Investment firms are wooing star advisers – in exchange for their client book

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Canada’s investor protection framework has long had a reputation for being weak and not particularly well-enforced. Investors are still often paying excessively high fees and hidden charges on investment funds. Advisers are often under no legal obligation to act in their clients’ best interest. And even when an investor has been harmed by their investment dealer, there is no binding dispute resolution system to ensure their losses will be recovered. This is the first part of an occasional series examining why the pace of progress in advancing investor rights in Canada has been so painfully slow, and what changes are needed to fill in the gaps.

If you, like millions of Canadians, work with an investment adviser, there’s a good chance they will decide to switch firms at some point, leaving you with a decision to make.

Do you follow your adviser to the new firm? They will certainly try to convince you to do so. You will probably be told that making a move will be an upgrade for all involved – it’s a better firm, bigger research department, more resources, better platform.

You probably won’t be told, however, that your adviser may have just received an enormous cheque to cross the street. Known as recruitment bonuses, these incentives are based on how much clients money the adviser can bring over to the new firm.

An industrywide bidding war has taken hold in the Canadian wealth management space, as investment dealers look to quickly add scale by luring away star financial advisers from their competitors. Multimillion-dollar payments are dangled as inducements, on the condition that the adviser brings the majority of their book of investors with them.

Canada's top wealth advisors 2022

They are under no specific obligation under current regulations, however, to disclose the bonus to their clients. The Globe and Mail spoke to several wealth management companies and investor advocates to confirm that lucrative payouts to switch firms are commonly not disclosed to clients.

“While all of this money is changing hands, clients, for the most part, are kept completely in the dark,” said John Milani, a 30-year veteran of the wealth management business and the founder of JP Milani Asset Management in Toronto. “Clients are being bought and sold, and they’re not even being told about it.”

This raises a potential conflict of interest. Is switching to a new dealer really in the best interest of the client? Or is the adviser just chasing a windfall? With huge amounts of money showered on the country’s top talent, the potential for abuse is significant, according to several investor rights advocates.

Individual investors may face a disruption of service during the period of transition. They may be encouraged to move to a firm that doesn’t meet their needs, one with higher fees, or a limited product shelf. Some advisers may bounce around from one dealer to the next to keep the cheques coming. And in the end, all of the money flowing to advisers has to come from one source – the client.

Big changes across the investment management landscape in recent years have made for heated competition between firms. A push for lower fees and greater transparency around the cost of financial advice has squeezed profit margins. Slowly but surely, mutual fund fees in Canada, as around the world, are trending downward, while more and more investors are drawn to a lower-cost passive investing approach.

Between 2013 and 2022, net assets in exchange-traded funds in Canada rose by 400 per cent – five times the pace of growth in mutual funds, according to the Investment Funds Institute of Canada. One way for investment dealers to defend against that pressure is to increase assets under management as much as possible. And the quickest way to scale up is to poach your competitor’s talent.

One firm paying richly to recruit advisers is Toronto-based Optimize Wealth Management. “Some say we pay too much,” reads Optimize’s information kit for prospective advisers. “We frankly don’t care.”

The document illustrates how much an adviser with $75-million in assets under management might earn. Between a transition bonus, fees from client accounts, and a succession bonus, total earnings come to $20-million over 10 years – 75 per cent more than they would earn at a typical dealer.

“It’s worth paying up to bring on high-end financial professionals,” said Matthew McGrath, chief executive officer of Optimize.

The generous bonuses mean that the company forgoes some earnings over the first few years of a new adviser contract, but pays off down the road with advisers who can expand their books of business, he said. The company’s new clients, he added, pay no more in fees than they were before the move. And they’re always told how much their adviser is receiving in bonuses. “If there are advisers out there that are not disclosing that, there’s something very wrong,” Mr. McGrath said.

Shelling out large recruitment bonuses has been a long-standing practice within Canada’s wealth management industry in order to obtain top advisers. But as the average age of advisers continues to rise and a wave of baby boomers prepare to retire, investment dealers are becoming more aggressive in their hunt to scoop up seasoned books of business, which typically includes top-producing advisers who manage clients with more than $1-million in investable assets.

Another one of Bay Street’s more aggressive recruiters is Wellington-Altus Financial. As the co-founder of an independent startup, Charlie Spiring knew he couldn’t compete against some of the more aggressive bonus offers in the market. So, in 2021, the company sold a minority interest to two private investor groups for about $85-million – an amount that has largely been allocated for recruitment. A year later, the company has added $4.9-billion in new assets by hiring 11 adviser teams.

Mr. Spiring pointed to his firm’s upgraded technology program, an open product shelf that does not include proprietary products, and the ability for advisers to own equity in his growing company. “When you can directly explain to a client what they will receive in a move, then it becomes pretty transparent on why you are suggesting a move,” he added.

In addition to his role as CEO, Mr. Spiring continues to work as an investment adviser himself – a role he has held for 40 years. Recruitment bonuses are necessary payments, he said, in order for an adviser to bridge the gap in income loss during a move. As someone who has worked at both bank-owned investment dealers and independent firms, he knows how disruptive moving firms can be for both an adviser and a client.

While many advisers make a move with good intentions, don’t assume, however, that every adviser switching firms has their client’s best interest at heart, Mr. Spiring said. “If you are moving from one bank to another bank, how is that beneficial for a client to take that move with the adviser?” he asked. “In some cases, it becomes quite clear it is a payday for someone looking to cash in.”

Historically, these incentives, also known as “chequebook recruiting,” were paid out in the form of cash – usually as a five-year, forgivable loan. They were seen as an upfront payment that would help an adviser financially during a period of transition as they moved their clients over to a new investment company. After all, most advisers’ income would effectively drop to zero as soon as they part ways with their old employer.

But these inducements in recent years have inflated well beyond what could be considered a reasonable cost of transition. “The amounts being paid are so gross that it would be shocking if consumers knew how much many advisers are being compensated,” said Harold Geller, an Ottawa lawyer who represents investors with claims against their advisers.

Bonuses of $5-million or more are not unheard of for a high-end adviser, said Mr. Spiring, who has seen a competitor offering of an all-cash bonus north of $7-million for an adviser generating $4-million in revenue. For most advisers, switching firms should only happen once or twice in their career. But some move frequently or look to double dip – change firms just prior to retirement so they can get a cash bonus in addition to a separate payment when they sell their book of business.

The companies cutting the largest cheques are not doing so out of generosity. They expect to make a return on that investment. Some firms can pay huge bonuses because they’re charging clients higher fees. Others can afford the additional expense by taking a bigger slice of an adviser’s revenue, or pushing clients into proprietary funds so they can collect fund fees. “It gets passed on to clients one way or another,” said Jason Pereira, a partner at Woodgate Financial Inc. and president of the Financial Planning Association of Canada.

Many Canadians rely heavily on the counsel of advisers when making financial decisions. A recent survey by FAIR Canada, an investor advocacy group, suggested that 80 per cent of investors in Canada work with an adviser. And most follow the advice given, while also being concerned about paying too much in fees and being sold unsuitable products. “Investors tend to place a great deal of reliance on their advisers, but they don’t necessarily trust them,” said Jean-Paul Bureaud, FAIR Canada’s executive director. “It’s an uncomfortable relationship.”

The level of financial literacy in Canada is not particularly high, which puts investors in a vulnerable position, Mr. Bureaud said. That imbalance is exacerbated when investors aren’t in possession of all the relevant information.

The New Self-Regulatory Organization of Canada, which is the temporary name given to the group of merged regulators overseeing all investment dealers in Canada, said advisers are expected at all times to properly manage conflicts of interest. “Should an adviser choose to move to a new firm they, and their firm, must continue to follow all disclosure and conduct requirements including those relating to conflicts of interest,” the New SRO wrote in an e-mail. “We believe our principle-based conflict provisions are sufficient at this time.”

Many advisers, however, choose not to divulge their bonuses to their clients, said Thomas Caldwell, the founder of Caldwell Securities and a past governor of the Toronto Stock Exchange. “The clients are always given bogus reasons for leaving, while this inducement is not disclosed,” he said. “This is a massive conflict of interest and a lack of disclosure of exceptional proportions.”

Over a decade ago, the Financial Industry Regulator Authority in the United States proposed a rule that, if approved, would require advisers to disclose their incentive bonus to any client who follows the adviser to the new firm within one year of the transition.

At the time, Canadian regulators said they were closely monitoring their U.S. counterpart’s decision. But in 2014, the U.S. dropped the original proposal that would have placed a duty of care on the investment adviser and the financial firm to disclose any bonus amount of $100,000 or more.

Instead, a watered-down requirement for financial advisers to provide clients with “educational communication” was put in place. It includes questions clients may want to ask their adviser during a move to a new investment firm. Several U.S broker dealers, such as UBS Wealth Management USA and Merrill Lynch, voluntarily disclose to clients that an adviser could receive an incentive if they choose to move their assets over to the firm.

In Canada, despite new conflict of interest rules being adopted in 2021, the topic of specifically disclosing recruitment bonuses to clients was not addressed.

Advisers have a vested interest in convincing their clients to switch firms. After all, the return on investment paid to the adviser is only as good as the number of clients that move. When an adviser decides to jump ship, battles may arise over who owns the client relationship, and non-compete clauses can create a confusing time for clients who end up receiving phone calls from both parties. Competitors offer elite SWAT (support with adviser transition) teams, which are trained to assist an adviser in moving their client base over to a new company within weeks.

Most clients are completely unaware of the process until they receive their investment statement with a new logo on the front.

Mr. Spiring, who was also the head of the Investment Industry Association of Canada in 2014, said the New SRO should reconsider a rule proposal that would bring increased transparency to recruitment bonuses. “Advisers should absolutely disclose to their clients if they are getting a monetary benefit. It should be right in the package saying, ‘I’m changing firms and here’s what I earned,’” he said.

“We need to just put it out there and tell the world because quite often when someone does make a move for a hefty paycheque, it just puts the stink in our industry.”