Disclaimer: The advice offered in this column as is intended for informational purposes only. Use of the column is not intended to replace or substitute for any financial, legal, or other professional advice.
Some of you may remember how the infamous bank robber Willie Sutton allegedly responded when asked why he robbed banks.
“Because that’s where the money is”.
After a lifetime of hard work and saving, there’s no denying that older Canadians have amassed a concentration of assets. This alone makes them great targets for financial fraud.
The benefits of experience may help protect us: research by behavioral economist David Laibson and others found that financial acuity increases with age but that at a certain point it declines. We are apparently at the climax of our decision-making abilities by 53.3.
When viewed through the lens of vulnerability to financial fraud, the prevalence rates of cognitive impairment among older Canadians are even more ominous. Alzheimer Disease and related dementia (AD&D) currently affect 8% of seniors aged 65+, with rates increasing to 1 in 3 seniors or higher among the oldest seniors (85+).
Add to that the current state of today’s volatile market and low interest rates that make traditional low-risk savings vehicles rather unattractive and you have a confluence of events that could lead to a perfect storm of financial insecurity. According to the MetLife Mature Market Institute, financial abuse is “the crime of the 21st century”.
To make matters worse, the number of scams that can be perpetrated is virtually endless and as the FBI notes, “is limited only by the imagination of the con artists who offer them.” In this article we will lay out a few of the more common investor scams scenarios you should look out for but we will also explore some broader techniques that will help you combat fraud in general.
In the last issue of CARP Action Online we discussed the recent Supreme Court Ruling against a National Securities Regulator and its impact. CARP had called for a single, national securities regulator that would address the issue of inadequate enforcement and inconsistent investor protection across Canada. It looks like for the time being, we are to remain with the current legislative and enforcement landscape, which we surveyed in our article on the Supreme Court ruling. So now what? This article will help you understand the resources at your disposal and the best way to use them so that your investments are protected from financial fraud.
But just how common is financial fraud? Our January 13th 2012, 2127 CARP members filled out our investor protection poll which revealed some alarming information. One tenth of readers had been the victim of financial fraud and four times as many readers knew someone had had been a victim. This statistic alone points to significant under-reporting. Extrapolating from these findings – more than 400, 000 thousand older Canadians have fallen prey to elder abuse, most commonly financial fraud, and close to 2 million know someone who has. To read more about our poll report/findings, please click here.
Fraud is a daily occurrence in Canada. According to investor and consumer advocates, so little resources are devoted to prosecution and enforcement that they amount to a drop in the bucket and are little more than token gestures. Over the past eight years, the RCMP has only managed a total of five investor fraud prosecutions.
It would appear that the best protection is prevention.
Caveat Emptor (Buyer Beware)
A good place to start is self-examination. Investors must be self-aware and honest with themselves. Studies and surveys have shown that some individuals have a tendency to overestimate their knowledge and skills when it comes to financial literacy. Consequently, such individuals discount the need for financial literacy education or informed advice and may engage in risky activities. Don’t underestimate the importance of financial literacy!
With the internet flooded with information that is not quality controlled, it is hard to know which websites can be trusted for financial information. You can at least trust the content provided on the following websites:
- www.moneytools.ca (hosted by the Financial Consumer Agency of Canada)
- www.getsmarteraboutmoney.ca (Investor Education Fund)
- www.yourmoney.cba.ca (Canadian Bankers Association)
- www.moneymadeclear.org.uk (This website has been created by the U.K. Consumer Financial Education Body but is a good example of what can be done on a National basis – it contains information that would also be of value to Canadian investors).
Be On the Lookout for the Following Broker Practices:
No such thing as a “free lunch”: Many brokers try to attract an older clientele by offering so-called “free lunch seminars”. Although honest brokers can hold such seminars as legitimate way to recruit clients, you should remain guarded. An investigation by federal and state regulators in the United-States found that more than half of these seminars involved misleading or exaggerated claims, and 13% included fraudulent practices, such as the sale of fictitious investments. Even brokers who claim to be hosting the event said to inform their audience are usually working a sales angle. Be prepared to fend off high-pressure follow-ups after the session.
Steering You Away From A “Breakpoint”: Many brokerages charge their investors a sales charge based on the dollar value of the investment that is made. Some will charge 5% on an investment of less than $10,000 and 4% on investments $10,000 or higher. Although this is a fairly common practice and is not in and of itself dishonest, an unethical advisor may tell you to invest $9,950 instead of $10,000 (the breakpoint), thereby preventing you from receiving a 1% savings in brokerage fees. Ultimately, this so-called advice will yield higher commissions for the brokerage. Note that your broker may also split up your investment and spread them across multiple companies, thereby racking more fees, due to the larger number of transactions.
You should be aware that investment fees can prove quite costly and be aware of just how much you are paying. This video http://business.financialpost.com/2012/01/10/this-is-why-investment-fees-matter/) by Jonathan Chevreau does a great job of explaining why fees matter so much to investors. He explains a simple calculation that shows how long it will take for the Management Expense Ratio (MER) to consume one third of your investment. If the MER is 2.0, it will take 20 years for one third of your investment to be consumed by fees. If the MER is 3.0 it will take 13.3 years. On the other hand, if you were to buy the Vanguard MSCI Canada Index, at 0.09%, it will would take 444 years.
Churning Your Account
Churning involves brokers that abuse their investing authority to use your money for excessive trading so that they can rack up commissions for themselves. If you have full service broker and rely on someone to handle your accounts, then you should think twice about giving your express permission to your brokerage firm to do anything without your involvement. Without your permission your broker will need you to put in an order to buy or sell before he/she can make trades in your account. Or you can also open a wrap account and pay one flat fee for all transactions.
Case Study: When a Broker Uses Churning to Defraud You – If the description failed to convince you of the nefarious effects that churning can have on your account this is a case study that was culled from the Ombudsman for Banking Services and Investments website. OBSI is the only regulator that provides case studies and it is a good idea to familiarize yourself with them to get a better idea of what your responsibilities might be as an investor and of the type of situations where you may have a case for restitution. Read more case studies on the OBSI website by clicking here
2006: The client, a novice investor in her 60s, was looking to invest $75,000 of an inheritance she received. This money was a significant portion of her net worth. With the help of a long-time friend, she opened a margin account with the firm. Through her friend, the client completed the account opening documentation. She never met with the advisor. In fact, they only spoke twice by phone when the client wanted to withdraw money from her account.
The account was opened mid-month and the client’s first statement showed 18 trades in two weeks.
She received a handwritten note from the advisor assuring her that the trading activity was normal and that she was making money.
In the second month, the advisor executed another 71 trades. Another handwritten note from the advisor said that even though the account had lost some money, it was well positioned going forward.
Over a period of 18 months, 582 trades were placed in almost 100 different stocks without the client’s consent. The aggregate value of the buy orders executed on the $75,000 investment totaled over $4 million. In one month alone, over $1 million was traded with equity in the account of only $20,000. In the end, the portfolio’s worth was only $4,785.
The firm argued that the client should accept some responsibility for her losses because she received statements showing the account activity. OBSI concluded that the client could not be expected to identify and stop the inappropriate trading activity when the firm’s own supervision, led by licensed and experienced financial professionals, failed to do the same. OBSI recommended that the firm compensate the client for 100 per cent of her losses.
Telling You to Buy Stock For The Wrong Reasons
Some brokers may try and convince you that you should hurry and snap up that stock but it has to be now. There are a variety of pressure tactics brokers may use to get you to agree to a purchase before you’ve had the time to properly research what they are suggesting.
One of the more common pitches is that the stock is getting ready to pay dividends. What the broker might not tell you is that the value of your stock could quickly decrease after those dividends are paid out to shareholders (and in so doing subtracted from the company’s overall value). If the stock is weak and you purchased it solely based on the fact that it was about to pay dividends you could end up loosing a lot of money.
Questionable Advice: If it seems Unlikely or Too Good to Be True, It Probably Is
A broker may not be actively out to commit fraud but they may give you advice that is completely unsuitable for you and your goals. It is very important for you to understand the concept of risk and know your risk tolerance going in so that you are able to identify what makes sense for you and what doesn’t. If you broker is trying to sell you something that seems extremely high risk and guaranteeing you stellar returns that seem too good to be true – stop right there. They cannot guarantee those returns – if you stand to gain in a big way you also stand to lose in a big way.
Being aware of your diversification profile– like knowing your risk tolerance might seem like a very basic investment concept but it is easy to lose sight of logic when profit is involved. Look out for brokers trying to concentrate all your funds into only a few investments or insisting on over diversifying your assets in order to let them achieve higher commissions from the transactions that are made.
In some cases, investment advisors, financial planners or brokers can be an effective component of you investment strategy. But first you must land an honest scrupulous professional who will help you gain an understanding of the balance of risk and reward in the market as it relates to your own risk tolerance while handling day-to-day trading decisions you might not be equipped to make.
However, if you aren’t paying attention to what your broker is doing, they can certainly cost you quite a lot! So the lesson here is that you really should keep tabs on your investments and your broker (or advisor) no matter how well you trust them. If something does go wrong it is very important that you react right away so if you see something wrong with your portfolio – don’t be afraid to ask questions. Don’t be afraid to ask someone else for advice as well – you do not have to take your broker/advisor’s word for everything.
You should also look into the lower-risk options available that don’t wear down your investment with giant management fees. Low-risk investments include (but of course are not limited to:
• Savings accounts
• Canada Savings Bonds (CSBs)
• Guaranteed Investment Certificates (GICs)
• Treasury bills (T-bills)
In the next installments of this series we will examine how to go about deciding on a broker, which questions you should ask and how to run a background check on them to ensure that there are no outstanding complaints against them. We will also delve into the complaints, mediation and restitution system available to retail investors.