The best interest standard for registrants has been on the Canadian Securities Administrators’ (CSA) radar for the past few years. On October 25, 2012, the CSA published CSA Consultation Paper 33-403 The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty When Advice is Provided to Retail Clients. On December 17, 2013, the CSA published CSA Staff Notice 33-316 Status Report on Consultation under CSA Consultation Paper 33-403: The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty When Advice is Provided to Retail Clients. However, the CSA ended up concluding that more work was needed.
Recently, the CSA released Consultation Paper 33-404 Proposals to Enhance the Obligations of Advisor, Dealers, and Representatives Towards Their Clients (Consultation Paper), which proposes to impose higher duties on all dealers, advisers, and representatives (Registrants), including those who are members of the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA). The proposed changes concern two key areas: the Best Interest Standard and Targeted Reforms. The Consultation Paper also highlights the split at the CSA on how to improve the relationship between clients and Registrants.
Best Interest Standard
The introduction of a Best Interest Standard would mean that all obligations which the Registrant has to the client must be carried out with a view to the best interests of the client. Specifically, a regulatory best interest standard would require that a registered dealer or registered adviser deal fairly, honestly and in good faith with its clients and act in its clients’ best interests and exercise the degree of care, diligence and skill that a reasonably prudent person or company would exercise in the circumstances. In complying with the standard of care, Registrants would be guided by the following principles:
- Act in the best interests of the client
- Avoid or control conflicts of interest in a manner that prioritizes the client’s best interests
- Provide full, clear, meaningful and timely disclosure
- Interpret law and agreements with clients in a manner favourable to the client’s interest where reasonably conflicting interpretations arise
- Act with care
According to the Consultation Paper, any best interest standard would be formulated as a regulatory conduct standard and not as a restatement of a fiduciary duty.
CSA jurisdictions split on support for Best Interest Standard
The CSA is split on whether the Best Interest Standard is appropriate for Registrants. Ontario and New Brunswick strongly support the introduction of the Best Interest Standard. Conversely, British Columbia is opposed to such a strict regulatory standard. In the middle of the spectrum, there is Alberta, Quebec, Manitoba, and Nova Scotia, who are not entirely on board with the idea, but are willing to receive and review comments on the proposed new standard.
Ontario and New Brunswick believe that introducing the Best Interest Standard would materially enhance the effectiveness of the reforms and strengthen the foundation of the Registrant-client relationship. These two jurisdictions believe that the Best Interest Standard would have a number of benefits, such as guiding Registrants in the interpretation of specific obligations and addressing issues that arise out of novel situations.
Meanwhile, Alberta, Quebec, Manitoba, and Nova Scotia are consulting on the Best Interest Standard. However, these provinces have expressed strong reservations regarding the actual benefits of the introduction of an overarching Best Interest Standard above the Targeted Reforms and have fears that such a standard of conduct will lead to a host of unexpected issues.
Saskatchewan is interested in receiving and reviewing all comments on the proposed standard with a view to the fact that the new standard will have a significant regulatory impact.
British Columbia is firmly opposed to an over-arching Best Interest Standard, arguing that the proposed Target Reforms will do an adequate job of strengthening the standards of conduct and advancing investors’ best interests. British Columbia argues that imposing a Best Interest Standard will exacerbate one of the key concerns regarding investor protection, i.e., clients mistakenly believing Registrants are acting in their Best Interests in all situations when, in fact, certain fundamental conflicts between Registrants and their clients will continue to exist and be permitted. Furthermore, British Columbia believes that an overarching Best Interest Standard is vague and unclear and will lead to more uncertainty for Registrants.
If the Best Interest Standard is introduced, there is the obvious concern among Registrants, particularly in relation to litigation/civil liability in respect of negligence claims. In addition, Registrants would have to overhaul their businesses in order to comply with the new requirements, thereby increasing their compliance and training costs. These costs would likely have to be passed onto clients.
The Targeted Reforms would require amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) and have been introduced as a separate proposal from the Best Interests Standard. This will allow the Targeted Reforms to potentially be adopted even if the more stringent Best Interest Standard is rejected.
The Targeted Reforms would significantly increase the duties of Registrants in the following key areas:
- Conflicts of Interest – General Obligations: Registrants would need to respond to material conflicts of interest in a manner that prioritizes the interests of the client ahead of the interests of the firm and/or representative. Disclosure of a conflict of interest to a client would need to be “prominent, specific and clear.”
- Know Your Client (KYC) and Know Your Product (KYP): In terms of KYC, Registrants would be required to maintain up-to-date information regarding client needs and goals, financial circumstances, and risk appetites. In regards to KYP, Registrants would be required to understand the product strategy, features, structure, risks, and costs of each product offered by their firm, the differences between products, and the performance of the product, client account, and investment strategy after deduction of all associated fees, costs and charges.
- Suitability: Registrants would be required to analyze investment strategy suitability, financial suitability, and product selection suitability in compliance with specific criteria every time they make a recommendation concerning or accept a client instruction to buy, sell, hold or exchange a security, or to make a purchase, sale, hold or exchange of a security for a managed account. Where an unsuitable investment is identified within an account, the Registrant would be required to take appropriate measures to ensure the client receives advice considering the client’s investment needs and objectives, risk profile, and other particular circumstances (for example, an appropriate measure or course of action may include contacting the client in a timely manner to recommend changes). Currently, suitability focuses on trades; Registrants are not required to conduct a suitability analysis for a recommendation or decision to hold or exchange securities.
- Relationship disclosure: Registrants would be required to disclose the nature of the Registrant-client relationship in terms the client can easily grasp. Registrants would have increased disclosure obligations at the time a client opens an account. Registrants would be required to state whether they have a proprietary or mixed/non-proprietary product list.
- Proficiency: Representatives would have to meet more stringent proficiency requirements, including standards that explicitly incorporate the knowledge elements required for compliance with the proposed targeted reforms, including that all representatives must generally understand the basic structure, features, product strategy, costs and risks of all types of securities, such as equities, fixed income, mutual funds, other investment funds, exempt products, and scholarship plan securities.
- Titles: Registrants would be required to use prescribed business titles for all client-facing representatives.
- Professional designations: Stricter rules would apply to the use of professional designations (i.e., credentials that are used to indicate that the individual has specialized knowledge or expertise in an area gained through education and/or experience).
- Role of the Ultimate Designated Person (UDP) and Chief Compliance Officer (CCO): NI 31-103 would be amended to describe the duties and obligations of the UDP and CCO in greater detail.
- Statutory Fiduciary Duty When Client Grants Discretionary Authority: Existing securities legislation in British Columbia, Saskatchewan, Ontario, Québec, Nova Scotia, Prince Edward Island, Nunavut, Yukon, and the Northwest Territories would be amended to introduce a statutory fiduciary duty for registrants when they manage the investment portfolio of a client through discretionary authority granted by the client.
In connection with the Best Interest Standard and the Targeted Reforms, the CSA set out specific consultation questions and are seeking input on both the proposals. Comments on the Consultation Paper may be submitted until August 26, 2016.