The management of endowments or capital pools of any significant size is most often entrusted to a professional money manager. Recent changes to securities regulation have been made with the stated intent of better protecting investors, including institutional investors such as charities. The changes affect the way that money managers conduct business. In particular, under the new regulatory regime, money managers of all stripes and colours will be required to maintain stringent standards of business conduct and have in place appropriate risk management policies and procedures. The new rules enhance certain disclosures which money managers are required to make to clients about the nature of the manager-client relationship. Organizations which have appointed money managers should take this as an opportunity to review existing account documentation to ensure it is complete and that additional information which money managers are now mandated to supply has been or will be properly furnished.
Professional money managers are generally subject to the supervision of securities regulatory authorities. Canada enjoys the dubious distinction of being the only developed country without a national or federal securities regulator. Securities regulation is a provincial responsibility, meaning that technically speaking, we have thirteen separate securities regulators (the ten provinces and three territories). In practice, to make the system workable, the regulators co-operate where possible to have rules which are consistently applied across the country. This requires sustained effort, continual monitoring and the expenditure of a great deal of time. (Readers should note that the Government of Canada has an initiative underway for a national securities regulator and it has established the Canadian Securities Transition Office to put together a plan whereby provinces will be able, but not obligated, to “opt in” to a Canadian Securities Regulator. )
A recent and significant example of coordination and cooperation on the part of securities regulators is the release and implementation of National Instrument 31-103 (NI 31-103), Registration Requirements and Exemptions. In securities regulatory terms, professional money managers, when they manage client money on a discretionary basis, are engaging in the activity of "advising". Like other regulated professions, the business of advising with respect to investments can only be carried on by persons properly registered to do so. This registration requirement is the primary regulatory means by which the consumers of these services can be assured of some degree of protection from incompetence, negligence or fraud. Since “advising” can encompass such a wide range of activities, the rules provide for certain exceptions to the registration requirement in appropriate circumstances.
As far as money managers are concerned, NI 31-103 provides for a more consistent, harmonized and efficient registration regime that applies in all Canadian jurisdictions. To take one example, prior to NI 31-103, a money management firm with offices in Ontario, Quebec and British Columbia would have to register separately in each of those provinces. There were often minor, and idiosyncratic, local variations so that for example, the individual portfolio managers employed by the firm would be registered in different "registration categories" depending on the jurisdiction. More significantly, the various exemptions from the registration requirements could also vary by province. NI 31-103 largely addresses and eliminates these discrepancies.
Enhanced Investor Protection Measures
Importantly for the clients of money managers, the new national registration regime contains enhanced investor protection measures. Chief among the new rules are those relating to the maintenance of an effective compliance and control regime by every registered money manager. Investment advisory firms must designate a senior officer as its Chief Compliance Officer or CCO. The CCO is to be responsible for the overall design and effectiveness of the firm's compliance system. The compliance system overseen by the CCO must have policies and procedures that provide reasonable assurance that the firm and its professionals act in compliance with applicable securities legislation. The firm’s documented set of internal controls must be designed to detect incidents of non-compliance and address any breaches in a timely and appropriate fashion.
Supporting this are provisions relating to financial reporting to authorities, prescribing the amount of regulatory working capital that firms are to maintain, mandating the type and amount of insurance a firm must have, and setting out the minimum professional qualifications for the individual portfolio managers.
There are also new rules on how client complaints must be handled by money management firms, and a mandatory requirement for dispute resolution. A firm is required to respond to complaints "in a manner that a reasonable investor would consider fair and effective". If a complaint is not resolved to the satisfaction of the client, the firm must make available, at its expense, a dispute resolution or mediation service. These rules will be phased in and become operational over the next two years.
Finally NI 31-103 reinforces the view that disclosure, particularly of fee arrangements and of any conflicts of interest, is key to investor protection. To that end, every firm must provide a package of information, called the "relationship disclosure information", which describes for the client:
- the nature of the client's account with the firm
- the products and services offered by the firm
- the risks that the client should consider, including risks associated with borrowing to invest
- the conflicts of interest applicable to the firm
- the costs to the client in operating the account
- the basis of the compensation paid to firm
- the content and frequency of the firm's reports to the client, and
- certain other information about the client's rights (for example the right to the dispute resolution service) .
These rules also are being phased in and will be fully effective by September 28, 2010.
If an organization has retained the services of one or more professional money managers, now would be a good time to review the legal documentation pertaining to that relationship. This would generally consist in most cases of a legal agreement known as the investment management agreement, or IMA. In addition, there will be various pieces of account opening documentation, including suitability and “know your client” forms. In view of NI 31-103, certain amendments to this documentation may be in order.
Although the money manager is a fiduciary for legal purposes, the client nevertheless has a responsibility to be informed as to their rights and remedies. So clients should be inquiring about those items listed above as constituting the relationship disclosure information. They should inquire about fee arrangements, about transaction costs in addition to fees, and about possible conflicts of interest and how the firm addresses the conflicts. Clients should ensure that they understand the responses and ask for additional explanation or clarification where required. They should engage in a frank discussion with the investment management firm on risk management policies and procedures. If the past two years have taught us anything, it is that the sheer size of a financial services company is no guarantee against recklessness or the taking on of inappropriate and poorly understood risk.
NI 31-103 marks a significant milestone in the regulation of money managers. Organizations will be well advised to make sure that they are positioned to take full advantage of the benefits and protections afforded clients through these new rules