IIROC’s Rule 42 viewed as good first step

IIROC’s Rule 42 viewed as good first step

IIROC’s Rule 42 viewed as good first step In an open letter, Investment Industry Association of Canada (IIAC) President Ian CW Russell made statements concerning a compliance review conducted by the Investment Industry Regulatory Organization of Canada (IIROC).

The review focused on compliance with Rule 42, a rule that IIROC implemented in 2012 that obligates firms to identify and manage conflicts of interest in their business. Aside from the fact that Rule 42 is broad-based, it also requires firms to manage conflicts consistent with the best interests of the client.

According to Russell, the review uncovered four problems:
  • inadequate disclosure of compensation-based conflicts
  • reliance on disclosure without firms addressing the specific conflict
  • lack of firm ‘review’ or focus on conflict problems related to compensation
  • lack of proper monitoring of risks related to fee or compensation conflicts unique in fee-based and managed accounts

He pointed out that compensation-related conflicts can be very complex and that firms may have lacked sufficient industry guidance in dealing with specific issues, making conflict mitigation a problem.

“Beyond disclosing the payout differences [between third-party and in-house funds], how should [the funds] be treated in terms of adjusting payouts and client charges? What about concerns regarding the independence of supervisors? Should supervisors be entitled to a portion of advisor revenues even if fully disclosed, and what should the portion be?” he said.

Russell also noted that some firms may have been judged as non-compliant to Rule 42 based on observed transaction activity in fee-based and managed accounts, as well as the observed account fees.

“However, the conflict related to relative fee charges may have been addressed, not through specific policies related to the principles-based conflicts rule, but through Know-Your-Client and suitability obligations, and appropriateness of the fee-based or managed account for the client,” he said.

Another consideration is the fact that many fee-based and managed accounts have features beyond securities transactions, including financial planning, tax reporting, and execution and clearing costs related to the switching of funds into and out of managed accounts. A perceived conflict of less transactional volume may also be explained by the implementation of “buy and hold” strategies, which can be advisable under certain market conditions.

“Proper disclosure of the detailed services provided in fee-based accounts, and documentation of the suitability decision related to the account, represent the appropriate compliance response,” Russell said. “[E]xcessive focus on transaction volume in individual fee-based accounts could lead to costly ‘fishing expeditions,’ and result in needless and inefficient compliance reviews.

“The industry views this review as a positive initial step, anticipating more detailed guidance on compensation-based conflicts and an assessment of the overall effectiveness of Rule 42, particularly in conjunction with other IIROC rules and guidance dealing with conflicts of interest,” he concluded.


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