Reputation at risk

(May 2008) This article first appeared in the April 2008 issue of Advisor’s Edge Report.

There’s a lot of carnage in today’s markets. It stretches far beyond market losses and prudently calculated risks, and actually touches on the notion of trustworthy advice.

Sure, there are unexpected illiquidities. Non-bank asset-backed commercial paper is one; Mount Real Corporation promissory notes another. These are investments that apparently fell below the threshold of prospectus-level disclosures, whether because the regulators felt them to be safe for sophisticated investors, or because they didn’t pay attention.

There are also fund companies that seemed solid — appeared to be playing by the book — Norbourg Asset Management, Portus Alternative Asset Management and Norshield Financial Group spring to mind. Yet, despite the whole apparatus of fund administrators, trustees and auditors, somehow missing funds or impaired investments or prepaid commissions were counted as assets.

No matter what the courts decide, it’s the advisor who recommended the product who faces the fallout. And that fallout will come in face to face meetings with clients.

Which broaches a larger question. Who’s at fault when an investment fails? Is it the company the advisor recommended? Is it the advisor? In law, it has been suggested that investment advisors — as opposed to investment counsels with discretionary portfolio trading powers — are held to lesser standards. They’re not technically fiduciaries, so when investments go sour, the client bears a share of the blame.

Increasingly, however, advisors are being sued as fiduciaries and that raises the bar for professionalism quite considerably. It’s not just about making the right trade, or constructing the right risk-adjusted portfolio. It’s about doing the right thing by the client: by acting as prudently as you would for yourself. Pretend it’s your money and you can’t go wrong.

To be sure, many advisors subscribe to this. But doing right by the client isn’t necessarily always the right thing: not if all the due diligence and KYCs and ISPs blow up the client’s assets. And, not too long ago, the IFA lobbied the OSC against even this, arguing the advisor’s duty of care extended only to whether an investment was suitable for the client’s risk tolerance, not whether it fit a comprehensive financial plan.

It’s hard to define what the right thing is. Clarity comes incrementally, and only in retrospect, as the courts offer their opinions. But retrospective truths are not very helpful when advisors need to protect against future perils. Investing always involves risks, and many risks offer no forewarning. They are the black swans.

Consider ABCP. It seemed safe — until the liquidity pool was drained. Even investor advocates such as Diane Urquhart admit there’s little that investment advisors could have foreseen. And yet, clients face an uncertain future, and advisors, a diminished reputation.

Sure, maybe OFSI should have had tighter regulations on the issuance of debt. Perhaps the ratings agencies should have been more aware of worst-case scenarios — even of black swans. Maybe the banks should have looked at what they were making a market for.

To suggest, after the loss, that the regulators failed, or the banks blew it, or the product manufacturer messed up is cold comfort to the client. Advisors are there to protect against regulatory, banking or product failure — at least that’s how clients are starting to see it. It’s the evolving market reality. And it will test all the wits and skills advisors have acquired to turn cold comfort into cautious risk management for their clients.

Regardless of whether all advisors are treated as fiduciaries under the law, they must be ever mindful to act like ones. The day will come when public outcry leads to changes in the laws that govern advisor responsibilities. Start preparing for it today.

Scot Blythe is the editor of Advisor’s Edge Report. This article first appeared in the April 2008 issue of Advisor’s Edge Report. scot.blythe@advisor.rogers.com

(05/08/08)