Advisors’ Failure Rate in Recent “Mystery Shopping” Tests: 37% – Imagine if Doctors Performed That Badly

About a year and a half ago, CBC’s investigative consumer affairs show Marketplace aired a report exposing atrocious investment advice. Concealed cameras and microphones recorded advisors exaggerating the returns that could be expected from low-risk investments, deflecting discussion about a product’s risks, giving vague or mangled answers to questions about mutual fund fees, and misstating how trailing commissions and other fees are calculated and charged.

Some said fees were charged only on profits. One advisor even claimed there was effectively no fee: “It’s free. It’s like a free ride.”

Viewers could see and hear these things for themselves. It was compelling TV, and it was disturbing. But the sample size was tiny – only 10 advisors were visited, and nothing negative was reported about four of them.

Even so, the fact that inept or improper advice had been given at 60% of the meetings hung heavily in the air. Would such a high failure rate be found everywhere? We now have a clearer answer to that question.

In mid-September, results from a much more extensive “mystery shopping” exercise were released. This exercise was conducted jointly by three of Canada’s largest investment regulators — the Ontario Securities Commission (OSC), the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA). They hired a marketing company to send undercover testers into more than 100 investment firms.

Unfortunately, the meetings were not recorded. No hidden cameras or microphones were used, so regulators couldn’t see or hear for themselves what actually occurred. They had to rely instead on the recollections and impressions provided by testers afterward. This meant that regulators had no opportunity to pick up subtle indicators of incompetence or impropriety that the testers may have been unable to perceive, and therefore did not report.

Also, the meetings were preliminary only. No accounts were opened at any of the firms and no investments were purchased. This meant that the exercise didn’t span the entire sales process, and thus failed to capture a complete picture of what investors are told through the course of that process.

Yet, despite these methodological shortcomings, the exercise yielded some very important findings:

  1. Advisors made product-specific purchase recommendations in roughly one-quarter of the meetings, but almost 30% of those recommendations were made without the advisor obtaining sufficient information about the prospective client’s financial circumstances, investment objectives or risk tolerance. In other words, in almost 30% of these cases, advisors failed to obtain key information necessary to properly formulate a recommendation for the client.
  2. In an equal number of cases, the advisor failed to disclose all costs associated with purchasing or holding the recommended investment. That’s a significant failure because costs are a tremendously important factor in determining an investment’s performance, especially over a long time period. Clients therefore need accurate and complete information about costs in order to make good decisions about whether to accept the advisor’s recommendation. They didn’t get that information almost 30% of the time.
  3. Ultimately, the regulators deemed 14% of the recommendations to be unsuitable. That’s 1 out of every 7 recommendations. In addition, the study concluded that only 63% of advisors had met or exceeded regulatory expectations — meaning that 37% failed this task.

Just imagine for a moment what would happen if 37% of doctors were found to be practicing below the standards of their profession, prescribing drugs without adequately examining patients 30% of the time, or performing the wrong surgery in 1 out of every 7 cases. There would, quite rightly, be consternation. Remedial action would be taken swiftly.

The reaction should be precisely the same here. Advisors perform a critical role that greatly affects Canadians’ financial health, so a failure rate of 37% is alarming.

The “mystery shopping” results represent sobering evidence of an urgent need to reform current proficiency standards. They are too lax. Anyone can become licensed to sell a variety of securities in Canada merely by taking an online course and scoring 60% on a multiple choice quiz — a lackluster competency level that, perhaps not surprisingly, got reflected in both “mystery shopping” exercises.

Also, these exercises have shown that investors’ interests are not being properly served in many instances by a significant number of advisors. Through ineptitude or impropriety, or both, those advisors are exposing many Canadians to inappropriate risk and saddling them with poor financial outcomes on a daily basis. There is no acceptable reason why this should continue to be so.

The solution is clear: more rigorous proficiency standards must be reinforced by an unequivocal duty to act professionally and in every client’s best interests. That duty must be adopted now so Canadians can get the high-caliber investment advice they need and deserve.

This article appears as an Inside Track op-ed in the online version of Investment Executive.

September 28, 2015