Investor Protection Moves in the US and Canada

Investor Protection in US and Canada

It has been a noteworthy past few days in the realm of investors’ rights. Two different stories that may seem completely unrelated are sewn with some of the same thread, especially for investors that are actively looking at the cannabis space. The first story regards the Canadian Securities Administrators concluding a review of at least 25 publicly-reporting medical marijuana producers that are beginning to operate within the nation’s 13 provinces and territories.

In its press release, the CSA noted that almost all of the companies it reviewed had failed to provide a “sufficient and balanced disclosure on their intent to enter the medical marijuana field.” In essence, the CSA thought these firms (which are very early-stage entrants) were too heavily promoting the potential upside in their business, without properly disclosing to investors all the risks, costs and time required to gain regulatory approval. As a resolution, the CSA stated that they have sent letters to most of the companies in question. The letters required the companies to update their investor disclosure, which the CSA says has happened.

As a quick primer, the CSA’s main responsibility, per its mission statement, is to “give Canada a securities regulatory system that protects investors from unfair, improper or fraudulent practices and fosters fair, efficient and vibrant capital markets, through developing the of a national system of harmonized securities regulation, policy and practice.”

The closest analogy would be to say that the CSA is a hybrid of the Securities and Exchange Commission and the Financial Industry Regulatory Authority here in America. The CSA seeks to educate investors and promote a level playing field, but also has the power to punish. To that end, the CSA noted at the end of its statement that it would be reviewing on an ongoing basis the announcements coming out of companies that are new to or entering the cannabis space.

Judging from the filings and investor relations pages of these companies, there doesn’t seem to be an overall trend of firms trying to mislead investors. If anything, there is a chronic issue with companies being very talented at getting their PR in front of millions of eyeballs, while just a small fraction of those same people dig deeper into public filings on Canada’s SEDAR or the SEC’s EDGAR database.

After performing due diligence on these companies, there may be several instances where management was being too rosy in their outlook, or too optimistic in their timeframes for specific operating goals. But this is not an isolated phenomenon; overeager management teams often overshoot in their forecasts.

Thousands of lawsuits are filed each year in the U.S. by firms representing investors who are disgruntled over an alleged malfeasance or some improper financial reporting. Many of the suits have merit, and some do not. However, investing is a risky business; it always has been and always will be. It is a fundamental truth that risk and risk alone is what allows the potential for big gains to exist. There are a thousand things that can go wrong in any given investment or stock; some are avoidable but most are not.

When considering investment in early-stage industries like cannabis, there is likely more risk involved than in any other area of the stock market. Many companies will not succeed; in almost all of these cases, equity will be entirely wiped out. In order to confidently invest in the space, it is imperative to have a professional eye on your total asset allocation, time horizon, liquidity needs and overall risk tolerance. That is a whole lot of responsibility for an individual investor, which is why so many choose to outsource the task of deciding where to allocate investment dollars.

This leads us into the second story: yesterday, the White House came out with a new proposal that aims to protect investors from hidden fees and conflicts of interest from their financial advisors. President Barack Obama stated his intention to reduce an estimated $17 billion in fees and charges U.S. investors pay each year because of brokers and financial advisors not acting purely in the client’s best interests.

The proposed changes, which will be formally introduced by the Labor Department later this year, are focused mainly on brokers that manage retirement account assets like 401(k) plans and IRAs. But the implications are broader, and get to the heart of a murky designation we have in the U.S. between “suitable” financial advice and fiduciary responsibility.

 

The Devil is in the Distinction

“Financial Advisor” by itself is a pretty nebulous term. The core of it is nothing more than someone (or some company) giving you financial advice or managing your assets in return for compensation. Sounds pretty simple, right? But there are a myriad of ways brokers and advisors get paid. Some of the ways, like the expense ratio on an exchange-traded fund (ETF) or a commission on a transaction, are pretty clear for an investor to see. But often there are fees hidden behind the scenes, and conflicts of interest most investors will have never considered, like whether their broker gets a bonus for diverting assets into particular funds that charge higher management fees.

The White House proposal wants to require all advisors/brokers that touch retirement assets to be acting as fiduciaries. Under current regulations, many brokers and institutions only have to act in a “suitable” capacity when allocating assets and suggesting financial products. In a nutshell it means that as long as they offer you something suitable to your needs, the responsibility stops there. A fiduciary duty, on the other hand, goes much deeper, and has longstanding roots in both legal and equity common law. Fiduciaries must always act solely in the client’s best interest, and put the client’s interests above their own (financial) motivation.

The CFA Institute administers the Chartered Financial Analyst accreditation, which is generally considered to be the gold standard for financial advisors worldwide. Almost a full third of the exam to earn a CFA is based on the fiduciary relationship. The CFA notes in its testing materials that:

“The duty required of a fiduciary exceeds that which is acceptable in many other business relationships because the fiduciary is in a position of trust. Fiduciaries owe undivided loyalty to their clients and must place client interests before their own. Such priorities enhance investor confidence in the capital markets, and in the reputation of investment research analysts, their firms, and financial markets.”

 

Tying it All Together

In both Canada and the U.S., we are seeing some concerted efforts to make investing a safer and more transparent journey. There is no better professional feeling than when clients know for sure that a fiduciary’s only incentive is to see them reach their goals.

We strongly urge investors to understand the relationship they have with their primary advisor or broker. The peace of mind in knowing that your advisor is bound by fiduciary duty will enable you to make better decisions with all of your assets. For investors who are looking into high-growth, high-risk industries like cannabis, it is all the more important to know the threshold of responsibility your advisors have for your primary asset base.

Ryan has spent nearly 20 years analyzing financial markets and investment opportunities for institutional and high-net worth investors. He specializes in determining the size and scope of new markets, changing industry trends and the market potential of new companies, products and services. Ryan has also published hundreds of articles on investment topics, market commentary and macroeconomic analysis.

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