Better suitability needed in client relationship model

Having a comprehensive, “know your client” process is a best practice for the majority of advisors, but the Investment Dealers Association–proposed client relationship model, which is currently seeking comment from its members and the industry, is going to make this a rule replete with enforcement.

Paul Bourque, senior vice-president of member regulation for the IDA, says the CRM has derived its core concepts from the Ontario Securities Commission’s controversial 2004 fair-dealing model, which sought to impose greater transparency on the investment industry.

“I think we have stuck with the core concepts of the fair-dealing model. Those core concepts were to improve transparency by making conflicts of interest, account costs and performance of investments clearer, and to provide a harmonized solution, so whatever proposal went out, it would be the same across Canada,” Bourque says.

The IDA has approved CRM and has sent the new rules for review by the Canadian Securities Administrators and for public comment.

It’s difficult to know how exactly the rules will affect the end advisor because the IDA has structured the rules according to how they relate to the dealer’s obligations to the end investors. Since advisors are all-important brokers in this relationship, it’s assumed the execution of some of these new processes would fall on their shoulders.

Probably the most drastic change will be the investment suitability rules the dealer must follow in which they will be required to reexamine investment plans during so-called trigger-events, which are drastic changes in a client’s life circumstances that could affect his or her financial objectives.

“The essential suitability requirements have not changed. Due diligence must be done to ensure investments are suitable and based on financial objectives and risk tolerance,” Bourque says. “Different firms have different practices. We will require the firm to disclose those, and we will require the firm to do a suitability review not only when there is a transaction or account transfer but also during what we call ‘trigger events,’ where there is a change in a client’s life circumstances.”

Bourque says trigger events could include things like divorce, a job change, or even caring for an elderly dependent. He notes the onus will be on the client to inform the firm about the life-changing event. Once the firm is made aware of the trigger event, the firm will be required to conduct a suitability review.

Bill Donegan, chief compliance officer at Worldsource Wealth Management, wants the IDA’s proposal to include a provision that says the dealer should be responsible for only the material changes he or she is aware of. “The IDA is silent on that point,” he says.

A review would also be triggered when a new advisor takes over an existing client. Donegan says there’s a “practical issue here.” He explains that changes could occur when an advisor leaves a dealer or if a large number of accounts are transferred to another advisor. “In those circumstances,” he says, “there should be time permitted to allow for a review to occur. Our suggestion is the suitability review should occur prior to the first transaction after the change in advisor.”

As well, if there is a bulk transfer, the firm will need significant time to review the accounts. Donegan adds that automated transfers, which include SWPs, should be allowed to continue.

The main concern for Gordon Martin, chief operating officer for Dundee Securities’ retail division, isn’t suitability; it’s flexibility. His issues revolve around “defining what cost information is going to be provided on a position-by-position basis,” he says.

He needs the IDA to clarify what “cost positions” really mean. “If we have to start calculating return of capital for trust units and other things, systems right now don’t handle that,” he says. “So we’d like definitions on exactly what costs are going to be used.”

The other major change being proposed is for account cost disclosure. The IDA wants to make it mandatory that member firms disclose to clients on an annual basis the cost of securities they have purchased and the account activity of those securities.

“There should be an account security position cost disclosure. We would mandate that account security cost information be provided to all retail clients on an annual basis,” Bourque says. “We also propose to mandate that account activity information be provided to all clients on an annual basis. It would detail the activity in the account that has taken place.”

One aspect is fee disclosure. The IDA proposes that dealers tell clients about “account service fees and charges the client will or may incur relating to the general operation of their account.” Donegan doesn’t have an issue with this per se; it’s the way the IDA wants its dealers to reveal fee information he doesn’t like.

He says disclosure documents need to be signed by the client every time there is a change, which could be difficult considering how often fee structures change. “The best way to make reference to fees is by a dealer fee schedule,” he says, “a separate document that could change over time without having to have a new disclosure made and acknowledgment required every time fees change.”

While most advisors and their firms already tend to have many of the CRM’s proposals already in place as best practices, the news of more regulation is not being openly welcomed by advisor advocacy groups, who argue that the compliance costs will be too onerous on advisors.

“Generally, we are always in favour of streamlining of transparency for consumers. What is of concern to us, though, is increasing the regulatory burden, particularly for [advisors] who work with consumers with smaller accounts,” says Susan Allenmang, head of regulatory affairs of Independent Financial Brokers of Canada. “There is a cost-benefit analysis that has to be done when working with consumers with smaller accounts. Making it more expensive to work with them pushes them out of the market and denies them personalized financial advice.”

Allenmang says her organization instead advocates a principles-based approach that has been established already by insurance regulators.

“The principles-based approach is used on the insurance side with success,” she says. “These kinds of relationships between advisors and clients are very fluid and very subjective in some ways, and it’s difficult to itemize all the details when determining suitability and so on.”

Peter Tzanetakis, senior director of regulatory affairs for Advocis, believes if the IDA mandates rules already practised by the majority of firms, then it actually creates a lower benchmark of conduct for advisors to adhere to.

“When a regulator wants to put parameters around practices that are already well-formed, it is sort of limiting what the advisor can do. In fact, it can create a lower standard, not a higher standard,” he says. “Given the already significant degree of sort of proscriptive regulation found in securities acts and the current IDA rulebook, we believe that a principles-based approach to regulation really needs to be considered at this time.”

Tzanetakis says his organization would rather see regulators focus more on enforcement that stamps out fraudulent activity.

“We believe that most investor complaints concern misappropriation of client funds and fraud, so we believe that regulators should have the necessary recourse to investigate complaints with significant enforcement powers,” he says. “[Instead,] we see greater emphasis on developing rules that create a greater burden for compliant advisors, which is not really in the public’s interest.”

Both the IFB and Advocis intend to file formal submissions before the commenting period concludes.

Filed by Bryan Borzykowski and Mark Noble, Advisor.ca, bryan.borzykowski@advisor.rogers.com mark.noble@advisor.rogers.com

(04/22/08)