Is Your Stock Broker Acting in Your Best Interest?

The OSC is considering imposing a 'best interest' duty on stock brokers. Their industry body is resisting.

How do stock brokers choose investments for their clients? Most investors assume that stock brokers (who call themselves investment advisors,) assess their client's risk tolerance and investment objectives and select investments that best match them. Michael Sprung, president of Sprung Investment Management, explains that stock brokers are not required to act in their client best interest. They are only required to select investments that are 'suitable' for their clients. How then do brokers choose investment for their clients?

Mutual Funds - there are over 5,000 mutual funds are available in Canada. They're classified into more than 30 categories: bond funds, equity funds, sector funds, specialty funds, regional funds, diversified funds, balanced funds, index funds, etc. Stock brokers like mutual funds because they are paid sales commissions and ongoing trailer fees that are invisible to their clients.

Stocks - brokerage businesses earn large fees by raising capital for publicly traded companies (known as IPO's or initial public offerings,) and from mergers and acquisitions advice, (M&A's). The vast majority of analyst reports are buy recommendations, rather than hold or sell recommendations.

Exchange Traded Funds - while ETFs offer low cost diversification and low management fees, investors are switching to ETF's without fully understanding what they are buying. Brokers often charge clients a management fee to select funds on their behalf. Holding a large number of ETFs can lead to over-diversified and potentially inappropriate portfolio diversification in relation to clients' risk tolerance.

Alternative Asset Classes - Hedge and Private Equity fund managers typically charge clients based on a '2 and 20' fee structure: an annual management fee of 2% of assets, plus 20% of profits above a pre-set threshold. This means managers have a big incentive to take on more risk. They also share those fees with stock brokers who sell their funds.

How can investors protect themselves from the many conflicts of interest inherent in the brokerage business? Independent portfolio managers or investment counsellors are firms and people who manage investment portfolios on behalf of private clients, foundations, endowments and pensions. Investment counsellors differ from mass-market or retail investment managers. They are independent of any bank or broker and their only source of revenue comes directly from their clients. They are committed to meeting a fiduciary duty. A fiduciary duty or best interest standard (already the norm for lawyers, accountants and some other professionals) is a legal requirement that they put the client's interests first. Continue reading here>>