One of the biggest sources of strife between financial advisors and their clients is the issue of suitability. That’s why the Mutual Fund Dealers Association of Canada is focusing its members’ attention on meeting their suitability obligations and suggesting that the MFDA may have to introduce new rules in the area.

It’s not hard to see why suitability issues are often at the top of the list of complaints that regulators hear from investors. Clients use financial advisors because they want to make money and grow their nest eggs. So, when an investment they’ve been sold loses money, many clients believe that this shows the investment wasn’t suitable for them in the first place.

In some cases, they are right. In others, they have probably been victims of ordinary market fluctuations. Sorting that out after the fact can be a tricky task, which is why regulators want to ensure that firms are doing as much as they can to ensure their sales are suitable and well documented.

“For any regulator, the No. 1 complaint we receive is with respect to suitability,” says Larry Waite, president and CEO of the MFDA in Toronto. “It’s a common theme.”

A couple of the provincial securities commissions have also identified suitability issues as an area on which they plan to focus more attention in the year ahead.

Indeed, the latest review of the investment counsel/portfolio manager firms that are under direct oversight of the Ontario Securities Commission identified know-your-client and suitability issues as one of the areas in which firms are falling behind in their compliance efforts. Suitability issues rose from eighth place on the list of top compliance issues to third spot.

Suitability has also been at the heart of securities regulators’ concerns with the sale of principal-protected notes. In a notice published this past summer, the Canadian Securities Administrators singled out the issue, saying: “Suitability obligations are a critical aspect of investor protection and should apply to sales of all PPNs.”

Regulators aren’t the only ones concerned about these issues; firms are, too. Waite notes that the MFDA frequently receives requests from its members’ compliance officers seeking guidance on suitability issues — insight they’d rather have before they find themselves facing a regulatory review.

With suitability concerns registering so prominently on the industry radar, the MFDA is aiming to develop some consistent, objective standards for assessing suitability.

In a notice published in mid-April, the MFDA explains its staff’s view when assessing suitability as part of a compliance examination or enforcement case; it offers guidance on assessing suitability when leverage is involved; and, among other things, it highlights a common misconception it has uncovered during compliance exams of firms.

That misconception is the belief that disclosure justifies an unsuitable recommendation. It notes that if a sales rep recommends securities that are not suitable, “disclosure to the client is irrelevant to the suitability obligation.” It doesn’t matter how complete the disclosure is or if the client claims to accept the risks involved; the only way a firm can make an unsuitable trade for a client is if the trade is unsolicited.

The regulator also indicates that certain aspects of the notice will be the subject of future rule and policy proposals. The areas that are subject to new guidelines, and may result in future rule changes, include material changes to KYC information, suitability triggers and the criteria for account and trade supervision, the notice explains.

Waite reports that putting together its suitability notice “has been an awful lot of work.” He believes that it’s not something that has been done before by any regulator.

However, not everyone is likely to be thrilled with the MFDA’s efforts. By setting out the sorts of things that may be considered offside, some firms will probably find themselves somewhat constrained — and, with this new guidance, they’ll no longer be able to plead ignorance. IE