Regulatory changes shaking up the advisor-client relationship

Financial regulators seek to improve investor protection through some rule proposals

Regulatory changes shaking up the advisor-client relationship

Since we are living in a fast-changing world, people’s needs are changing fast as well. Financial regulators need to keep up with the times and continuously review the appropriateness of the rules they have imposed on the industry.

Below are some of the regulatory changes that have transpired in recent years:

CSA Consultation Paper 33-404
In April 2016, the Canadian Securities Administrators (CSA) published a consultation paper titled “Proposals to Enhance the Obligations of Advisers, Dealers, and Representatives toward Their Clients.” It sought comment on proposed regulatory action aimed at strengthening the obligations that advisors owe to their clients.

The paper outlined five key concerns with the advisor-client relationship that the CSA had identified:

  • Clients are not getting the value or returns they could reasonably expect from investing

  • The expectation gap created in some cases by misplaced trust or overreliance of clients on their advisors

  • Conflicts of interest

  • Information asymmetry between clients and advisors

  • Clients are not getting outcomes that the regulatory system is designed to give them

The CSA developed a set of targeted reforms to National Instrument 31-103 (Registration Requirements, Exemptions and Ongoing Registrant Obligations) to align the interests of advisors with that of their clients and enhance various specific obligations that advisors owe their clients. Those reforms covered areas such as conflicts of interest, know-your-client (KYC) obligation, know-your-product obligation, suitability, and relationship disclosure.

The paper also set out a proposed regulatory best interest standard that would serve as an overarching standard and governing principle that all other client-related obligations would be interpreted by. The following principles guide the interpretation of the proposed best interest standard:

  • Act in the client’s best interests

  • Avoid or control conflicts of interest in a way that prioritizes the client’s best interests

  • Provide full, clear, meaningful and timely disclosure

  • Interpret law and agreements with clients in a way that is favourable to the client’s interest where reasonably conflicting interpretations arise

  • Act with care

After the comment period that ended in September 2016, CSA has reconsidered some of the proposed targeted reforms, including:

  • The mandatory collection of basic tax information as part of the KYC reforms

  • The element of the KYC proposal that requires the market investigation of a reasonable universe of products, and the differentiation of KYC requirements based on whether a firm is proprietary or mixed/non-proprietary in terms of its product offering

  • Considering adding an element of reasonableness or other modifications to the requirement for advisors to understand and consider the structure, product strategy, features, costs and risks of each security on their firm’s product list

  • The requirement to perform a suitability assessment at least once every 12 months absent a triggering event and if there is a significant market event affecting capital markets to which the client is exposed

IIROC’s Client Relationship Model (CRM)
The Client Relationship Model (CRM) project is a continuation of a previous project of the Ontario Securities Commission Fair Dealing Model Committee, which released the Fair Dealing Model Concept Paper in January 2004. In September 2004, the Fair Dealing Model initiative was brought under the umbrella of the CSA Registration Reform Project (RRP). Under the RRP, the Fair Dealing Model initiative was rebranded as the CRM, and its focus was narrowed to:

  • Account  opening documentation

  • Conflict of interest management

  • Costs and compensation transparency

  • Performance reporting

In May 2005, CSA asked the Investment Dealers Association of Canada – which later became the Investment Industry Regulatory Organization of Canada (IIROC) – and the Mutual Fund Dealers Association to develop rule proposals to address these areas. The resultant rule proposals were collectively known as the “IIROC CRM1 Amendments,” which were approved in March 2012.

In December 2013, IIROC published for public comment proposed amendments to Dealer Member Rules 29, 200 and 3500 and Dealer Member Form 1 (collectively the “IIROC CRM2 Amendments”) to address the following set of regulatory objectives:

  • Annual account performance reporting

  • Pre-trade and trade confirmation disclosures

  • Annual account fee/charge reporting

The IIROC CRM2 Amendments were published at that time to adopt IIROC rule requirements that were substantially similar with the amendments adopted by CSA, collectively the “CSA CRM2 Amendments,” which came into force in July 2013.

In May 2014, IIROC announced the implementation of the following elements of its CRM2 Amendments, effective July 15, 2014:

  • Pre-trade disclosures of charges

  • Trade confirmation disclosure of debt security trade compensation

  • Relationship disclosure relating to investment performance benchmarks

In September 2014, IIROC republished the revised proposed 2015 and 2016 CRM2 Amendments, which include the following client disclosure-related requirements:

Proposed IIROC 2015 CRM2 Amendments (effective Dec. 31, 2015):

  • Revised client account statement requirements

  • New requirement to provide a quarterly report on client positions held outside of the dealer member

  • Revised requirements on the timing of sending statements/reports to clients

  • Corollary amendment to Dealer Member Form 1

Proposed IIROC 2016 CRM2 Amendments (effective July 15, 2016):

  • New requirement to provide an annual performance report

  • New requirement to provide annual fee/charge report

  • New trade confirmation requirement to disclose deferred charges, where applicable

  • Revised requirements on the timing of sending statements/reports to clients

The beauty of both CSA and IIROC’s rule proposals is that they considered the public’s comments on them and, as a result, underwent several changes to become more suitable to both advisors and their clients.