: David McGruer - Submission

September 14, 2015

Expert Committee to Consider Financial Advisory and Financial Planning Policy Alternatives c/o Frost Building North, Room 458 4th Floor, 95 Grosvenor Street Toronto, Ontario M7A 1Z1

Dear Expert Committee Members:

My name is David McGruer and I am submitting this letter to the Expert Committee to Consider Financial Advisory and Financial Planning Policy Alternatives. I have been a financial advisor since 1993 and have closely followed and experienced massive regulatory changes. I speak for the benefit of many thousands of advisors and millions of their clients but my opinions are my own and are not necessarily shared by any companies, associations or standards organizations I am affiliated with.

Most, perhaps even all the opinions you receive will agree on basic principles or make no reference to such principles and focus only on the type of regulation necessitating the steadily growing government use of force against its citizens. In sharp contrast to others, it is on the subject of principles - moral principles - that I wish to focus my comments. I will conclusively demonstrate the right type of financial regulation for Ontarians by first identifying the base of our individual rights, extend this concept to identify the proper roles for government in a free society and close by concretizing what this implies for the issue you are charged with studying. Along the way !will be very careful to define key words and identify them with bold type so my message should be very clear. It would take a much longer essay to do this job thoroughly so I will attempt a very condensed version of the full validation for these ideas, though their validation has been proven extensively by greater minds such as John Locke, Thomas Jefferson, Frederick Bastiat, Ludwig Von Mises, Ayn Rand, Henry Hazlitt and George Reisman among others, whose writings are available in most libraries and bookstores. My text includes many of their words and ideas but !will not reference them specifically as this is not an academic paper and I am striving for readability and flow.

Before addressing specifics, I wish to define what I mean when I say principle: a fundamental, primary or general truth, on which other truths depend. Thus, a principle is an abstraction which unites an unlimited number of concrete examples. When understood in its proper context, a principle is an absolute, a certainty, a fact. It is definitely not a grey, malleable, undefined idea that is subject to the wishes or whims of any group, no matter how large, opinionated or powerful. Further, there are many concepts that are held out as principles but which can be shown to be self-defeating and thus false or false applications. For example, diversification is a valid principle of investing that indicates how the spreading of the risk of permanent capital loss among a number of securities prevents both catastrophic losses and fantastic gains. Many people mistakenly take the principle of diversification to mean they should have diversity in financial advisors but this takes this principle out of its proper context. It does not make sense to have multiple plans for your financial future, likely disconnected or even in conflict and leaving the mind of each advisor with incomplete data and thus unable to provide optimal advice. That would be like having a different architect for each room in your house and not integrating the planning. The result is chaos. Similarly, once diversification reaches a certain point, further diversification adds no significant value to a portfolio. Diversification follows the law of diminishing returns, another valid principle.

Since the present discussion is generally about the economic activity of man as it pertains to financial advice, my most fundamental task is to identify the essential nature of man. Man is homo sapiens, the rational animal. Man is different from all other living things in that he has no automatic mechanism or instinct that tells him automatically what to do and how to survive. To survive, man must reason and then choose actions that further his life. If he does not think, he dies. If he does not act, he dies. If he chooses the wrong actions, he dies. When man acts on his rational judgement he is acting in accordance with the requirements of his nature. In order to survive long term, man needs to learn and develop a code of values to guide his actions. This code is a principle called ethics or morality and it forms the basis to guide man in the productive work he must accomplish if he is to live.

Another distinctive feature of man is that he survives by re-shaping his environment through productive work. Man built crude shelters and now skyscrapers using raw materials; he creates farms by modifying seed, land and water use; he makes clothing using vegetable, animal and mineral materials he finds or invents; he discovers principles of science that help him travel, transport, control energy, communicate, entertain; he even creates financial products that enable many individuals to participate in the ownership or financing of the means of production. In a free society, financial advisors, like everyone else, offer their reasoning mind, knowledge, experience and advice to potential clients and each individual prospective client is free to exchange values with the advisor or not. Though ostensibly intangible, the provision of financial advice is valuable productive work, serves to further the lives of advisors and clients alike and is thus a most profoundly moral activity. Indeed, since financial security enables clients to enjoy many other aspects of life and may even make the difference in the length and quality of life, financial advisors fulfill a critical role in modern society.

Such economic exchange is an illustration of how men gain enormous values from dealing with other men in a division of labour economy. One man studies and gains valuable experience in the provision of financial advice while another becomes a valuable mechanic. A mechanic will likely want help by a financial advisor while an advisor will almost certainly value the work of a mechanic. They both want the other to use his full mind and abilities, unconstrained by coercive action or arbitrary rules and be able to offer the advice judged by each man to be the best he can offer. Living in society is man's proper way of life, but only on certain conditions. Man has to plan his life long-range, make his own choices, deal with others by the principle of voluntary agreement and be able to rely on their observance of agreements made. This leads me to the concept of rights.

A right is a moral principle defining and sanctioning a man's freedom of action in a social context. The only fundamental right is the right to life and the other rights, especially property (the right to keep and dispose of the product of your effort) and freedom of action (liberty), derive from it. For man, the rational being, the right to life means the right to engage in self-sustaining and self-generated action, meaning the freedom to take any and all the actions required by man's nature to further, fulfill and enjoy his life, according to his own judgement. This concept applies only to freedom of action and means freedom from compulsion, coercion or interference by other men. There can be no such thing as a right to the life, work or property of others as that would destroy all rights and make some men the slaves of others. To live in a peaceful society, man's nature means he must recognize the rights of all other men and deal with them only through voluntary arrangements. Thus, it is wrong fora financial advisor or anyone else to use force or fraud in any economic exchange. For example, it is wrong for me or any group, no matter who they are or how large, to prevent a willing buyer and seller from concluding a transaction, any transaction, that does not violate rights.

This leads me to the proper role for government. Peaceful coexistence in a free society requires men to delegate the use of retaliatory force to an objective agency - government. When one man threatens or uses force against another it is government that must act to protect the victim and punish the initiator, according to objective laws. Fraud is simply one version of force - a deliberate hiding of reality in order to deprive another man of his property and time, thus a portion of his life. When one man believes an agreement has been broken he requires a an objective agency, with the legal power to enforce its decision, to arbitrate and decide according to principles of objective justice. A government whose only moral action is the protection of individual rights is an indispensable value in a free society. The creators of Magna Carta (1215), the British Bill of Rights (1688) which is part of the common law of Canada, the Canadian Constitution (1867) and the Canadian Bill of Rights (1960) recognized the basic principles of freedom, the value of living in society and (mostly) the proper role of government in society. However, we have come a long way from those principles and now have government controls in almost every aspect of daily life, especially in finance.

It is crucial to identify that government's source of authority is the principle known as the consent of the governed, meaning government is not the ruler, but the servant or agent of the citizens. No individual or group has the legal power to compel others to act against their voluntary choice, only government does. The very nature of government power is coercive action and nothing else. The nature of political power is the power to force obedience under threat of physical injury, seizure of property, imprisonment or death. In a proper social system a man is free to take any action so long as he does not violate the rights of others, while a government official is bound in his every action to do nothing except that which is legally permitted in his role as protector of individual rights.

Now let us turn to the topic of your assignment: the study of the proper form of regulation of financial advice in Ontario. Before examining this we must first define regulation. According to the Business Dictionary, in general it means: principle or rule (with or without the coercive power of law) employed in controlling, directing, or managing an activity, organization, or system. This makes it clear there are two fundamental types of economic regulation: one where the regulation serves to protect the rights of innocent citizens without coercion and the other where coercive regulation violates rights unless it is used in retaliation against those who have violated the rights of others. The former elevates man, his mind and his choices and the latter denigrates and sacrifices them in the name of others, the government or even in the name of nothing at all. Figure 1 on the following page identifies these two options and a few of their logical implications.

Further, the definition of regulation makes it clear that regulation definitely exists in the absence of coercion by means of the application of voluntary rules. Unfortunately, because the type using coercion is so pervasive today, many find it hard to understand the most beneficial and moral type economic regulation. Consider the case of a financial advisor who wishes to raise his credibility in the marketplace and decides to obtain a professional designation. The governing body of the designation sets standards in areas such as academic knowledge, professional practices and professional ethics. If the designation is to have true value and integrity, the relevant standards must have meaning and relevance and it is only consumers who can give it ultimate credibility by choosing to recognize it as a value in their selection of financial advisor. The governing body and financial advisors are free to try and persuade clients the designation has value, but only the client decides if this is so. Especially today in the time of social media, the reputation of a professional is of tremendous and irreplaceable value to him. This is but one example of how in a free economy the customer is the ultimate arbiter of value and is the proper regulator.

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Figure 1: Two types of regulation.

Now what is the cu-rent attitude towards the value of financial advisors by coercive regulators? Do they believe advisors are educated, experienced, caring creators of value for clients? Absolutely not Consider that mutual fund documents are now forced to provide an ilustraton that management fees, which Include the compensation for financial advisors, 'Mel r branch and their head office, detract directly and totally from the dent rate of rehrn. Each and every such document, and there are thousands of them in use every day, tells the client that advice has no value and detracts from their financial seculty. At the same time, there Is a large body of scientific knowledge documenting the value of financial advice. Which is correct the dictate of the regulator or the body of scientific knowledge, the whim of the bureaucrat or objective measurements?

Consider the following example of the destructiveness of regulation by coercion. The principle of portfolio theory has made significant advances in the last several decades and this has been recognized by more than one Nobel Prize in economics. What may seem like a basic principle to us now, that by combining two assets having different mean variances reduces risk in the overall portfolio, was not known, or at least was quite unclear when many of us were born. The job of a financial advisor often includes recommending investments suitable for a particular client goal and an advisor who knows of portfolio theory can rationally recommend a mix of assets which may individually have high price fluctuations but when combined are much more stable. Yet, the Know Your Client (KYC) form and process advisors are forced to follow specifically prevents the advisor from fully considering this important principle. Instead, each individual security is assigned its own "risk" characteristic and the portfolio is assumed to be composed of the raw sum of those characteristics, ignoring the fact they have less than perfect correlations and thus the portfolio has a lower fluctuation than the sum of its parts. This is but one important example of howregulation prevents advisors from even thinking about howto reduce the risk and volatility of a portfolio and thus use their knovtledge and experience to better serve the interests of their clients. Advisors are prevented under threat of censure, fines, punishment or even loss of livelihood from doing what they believe is best for their clients. Does this make any sense? If such a fundamental wrong is committed at the level of basic client documentation and recommendations, do you think there are not dozens more examples of this type?

Here is an example of how current regulation considers financial advisors to be criminal-minded by default. Did you know that a recent regulatory directive now forces advisors to NOT write the current date beside form fields where the client will sign? The obvious assumption is that the advisor may deliberately write an incorrect date for some fraudulent purpose. This means that when a package of forms is required, again many of them by regulators, that the client is forced to write the same date repeatedly, perhaps a dozen or more times in some circumstances. This then forces advisors to watch clients like hawks as they sign forms they are unfamiliar with, knowing that different forms have different required date formats such as MM/DD/YYYY and DD/MM/YY and YYYY/MM/DD. With more than one client present, the advisor has to proofread every signature line to make sure there are no errors or inconsistencies. Further, it can be hard to read the client's handwriting and the date may be thus uncertain. In contrast, since most forms are filled out on a computer and then printed for signing, a date typed by an experienced advisor or assistant is more likely to be both clear and accurate and also saves the client valuable time during meetings instead of being asked to repeat monotonous tasks. Right after this requirement came out, I received a form back from a client that had the date stamped on the form, not handwritten. Regulation would require me to ask the client to re-print the form and handwrite the date. Just imagine the attitude a busy client would have towards me if I asked for such a wasteful activity! And what if an advisor emails forms to the client and the client fills in the dates on the computer prior to printing - is the advisor then to tell the client to repeat the whole process but write the dates by hand? Do you believe there are not many more examples of this type of micro-level control over financial advice? Think again. Do you think this type of regulation is rational and thus moral?

If an advisor explains and offers his services with specific conditions, obviously including a method of compensation and a prospective client disagrees with the offer, then no exchange takes place. It is ONLY if both the advisor and the client are in agreement then an exchange takes place. The competitive marketplace of a free economy means there can be an unlimited variety of types of advisors with individual specialties and various mechanisms of compensation. If an advisor holds a specific designation, qualification or is a voluntary member of an organization that requires adherence to a set of rules, prospective clients understand the advisor has knowingly chosen to associate with and adhere to those standards and is not acting under compulsion. For coercive regulation to override any of the above aspects in a voluntary exchange is to negate the minds, choices and lives of both parties, and is clearly immoral. Which advisor would you prefer: one who chooses to practice by a set of published standards set by professional peers and whose reputation depends on consistent adherence, or one who is forced under threat of government punishment to obey a set of standards set by an organization whose sole authority and purpose is through coercion? Would you rather have your country defended by an army of volunteers who know why they are fighting or a group of conscripts, forced to fight under threat of imprisonment? These questions are two applications of the same principle.

What is lost to society when instead of regulation by market competition we replace it with regulation by coercion? Instead of relying on reputation and success, the public relies on government licensing and supervision. Instead of the widest variety of advice models competing for market share - the very definition of conscious approval by consumers - we get a restriction of models that prevents consumers from even considering whether they see value in a particular model. Regulators are discussing the banning of commissions and/or mutual fund service fees and it has already been done in some jurisdictions, causing terrific loss of advice for consumers, especially those of lesser financial security, and a large loss of financial advisors who did not wish to or could not continue under the new restrictions. The choices once available to consumers and advisors have been obliterated by arbitrary bureaucratic dictate, leaving all involved without recourse against those who have caused the harm. Advisors work under the absolute power of regulators ability to terminate their means of livelihood, have almost no voice (notice that your committee has how many professional advisors on it'?) and consumers have no idea what is going on.

Valuable economic information about consumer and producer preferences is destroyed before it can be created and we never know what value has been lost or how much better off we would be if freedom prevailed. Consider what we would have unknowingly lost if Bill Gates or Steve Jobs had been forced to work under such enormous regulation as the financial services sector! With regulation by coercion, instead of the presumption of innocence we get government rules that presume advisors are guilty souls by nature and that only coercion can prevent them from harming their clients - as if an advisor or any businessman can actually succeed long term by harming his clients! What happens when groups in all types of businesses lobby for government protections and favours at the expense of their competition, their customers and the public at large? Such a society becomes one dominated by pressure group warfare, each lobbying for the political power to violate the rights of others. What is lost is peaceful coexistence and the freedom to choose. This is not the proper type of society for homo sapiens.

So what type of regulation should you recommend to the Ontario government? What type of regulation is the best one to protect the rights of Ontarians, not forgetting that financial advisors are Ontarians too? If coercive regulation under threat of physical force, seizure of property, and imprisonment such as is exemplified by the current system is not a moral form of regulation of financial advice, then what is?

The answer is that there is no one specific form of regulation that is best but rather many forms, some yet to be invented, and only a liberated system that allows for and even encourages experimentation among a diverse list of forms of regulation will best serve the interests of all Ontarians. This system is known as a free market or capitalism, though these are much misunderstood by most of us and much maligned by those who advocate for coercive regulation.

Would the definition of the title "financial advisor' in law be of value? Maybe, so long as it does not establish a monopoly. For example, a financial advisor could be defined in law as a person who belongs to any professional body that requires a minimal amount of objectively relevant knowledge, meets a code of ethics and has insurance to protect customers. Such a standard could be set with a low level of requirements, leaving all higher standards to designation granting bodies, specialties, associations and such groups as may be created in the future.

The financial sector is almost certainly the most heavily regulated sector of our economy. Across the country dozens of government departments and agencies already have created thousands of rules, regulations and edicts in a swirling web so large and complex that no human being can claim to know it all, never mind obey its often contradictory dictates. We have associations that are not associations at all, but mandated organizations of forced membership. Not associations created for mutual support but agencies designed to control business people's choices in the absence of wrongdoing. We have an enormous multiplication of red tape, documentation, disclosure and collection of formerly private information so much that no client ever reads it all. Enforced disclosures take the form of an avalanche of information that only an obsessive-compulsive personality would want to wade through. We have companies forced to replace innovation and experimentation with conformity and stagnation. We have the growth of bureaucracy and legal departments at the expense of client service. We have rising costs that block the provision of advice to clients of lesser financial means.

Conclusion and recommendations

I strongly discourage you from any recommendation that causes further regulatory agencies to be created unless the new one replaces multiple existing ones and serves to improve the protection of individual rights and increase the economic freedom of all Ontarians, whether financial advisor or client of an advisor.

To improve the financial sector, government must begin the long process of withdrawing political power from the administration of financial services and return power to citizens in the form of a true competitive marketplace, a level legal playing field where the government restricts itself to seeking out and punishing those very few financial advisors who violate the rights of their clients through fraud or theft, leaving regulation of legal and moral business activity to voluntary associations, professional bodies and standards organizations. In short, Ontario should lead the way to a revival of the founding principles of our country and our legal system. Now that would be both moral and eminently practical!

I wish you the best in your deliberations and on request am prepared to provide a full validation for any of the ideas presented in my commentary or participate in a phone call or face to face meeting.

Yours truly,

David McGruer Ottawa