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Investing Smarts - Investment Ownership Comes with its Risks - So Know Yours

By John D. Peart on January 7, 2011

Despite its headline, this article does not contain any information on investment strategies, portfolio composition or stock picking tips (except the old adage of “buy low and sell high”).

It is, however, about investor protection and investment ownership, and may dispel some myths that you have heard.

Over the past four years, I cannot think of a topic that has been discussed more by everyone than what to do to improve a person’s investment returns. The 2008 market meltdown affected many people and the low returns now available on secure investments (not to mention the roller-coaster ride of the investment market) have made people very anxious about investment protection and growth.

But let’s say that you have some money to invest or a RRSP/RRIF that is languishing. What are you going to do? You might buy GICs or mutual funds from a financial institution. You may even establish an investment portfolio with an investment dealer.

Placing your assets with any financial institution or investment dealer does mean some decision making on your part: where is your investment comfort level? Bank accounts and guaranteed investment certificates? Bank mutual funds? Independent mutual funds sold by investment dealers or financial planners? The wide range of other investment products sold through investment dealers or financial planners (stocks, bonds, exchange traded funds, etc.)?

The investment decisions that you make are your responsibility. You will get advice or recommendations on the possible investment choices, but whether you like it or not, short of fraud or bankruptcy on the part of your advisor or financial institution, it is you, the investor, who reaps the rewards or suffers the losses with your investment.

The Canadian Deposit Insurance Corporation (CDIC) insures up to $100,000 of the total amount of savings accounts, GICs (with a term of not more than five years), TFSAs (with the same type of savings or GIC investments) and certain loan company debentures held by an investor/customer (alone or jointly) with a CDIC member.

RRSPs/RRIFs with the same type of investments, and held with a CDIC member are additionally insured for the same amount.

The Canadian Investment Protection Fund (CIPF) is an industry sponsored fund that protects investors from losses resulting from the bankruptcy of a member firm. The maximum coverage is $1 million per account.

Not all deposit taking entities are CDIC members, and not all investment firms are CIPF members. Obviously, the first question that any investor wants to ask is what insurance protection is in place if my investment firm/bank declares bankruptcy? The simple answer is that investor protection is limited to CDIC and CIPF coverage.

The second question is: what insurance protection is in place if my investment advisor commits fraud or simply disappears? The simple answer is not much, if anything - although the investment firm that the advisor was with may have some form of coverage or commitment to protect the investor.

The third question is: What insurance coverage is in place if my investment advisor does not follow my instructions and my investments decrease or disappear? The simple answer is none - unless you can prove their failure to follow your instructions. The whole issue of who is to blame if the value of a person’s investment portfolio decreases was a growth area for lawyers following the last financial meltdown. The outcome of the “blame game” depended on a document that most investors forget even signing. It has different names but is known generically as the “Know Your Client” (KYC) questionnaire.

The KYC document is a series of questions and answers that will determine for the investment advisor, and that advisor’s firm, your net worth/income/employment, your investing experience, the value of your assets, your short/long-term goals and your risk tolerance. It pays to spend some time with your advisor over this and ensure that you understand the questions and the potential risks that might follow from your answers.

Completing a rather aggressive KYC document during a bull phase in the market may not be quite so smart during a bear phase or if you later lose your job. If your portfolio does melt down, the advisor will respond to your anger by showing you what you said in the KYC document.

Fortunately, the investment industry is now mandating that investment firms who are members of the Investment Industry Regulatory Organization of Canada (IIROC) must update client KYC documents regularly. Again, however, not every investment firm selling investment products is a member of IIROC. One more question to ask.

A side, but important issue, to investing is the decision as to who should own the investment. It makes sense that if a person buys an investment, it should be in that person’s name.

Some options:

Own it alone. This enables the individual to deal with the investment when and how they wish. If the individual dies, the investment forms part of the individual’s estate.

Own it alone with a named beneficiary. This is not always possible and depends on the investment. If it is possible to name a beneficiary, this allows the individual to name a person, or even persons (in some cases), who will receive the investment on the owner’s death. The owner’s Will is bypassed and the named beneficiary receives the investment without the owner’s estate paying probate tax. Unfortunately, the owner’s estate, not the named beneficiary, must pay capital gains taxes arising on the owner’s death to the possible prejudice of the Will beneficiaries.

Own it in joint ownership or joint tenancy with a third party (e.g., spouse, child, sibling, etc). The legal theory of joint ownership used to be that at the death of one owner, the surviving joint owner became the sole owner of the asset and could deal with it as their own. This is no longer always the case. In 2007, the Supreme Court of Canada decided two cases on joint ownership and entitlement of an asset after death. The result of these cases is that in the absence of some proof that it was the deceased’s intention that the surviving joint owner would take the asset for their own, the surviving joint owner is deemed to hold the asset in trust for the deceased’s estate.

There is generally a presumption that if spouses own an investment in joint names, the surviving spouse was meant to be the owner of the investment on the death of the first spouse. Even this presumption can be rebutted on evidence. More often than not, joint ownership of an asset is one of convenience or to benefit a child or to ensure that there is enough liquid capital to deal with the individual’s burial and related expenses on death. In each of these situations, the deceased will want to ensure that their wishes and intention of the joint ownership are clear.

Canada Revenue Agency is always interested in ensuring that all possible income is declared and all possible taxes are paid. If a joint ownership is created but one owner still wishes to maintain complete control over the asset, the other joint owner can sign a declaration of trust to allow the income, dividends and capital gains arising from the investment to be declared by one of the owners and not both.

Investing can be more complicated than you think. Before you even get to the investment strategy part of your discussion with your advisor, you should determine what, if any, type of insurance protection that advisor and their firm carry in the event of fraud, bankruptcy or bad advice. You should also take some time to complete the KYC document honestly and carefully. This is the document that will be referred to time and again, both by the investment advisor and, if necessary, the courts.

During this time, you will also have decided on how or with whom the investment will be owned and whether there are any beneficiaries that can be noted on the investment in the event of death.

Diligence to begin with will mean that you can then focus on the original plan: buy low and sell high!

Consulting advisors for this article included Daniel MacMillan, Wealth Advisor, BMO Nesbitt Burns and Carol Fensom, Investment Counsellor, MD Private Investment Counsel.

John Peart is a partner with the Ottawa law firm of Nelligan O’Brien Payne LLP (www.nelligan.ca) and member of the Wills and Estates Group. John is Certified as a Specialist (CS) in Estates and Trusts Law by the Law Society of Upper Canada and is also a member of the International Society of Trust and Estates Practitioners.

[This article was originally published in the July/August 2011 issue of Fifty-Five Plus Magazine.]