Regulation of Financial Advisors

March 20th, 2014 by Potato

CBC Marketplace recently ran an episode looking at financial “advisors”, sending a woman in to several with money to invest and a hidden camera that has made some waves. Some advisors were ok (which of course didn’t air), but there were some that were just atrocious. They provided shockingly bad advice, or couldn’t answer simple questions about how much they were paid and what fees would be.

I don’t know how the advisors were selected: the show gave the appearance of picking randomly from large firms, but they may have been tipped off about bad ones in advance. The industry has tried to couch this as just a case of running into a few bad apples, but as Sandi says, that’s a load of bull and lets them continue to get away with a broken model for the industry. Some of them were so bad that a bad apple metaphor doesn’t cut it, but rather one with a grenade in it. That should never have happened.

Yet such incredibly bad advice is not so unusual — the system and the major firms do not set a high bar for financial advice.

This is a major issue. Financial advice/planning has a large impact on people’s lives, yet conflicts of interest abound and problems take years to show up. Moreover, people who need advice largely do not have the ability to evaluate the quality of their advisors (even with the benefit of hindsight), so recommendations from friends are basically useless. Combine all that with hidden and confusing fees, and this is an industry that cries out for regulation. A we-can-do-better retreat and voluntary code of conduct is not going to cut it.

Regulation can come in many forms: the government can step in to regulate from the top down, or industry groups can self-regulate. Often a hybrid emerges, where the government will help legally protect a professional title, and members of that organization will self-regulate.

Right now, the conflicts of interest inherent to the existing salescritter-cum-advisor model are making it to the public consciousness. That erodes trust in the whole system, yet there’s very little in place to replace it.

Here is the central issue as I see it: the system needs to be reformed so that someone with no knowledge and no way to evaluate quality in advance can go to get advice from someone and trust in that advice (and get reasonable value for the fees that they pay while they’re at it). And really the best way to build trust for the lay public is to have a trustworthy expert give the thumbs-up — that is, regulation.

What does good regulation look like? There’s some kind1 of quality standard set, with a mechanism to get it there in the first place (training, examinations). There’s a mechanism to maintain quality, through reducing conflicts-of-interest; ongoing training and continuing education; ongoing oversight, evaluation, and auditing; and even formalized specializations. And a way to make things right when the few bad apples inevitably get in: dispute resolution mechanisms, compensation funds. In return, a profession gets formalized and protected credentials and naming rights. Culture is important: a focus on ethics and client needs, on openness and honesty.

Not every element is required there. And government isn’t necessarily required: creating a brand that people can trust can also work. That can be a faster approach to get started, but doesn’t carry as much weight without the government behind it. In the next post I’ll look at some examples of professions that are out there now and how they are regulated. In the meantime, check out this week’s BecauseMoney podcast where I discussed this issue with hosts Sandi Martin, Jackson Middleton, and special guest Noel D’Souza.

1- actually the quality standard itself is important too — it should serve the right people (i.e. the public rather than the banks), have associated metrics, be achievable, consider structural issues and conflicts-of-interest, etc.

4 Responses to “Regulation of Financial Advisors”

  1. Neil Murphy Says:

    I’m going to keep harping for a long time on this one point, but if we eliminate the conflict of interest in how advisors are paid, we will eliminate most of the problems. I am building Portfolio Audit on this fundamental truth. Advisors should be paid for the work done, and nothing else, just like accountants and lawyers. Full disclosure, fully accounted for. And most of the problems will dissipate like vapour. Great article, thanks!

  2. Rezdent Says:

    Agree that something needs to be done. I agree with Neil that eliminating the conflict of interest in the reward structure would solve the majority of issues.

  3. Ken zkivenko Says:

    Good article.
    A Best interest standard needs to replace the suitability standard.
    Mutual fund embedded commissions need to bebeliminated.
    Advisor proficiency standards need to be raised.

  4. Nicole Says:

    Nice article! It’s scary how the media will create the scandals and paint the whole industry as corrupt or inept for ratings. Full disclosure should put everyone on the same side of the table, I agree with Neil on that. I’m on the fence about taking away the trailers for mutual funds. On the other hand our regulators are making it onerous to run a business. Please check out this well written article on how the regulators are strangling the industry.