There is an on-going trend in the global investment industry to increase the standard of care expected of investment advisers. Canadian Securities Administrators (CSA) Consultation Paper 33-403, released in October 2012, points out that the U.S., the U.K., Australia, and the European Union “have either implemented, or are proposing to implement, a qualified best-interest standard.”

This is a departure from past approaches that tended to be caveat emptor in nature, focusing on improving disclosure as the means of enabling investors to fend for themselves. Recent initiatives, such as “fund facts” and the Client Relationship Model, are designed to provide this greater disclosure so that investors will be better informed and therefore better protected.

But while most would agree that greater disclosure is desirable, it will never be a complete solution. The information and financial literacy asymmetry between adviser and client is just too great, and often the complexity of the disclosure appears designed more to increase dependency than to increase understanding.

Perhaps the most compelling reason for insisting on a fiduciary standard for advisors, rather than lesser standards of suitability and fair dealing, is that most Canadians already believe (perhaps naively) that their investment advisors owe them this legal duty. A 2012 study conducted for the Investor Education Fund found that “seven out of 10 investors believe their advisor has a legal duty to put the client’s best interests ahead of his or her own personal interests.” Interestingly, the same study found that “two thirds of investors know little about their advisor when they enter into a relationship with that advisor.”

Of course, CFA charterholders should welcome an increased standard of care, because the CFA Institute Code of Ethics and Standards of Professional Conduct require CFA charterholders to act for the benefit of clients, so a best-interests standard merely imposes this same standard of care on all advisers. And indeed, many advisers feel that they already act in the best interests of their clients, although some of these claims may be disingenuous, given that some of these same advisers are arguing against the CSA proposal to codify this standard of care.

Clearly, establishing a fiduciary standard for investment advisers will only be effective if there are few exceptions and few categories of financial intermediaries that are not covered by the standard. Having some advisers under securities regulation held to a best-interests standard while others who fulfill similar roles under insurance regulation are held to a different standard would be problematic. Similarly, exempting classes of advisers in limited roles from the best-interests standard would also be problematic. The onus should not be on the investor to have to sort out different levels or types of advisers with different standards of care.

A full fiduciary standard of care for anyone providing investment advice or exercising discretion or control over client assets would have major repercussions for the investment industry in Canada. One obvious ramification of such a standard would be the need to revise the way in which many investment advisers are compensated (see CSA Discussion Paper 81-407 regarding mutual fund fees). Arrangements that motivate an adviser through differences in compensation to put a client in one particular fund instead of a similar competing fund lead to conflicts of interest that are difficult to reconcile with a best-interests standard of care.

The simplest approach to reconciling a fiduciary standard of care with mutual fund fees is to decouple adviser compensation and mutual fund fees. If investment costs are separated from the costs of investment advice, and both are separated from any sales costs, then there is no conflict. And at the same time, a greater level of transparency is achieved without convoluted disclosure requirements.

Once again, the U.K. and Australia are ahead of us in decoupling mutual fund fees and adviser compensation. I would expect Canadian regulators to proceed slowly. But there are two good reasons why governments in Canada will eventually need to push forward with these reforms, even in the face of considerable inertia and resistance from status quo lobbyists within the industry:

1. This is what Canadian investors need, what most want, and as discussed above, what a large number already think they have. In fact, it might take a considerable educational effort to convince Canadian investors that their advisors do not already have a legal duty to act in their best interests. In the same way as the Canadian public expects the government to ensure that the food on the shelves in the supermarket will not be poisonous, the Canadian investing public expects advisors to not be selling investment products that are tainted by self-interest.
2. One of the major emerging social issues of our time is retirement income adequacy. Given demographic trends and the demise of defined benefit pension plans, the gap between the financial assets people need to retire, and what they have, will likely continue to widen. And a major contributing factor to this retirement funding inadequacy is the cost structure of mutual funds and other retirement savings arrangements. Canadian governments will never be able to fix the retirement problem until they improve the cost structures of mutual funds and other retirement savings vehicles. The proposed Pooled Registered Pension Plans (PRPPs) certainly are not a viable fix. Although political leaders promised a low-cost solution, the regulations proposed to date do not adequately address the costs of financial intermediation.

The only way to achieve real transparency in the investment process is to clearly separate selling from the provision of investment advice. Key to achieving this level of transparency and investor protection are a heightened fiduciary standard for investment advisers and the resulting changes in the way the industry does business. This is an essential evolution, required to ensure that the investment industry lives up to the needs and expectations of Canadian investors.