When you and your firm clash over client communications

The quandary

Your firm’s latest newsletter to clients says, “Now is the time for skilled active management.” However, you typically advise your clients to invest in low-cost index funds. When you write your own newsletter to clients clarifying your position and explaining that active managers don’t beat their indexes over longer time horizons, compliance won’t approve the newsletter, citing rule 3603 (1) (advertising) of the Canadian Investment Regulatory Organization (CIRO). What do you do?

The experts

Noah Billick, partner and director of regulatory, funds and compliance, Renno & Co., Montreal

The underlying question in this scenario is whether the firm is breaking a rule [with its marketing message], and can we force it to stop. We can back up from the CIRO rule and go to the law. All provincial securities acts have similar language about conditions of registration: every registered dealer or advisor shall deal fairly, honestly and in good faith.

I understand why the firm’s marketing annoys the advisor. But I don’t think the marketing rises to the level of non-compliance (though firms should be careful as regulatory expectations evolve).

Is the firm’s message misleading and would a reasonable investor rely on it to their detriment, or is it understood as marketing puffery?

Is the firm’s message about buying undervalued funds? Certainly, during Covid, we saw certain sectors become overvalued and others become undervalued. (I believe a value approach, which is Warren Buffett’s approach, is best over the long term.)

There are many licensed discretionary managers who spend a lot of time doing fundamental research to identify securities that will outperform for a period. I don’t think they should be penalized or told that that approach is wrong.

Context also matters. Does the marketing message appear alongside images of bags of money or of a person walking on the beach? What disclosures are made?

If the firm were going too far with a definitive statement — “people who pick the right stocks right now will make more money than those who take a passive approach” — then that’s misleading and breaches the law.

I can also imagine a scenario in which a firm tells an advisor not to trade but to buy and hold, and the advisor disagrees.

So, one, there is a range of suitable [investing] approaches and possible outcomes that depend fundamentally on the personal circumstances of the investor — particularly when it comes to high-net-worth investors. The obligation of compliance is an obligation of process, not outcome. Having a good process, performing your due diligence and satisfying your know-your-product obligations, ensuring your investment strategy is appropriate for your client — that’s your obligation.

Two, an advisor needs to find a firm that meshes with their investment approach. Otherwise, there will always be tension between the advisor and firm.

The advisor and firm in this scenario are a poor cultural fit. If the firm puts out marketing material that doesn’t square with the advisor’s view of how client money should be managed, the advisor should consider finding a firm that doesn’t put out firm-wide marketing about its investment approach or one that does more general advertising.

Other options are finding a firm that favours a passive investing approach or starting your own shop. I don’t like giving this advice [to leave] because I know what a big deal it is to move shops — it’s traumatic.

The advisor’s position, as an evidence-based one, is defensible. Compliance is preventing the advisor from doing something not for compliance reasons but for business reasons. That flips a typical issue with compliance — that it doesn’t understand business realities — on its head.

It’s bad, but I have seen firms use compliance as a cudgel to punish advisors who aren’t falling in line. Fundamentally, you work at a company, you have to toe the party line. I go back to my point that this is a bad shop for this advisor.

Ayn Greaves, compliance consultant, AUM Law, Toronto

First and foremost, since the introduction of the client-focused reforms (CFR), misleading communications are prohibited no matter if they are produced by a firm or advisor (NI 31-103, section 13.18). Further, when it comes to recommending or “pushing” products, the firm and its registered advisors must adhere to the requirements under NI 31-103, section 13.2.1, which require the firm to have a know-your-product (KYP) process in place. 

The advisor should keep in mind that their actions and advice must always be in the best interest of their clients (a CFR obligation). The recommendation of low-cost index funds is assumed to be based on meeting know-your-client (KYC), KYP and suitability requirements for each individual client.  

If an advisor’s newsletter is rejected by the compliance department, it may be for valid reasons other than countering the firm’s latest marketing strategy. (Most firms do not allow individual advisors to produce their own marketing materials/email communications content.) Keep in mind that one size does not fit all. A firm is allowed to push a marketing strategy aimed at certain clients if it wants, provided it has a KYP process in place for the products it recommends. 

If the compliance department rejected the advisor’s communication, it will have documented its reason. Do not go ahead and self-produce and distribute a newsletter; this will be offside of firm policy and the regulations.

If the advisor has a good relationship with their clients, then a firm newsletter shouldn’t upset their clients nor the individual investment strategies the advisor has devised for them. The firm’s newsletter should encourage the advisor to engage in ongoing discussions with their clients regarding suitable investments that fit their needs (fulfilling their KYC/KYP and suitability requirements). Whether that is a low-cost index fund or an actively managed fund, it’s the advisor’s job to work through what is the best investment strategy with their client and together decide on the best option for the client.

Zachary Pringle, associate, Babin Bessner Spry LLP, Toronto

The dealer and advisor each need to be careful they’re not implementing a one-size-fits-all strategy for clients. It’s fine to prefer one method of managing a portfolio or account, but they must consider what is in the client’s best interest, which might sometimes mean that actively trading an account is better for that particular client than a low-cost index fund; the inverse is also true.

If the firm’s accounts generate commissions from trades (the accounts aren’t fee-based), and the firm specifically communicates a message to earn more commissions (“you should actively trade to boost returns”), that poses a serious conflict of interest, and the firm should not do that.

In this case, the advisor should first consult the firm’s policy manual to confirm what kinds of communications the firm permits the advisor to deliver to clients. Some policy manuals specify the channels that a newsletter must go through to get approved; some say the firm has the ultimate discretion to determine what can and can’t go out.

Assuming the policy poses no issue, the advisor can arrange a meeting with the firm to explain why they disagree with the firm’s view. The tone should be collaborative, not antagonistic. Explain why you’re trying to convey a different message from the firm. This meeting might reveal underlying differences that can be resolved.

If speaking with the firm doesn’t readily resolve the issue, another option is to use more nuanced language in the communication to clients so that the two messages don’t convey different positions. For example, the advisor’s message could be about the preference to have clients invest in low-cost index funds.

It’s about collaborating and cooperating with the firm. Aside from client relationships, an advisor’s most important relationship is with the firm, and you don’t want to ruin it over a newsletter. A divorce can get quite messy and expensive.

If you do everything you can to collaborate, and you and the firm are diametrically opposed, and you recognize that the issues won’t be resolved, then sticking around could cause you serious risk in the long term.

When an advisor doesn’t agree with what their firm says and doesn’t want to engage with clients in a specific way prescribed by the firm, then the advisor is exposing themselves to a regulatory infraction as well as putting their employment or agency agreement at risk.

Editorial note: Thanks to John De Goey for contributing the idea for this quandary.