Canadian individual or retail investors rely on the integrity of the client-financial advisor relationship, often believing that those providing investment advice are acting in their best interests. Financial institutions and financial advisors’ marketing and advertising create the impression that they will provide advice in the client’s best interests. However their regulatory requirements and remuneration systems are often not consistent with doing so and, many argue, are in dire need of change in order to be better aligned with investor expectations.

On 23 February 2011, Toronto CFA Society joined with FAIR Canada* and The Hennick Centre for Business and Law to convene a roundtable of investor advocates, industry participants, regulators and governments to examine the need for, and implications of, introducing a requirement for financial firms and financial advisors to put clients’ best interests first when providing financial advice.

Current Canadian requirements don’t protect investors

Most individual or retail investors assume that such a requirement already exists but, in fact, the suitability requirements of Canada’s securities commissions and self-regulatory organizations fall far short of imposing a “best interests” duty on persons whose job titles and representations to their clients suggest that they are providing advice that is in the best interests of their clients. In its recently published Client Relationship Model proposal, the Investment Industry Regulatory Organization of Canada (“IIROC”) examined the relationship between dealer members and their clients, and proposed requirements to reinforce the broader obligation for dealer members to deal fairly, honestly and in good faith with their clients. To that end, the proposed new rules and amendments establish requirements addressing account suitability assessments, account performance reporting, relationship disclosure and conflicts of interest management and disclosure. However, suitability is a broad standard and the aforementioned requirements do not require a client’s interests to always be placed first. Also, trailing commissions, which remunerate salespeople to sell certain financial products and encourage their clients to buy and hold certain investment vehicles regardless of their relative performance, remain common in Canada.

Canada is not keeping pace with reforms in the U.S. and U.K.

Certain countries, including the U.S. and the U.K. have moved ahead of Canada in their initiatives to strengthen investor protections within the client-financial advisor relationship.

Notably, on 11 January 2011 the U.S. Securities and Exchange Commission delivered to Congress its study on investment advisers and broker-dealers under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The SEC has recommended the adoption and implementation of a uniform fiduciary standard of conduct for broker-dealers and investment advisors when providing personalized investment advice about securities to retail customers.

In the U.K., financial advisers will not be permitted to receive embedded, product provider commissions from firms for recommending their investment products and advisors will be required to clarify for clients whether the advice being provided is independent. The ban is part of a package of measures introduced by the Financial Services Authority to help restore consumer confidence in the investment market. From the end of 2012 advisers will instead have to charge the consumer directly for their services. This will force them to be more transparent about how much their advice is costing consumers. The measures, which are part of the FSA’s retail distribution review, will also require anyone advising on life insurance policies, pensions and other investment products, to describe the advice on offer as either “independent” or “restricted.” Firms offering independent advice will have to demonstrate that their recommendations are based on a comprehensive and unbiased analysis of the market, and that any product selection is made in their clients’ best interests. If a firm chooses to limit its product range to certain investments or strategies, this will be considered “restricted advice” and the firm will have to clearly set this out to its customers at the outset.

Notes from the Roundtable discussion

“Canadian investors need clearly defined protections,” Ilana Singer, deputy director of FAIR Canada, noted after the roundtable. “A uniform, national requirement for financial advisors to place their clients’ interests ahead of their own and their firm’s interests would help clarify the financial client-advisor relationship. It would also demonstrate that Canada is keeping pace with best practices in other developed markets in this important area.”

The roundtable discussion focused on three key areas:

1. The current regulatory framework governing client-advisor relationships;
2. What, if any, changes might offer better protection for investors; and
3. What the practical implications of a change in framework might be for industry, investors and regulators. A range of views was expressed, some diverging little from the status quo, but others urging decisive action to raise Canadian standards

In grappling with this complex issue, some observed that investors can be faced with enormous challenges when working with financial advisors. “Codifying a standard that puts clients’ best interests first will only ignite positive change if its meaning is clearly defined in comparison to the existing standard,” noted Ilana Singer.

“Regretfully, many investors are vulnerable to being sold complex, high-fee products that can be contrary to consumers’ best interests by salespeople that hold themselves out as trusted financial advisors,” said Ermanno Pascutto, executive director of FAIR Canada.

Mr. Pascutto added, “Current legal requirements for financial advisors are a mix of “suitability” obligations and “buyer beware”, although consumers may not be aware of this.

Mandating a uniform national requirement, together with clearly defined consequences for failure to comply, would display strong dedication and commitment by Canada’s regulators and governments to strengthening investor protection. The financial industry should support a duty to act in the client’s best interests if they want to restore public trust in the financial industry.”

The need for a single national regulator

The federal government’s current efforts to create a national securities regulator provide a timely context for introducing such a requirement into law. Progress in this regard has been slow, but is continuing.

Faced with challenges from provinces, the federal government has decided to seek the opinion of the Supreme Court of Canada on whether establishing a single regulator is constitutionally acceptable. The Supreme Court is scheduled to hear arguments on this issue in April. The Canadian Bankers Association (CBA) filed a factum with the Supreme Court in support of the federal government’s move to create a single regulator, saying the entity falls into the rights of the federal government and would help to assure the integrity and competitiveness of Canada’s capital markets.

“A single, Canadian regulator will offer improved investor protection and greater efficiencies in capital markets and will reduce the cost of raising capital for businesses of all sizes across the country,” commented Nancy Hughes Anthony, CBA’s president and CEO.

Currently Canada has 13 provincial and territorial securities commissions. The federal government has described the lack of a national regulator as “an embarrassment”. “Canada is the only industrialized nation in the world that does not have a national securities regulator,” Finance Minister Jim Flaherty recently told Parliament.

The creation of a national securities regulator could greatly assist efforts to mandate a national requirement for investment firms and advisors to put their clients’ best interests first. Canada’s financial system has won international kudos in the wake of the global financial melt-down and crisis of the last three years. It is time for Canada to continue to show that it is at the forefront of investor protection initiatives and introduce a requirement for investors’ interests to be put first.

The Canadian Foundation for the Advancement of Investor Rights (“FAIR Canada”) is a national, non-profit organization dedicated to putting investors first. As a voice of Canadian investors, FAIR Canada is committed to advocating for stronger investor protections in securities regulation.