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While regulators ponder the complexities of  new rules, investor advocates focus on a quicker solution

IN THE WAKE OF THE GLOBAL financial crisis and assorted financial services-related scandals around the world, the question of imposing fiduciary duties on retail financial advisors has become a hot topic in various countries.

In Canada, the call to hold advisors to a fiduciary duty also has been growing louder. And the Ontario Securities Commission is now studying the issue.

Yet, while requiring advisors to act in the best interests of their clients seems like a logical and appealing concept, actually enshrining this fiduciary duty in law may be no easy task. Experience shows that it often takes years for Canadian securities regulators to agree on seemingly basic reforms; and when this involves possible legislative changes, the pro¬cess is even more prolonged. So, even though the issue has finally reached the regulators’ attention, that doesn’t mean such a duty is likely to be imposed soon.

It may be that regulators could effectively achieve the same result as adopting a statutory fiduciary duty by tightening the existing suitability regime without requiring specific statutory change.

Take, for example, the latest effort to tighten suitability rules by the Mutual Fund Dealers Association of Canada. The MFDA has proposed amendments to its “know your client” rules in order to clarify that suit¬ability obligations do apply to strategies involving leverage, and to set minimum standards for firms and reps in assessing the suitability of leveraging.

The proposed amendments raise the bar on suitability with specific requirements that re¬late to the use ofleveraging strategies, including a requirement that leverage suitability must be assessed when certain “trigger events” occur, such as a change in the rep responsible for a client’s account or when a client transfers assets acquired with borrowed funds into an account.

This is in line with the latest version of the Investment Industry Regulatory Organization of Canada’s proposed client rela!ionship model, which would also require that suitability be reassessed in response to trigger events, and that the obligations apply not just to orders and recommendations but also to overall trading strategies and financing methods.

As regulators take these steps to increase suitability requirements gradually, they are also demanding more from firms.

“Assessing suitability where leverage is involved is more complex,” notes Karen McGuinness, vice president of compliance at the MFDA, “as the [dealer] is responsible for not only assessing the suitability of the investment advice but also the suitability of the leverage strategy. This com¬plexity adds additional compliance risk, given the need for additional supervisory requirements.”

But the Canadian Foundation for Advancement of Investor Rights argues that regulators should be going even further. FAIR Canada’s submission on the MFDA’s proposed amendments says the proposed minimum criteria for leverage suitability is still too low. It recommends the amendments he toughened.

The FAIR Canada submission also recommends: there be a pre¬sumption that leverage is unsuit: able for retail investors, and that the onus to prove that leverage is suitable for a particular client be placed on the rep that is recommending it; that investors be required to meet a minimum level of investment knowledge before they are allowed to use leverage to invest, and that both reps and clients be required to certify that the client has a proper understanding of the risks; and added disclosure of any compensation generated by the use of client leverage.

Pushing the envelope of what is required to ensure suitability in this way would enhance investor protection, and drive firms and reps incrementally closer to that holy grail of investor protection – fiduciary duty. FAIR Canada’s submission suggests that regulators go one step further and implement what it refers to as a “clients first” model, which would “require that all client recommendations be in the best interests of the client ratter than simply requiring that they be suitable.”

As the FAIR Canada submission goes on to explain: “The fundamental principle of the [“clients first”l model would be a general rule Slating thal, in all aspects of their dealings with their retail investor clients, including recommendations, compensation practices. disclosure. management of conflicts of interest and all ongoing aspects of the client relationship (such as performance reporting). financial service providers must put the interests of clients foremost.”

Adopting this sort of rule would better protect investors from inappropriate uses of leverage, the submission continues, and it “could be introduced as an element of suitability, which could reduce the amount of time it would take to implement such a standard.” As well, this method also would be free of the legal baggage that would come with imposing a statutory fiduciary duty.

Pushing the suitability rules in this direction also could help close the gap between the sort of relationship that many clients believe they have with their advisors and the regulatory reality. FAIR Canada’s submission says this sort of change is “essential to remedying the imbalance and misalignment of interests and expectations in current registrant/client relationships.”

Resetting that balance by statute could be very demanding. But regulators may find it’s possible to accomplish it by stealth. IE 


November 2011
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