Close to 20 years after its publication, the Stromberg Report remains relevant. Even if at the time it was much discussed in the investment industry, little has been resolved, says its author.

“I don’t want to be unduly critical of the regulators, but they have dropped the ball,” she says, adding, “Their mandate is investor protection and yet the investor, the individual investor, is the last person on the totem pole that they ever think about,” says securities lawyer, regulatory author and former Commissioner of the Ontario Securities Commission, Glorianne Stromberg.

Advice is one of the first areas of business that needs more scrutiny by regulators, she says, adding that the system in Canada is broken, fragmented, and continues to remain focused and centred on product regulation silos.

“For as long as I’ve been around, I’ve heard people say: ‘If it ain’t broke, don’t fix it.’ Well you know what? It is broken. It’s badly broken, and it’s the most vulnerable people who are suffering from it. It’s not the lobbyist, it’s not the institutions and it’s not the entrepreneurs. It’s the individual investor who is exposed to things they have no concept of.”

The trail or series of conflicts of interests she describes starts at the advice level, moves up the chain to the corporate level where compensation structures are determined, and to the company level where products are created and underwritten.

Computerization in the industry over the past 20 years has gone a long way to further develop a lot of problems, as well, enabling the creation of structured products that never could’ve been offered in the past.

“It’s led to the ability to trade globally and instantaneously, but it’s also led to the fact there is virtually no liquidity in the market. That has produced its own set of conflicts, because there really isn’t a free market – it’s all based on arbitrage and what you can get out of the house inventory.”

When these products are pushed back down the chain, representatives then “pretend they’re offering advice.”

Conflicts of interest

“They hold themselves out as offering advice, but it’s all a sales transaction. Their compensation structures are designed to force those so-called advisors or representatives to deal in those products (proprietary products or those underwritten by the company), or they’re without a job. They’re setting up irreconcilable conflicts of interest on all sides of every transaction.” It’s a situation she says most investors know very little about. “Then they talk about managing conflicts. ‘There’s nothing wrong with conflicts.’ But you know what? There is. There’s a lot wrong with them.”

In likening the situation to other world examples, she points out that any decision to give patients a medical device which might not be suitable for them, but in which the doctor had a proprietary interest, would certainly draw scrutiny or ire. “It would take you a nanosecond to say there’s something wrong with this picture.” Similarly, when going to a lawyer, clients expect to get advice that is best for their situation, and not advice that is benefitting companies the lawyer has ties to.

The mantra: “let the market prevail,” is flawed. This is fine when the market is made up of fully informed people who are armed with all the facts needed to help make rational decisions but this scenario, she says, is one that simply doesn’t exist.

The situation today sits in stark contrast to that ideal: With the help of computerization, increasingly complex products are being created that are difficult to understand, and which generally have high-fees attached. “Never mind the complexity, the fees by themselves are self-defeating for accomplishing any objective of investors buying them.”

Second, clients who were once able to earn a rate of return from their savings that was sufficient to live on, find themselves earning very little, while also paying fees, just to keep their money in the bank. “People are reaching for income, not realizing that, as they do so, they are risking their capital,” says Stromberg. “No matter what you tell them about it, they’re desperate. What can they do?”

Product risks

And all of this doesn’t even begin to approach situations where willful blindness about product risks at the compliance and oversight level, has resulted in scandals or blowups that have caused investors to lose out.

In cases where investors were sold asset-backed products, for example, many were told their money was invested in a vehicle that was almost as safe as an investment in Government of Canada bonds.

More recently, outside of Canada, Barclays Bank’s admitted manipulation of the London interbank offered rate (LIBOR) interest rate index – the rate banks use to borrow from other banks, which, in turn affects the rates set for mortgages, commercial loans, and other instruments – is another sign, she says, of the industry’s “moral failings.”

What’s worse, she says there appears to be little evidence that the industry is not simply moving from one crisis or disaster to the next.
In Canada, if you were to remove the date from Stromberg’s reports, written almost 20 years ago, “you would think they were written yesterday. The issues I identified 20 years ago are the issues of today,” she says.

“They’ve done a lot; they’ve spun their wheels on enhanced disclosure and meaningful disclosure but, at the same time, the industry has persuaded them (the regulators) that no matter how much disclosure is made, you don’t give it to an investor unless they ask for it.”

Too fragmented

Going forward, she the regulatory system needs to be rationalized. “It’s far too fragmented. It needs to be one system and it’s got to be consistently and uniformly applied,” she says. What’s more, the system needs to refocus or centre on the best interest of end clients, with the thought that ‘what is good for investors is good for the industry.’ “I still believe that,” she says.

“I am ever hopeful that investors will step up to the plate, as well,” she adds. “That investors will become knowledgeable, and demanding, and refusing of things that are not in their best interest. I would hope that increased knowledge, and awareness, and ability to really bargain will not only save investors, but the industry as well.”