Disclose material facts

(March 2008) How exactly might a person define the word “material” — as in: “Professional Advisors must always disclose all material facts when making product and strategy recommendations to clients?” The dictionary suggests synonyms like relevant, substantial and pertinent could all be used in place of the word “material.”

To my mind, any piece of information that causes a person to change their opinion or behaviour is material. For example, if you were a smoker and I were the first to inform you that cigarettes cause cancer, I would say that the information was material if it caused you to change your habits.

Obviously, one could quite properly add that the information could be relevant, substantial and pertinent whether one gives up smoking or not. At that point, materiality is debatable. However, once the end-user’s behaviour changes, genuine materiality can safely be assumed to be the cause.

For some time now, I’ve been making written disclosure to my clients that most actively managed mutual funds lag their benchmarks and that the few that seem to outperform cannot be reliably identified in advance. Not surprisingly, most of my clients resist using actively managed funds once they’ve been presented with this information. There is nothing in the industry that requires that this disclosure be made.

As a result of this, it has become clear to me that disclosure is a significant contributor to consumer decision-making and can be used to manipulate choices. Similarly, non-disclosure can be used to direct and impact on decisions, too. What a financial intermediary (be it an advisor or product manufacturer or advisory firm) discloses often has an impact on what a consumer chooses. This then begs the question: where does one draw the line on what does and does not need to be disclosed?

Most advisors don’t make disclosures about the relative merits of active and passive management approaches. Similarly, most clients don’t change the way they invest or their belief systems about the subject after meeting an advisor. Ask me no questions and I’ll tell you no lies.

I can’t help but notice that disclosure often has a direct impact on the selection of products and strategies. After all, how can anyone be concerned about something that they are unaware of?

In the financial services industry, the sales culture holds sway over the professional culture largely because material disclosure, which is a primary attribute of professionalism, is bad for business. If advisors and the firms they work for were genuinely concerned about their clients’ welfare, they would not only give good and comprehensive advice, but full disclosures would be commonplace.

As it now stands, only a small number of STANDUP (Scientific Testing And Necessary Disclosure Underpin Professionalism) advisors ever bother to explain this to their clients.

Advisors ought to be able to think for themselves and to recommend whatever products and strategies they feel are best for their clients. However, I don’t believe that exonerates them from the willful concealment of material facts.

If nothing else, advisors shouldn’t deny their clients of a right to be wrong. Advocate whatever you feel is best, but tell clients the other side of the story. Get them to sign off on your disclosure and then let them decide for themselves. Collectively, we have been too paternalistic for far too long.

This article first appeared in the February 2008 issue of Advisor’s Edge Report.

John J. De Goey is a Senior Financial Advisor with Burgeonvest Securities Limited (BSL) and author of The Professional Financial Advisor II. The views expressed are not necessarily shared by BSL.john.degoey@burgeonvest.com

(03/06/08)

John De Goey

Planning and Advice