The so-called “mystery shopper,” in which a researcher poses as a client to assess the quality of services provided in real-world conditions, may be coming to a brokerage firm near you. The Ontario Securities Commission (OSC) is proposing to use this tactic in order to evaluate the quality of financial advice that retail investors are receiving.
Amid regulatory deliberations over whether to require that financial advisors act in the best interests of their clients and/or to intervene in the long-standing industry practice of mutual funds paying embedded commissions to dealers and advisors, regulators are aiming to get a better understanding of the current quality of retail financial advice.
To that end, the OSC is proposing in its draft statement of priorities to carry out a mystery-shopping exercise. The OSC’s draft priorities, which set the regulator’s agenda for the year ahead, are out for comment until June 3 and must be finalized and delivered to the federal minister of finance by June 30. The draft priorities, in their current form, indicate that the OSC is proposing to conduct mystery shopping on advisors to “gauge the suitability of advice currently being provided and identify areas of concern and assist in targeting future OSC suitability sweeps.”
Given that the priorities have yet to be finalized, the OSC is reluctant to say anything about its plans in this area. The regulator suggests that the proposed research is still in the planning stage and that its goal, as outlined in the draft version, will be to assess the suitability of advice being provided to clients.
Typically, these initiatives involve researchers posing as clients and presenting a particular scenario – for example, as novice investors who have just gained a financial windfall and are seeking advice on what to do with it. This mystery-shopping exercise will be done in order to determine whether the proper account opening, “know your client”(KYC) and suitability assessment procedures are being carried out and whether the advice the mystery shoppers receive is fundamentally sound.
Novel research
The use of this research technique would be fairly novel for Canadian securities regulators. Other financial services authorities in Canada, such as the federal Financial Consumer Agency of Canada (FCAC) and the Canada Deposit Insurance Corp. (CDIC) have used mystery shoppers in the past to examine practices within their respective spheres of authority. As well, securities regulators in other parts of the world have used this method to assess the quality of financial advice in their markets. However, it’s not something Canadian regulators have employed much.
The one time in recent memory during which a Canadian regulator did commission a mystery shopper, it ended up rebuking the organization that carried it out. In 2007, Québec’s Autorité des marchés financiers (AMF) funded mystery-shopping research by a consumer group through the regulator’s investor education fund.
However, when the consumer group published the results of its work in a magazine, the AMF criticized the objectivity of the research and said that the group overstated the significance of its results, which were based on a relatively small sample size but were presented as being indicative of “rampant incompetence” in the province’s financial services industry. At the time, the AMF said, the group “tarnished the reputation” of the entire industry and spooked consumers needlessly.
Despite that episode, mystery-shopping exercises have proven to be very revealing to regulators in other jurisdictions, giving them genuine insight into how policies that are drawn up in their ivory towers actually work in the real world.
For example, in 2011, the Hong Kong Securities and Futures Commission and the Hong Kong Monetary Authority co-commissioned a mystery-shopping exercise to examine KYC procedures, product disclosure and suitability assessments. That exercise revealed a variety of deficiencies, including: failure to collect certain KYC information in 19% of cases; disclosure deficiencies in 16% of cases; and other assorted suitability failures.
Last year, the Australian Securities and Investment Commission published the results of its so-called “shadow shopping” research, which examined retirement advice. That exercise found that the advice people received was judged as “poor” in 39% of cases; that 58% received “adequate” advice; and just 3% received “good” advice. Moreover, the research discovered that consumers generally were poor judges of the advice they received, rating their advisors highly even when they received poor advice.
Good advice
And, earlier this year, the U.K.’s Financial Services Authority (FSA) reported that its latest mystery-shopping review into the quality of investment advice that banks and other lenders provide found that approximately 75% of customers in that research received good advice, but the advice was unsuitable in 11% of cases; and, in another 15% of cases, the advisor didn’t gather enough information to judge suitability properly.
The FSA’s research was carried out before its ban on embedded sales commissions took effect at the start of this year. Nevertheless, the FSA reports, as a result of the research, firms have agreed to make changes to their practices – and one bank was referred to the FSA’s enforcement division.
“Mystery shopping allows us to understand what customers experience when they purchase financial products,” noted Clive Adamson, director of supervision at the FSA, upon releasing the regulator’s research. “This review shows that customers are not consistently getting the quality of advice on their investments that they should expect.”
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