In January 2004, the Ontario Securities Commission released a concept paper advocating a "fair dealing model." The paper acknowledged that the regulatory regime -- regulating dealers and their representatives through the products they sell -- was based on the outdated assumption that transaction execution is the primary reason people seek financial services. Recognizing that most customers are seeking advice, the concept paper proposed changing the regulatory framework to focus on the advisory relationship.

Financial professionals and salespersons in Canada are allowed to call themselves advisors, irrespective of their professional designation. Few, however, are compensated directly for their advice. Instead, they are paid commissions to sell specific products. Addressing the conflicts of interest that result from commission-based compensation, the paper proposed that retail clients should be entitled to rely on objective advice that is in their best interest and, when there are conflicts of interest, they should be clearly disclosed so that the client can understand the conflicts and how they may affect the advice given.

In September 2004, the proposal was swept into a broader project of the Canadian Securities Administrators (CSA) and rebranded as the "client relationship model." Last month, the Investment Industry Regulatory Organization of Canada (IIROC) published its proposed reforms to establish requirements for the client relationship model. They specifically avoid imposing a duty on firms and their representatives to act in the best interest of clients, focussing instead on improving compliance with the existing "suitability" standard and improving disclosure with respect to conflicts of interest and performance reporting. IIROC noted that part of what influenced its thinking was an effort to harmonize with existing and proposed CSA standards (and other standards applicable to firms not under its jurisdiction).

To understand the difference between a "suitability" and "best-interest" standard, think of a student seeking advice at an electronics store about her need for a laptop. The salesperson recommends a highly priced unit with an expensive extended warranty -- all designed to generate the highest commission. The laptop is suitable--it will satisfy the student's needs. It clearly isn't the best solution and a disclosure obligation isn't likely to stand in the way of a motivated salesperson. If the salesperson had been bound by a "best-interest" standard, he would recommend a simpler, more reliable and affordable unit.

In the U.S., brokers and investment advisors are subject to different standards when providing investment advice. Many investors are unaware of these differences or their legal implications or find them confusing. In the wake of the global financial crisis, the Dodd-Frank Act required the Securities and Exchange Commission (SEC) to evaluate the effectiveness of existing legal or regulatory standards of care for providing personalized investment advice to retail customers. Five months later and with the benefit of over 3,500 comment letters as well as a survey conducted by the CFA Institute (which already requires both a suitability and best-interest standard of its members in order to use the Chartered Financial Analyst professional designation) SEC staff released its analysis and recommendations. It has proposed a uniform standard of conduct for all brokers, dealers and investment advisors providing personalized investment advice about securities to retail customers to act in the best interest of the customer.

The SEC staff study acknowledges that working through the details of such a standard so as to ensure it is practicable and cost effective will be complex. It does not propose a strict fiduciary duty, nor does it suggest rules to try to eliminate conflicts.

The U.K. Financial Services Authority (FSA) recently banned commissions for advised sales of retail investments and released proposals which would require advisors to explain why a product is better than a cheaper alternative. This and other more intrusive proposals are based on the FSA's realization that there are "fundamental reasons why financial services markets do not always work well for consumers."

The contrast in the direction, speed and intensity of regulatory reform between Canada and other major developed markets raises a number of questions and suggestions. Why did the OSC start down the path of a "best-interest" standard in 2004 and, while others (including the U.K., Europe and Australia) have caught up, we appear to have fallen back to where we started -- disclosure requirements and a relatively static "suitability" standard? To what extent is this a function of a fragmented regulatory framework suffering from bureaucratic inertia (and an industry suffering from regulatory fatigue)? What accountability mechanisms are required to motivate a more focussed and intense effort?

Why is it that Canadian regulators have shied away from proposing a "best-interest" standard? As one commentator to the SEC staff's study noted, "If the product sold is that of advice, then that advice should be in the best interest of the client. Anything else is fraud, because the seller is delivering a service different from what the consumer thinks he or she is buying." Many argue that it's the buyer's responsibility to do due diligence and shop around for the best price. But should caveat emptor apply when buyers think they are hiring a professional to do the shopping?

There may be light at the end of this tunnel. Hopefully, the robust regulatory reform efforts underway elsewhere will inform and impose some discipline on our own. The OSC has a new chair. It recently established a highly credible Investor Advisory Panel, which has added this issue to its list of initiatives. FAIR Canada, the Hennick Centre for Business and Law, and the Toronto CFA Society are convening a second annual symposium on the subject next week. Finance Minister Jim Flaherty has demonstrated genuine interest in investor protection -- most recently supporting a national strategy to strengthen financial literacy.

Canada takes justifiable pride in its financial institutions and infrastructure. In doing so we can ill afford to gloss over the nature of customer relationships or be perceived to lag other markets in our efforts to ensure fair dealing in financial markets.

As published in Tuesday's Financial Post