While all Canadians are vulnerable to deceptive and biased financial advisory practices, there is ample evidence to suggest that senior citizens are hit first and hardest. Incidents of elder financial abuse are increasing. Some financial service providers have been known to mislead older clients, embellishing their credentials and purporting to have special certification in advising senior citizens. The North American Securities Administrators Association has decried these practices as dishonest and unethical, but in the absence of proper regulation, this issue will only get worse.
Even when financial advisors operate with the best of intentions, problems arise. Rates of financial literacy are relatively low across Canada, meaning that few people possess the knowledge and ability to properly evaluate investments and financial products. Without the assurance that their rights will be fully protected, investors cannot comfortably confide in financial service providers. It’s clear to CARP that regulatory authorities must protect the retirement savings and financial well-being of older Canadians by legally requiring advisors to act in their clients’ best interest.
Information Asymmetry and Disclosure: Leveling the Playing Field
According to the United States’ Securities and Exchange Commission, a widespread lack of public information about certain financial products, such as mortgages, worsened the damage caused during the 2008 financial crisis. In Canada and the United States alike, financial advisors took advantage of their clients’ relative lack of economic literacy to understate the risks of investing in these types of securities. Investors and regulators alike therefore weren’t made fully aware of the costs and benefits of investing, which limited their ability to truly understand the financial decisions they made.
Canadians’ investment and financial literacy is very low. A recent study of Quebec and Ontario investors’ knowledge found that there are “significant gaps” in investor knowledge of risk and return of asset categories and that the general level of investor knowledge is “mediocre”. The study notes that this “mediocre knowledge of the performance of categories and of the concept of risk premium calls into question investors’ financial planning ability.”1 Investors fail to understand a number of significant aspects of sound financial investment, according to the findings of the study:
- The majority of investors underestimate the risks associated with shareholding
- The majority of investors think that there is no systematic risk-return relationship
- Almost all investors believe that some stocks offer a high return with low risk
- A significant portion of investors does not sufficiently understand portfolio diversification
- 35 percent of investors do not know how to diversify
- 20 percent investors don’t know that stock portfolios can be diversified with mutual funds
- Only 20 percent of investors know that there is no reliable means of detecting overvalued or undervalued stocks
- Half of investors largely overestimate the probability of obtaining an exceptional return when they invest in a company on the TSX Venture Exchange
In the wake of the Great Recession, many regulators have proposed that financial providers should aim for high levels of public disclosure and accessible, easy-to-understand information about their products. Economists note that financial providers tend to widen the knowledge gap between advisers and investors, using deceptive marketing and incomprehensible jargon to reduce their customers’ ability to make informed choices. This behaviour drastically undermines consumer confidence, which in turn can lead to an overall lack of faith in the financial system and spark economic distress.
Many studies suggest that clients of firms with high levels of disclosure are more confident that their transactions are conducted fairly. When firms make an effort to educate their customers, they experience higher stock liquidity and greater consumer confidence. So why do some providers continue to leave their clients in the dark?
Risky Business: Acting in Canadians’ Best Interest
Part of the answer boils down to risk. While investors may prioritize risk management to protect their assets, financial advisors may seek to engage in riskier transactions in hopes of maximizing their bottom line. According to a report by the Canadian Securities Administration, “The current regulatory framework for advisors does not adequately protect Canadian investors… it does not explicitly require that advisors put the interests of their clients ahead of their own and therefore does not align advisors’ interests with those of their clients.”
Worsening matters, the average Canadian’s financial knowledge is quite limited. This lack of financial literacy can contribute to consumers’ mistaken belief that their advisor is required by law to act in their best interest. In reality, current standards require advisors to recommend products that match their clients’ needs, not investment options that are in their clients’ best interest. Rather than offering the product with the fairest price for the investor, financial providers frequently recommend those with higher rates of advisor compensation.
In CARP’s view, it is high time for a system that legally requires advisors to act in their clients’ best interest. Making this a mandatory industry standard would result in more objective and less expensive product recommendations for all Canadians. It would go a long way to reducing rates of financial elder abuse. And it would enable older Canadians to protect their hard-earned retirement savings for years to come.
September 21, 2015