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How to spot abusive advisor practices

Tuesday January 20, 2015

Most of the financial advisors I meet in the field or at educational seminars are wonderful people who work hard for their clients and do right by them. But there are exceptions. I sat down recently with a prospective client who had what I would call an abusive financial “advisor” who is in the business only for himself. As a result of that meeting, I thought I would revisit the red flags clients need to be aware of when dealing with advisors.

1. Pushing DSC funds

For most advisors, the days of selling funds with MERs of over 2.6% were over long ago. Same thing with selling funds on a deferred sales charge (DSC) basis. The only thing a DSC does is to lock an investor into a fund company for six or seven years. Why would anyone choose that option when 0% front end load funds that you can sell any time are widely offered?

Investors need to know all their options. Some advisors will say that Buying DSC doesn’t hurt you and allows him to get paid. That is rubbish, of course. Flexibility and liquidity are always preferable. And somehow, tens of thousands of advisors seem to get paid – many of them quite handsomely – without locking in their clients into DSC arrangements.

2. Churning DSC funds

Churning is one of the most abusive and hurtful practices to clients, and it shows tremendous greed on the part of the advisor. Churning occurs when a mutual fund is sold on a deferred sales charge basis, generating a commission for the advisor, and as soon as the DSC schedule allows, units are moved into another DSC fund, paying the advisor twice on the same money.

Sometimes the advisor waits until the fund is halfway through the DSC schedule and convinces the client it’s in their “best interest” to move to a new DSC fund with a different company. The client pays early redemption fees for exiting the first fund early, and new commission and DSC fees on the new fund. (If you move a DSC fund to another fund in the same company, the DSC schedule is unchanged.)

Another churning technique is to take out the 10% fee-free units and move back into another DSC fund, which, of course, pays the advisor again.

The trouble here is that these sorts of fund switches and purchases are done with the sole aim of generating commissions for the salesperson rather than returns for the client. Churning generates big commissions in addition to ongoing trailer fees. Some dealers fire advisors who do this, others get away with it for years.

If you suspect your fund salesperson is involved in this type of activity, get a second opinion before agreeing to any further DSC sales or early redemptions.

3. Leveraging

Leverage involves persuading people to borrow money and invest it (usually in DSC mutual funds, which make it a doubly bad practice). The idea is that you deduct the interest on the loan and watch your investment grow. Sometimes it grows nicely; other times the market corrects, and you are left with a decreased portfolio (or even worse, a portfolio worth less than the value of the loan), plus you have had to pay thousands of dollars in interest payments.

The practice of leveraging has hurt more clients than any other “strategy.” I have seen elderly retirees living on $30,000 a year get roped into high-risk leveraged investing through aggressive sales techniques and pressure tactics. It is a long and painful process to get out of leverage if your income is low or you’ve lost your job.

Don’t even consider leveraging investments unless you have a very high tolerance for risk, a stable job, you’ve maximize your RRSP contributions, and have no mortgage (or a small one).

If you spot the red flags…

If you suspect that your current financial advisor is churning, offering DSC funds to the exclusion of other low-cost alternatives, or pressuring you into leverage strategies, run in the opposite direction. Get a second opinion from an objective advisor at an unrelated firm. Find an advisor who works with you and for you – one who puts your interests first. Report the others to a supervisor at their firm, their head office, or the appropriate securities commission or regulatory bodies in your province.



Generic Mutual Fund Disclaimer

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

Personal Opinions & Recommendations Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. However, please call the author to discuss your particular circumstances.