For financial advisors who sell mutual funds and their firms, the advent of the client relationship model, phase 2 (CRM2), holds some special challenges. That’s because Fund Facts, a parallel regulatory initiative also aimed at investor protection and greater disclosure in the sale and management of securities products, has been launched at more or less the same time.
Like CRM2, Fund Facts has been many years in development. Although the principle of transparency is common to both initiatives, the methods for communicating information to clients about the fund they are buying – as well as the types of information that must be included – vary between the two regimes.
Why have two systems? Partly, regulators say, to provide additional information for investors with smaller accounts and who may have less knowledge about investment industry compensation practices and principles. Many of these investors choose mutual funds; hence, Fund Facts‘ greater disclosure of items such as fund objectives, risk and expenses.
Fund Facts is founded on the principle that brevity and plain language will promote meaningful communication between advisors and their clients. It replaces the lengthy, simplified prospectus – seldom read by clients – which, in the past, was the required disclosure document for mutual funds.
“[The prospectus] was not the most perfect document for individual retail investors trying to get key facts in their head,” notes Joanne De Laurentiis, recently retired past president & CEO of the Investment Funds Institute of Canada and a longtime investment industry expert.
Instead, the two-page, double-sided Fund Facts document, which must now be delivered to clients at the point of sale, cuts to the chase and provides clients with simplified answers about a fund in key areas. As a result, clients purchasing mutual funds will receive additional details about the features of individual mutual funds – before the transaction takes place – than is required at the pre-trade stage under CRM2. (The CRM2 regime provides additional detail when clients receive their annual cost and performance reports for their accounts as a whole).
Items that are specific to Fund Facts and not CRM2 include: charges for the management of the fund (included as part of the management expense ratio); a risk rating that indicates the volatility of a particular fund (with the methodology chosen by the fund manager, although that may change in the future); and the past performance of the fund (without benchmarks), but with a caution that future performance may vary and that clients “could lose money.”
Fund Facts – but not CRM2 – also tells clients the names of the fund manager and the portfolio-management firm, the size of the fund, its investment objectives and a summary of its largest holdings.
Using the Fund Facts document
The good news is that advisors selling mutual funds can use the Fund Facts document as a tool to discharge some of their obligations under the client relationship model, phases 1 and 2. The main items in this category are: pre-trade disclosure of charges, fees and other sales costs related to the purchase of the fund (as well as other charges, such as switch fees); whether the risk associated with a particular fund is appropriate for that client (suitability of that fund); explaining how conflicts of interest can arise if similar funds carry different commission levels; and, if a best interests standard does eventually come into force, Fund Facts possibly could be used to satisfy some of the details of that proposed standard, such as “know your client” and other suitability obligations, although its usefulness for these purposes remains unclear.
There may be a challenge explaining to clients who own mutual funds why the fees set out in the Fund Facts document are not consistent with those that are reported in the annual cost reports required under the final phase of CRM2, notes Kathryn Fuller, a partner at Borden Ladner Gervais LLP. For example, the CRM2 report on compensation – which covers amounts paid to dealers – won’t include compensation paid to the mutual fund’s manager (i.e., the management fee). The CRM2 cost and performance reports also provide a picture of the results relating to a client’s total account, while Fund Facts pertains only to individual investments.
As well, keep in mind that neither CRM2 or Fund Facts require disclosure of the advisor’s compensation, so being prepared with answers for this question from clients may be prudent.
Although regulators are considering extending some or all of Fund Facts‘ rules to exchange-traded funds (ETFs) and certain aspects of segregated funds, those steps have not been taken yet. The different rules for these investments could create additional confusion for clients, as they may not receive Fund Facts-style disclosure documents for these types of investments.
Clients need to digest reports
Advisors must also cope with the challenge of clients digesting a variety of reports that are new and which contain material that clients “are not terribly familiar with,” says Susan Silma, lawyer and co-founder of Guelph, Ont.-based consulting firm CRM2 Navigator, which advises firms regarding CRM2 initiatives.
“[CRM2] will have an impact on clients [that is] far greater than most typical regulatory objectives,” says Silma. “There’s a real concern among advisors on how to properly have a conversation with clients.”
The potential confusion created by the compensation reports mandated by CRM2 was noted in Dentons LLP lawyer Pierre Lortie’s seminal study of the impact of going further than CRM2 and banning embedded fees from products.
In the study, commissioned by the University of Calgary’s School of Public Policy and released earlier this year, Lortie observed that comparability is necessary to promote market efficiency – which is where CRM2 disclosures still fall short.
“The new set of cost- and performance-reporting requirements introduced by the [Canadian Securities Administrators (CSA)] – generally known in the industry as CRM2 – is lacking in this regard,” the report states. “The charges and compensation information to be provided to individual clients is limited to the amount paid directly or indirectly by an investor to the dealer firm. The report does not provide a breakdown of how much is paid to the advisor or for the different services rendered by the firm, it does not include the amount paid by the investor to the investment manager of the mutual funds or ETFs in his or her portfolio, thus blurring transparency on total fees, nor does it address industrywide transparency.”
Fuller notes that all of the recent regulatory changes focussing on disclosure can be overwhelming at times. “There has not been a moment when the industry has been able to pause and digest it all.”
De Laurentiis takes it all in stride, noting that when someone works in a highly regulated industry like this one, “regulation is a journey that never ends.”
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