Compensation models must be suitable to clients: IIROC

In the guidance, IIROC stresses that dealers are free to utilize a variety of compensation arrangements, including commission- and fee-based accounts, but that “any compensation arrangement being offered to a client must be suitable.”

Indeed, it says that dealers must ensure that proper procedures are in place to: assess the initial suitability of each account opened, including the compensation method; provide proper disclosure to clients about the features of both types of accounts and how they differ; effectively supervise ongoing account activity; and, prevent double-charging due to embedded commissions or improper transfers between commission and fee-based accounts.

According to the guidance, assessing the suitability of a particular account type includes considering factors such as whether the client is likely to trade a lot, or if they are a buy-and-hold investor; whether they require frequent advice; their time horizon; the size of the account; whether they invest primarily in products that have embedded fees; among other things. And, in order to ensure suitability, it says that dealers “may need to adjust long-standing supervisory practices that were designed for commission-based accounts so that current practices are appropriate and effective for fee-based accounts as well.”

The notice indicates that IIROC recognizes that the lowest cost account is not necessarily the only suitable account type for a given client, but that if a client opts for a more expensive option, the details of this decision should be documented by the dealer.

Also, it says that clients should only be moved from one account type to another when it clearly benefits them. The lack of a demonstrable benefit, “may give rise to regulatory scrutiny and, in more extreme cases, disciplinary action”, it notes.

The notice also sets out the minimum disclosure dealers should be making about compensation arrangements under new client relationship model (CRM) rules. And, it notes that the Canadian Securities Administrators (CSA) are currently consulting on their own proposals regarding cost disclosure, performance reporting and client statements; which, it says, are, in some ways, more prescriptive than IIROC’s new guidance.

In terms of account supervision, the draft guidance says that dealers’ policies and procedures should be designed to enable them to detect improper activity occurring in any account—whether commission- or fee-based—including unsuitable transactions, trading in restricted securities, conflicts of interest, unauthorized trading, outstanding margin calls, front running and manipulative or deceptive trading, among other things.

Double charging clients could be considered a violation of IIROC rules, it warns, and it says that dealers should also have procedures in place to sniff out and prevent any double charging.

The IIROC guidance comes in the wake of efforts by securities regulators in other countries to address advisor compensation issues, including moves to ban conflicted compensation structures in Europe and Australia. “The emergence of significant and wide-reaching advisor compensation-related reforms around the world underscores the need for Canadian regulators, industry and investors to be aware of these international developments and to monitor their impact, if and when implemented,” it says.

The draft guidance is out for a 90-day comment period, and IIROC indicates that it is particularly interested in hearing from frontline reps, as well as dealers.