The Bay Street Financial District is shown with the Canadian flag in Toronto on Aug. 5, 2022.Nathan Denette/The Canadian Press
Andrew Auerbach and Jean Blacklock are contributing columnists for The Globe and Mail. They are co-founders of Delisle Advisory Group, an independent wealth management firm serving high-net-worth families.
In years past, there was clear distinction in the investment management world between different types of client-adviser relationships.
One option was for investors to delegate their investment decision-making to an investment manager without requiring approval for each transaction, referred to as discretionary investment management. These clients clearly expected a fiduciary relationship, similar to that of a lawyer-client relationship, in which the adviser only acted in the clients’ best interest.
Other investors wanted to control the decision-making, retaining investment brokers to provide advice and to execute transactions based on the clients’ decisions. With ultimate control and decision-making resting with the client, the broker was arguably not a fiduciary in the legal sense.
Firms offering discretionary investment management were often referred to as investment counselling firms. Ones that took decisions from clients were known as brokerages. Firms were generally understood to offer one type of service and not the other.
But over the last 20 years, the line between these two distinct investment approaches has blurred. Brokerage firms, which traditionally only took decisions from clients, started offering to manage funds on their behalf.
These sorts of discretionary relationships, where the investment counsellor or broker makes the investment decisions have grown increasingly popular across the board. Today, approximately 60 per cent of discretionary relationships reside in brokerage firms.
Fiduciary standards haven’t fully caught up with this shift in the industry, and a recent case illustrates the issues that can arise from the increase of discretionary management in brokerage firms.
A family of ETFs from Emerge Canada was delisted last year by the Ontario Securities Commission and ordered to liquidate owing to its significant debt. Last month, the Globe and Mail reported that there was a potential conflict of interest on the part of the founder of brokerage firm Wellington-Altus, which was holding 25 per cent of the delisted ETFs’ assets on behalf of its clients. The founder was also a significant personal investor in the ETF company itself – and the connection was disclosed in a single sentence within a 12-page document.
Many of the brokerage firm clients holding these ETFs did so through discretionary client relationships, meaning fiduciary standards should have applied, including full disclosure of this type of conflict of interest.
This particular story is not concluded and it is possible that the disclosure given by the firm was in fact compliant with regulatory requirements. However, the incident calls for a broad-based review of how fiduciary standards are applied across the investment industry. The industry must pay close attention to the application of fiduciary standards, given the unique trust clients place in discretionary relationships.
Regulators in Canada introduced significant legislation in 2021 to ensure that potential conflicts of interest are brought to investors’ attention. While this is commendable, the sea change over the past 20 years in the size and scale of discretionary management requires the industry to take a serious look at how fiduciary standards are applied in practice.
For example, commission grids and other compensation programs prevalent in brokerage firms offer significant financial incentives to advisers based on the types of products offered to their clients. Such forms of compensation are a holdover from when the brokerage did not conduct discretionary investment management. Given the crucial fiduciary element of discretionary investment management, this type of compensation requires a close look.
An important step forward would be a standardized compensation framework for all discretionary relationships in any type of firm. This framework should be clear and consistent between investment counsel and brokerage firms, and easily explainable to clients. To hold the industry to the highest possible standards, other forms of compensation such as incentives and referral fees should be eliminated.