Why the industry still creates conflicts of interest

"Society relies on a balance: most people want to do the right thing, and rules and regulations help keep them on track. That works the vast majority of the time," says Colin White. "But put that same person in a desperate situation—like having a sick child at home and a weapon in their hand—then place them outside a store with cash in the register, and even these safeguards can fail. The real issue lies with those who create these high-pressure scenarios, driving people toward harmful decisions."

White is the CEO of Verecan, a boutique financial services firm. His metaphor of the motivated robber is how he opens a discussion about conflicts of interest in financial services. Despite the regulatory guardrails and new models we have in place, White still sees advisors arriving at conflicts of interest with their clients. Often, he argues, they won’t know that a conflict of interest is occurring, but that doesn’t mean they aren’t serving another party’s interest.

The roots of these conflicts, he argues, are in the wealth management industry’s roots in distribution. Despite the rise of fee-based models and the shift away from commissions, he argues that there is still a core of this business that functions as sales. While he sees fee-based models as a step in the right direction, White says that product manufacturers have purchased advisory firms to buy their distribution. He argues that these owners can use KYP regulations as a cover to limit their product shelves and continue to use advisors as their distribution agents.

“They build a system where they incentivize that to happen, that comes down to the compensation model, how much commission or salary is paid, or the bonuses paid for different kinds of products,” White says. “They motivate [advisors] to behave against the client's best interests in order to satisfy their own goals.”

White cites the example of a client of his firm whose 95-year-old father had been recommended a product that would lock his money up for four years. An individual who, as White puts it, “shouldn’t be buying green bananas” was told to lock away his money. White argues that the recommendation was distinctly against the client’s interest and speculates that the advisor’s firm had motivated him to put that client in a product that didn’t serve him.

“That’s what happens when advisors find themselves in a situation where their compensation or their job security is tied to them behaving in a certain way that benefits the firm but doesn’t necessarily benefit the client,” White says.

Fee-based models were meant to eliminate these conflicts of interest. By eliminating commissions from fund manufacturers for the sale of products and shifting compensation to fees paid by client accounts, the industry was meant to have exorcised the demon of distribution. While White agrees that fee-based models have helped eliminate these conflicts of interest, he argues that the rapid entry of fund manufacturers into the dealer space has kept these conflicts inherent in the advisory business.

One area where White sees these conflicts emerging is in the new rush for alternative investments. He sees firms developing their own internal alternative products and using their advisors to distribute them. He argues that rather than serving investor interests, these alternative products are simply higher margin.

“These are opaque, high-fee products that many of the distributors have a hand in putting together,” White says. “People are moving towards a fee model and that’s where things should be going, but even that’s getting co-opted.”

While White can’t say he’s seen an advisor’s job threatened by a lack of distribution, he notes the examples of recent hires he’s brought on from bank-owned firms. He claims these hires had been given around 600 clients to serve and if he didn’t meet a phone call, meeting, and new asset target every week, he would have no administrative support for his clients, which would effectively make his job impossible. Put in that situation, White argues that advisor is incentivized to work against clients’ best interest to ensure these assets come into the firm.

Know your product (KYP) regulations play a key role in White’s vision of these conflicts. Despite the positive intent of these regulations, the sheer number and complexity of the products available to Canadian advisors now makes meeting a KYP standard for the entire shelf functionally impossible. White says that major institutions, chiefly the banks, will only let their own product on their shelves and use KYP to cover themselves. If they can only recommend products they know, then they argue they can only truly know their own products.

Despite all these forces which he sees setting up conflicts of interest, White retains his faith in advisors. He argues that many advisors continue to put client interest ahead of the incentive structures they are surrounded by. He believes the roots of these conflicts run to the industry’s history in distribution and that by pushing against the tide advisors can help make that more fundamental change.

“There are fantastic people out there doing fantastic work in literally every institution on the street, but many of them are doing it despite their environment, not because of it. The environments are not conducive to doing the right thing most of the time,” White says. “When you watch the banks buy the brokers, I think we're probably in the direction right now where the manufacturers own more of the distribution and are acquiring more of the distribution as we go. I think that’s creating more conflicts that are more persistent today.”