If you visit a doctor, lawyer, or accountant, this professional has a legal duty to act in your best interests.
But if you visit a Canadian investment adviser, there is no such legal requirement. And that concerns UBC law professor Janis Sarra, an internationally recognized expert in corporate finance, banking, and securities regulation.
"If there is a series of three products that they might sell you—and one makes them a greater commission—then they're going to opt for that. And they don't have a legal obligation to act in your best interests," Sarra told the Georgia Straight in a recent interview.
She explained that investment advisers are required by law to "know their client", which means sitting down with them and assessing their capacity to invest and accept risk. The problem, Sarra noted, is that clients don't always appreciate their capacity to lose money.
This is particularly true when they're offered offered a "super secure tranche", which is how some risky bundled mortgages were marketed to investors before markets around the world melted down in 2008.
Sarra, director of UBC's Peter Wall Institute for Advanced Studies, recommended Canadian legislators follow in the footsteps of other countries that have required investment-industry employees to act in the best interest of clients. "I don't know why financial advisers shouldn't have that obligation," she said.
She made these remarks during a wide-ranging interview in advance of an artistic event at 6.p.m. on Sunday (April 15) at VanDusen Gardens, which is designed to enhance financial literacy.
Sarra will collaborate with UBC neuroscientist Dr. Lawrence Ward and LINK Dance on an interactive performance called "How Can It Be Fair?" at the BMO Hall.
"There are three dancers involved," Sarra said. "Part of it is a Powerpoint presentation with some visuals...but there is also this interactive part with the dancers trying to bring to life what these issues mean to us in terms of our access to financial services."
Debt levels rising in Canada
"How Can It Be Fair" will take place at a time when Canadians are carrying huge personal-debt levels. Bank of Canada Governor Mark Carney issued a warning earlier this month that "households’ dependence on debt financing remains the biggest domestic risk."
He pointed out that since the 2008 financial crisis, incomes have not risen to finance the growth in household spending.
"Moreover, much of the financing for the recent increases in household indebtedness has come from abroad," Carney declared. "These trends are unsustainable over the medium term."
Sarra said that Canada has one of the world's highest rates of per-capita credit-card debt. And she predicted that this will lead to financial distress in the next couple of years for many people and small businesses.
"That's something we also haven't come to terms with," she stated.
Individuals are turning to helocs—home-equity lines of credit. The problem, Sarra noted, is that with the declining number of workers belonging to private pension plans, people are more dependent on the equity in their homes as security in their retirement.
"If we are, in fact, using up our home equity much earlier, we're going to run into a big problem in the next 10 years as people start to become of age of retirement and don't have that cushion," she said.
Sarra explains roots of the meltdown
Many investors suffered enormous losses during the meltdown of financial markets in 2008. One factor, according to Sarra, was that banks didn't have enough capital to keep their promises to deposit holders.
At the root of the problem were financial derivatives, which are complicated products sold to investors. In some cases, they are a bundle of mortgages peddled as securities.
The issuer would pay a rating agency to determine if these products were of a "high", "medium", or "low" risk. Sarra said that the rating agencies had an incentive to rate these derivatives as highly as possible. That's because this would lead the vendors of derivatives to bring more business to the agency.
Further complicating matters, banks shed their riskier derivatives to the so-called vulture funds, which specialize in high-risk/high-reward investments. But the public wasn't told about this.
By this point, derivatives, which were initially designed to hedge risk, had become highly speculative and poorly rated financial instruments.
"[They were] sold to lots of people who were told the products were medium risk when in fact, they were high risk," Sarra stated.
She has a keen interest in the psychological dynamics that might lead an otherwise upstanding citizen in the financial-services sector to participate in swindles of this nature. The biggest example, in her mind, was in the derivatives market, which was controlled by a very small group of people in London and New York.
"They were making billions in fees up front, and they were completely disregarding all of the people they were going to harm at the tail end of the financial crisis," Sarra explained. "And one wonders—if they really are fine, upstanding people—how it could happen. They're not the Bernie Madoffs. They're not fraudsters. They're not psychopaths. But there is almost a disconnecting from the real impact of what they're doing."
She attributed this to the social conditioning of their immediate peer group overriding what they might otherwise think is the proper behaviour.
Sarra's solution is for the investment industry and regulators to focus more attention on preventing rewards for short-term activities that harm ordinary people. That could be accomplished, in part, by compensating investment bankers for the long-term sustainability of their organization.
"Just the sheer number of bank failures globally is quite shocking," she said. "I think that's an indication that we need some regulatory intervention."
Follow Charlie Smith on Twitter at twitter.com/csmithstraight.