|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.
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.