CSA’s New Consultation Paper Looks to Enhance Registrants’ Obligations
May 26, 2016
The Canadian Securities Administrators (CSA) recently released Consultation Paper 33-404 Proposals to Enhance the Obligations of Advisers, Dealers and Representatives Toward their Clients (Consultation Paper), which considers a number of reforms regarding the client-registrant relationship. If implemented, these changes may significantly raise the standard for registrants.
The Consultation Paper considers two different issues related to the registrant-client relationship:
- Amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) designed to “better align” the interests of registrants and their clients and “enhance” registrants’ obligations to their clients (NI 31-103 Reforms)
- The introduction of a “regulatory” best interest standard (Best Interest Standard)
All CSA members support the NI 31-103 Reforms; but only Ontario and New Brunswick fully support the Best Interest Standard, with British Columbia being strongly opposed, Quebec, Alberta, Manitoba and Nova Scotia having strong reservations, but being willing to see what comes of the consultation process, and Saskatchewan expressing no views.
The Consultation Paper does reject a “statutory” best interest standard that was most recently considered by the CSA in a previous consultation paper released in October 2012.
To discuss the background to the Consultation Paper in detail would be beyond the scope of this Bulletin. With respect to the Best Interest Standard, as far back as January 2004, the Ontario Securities Commission (OSC) published The Fair Dealing Model (Fair Dealing Model), in which it considered imposing a statutory fiduciary duty upon dealers and advisers in certain circumstances. Indeed, examinations of conflicts of interest in the mutual fund context (which seems to be a driving force behind this particular proposal and some other recent reforms) go as far back as January 1995, when the OSC Commissioner at the time, Glorianne Stromberg, released her report, Regulatory Strategies for the Mid ’90s − Recommendations for Regulating Investment Funds in Canada, or perhaps further back to the 1969 Report of The Canadian Committee on Mutual Funds and Investment Contracts. With respect to the NI 31-103 Reforms, the Fair Dealing Model evolved into the more limited “Client Relationship Model”, which in turn informed the development of NI 31-103, which came into force in 2009 and was considered to be a once-in-a-generation review and reform of registration requirements and exemptions and guidance for registered entities. Clearly, generations do not last as long as they used to.
More recently, we have seen:
- CSA Consultation Paper 33-403: The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty when Advice is Provided to Retail Clients (33-403), released October 2012
- CSA Discussion Paper and Request for Comment 81-407 Mutual Fund Fees (81-407), released December 2012
- CSA Staff Notice 33-316 Status Report on Consultation under CSA Consultation Paper 33-403: The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty when Advice is Provided to Retail Clients, released December 2013
- OSC financial adviser “town hall” meetings held in 2014
- The review of client-registrant relationship conducted by the British Columbia Securities Commission (BCSC) and the Alberta Securities Commission in 2015
- Brondesbury Group’s Mutual Fund Fee Research report, released June 2015
- The Mystery Shopping for Investment Advice report of the OSC, Investment Industry Regulatory Organization of Canada and the Mutual Fund Dealers Association of Canada, released September 2015
- Douglas Cumming’s research paper, A Dissection of Mutual Fund Fees, Flows and Performance, released October 2015
- BCSC’s National Smarter Investor Study, released November 2015
- OSC Investor Advisory Panel’s Current Practices for Risk Profiling in Canada and Review of Global Best Practices, released November 2015
In addition, there is ongoing OSC research into compensation practices, regulator registrant compliance reviews, and considerable third party research, all impacting the regulatory positions proposed in the Consultation Paper.
The CSA see the following problems with the existing regulation:
- Currently, registrants are subject to a suitability standard that requires registrants to recommend to clients investments that are suitable for the client. In determining suitability, registrants are not required to consider all relevant factors, and this results in investors acquiring investments that give them a lesser value or return than they could reasonably expect from their investments.
- Investors assume that their financial advisers are acting in their best interests, and therefore have a degree of trust or reliance on their advisers that is not warranted, and which could result in sub-optimal investments.
- Mandated conflicts of interest disclosure is ineffective in appropriately managing such conflicts, as investors do not understand the disclosure provided to them and actually place increased reliance on their financial advisers following conflicts of interest disclosure.
- Products are complicated, and investors have little financial literacy, which means there should be even more of an onus placed on financial advisers to put the client’s interests ahead of their own and ensure the client understands the information and advice being provided.
- Clients are not getting the outcomes securities regulation was designed to provide them with (more regulation would more easily allow for more enforcement actions by the regulators).
SUGGESTED SOLUTION, PART 1
In order to address these concerns, the CSA are proposing amendments to NI 31-103, in 10 different areas:
- Conflicts of Interest: Generally, conflicts of interest need to be avoided, disclosed and controlled in a manner that prioritizes the client’s interests. The proposed reform would first require registered firms and their advisers to respond to conflicts of interest “in a manner that prioritizes” the client’s interests. Second, conflicts of interest disclosure must be clear and understandable to a client, and firms and their advisers must have a reasonable basis for concluding the client fully understands such disclosure.
- Know-your-client Obligations: The proposed reform would include an obligation on firms to collect more information in this regard, including about the client’s investment needs and objectives, financial circumstances and risk profile, and an express requirement to update such information at least annually and in prescribed circumstances.
- Know-your-product Obligations for Financial Advisers: The proposed reform would require every adviser to know every product permitted by his or her firm to be offered, and before recommending a product, to do a comparison to all other potentially available products. It would also specifically require the adviser to take the fees and costs of the product into account in making investment recommendations.
- Know-your-product Obligations for Registrant Firms: The proposed reform would require firms to say whether they sell only their own proprietary products, only non-proprietary products, or a mix of the two. Those offering only non-proprietary products or having a mixed product offering would be required to select products on the shelf in such a way as to “optimize” the shelf in light of the client’s investment needs and objectives.
- Suitability Obligations: Under the proposed reform, the suitability obligation would apply not just when a product is purchased, exchanged or sold, but also whenever there is a recommendation not to purchase, sell or exchange a security or a recommendation to continue to hold the security. Suitability would also be required whenever a prescribed list of events occurs (e.g. a change in client adviser for an account). More significant, there would also effectively be a requirement that before acting for a client, an adviser would need to prepare a financial plan and develop an asset allocation strategy for the client. The basic financial suitability requirement would include a general analysis including whether there are any other financial strategies — such as paying down high interest debt or directing cash into a savings account — that are more likely to achieve the client’s investment objectives and needs than a transaction in securities. One of the specific questions in the Consultation Paper asks whether participants agree with the requirement for registrants to consider other basic financial strategies as part of the suitability obligations.
- Relationship Disclosure: The proposed reform would impose:
- An obligation to disclose the nature of the registrant-client relationship in clear and easy-to-understand terms
- Required disclosure as to whether the product shelf is proprietary (with warnings as to the implications of this for clients) or mixed/non-proprietary (in which case available products must be listed)
- Restricted registration category disclosure (which would require firms, such as mutual fund dealers that are only licensed, to sell specific products, to disclose the limits such restricted registration places on their ability to offer products to clients)
- Proficiency Requirements: The proposed reform calls for increased proficiency requirements for individuals for initial registration and a continuing education requirement to maintain such registration.
- Use of Titles by Financial Advisers: The proposed reform would mandate the use of prescribed titles for individuals registered with dealers or adviser in order to avoid client confusion around representatives’ roles and responsibilities. The Consultation Paper proposes and asks participants to comment on three alternatives for such a regime.
- Use of Designations by Financial Advisers: The proposed reform would require firms to ensure that misleading designations were not being used by their financial advisers.
- The Role of the Ultimate Designated Person (UDP) and Chief Compliance Officer (CCO): The proposed reform would explicitly make the UDP and CCO responsible for ensuring compliance in key areas, such as obligations relating to conflicts of interest and suitability.
This list of detailed targeted reforms should be closely reviewed as these changes may significantly raise the current standard for registrants and, in effect, achieve the objective of creating a regulated best interest standard without the need for a stand-alone overarching principle. In addition, the CSA included specific questions for consideration for each of the different areas of concern identified in the Consultation Paper.
SUGGESTED SOLUTION, PART 2
Securities legislation is proposed to be amended to adopt a statutory fiduciary standard for those managing money on a discretionary basis, in those provinces that do not already have this; however, in our view, such provinces effectively have this standard through the common law.
More controversially, Ontario and New Brunswick are proposing to add a statutory “best interests standard” (in effect, fiduciary light) for advisers and dealers not managing money on a discretionary basis. As noted above, BCSC is opposed, and Quebec, Alberta, Manitoba and Nova Scotia have strong reservations, to this idea. Under the proposal, firms and their advisers would be required to act in the client’s best interests, avoid or control conflicts of interest in a manner that prioritizes the client’s best interests, provide full, clear, meaningful and timely disclosure, interpret law and client agreements in a manner favourable to the client’s interests where reasonably conflicting interpretations arise, and act with care.
The “best interest standard” would be layered over the proposed NI 31-103 Reforms. This standard would likely provide regulators with a broader, discretionary power as, for example, Ontario and New Brunswick view this standard as an overarching governing principle that would be helpful in assisting to interpret more specific requirements and act as a guide for registrants to address situations that fall outside specific rules. BCSC, on the other hand, is of the view that the regulatory best interest standard is vague and would create uncertainty for registrants and the standard may further exacerbate the expectations gap between clients and registrants and may raise clients’ expectations about investor protection that may not be realized under a best interest standard. BCSC is also of the view that the targeted NI 31-103 Reforms proposed in the Consultation Paper, Point of Sale and Client Relationship Model Phase 2 initiatives must be given time as they may effectively address the client-registrant relationship concerns identified.
Comments are open until August 26, 2016, and the CSA plan to hold roundtable discussions with market participants in the fall of 2016 to discuss issues raised in the comment letters.
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