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Statutory Best Interest Standard Urgently Needed

FAIR Canada strongly believes that Canada urgently needs to implement reforms so that dealers and their individual registrants (“financial advisors”) have a statutory duty to act in their client’s best interests and to ensure that they will be able to meet their obligations to do so. FAIR Canada strongly believes this requires enactment of a statutory best interest duty. The Proposed Targets Reforms will not suffice. They are inadequate because they do not effectively address conflicts of interest and other problems that can, and frequently do, exist at the heart of the relationship between dealers, financial advisors and their clients. We agree with the CSA that the status quo will not suffice given the multitude of problems governing the relationship between dealers, financial advisors and their clients. A statutory best interest standard that results in professional, unbiased, objective advice focused on what is best for the investor is urgently needed.

The Content of a Statutory Best Interest Standard:

FAIR Canada recommends that, to be meaningful, the statutory best interest standard should require dealers and their individual registrants to:

  • Act fairly, honestly and with a duty of loyalty or duty of utmost good faith to the client.
  • Put the client’s interests first (in other words, make the client’s interests paramount).
  • Avoid conflicts of interest.
    • When, in exceptional circumstances, the conflict cannot be avoided, it should be addressed through management techniques such as informational barriers, or dealing restrictions, provided that any management technique will actually protect the interests of the client.
  • Require a standard of care where the financial advisors perform their services and provide advice with the degree of care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances; the standard of care should take into account the special knowledge or experience that the firm and the individual holds themselves out as possessing.
  • Take any step that, at the time the advice is given and throughout the continuation of the professional relationship, would reasonably be regarded as being in the best interests of the client, given the client’s relevant circumstances.

FAIR Canada believes the best interest standard must be articulated clearly and unequivocally in legislation governing both dealers and their advisors so that it will be fully enforceable and so that it will be understood to govern firms and individual registrants in all aspects of their relationship with their clients.

Necessary Reforms to Accompany a Best Interest Standard:

In order to meet a best interest standard, certain fundamental reforms are needed to ensure unbiased, objective financial advice is provided. The required reforms are:

  • Prohibiting conflicted remuneration (including embedded third party commissions) for all portfolio managers, dealers and financial advisors.
  • Increasing the education and the proficiency requirements for all financial advisors.
  • Prohibiting the receipt of commissions or fees in respect of amounts borrowed to invest based on leveraging strategies given the inherent conflicts of interest that exist in doing so.
  • Reforming the rules surrounding referral fees so that fees are transparent. Requiring that financial advisors subject to a best interest standard only refer their clients to others who are also subject to a best interest standard or fiduciary duty.
  • Reforming outside business activities. Investment related activities should not be considered “outside” and should be approved and supervised by the registrant’s firm. Firms should be liable for the harm resulting from the acts and omissions of their representatives with respect to all outside business activities, except (i) where the activity could not reasonably be viewed as part of the firm’s business; (ii) the firm has made is explicitly clear to its clients that the activity is not part of the firm’s business and the firm will not be responsible.
  • Making it easy for consumers to shop around for advice.Implement a requirement for dealers, portfolio managers and their individual registrants to disclose on their web-site the exact nature of their services in plain language – the type of advice they will provide and the cost of that advice including any minimum amount of assets required.
  • Ensuring there is effective enforcement so that the standard of conduct and accompanying rules are complied with and that action is taken against those who do not.
  • Reforming the consumer redress process (OBSI) so that consumers can obtain a binding decision of their complaint. This will improve compliance by dealers and their individual financial advisors while allowing consumers to resolve their complaints effectively and efficiently.

FAIR Canada recognizes that some investment firms and their financial advisors are unable to operate on a conflict-free basis because of the very nature of the business models they utilize. For example, firms with intimate ties to issuers, approved shelves containing only proprietary products or sales limited to one kind of product (ie mutual funds) lack the objectivity required to formulate advice based on their clients’ best interests. We would prefer to see these business models abolished. However, if registrants are going to be allowed to continue using these business models, FAIR Canada believes the activities of those registrants should be strictly confined to product sales (with associated reforms to suitability, know-you-client and know-your-product requirements and rules prohibiting conflicted remuneration including embedded third party commissions). These registrants should be prohibited from providing financial or investment “advice” and they should be prohibited from portraying themselves as advisors.

Strict Rules on Business Titles:

Business titles should be limited to three categories:

  • “Investment Advisor” or “Financial Advisor” for those operating within business models that allow them to comply with the statutory best interest duty;
  • “Portfolio Manager” for those licensed to exercise discretionary authority (including robo-advisors) while operating within business models that allow them to comply with the fiduciary duty already required of such registrants; and
  • “Salesperson” for those operating within business models that prevents them from complying with the statutory best interest standard.

FAIR Canada believes this straightforward nomenclature will allow consumers to distinguish between financial advice, which can be relied upon as being professional in nature, and sales pitches, which may be informative but which should be viewed guardedly and with some skepticism. All three categories of registrants should remain fully bound by know-your-client, know-your-product and suitability obligations (except to the extent exempted in discount brokerage (also known as “order execution only”) situations) and FAIR Canada believes certain targeted reforms that can strengthen those obligations should be adopted.

The Proposed Targeted Reforms Are Inadequate:

FAIR Canada is strongly of the view that the Proposed Targeted Reforms are not adequate to ensure adequate and effective investor protection. The Proposed Targeted Reform on conflicts of interest does not result in professional, unbiased and objective advice and is, therefore, deficient. Some of the other Proposed Targeted Reforms are helpful (KYC and suitability in particular) while others are too vague and tentative (proficiency) while others only work if the best interest standard is implemented with such a reform (titles, relationship disclosure). Therefore, FAIR Canada would not be supportive of an approach in which the Proposed Targeted Reforms would be implemented first and a best interest standard left for a later date.

FAIR Canada, shares the CSA’s view that the status quo is not acceptable, but we maintain the response required is not one of incremental steps. Such an approach would be woefully inadequate. Instead, the opportunity should be seized now to institute a profound shift to a statutory best interest standard that will ensure Canadians receive the objective, professional financial advice they need and expect. With the implementation of a statutory best interest standard as set out above, the trust placed in the advisor will be appropriate as will the degree of reliance.

Other leading jurisdictions have implemented reforms in this area – including best interests duties, banning conflicted remuneration, banning inducements (both monetary and nonmonetary) and increasing proficiency requirements for advisors while also providing investors with summary disclosure about different types of investment products. These reforms are yielding greater protection for investors in those jurisdictions. Canadians deserve no less.

Please click here to read the full submission.

October 20, 2016