes me to become extremely angry as I strongly believe that Financial Advisors operate from a position of trust in which clients seek their advice to help them reach their financial goals. When this trust is violated, not only has a client been hurt but the wealth management industry – and everyone who works in it – has been tarnished. The stories of Bernie Madoff’s and Earl Jones’ victims are recent examples — both of which involved outright fraud — but others quietly exist which are not fraud related but professional negligence. Now, I’m NOT saying that fraud and professional negligence are running rampant in the Canadian wealth management industry — because they are clearly not, despite media perceptions — but like any profession……there are good practitioners and, unfortunately, not so good practitioners. So what should an investor do to protect their hard earned, accumulated wealth. That is the purpose of this article! Investors do not need to be “investment gurus” to protect their wealth BUT they do need to be educated on some basic concepts and be prepared to ask some basic questions related to how their money will be managed, both of which are reviewed below:
Wealth can be destroyed by two broad means : Fraud and/or Professional Negligence. I’m not a lawyer but my definition of fraud, from an investment management perspective, is the theft of an investor’s assets through deliberate and deceptive means. Similarly, my definition of professional negligence is an act or omission in the carrying out of the work by an investment professional that constitutes a failure to maintain the standards that a reasonable and prudent investment professional would maintain in the given client circumstances. An investor’s best defences, from a practical perspective, are both reviewed below:
Dealing With Fraud:
I believe that an investor’s best defence against advisor fraud is to NEVER (1) Write a cheque, and/or (2) Transfer their assets to their individual Advisor directly. Specifically, ALL cheques should ONLY be written to, and ALL assets should ONLY be transferred to the client’s own NAMED & NUMBERED account held at a CUSTODIAN that is INDEPENDENT of their individual financial advisor. A custodian is a financially secure and well-respected financial organization who holds and safeguards an investors assets. The purpose of a custodial relationship is to separate the “holding and safeguarding” of an investors assets from an individual Advisor so that nobody can get access to the investor’s assets without their consent. Also key to a true custodial relationship is the “segregation” of the investor’s securities, separate from the custodian’s general corporate assets.
In the Canadian wealth management industry, there are two broad types of custodians: Trust Companies [regulated by the Federal Government through the Office of The Superintendent of Financial Institutions (OSFI)] and Investment Brokerage Firms [regulated indirectly by the various provincial securities commissions and directly by the Investment Industry Regulatory Organization of Canada (IIROC)]. While Trust Companies tend to provide their services completely independent of any financial advisory firm (ie: Canadian Western Trust, CIBC Mellon, RBC Dexia), Investment Brokerage Firms (ie: Richardson GMP, Canaccord, BMO Nesbitt Burns) tend to provide custody as an integral part of their overall investment advisory offering BUT the individual Advisors do not have access to deposit/withdraw assets from an investor’s custody account.
It’s important to note that for clients seeking the complete separation of duties between advice and custody, they should hold their assets at an independent custodian (either a Trust Company and/or Investment Brokerage Firm – subject to certain asset size limitations & securities segregation such as Pinnacle Correspondent Services, NBCN, TD Waterhouse) which is INDEPENDENT of their financial advisor as the division of duties between “custody” and “advice” are always separated. This service will cost investors (typically 0.10 – 0.30% of their asset values per year on the first $1 MM of assets) but for investors concerned about absolute separation of duties, it’s a small “insurance premium” to pay! If investors do choose to custody their assets at an Investment Brokerage Firm who is also providing the investor with Advice, they should recognize the conflicts of interest that exist (and the potential risks) & select only financially strong advisory firms with sterling reputations.
One of the key elements of the custodial relationship with the investor is the “asset reporting” service. Specifically, an investor should ensure that the custodial reporting — which will show each investor’s security holdings and transactions (ie: purchases & sales) — is issued DIRECTLY to the investor (and not through the hands of the individual Advisor) on a regular basis. As these custodial reports are designed to be an advisor-independent reporting of a client’s assets and transactions, my comments in the previous paragraph should be noted.
Dealing With Professional Negligence:
Contrary to popular belief, being a professionally competent Investment Advisor is (and should) not be about the perpetual pursuit of ever increasing (or stable and unrealistically high) returns BUT instead about seeking the balance of risk & return management and the matching of suitable portfolio structures against clients’ unique goals. It may sound boring and it may not provide a lot of entertainment value but an investor’s best route to sustainable wealth should be about having a financial plan that has a clearly articulated and quantified goal, with a portfolio structure that has a risk and return profile that balances their aspirations with their true tolerance for risk, followed by a formal process for review with their Advisor who will then show them how they are progressing towards their goal.
As a result, all investors should query their Advisor about the processes they use to manage their clients’ assets, and insist that their Advisors adhere to a well-defined and clearly articulated process that addresses the following three phases of money management:
1. Policy:
– The written articulation of the Investor’s investment objectives, risk tolerances and financial goals
– The written proposal of a recommended portfolio structure and why such structure will satisfy the Investor’s investment objectives, risk tolerances and financial goals.
– The written statement of the above elements in an Investment Policy Statement that has been customized for the investor.
2. Management:
– The written plans to transition any existing investment holdings towards the planned structure (by both proposed transactions and timelines)
– The Advisor’s (and their firm’s) practices for monitoring an investor’s portfolio to ensure compliance with their Investment Policy Statement.
3. Review:
– The Advisor’s process for reporting of the investor’s portfolio structure and performance (should be done no less than quarterly) and a review of the portfolio’s progress towards the investor’s financial goals, while respecting their investment objectives and risk tolerances (should be done no less than annually).
Although the above process is not “bullet proof” in preventing professional negligence, it will greatly assist investors in being able to differentiate between “investment product sales people” and “real financial advisors” who are genuinely trying to help their clients pursue their financial goals.
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