Industry still waiting for best interest clarity

At the National Institute on U.S.-Canadian Securities Litigation in Toronto this week, regulators and litigators discussed industry developments.

Best interest standard at a standstill?

Panellists expressed concern about the best interest standard’s regulatory uncertainty and unintended consequences for advisors and firms’ business models.

For example, the OSC needs to clarify the difference between a best interest standard and a fiduciary duty, said Pascale Elharrar, associate general counsel and managing director at BMO Wealth Management Group in Montreal. “Would [the regulator] be able to craft a meaningful and clear distinction that would […] be properly understood by the courts?” Further, she questioned how a best interest standard could be “operationalized.”

Regardless of whether the industry ultimately supports a best interest standard or the proposed targeted reforms, “at issue here for us is compensation-related conflicts,” said Elsa Renzella, IIROC’s vice-president of enforcement, referring to IIROC’s recently published compensation guidance.

Read: IIROC guidance on managing conflicts poses challenges for dealers

In the U.S., the fiduciary rule isn’t dead, but it’s under attack — administratively, legislatively and judiciously, said A. Inge Selden III, principal at Bressler, Amery & Ross in Birmingham, Alabama. Full implementation is likely to be pushed back to July 2019.

U.S. regulators warn of fixed income risks

U.S. cases involving municipal bonds or municipal bond funds have increased dramatically since 2013, Selden said. There were 51 cases in 2013 and almost 700 last year, reflective of Puerto Rico’s bond market collapse in 2013.

(Puerto Rico is unique, explained Selden, in that investors born in Puerto Rico or naturalized as U.S. citizens in Puerto Rico who hold Puerto Rican assets aren’t subject to estate tax. In contrast, those same investors owning non-Puerto Rican assets are heavily taxed.)

“What are we doing to make sure our investors understand the risks to the fixed income markets today?” asked Selden, listing the risks of interest rates, credit, geography and liquidity.

Read: How will rising rates affect a client’s investment portfolio?

Jessica Hopper, senior vice-president at FINRA, added concentration risk to the list, saying many investors were 100% invested in Puerto Rican munis. “For firms, it’s extremely important to keep an eye on concentration as part of suitability supervision.”

Sector concentration is also part of suitability. “That’s [not] as well understood by firms when they’re putting their supervision systems together,” she said. Though investments in Puerto Rican municipal bonds comprised many products, investors were still over-weighted in the sector, she said.

Read: Why government bonds aren’t safe

IIROC considers minority violation rule

IIROC’s pursuit of court authority to collect fines may have overshadowed one of its other key enforcement priorities: to research and evaluate alternative forms of disciplinary action.

That goal, listed in IIROC’s 2016-2017 annual report published in April, aims to avoid disciplinary hearings and the resulting fines.

The priority “is our attempt at looking at other ways that we can address misconduct,” said Renzella.

Currently, the enforcement process is binary, she said, with IIROC either doing nothing or proceeding with a disciplinary hearing and the associated requirements. “We’re trying to find ways to address prompt duty in a more streamlined and efficient way.”

Specifically, “We’re looking closely at a minor rule violation program,” she said, noting such a program has been implemented by FINRA and others. Industry comment will be sought on the issue.

FINRA’s minor rule violation plan (MRVP) allows the SRO to impose a fine of up to $2,500 on member firms or individuals for a minor rule violation. FINRA regulatory notice 13-32 says, “MRVP dispositions provide a useful tool for implementing the concept of progressive discipline to remediate misconduct.”

Hopper said that imposing remedial sanctions is challenging because the public is focused on fine dollars. “The fine dollars, for us, don’t define what we do,” she said.

For example, fines don’t weed out the bad apples, who should be banned, or in the case of firms, who should be expelled, she said. Enforcement on fraud and suitability — key FINRA priorities — identify these problem firms and advisors.

A third priority, supervision, helps identify root problems, she added. “A fine is appropriate to send a message. But what’s the problem and how do we fix it?”

Renzella noted that firms’ compliance authority to enforce terms and conditions on dealer members is a first step in remediation.