FAIR Canada commends the CSA for pursuing reforms to the client-registrant relationship with the goal to better align the interests of registrants and clients so that advice is not compromised by compensation related and other conflicts that result in the firm and their representatives placing their own interests above those of their clients, to improve outcomes for clients and to make clearer the nature and terms of their relationship with registrants. While we commend the CSA at arriving at a harmonized proposal, and we regard some of the reforms positively (and have suggestions for improvement), FAIR Canada strongly believes that a statutory best interest standard is necessary, desirable and feasible, with respect to securities advisers, dealers and individual registrants (“Registrants”) in their conduct towards retail investors. The Proposed Amendments nudge Registrants in their conduct but will not achieve the profound shift necessary to ensure Canadians receive the objective, professional financial advice that is needed and rightfully expected.
Our comments include:
Conflicts of Interest – Addressing conflicts in the best interest of the client is not the same as having a duty of loyalty (i.e. acting in the best interests) towards the investor in the advice and services provided. A best interest standard would prevent compensation structures that undermine investors’ interests. The conflict of interest rules that rely on dealers, advisers and individual financial service representatives (“Registrants”) to address and control for conflicts in the best interest of clients are complex, change is uncertain, unclear and possibly illusory. We recommend the CSA prohibit compensation structures that provide incentives that work against the interests of clients. A prohibition on compensation structures and practices that engender conflicts of interest will not only protect investors but will also improve the environment for the benefit of individual registrants who seek to provide the best possible advice to their clients. Further, we recommend the more clear language that Registrants be required to actively “mitigate” conflicts in the best interest of clients rather than “address” to make it more robust.
Know Your Client (“KYC”) – FAIR Canada supports the enhancements to the KYC process and recommends that the Proposed Amendments include a rule requiring Registrants to exercise reasonable diligence, care, skill and prudence in gathering and determining the information, and be required to document this process. There are many investor complaints that involve not accurately recording the information, getting clients to sign boilerplate documents regardless of how inaccurate or signing blank documents, as well as clients not understanding what they were signing off on nor its significance. The onus to ensure accurate recording of client information should be on Registrants and they should be required to take reasonable steps to verify that the information is accurate such as requesting documentation to verify income and net worth. Firms should be required to send the completed KYC information to the client within 30 days of opening the account or updating the information. We also recommend that firms utilize technological capabilities so that any changes to the client’s KYC information trigger an oversight response at the firm. Key terms such as risk profile should be defined.
Know Your Product (KYP) – We support the introduction of the KYP provisions and recommend that individual registrants know, at a general level, how securities available at the firm compare to those securities available in the marketplace, not just at the firm. Whether a recommendation is suitable, and whether that recommendation puts the client’s interest first, must involve more than simply reviewing the alternatives available on the firm’s product shelf. If there is a product available at the firm that is “suitable” but there is an investment product available in the marketplace that would be significantly better for the client, then the registrant should have to so advise the client.
Suitability Determinations – FAIR Canada recommends that the proposed rule be clarified so that Registrants have a clear obligation towards their clients regarding all financial recommendations or investment or retirement planning advice or course of action that may precede the recommendation of a particular securities transaction, investment strategy or investment action or the opening of an account. Such advice often occurs in order to earn the client’s trust and obtain the assets at the firm for management. For example, an individual registrant may recommend that they commute the value of their pension and turn over the monies to the individual registrant for investment. FAIR Canada recommends that a fiduciary duty or statutory best interest standard be applied to any generalized retirement planning, financial or investment recommendation that encourages bringing assets to the firm. Registrants should also be required to provide a written explanation of the recommendation and the reasons for it to the client, which should include a discussion of the actual costs and compensation. FAIR Canada also recommends, as discussed above, that suitability should require the consideration of a reasonable range of alternative actions available to the individual registrant through the registered firm or generally available in the marketplace. If there is an investment product available in the marketplace that would be significantly better for the client, then the registrant should have to so advise the client. If the products on its shelf would only just meet suitability, while an investment product exists in the marketplace that would be much better for the client, the individual registrant should so advise the client.
Cost as an Element of Suitability – FAIR Canada supports the addition of costs of the account and the features and the potential and actual impact of costs on the client’s returns, as factors in determining what is suitable. Given the importance of costs in determining long-term returns from investments, all things being equal the lower cost product should be recommended over the more expensive one. However, in the absence of removing conflicted compensation structures such as embedded commissions and having an obligation to act in the client’s best interest, we are skeptical of how much impact the enumerated cost factor will have on client outcomes. It is quite possible that Registrants will be able to justify their recommendation of a higher cost investment on a number of factors given the wide parameters of suitability and that the incentives to do so that will still be present. FAIR Canada recommends that Registrants be required to disclose, in writing, to the client an explanation as to why the recommended security is the one that is suitable and puts the client’s interest first despite there being a lower cost alternative, and explain the actual costs to the investor, including the compensation associated with the recommendation versus the other alternatives.
Portfolio Approach to Suitability – We support having a portfolio approach to suitability. We recommend that Registrants be required to make reasonable efforts to have an understanding of the client’s portfolio of investments not only comprised of accounts at the firm, but elsewhere (such as assets held in a workplace DC pension plan) in order to provide recommendations that take into consideration the client’s entire portfolio of investments.
Leveraged Investing – We call on the CSA to immediately prohibit the receipt of commissions or fees in respect of amounts borrowed given the inherent conflicts of interest. Such payments undermine the best interests of clients, create significant misaligned incentives, harm investors and undermine confidence in our capital markets and need to be immediately prohibited. FAIR Canada also recommends that referral fees from lenders to Registrants that incent representatives to recommend leveraging strategies be prohibited. We recommend that the disclosure when recommending the use of borrowed money, as set out in section 13.13 should be reworked using a behavioural insights lens.
Referral Fees – FAIR Canada supports reforming the rules regarding referral fees and trying to address regulatory arbitrage. However, we do not understand the basis for the limitations set. We continue to recommend that a best interest standard be implemented so that any referral arrangement only occur in the context of a client’s best interest, and therefore, when there is an absence of a conflict of interest. We support the provisions to have these arrangements in writing, to be recorded on the books of the Registrants and that such arrangements are disclosed to clients with full transparency about the referral fee, its amount and the purpose of the arrangement. We call for the immediate prohibition of referral fees from lenders (non-registrants) to Registrants that incent representatives to recommend borrowing to invest.
Relationship Disclosure Information – FAIR Canada supports a requirement for registered firms to make public information available including the types of advice options it offers clients, the services it provides, their costs and the types of investments available, in plain language. We recommend that the CSA require the information to be posted on the main page of a firm’s website, posted and accessible in print at the firm and available upon request by email or by mail. We recommend that key disclosures and terms be tested with investors to ensure understanding. We caution that relationship disclosure information that is provided upon account opening is often lengthy and difficult to read and should not be relied upon to address the Expectations Gap (the expectation of clients that they will receive advice in their best interest). We recommend that the CSA test summary relationship disclosure information with investors with a view to prescribing the format of the information and the language of the disclosures so that it is more likely to be reviewed and is more comprehensible to investors.
Dispute Resolution for Investors – FAIR Canada repeats its recommendations that the complaint handling process of the SROs be required to be in conformity with sections 13.16(3) and (4) of NI 31-103, that firms cease using the term internal ombudsman and that OBSI be given binding decision-making under section 13.16.
Misleading Communications in Holding Out – FAIR Canada supports the inclusion of a provision which prevents misleading a person when holding out as to: their proficiency, experience of qualifications of the registrant, the nature of the person’s relationship or potential relationship with the Registrant; and the products or services provided, or to be provided, by the Registrant. The use of the titles “financial advisor” or “investment advisor”, if not subject to a fiduciary duty or statutory best interest standard, is a significant misleading communication that needs to be addressed in section 13.18 and through reforms to the rules regarding titles. FAIR Canada recommends that title reforms occur at the same time as the Proposed Amendments.
Proficiency – FAIR Canada urges the CSA to not further delay reforms on proficiency.
Transition Period – FAIR Canada calls on an immediate ban on the payment of referral fees from lenders to Registrants to encourage borrowing to invest or leveraged investing. FAIR Canada calls for a 6 month time period to provide the publicly available information, and two years for the remaining amendments.
To review our full submission, click here.