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Statutory Best Interest Standard Highly Desirable and Feasible

FAIR Canada has submitted its comments to the CSA stating that it is highly desirable and feasible to introduce a statutory best interest standard for dealers and advisers when advice is provided to retail clients. FAIR Canada strongly believes that dealers and advisers should be required to act in their client’s best interest and that a statutory best interest duty is needed in order to protect investors.

In the comments, FAIR Canada points out the key benefits of a best interest standard, thereby demonstrating why it is desirable and feasible.

BENEFITS OF A BEST INTEREST STANDARD

1. The introduction of a statutory best interest standard for dealers and advisers would result in:

    • increased protection for consumers;
    • better financial outcomes for consumers
    • more effective competition;
    • an increase in the level of professionalism in the financial services industry; and
    • an increase in the level of trust in the financial services market.

2. Conflicts of Interest – A best interest duty would require regulators to consider whether embedded commissions are compatible with a best interest duty. FAIR Canada has great difficulty in understanding how an adviser or dealer (or their representative) required to act in the client’s best interest could accept payments from a third party and fulfill their duty to the client.

3. Costs – A best interest duty would improve outcomes for consumers because it would explicitly require registrants to consider the investment costs in determining whether the investment is in the best interest of the consumer.

4. Professionalism – A best interest duty would enhance the professionalism of the financial services industry and enhance public trust in the industry. Further, it would assist the financial advice industry in its ambition to be recognized as a profession.

5. Agency Costs – A best interest duty will reduce investors’ agency costs, which arise as a result of conflicts of interest, and which have a huge negative impact on consumers’ long-term savings. In particular, financial consumers will no longer need to analyze recommendations from financial advisors to factor in the effect of conflicts of interest, which research has demonstrated they are ill-equipped to do.

6. More Objective Recommendations – A best interest duty, which addresses issues relating to conflicted remuneration (payments that influence an advisor to choose a particular product over other products for the advisor’s own benefit or that otherwise colour the advice given to clients (such as commissions, grid-based compensation, bonuses, gifts-in-kind, volume-based payments etc)) will reduce bias in recommendations, thus making recommendations more objective. It will also eliminate much of the need for conflicts disclosure, which has been demonstrated not to work and to cause unintended negative consequences for investors.

7. Informed Consumer Choice and Innovation – A best interest duty will facilitate more informed consumer choice about the purchase of advice. We expect that, if embedded commissions were prohibited, investors would be encouraged to look more critically at what they are getting for what they pay. This would improve competition, and economic forces would spur innovation in the delivery of cost-effective advice that meets a best interest standard.

8. Obligations will Meet Expectations – A best interest duty would improve consumers’ trust in the financial services industry, as obligations will meet financial consumers’ expectations.

9. Improved Consumer Outcomes – A best interest duty would improve outcomes for consumers because it would ensure the most efficient allocation of responsibilities between the advisor and the consumer given the low level of financial literacy of many consumers, the degree of knowledge, specialized skills and abilities that the advisor needs to possess, and the complexity of financial products.

FAIR Canada has made a number of recommendations to the Canadian securities regulators to assist them with the mechanics of how a best interest standard should be implemented in Canada.

SUMMARY OF FAIR CANADA RECOMMENDATIONS

1. Best Interest Duty Recommended – FAIR Canada recommends that CSA members implement a statutory best interest duty for advisers and dealers when advice is provided to retail clients. FAIR Canada recommends that the CSA implement a statutory best interest duty as promptly as possible in order to create market conditions where advisers and dealers must determine that the products they recommend are in the best interests of their clients.

2. Conflicts of Interest – Regulators must consider, either within the best interest initiative or through a separate consultation, whether embedded commissions are compatible with the best interest duty. FAIR Canada has great difficulty in understanding how an adviser or dealer required to act in the client’s best interest can accept payments from a third party which itself has a duty to investors. A best interest standard should include a prohibition against the acceptance of embedded commissions. In order to be independent, advisors should be paid directly by the consumers they serve.

3. Applicable to All Registrants – A statutory best interest standard should apply to any advice or recommendation provided by securities registrants, including recommendations or advice not to purchase or sell securities and to purchase a non-securities investment product such as a segregated fund or a PPN.

4. Standard of Care – The best interest standard must include a duty to act honestly and to owe a duty of loyalty or duty of utmost good faith to the consumer. The standard of care should be that the adviser, dealer and financial service provider will perform their services with the degree of care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances, having regard to the special knowledge or experience that it is reasonable to expect of a person acting in that type of financial services business and having regard to any special knowledge or experience that the person holds himself or herself out as having.

5. The Duty of Care – The duty of care would be the same regardless of the sophistication of the client, but the steps taken to meet the duty will vary depending on the circumstances of the particular case.

6. Assessment of the Standard – When assessing the conduct of dealers and advisers, a court or arbiter should not substitute their own decision for that of the advisor, as long as the latter’s exercise of judgment as to what was in the consumer’s best interest was reasonable, sound or prudent in the circumstances, at the time the advice or recommendation was provided to the consumer.

7. Duty Owed to All Retail Investors – The best interest duty should be owed to all natural persons receiving advice for personal, family or household reasons and also for advice regarding investments held through personal holding corporation vehicles.

8. Mutual Fund Dealers – If the firm and its advisors are limited in the products that they sell (for example, only registered to sell mutual funds) then the advisor must investigate and consider products outside their registration to show that they have acted in the best interest of the client. If the advisor is unable to recommend a product due to its being outside the scope of their registration, but such product would be in the client’s best interest, the advisor must inform the consumer of the type of products that the client should investigate further, and advise the client which type of financial service firms it can be obtained through (with or without “advice”; for example, through a discount brokerage).

9. Make Wider Spectrum of Products Available – If the firm is restricted in its product list, such as with mutual fund dealers, consideration should be given to permitting registrants of such dealers to become registered to sell other collective investment products such as exchange traded funds (ETFs), provided they meet the necessarily level of proficiency, so that the list of products that they are permitted to sell more easily allows them to discharge their obligation to provide advice in the best interest of the client. If mutual fund dealers are able to sell ETFs and other collective investment products, they will be able to offer a wider spectrum of financial products that will meet the needs of many more consumers.

10. Two Tier Model – FAIR Canada believes that all investment advice should be subject to a best interest duty. However, we understand that given the structure of the industry, some current business models would need to be modified significantly in order to be economically viable under a best interest standard. If regulators are not willing to impose a best interest standard on all existing business models, FAIR Canada recommends that regulators take a phased approach, and those who would need to modify their business model in order to meet a best interest duty to consumers (where they would have a wide enough product list to practically meet a best interest standard) be permitted to provide “restricted advice” similar to the model in the U.K.

11. Restricted Advice – FAIR Canada recommends that those who provide “restricted advice” must use the title “salesperson”; be subject to suitability requirements; be precluded from holding out that they offer independent advice or holding out that they act in the best interest of the client; and must disclose in writing and orally that they are providing restricted advice, which is not required to be advice in the best interest of the consumer (i.e. “independent advice”).

12. Preclude Conflicted Remuneration – All registrants, whether providing restricted advice or independent advice, should be precluded from using conflicted remuneration structures.

13. Ongoing Duty – If the consumer pays for ongoing advice, they should be provided ongoing advice and the obligation to provide advice in the client’s best interest should be ongoing. On the other hand, if they request and pay for one-time advice, there is no ongoing relationship and the duty, correspondingly, should not be ongoing. The overriding issue is whether the relationship is ongoing and payment structures should not be designed to circumvent one’s obligations.

14. Discount Brokerage – Given that discount brokerages do not restrict their services to mere order taking, FAIR Canada recommends that CSA members examine the services provided by discount brokerages and assess whether certain services that are provided to customers should be subject to a best interest standard. Furthermore, FAIR Canada recommends that the issue of conflicts of interest between discount brokerages and their clients be considered by CSA members and addressed in the context of implementing a best interest duty.

15. Duty Applies to “Non-securities” such as Segregated Funds and Principal Protected Notes – A statutory best interest duty should apply to a recommendation by a securities registrant to purchase a segregated fund or a principal protected note or other investment product regardless of whether it falls under the provincial securities legislation’s definition of “security”. The recommendation to invest in comparable products necessarily constitutes advice about securities (that is, a recommendation to not invest in a security) and should therefore be subject to a best interest standard. Failure to apply the standard to a securities registrant selling non-securities products will create incentives to sell such products to get around consumer protection measures.

16. Refuting Industry Lobby Arguments – Throughout this submission, FAIR Canada articulates the benefits of a best interest duty and refutes industry’s arguments that it is unfeasible due to perceived additional costs. FAIR Canada believes:

    • Business models will evolve through market forces to serve consumers’ needs;
    • Costs of advice will not be higher;
    • Legal costs will be lower;
    • Products will emerge and be promoted that meet consumers’ needs; and
    • Quality of advice will improve as will the quality of interactions between the consumer and advisor, leading to better outcomes for consumers.

17. Cost-Benefit Analysis – FAIR Canada questions the efficacy of attempting a quantitative cost-benefit analysis to determine whether to implement a best interest standard. Such an analysis risks being (1) highly inaccurate and (2) not the correct yardstick with which to measure the concept of a statutory best interest duty. It is exceptionally difficult to quantify the value of consumer protection, and we do not believe that this is the appropriate approach to justifying the imposition of a best interest duty.

18. No Delay – FAIR Canada strongly believes that it is desirable and feasible to implement a best interest duty that ensures that consumers are protected and that they are able to have access to the financial services that they need to achieve their retirement or other investment goals. We urge the CSA to not delay and to move forward to implement such a duty as soon as possible.

February 28, 2013