Regulators to answer tough questions

In the next couple of months, the industry can expect to hear where the regulators’ heads are now at on these issues. The CSA is planning to publish responses sometime this autumn to both the fund fee and the fiduciary duty consultations – which, hopefully, will provide some clarity on whether the CSA intends to proceed with further reforms or is content to preserve the status quo.

The industry, for the most part, favours the status quo, of course. In both the written responses to the consultation papers and at the OSC’s roundtable meetings, industry members have questioned the need for such reforms. In particular, industry members worry that such moves as outlawing trailer commissions or imposing a fiduciary duty on financial advisors would be costly, could create more confusion and, ultimately, would reduce investors’ access to financial advice.

In addition, industry members argue that regulators should wait to assess the impact of both the reforms that are in the process of being implemented in Canada – such as the client relationship model reforms to cost disclosure and performance reporting, as well as the adoption of the new Fund Facts disclosure document – and the major investor protection reforms that are being undertaken in the U.K. and Australia before deciding whether to go ahead with such changes here, too.

Conversely, investor advocates in general are in favour of big changes to the existing regulatory regime in Canada, arguing that the current system is failing investors and that fundamental reform is a must. Moreover, these advocates insist that there’s no need to contemplate the effects of other efforts first – and that it’s time for the regulators to act.

These diametrically opposing stances were set out clearly, yet again, at the OSC roundtables this summer. And it remains to be seen if those hearings did anything to help to move regulators toward decisions on these key issues.

“We’re very pleased with the success of our recent consultation sessions,” says Jill Homenuk, director of communications and public affairs with the OSC. “We were pleased with the level of industry and investor participation at these events, both as panellists and as observers. This face-to-face dialogue enabled us to probe deeper on these issues, which will assist in reaching a decision on these critical policy issues.”

Nevertheless, both the industry’s and the investors’ entrenched positions puts regulators in a tough position, having to choose between two very distinct visions. That’s a tricky spot because if regulators conclude that reforms are needed, they’ll face what’s sure to be a pitched battle with the industry; if regulators conclude the opposite, it will look like they’re bowing to industry pressure and shrinking from the commitment to improve investor protection.

Indeed, the CSA seemingly has made it a habit of late to avoid taking definitive positions on sensitive regulatory issues. From various shareholder democracy issues and the CSA’s recent examination of market data fees to these current investor-protection topics, the regulators have thrown a series of subjects open for discussion during the past year or so while remaining agnostic on the issues themselves.

Ideally, the forthcoming statements from the CSA this autumn will be conclusive about whether or not it sees the need to act – although the latest roundtable session on fiduciary duty, which the OSC hosted in late July, suggests that regulators are looking for ways to avoid making the stark choice between the two diametrically opposed sides.

In that session, the regulators went over the basic issue of whether a fiduciary duty should apply to advisors but also encouraged a discussion of alternatives to imposing such a duty. In response, panellists suggested, among other things, that regulators could better regulate the titles that financial advisors use and ensure proper proficiency requirements.

This is one topic on which there actually does appear to be a bit of consensus by the industry and investor advocates. Indeed, according to transcripts from the OSC session, one of the industry panellists, who opposes adopting a fiduciary duty, nevertheless questions the adequacy of the current standards for working in the industry.

“How tough is it to become a licensed advisor in Canada today? Two courses and a job offer. The courses are not even that hard,” noted Jim Kershaw, senior vice president and regional manager, Ontario Main, with TD Wealth Private Investment Advice in Toronto. “Shouldn’t being an advisor to the public in the context of the uncertainty of the capital markets be one of the toughest jobs to get and one of the easiest jobs to lose?” To that end, Kershaw suggests regulators look at tougher enforcement of the existing rules in order to do more to weed out the bad apples.

His position was echoed by another opponent of introducing a statutory fiduciary duty, securities lawyer John Fabello, a partner with Torys LLP in Toronto, who suggests that deterrents for securities-law violations could be enhanced by increasing damage awards or by creating a statutory cause of action to address intentional wrongdoing.

However, the idea that tougher enforcement is the way to resolve these issues did not get much traction with investor advocates. For them, this isn’t simply a question of getting rid of the bad apples. They see the need for a fiduciary duty to correct a fundamental flaw that permeates the industry and affects clients of all advisors: client interests don’t have to come first.

“It’s not about bad advisors; it’s about the rules,” argued Connie Craddock, formerly vice president of public affairs with the Investment Industry Regulatory Organization of Canada and now a member of the OSC’s Investor Advisory Panel. “All [you] need to do [now] to be fully compliant with the rules is to recommend a product that is a match. That’s like going into a store and there’s a rack of dresses and someone recommends the right size. So, it’s a very low standard that governs what constitutes a suitable recommendation.”

The recommendation doesn’t have to consider the full range of products, doesn’t have to account for costs and doesn’t have to be free of conflicts, she noted: “And it’s important to stress that this is a registrant who is fully compliant. I’m not talking about people who break the rules or rogue advisors or anything like that. I’m talking about what the rules are today and what people can do to be compliant with them.”

One of the fundamental questions underlying this whole debate is whether improving investor protection is simply a matter of doing more to weed out the “bad guys” or whether the system itself needs to change because it simply puts investors at too much of a disadvantage.

If it’s the latter, Fabello suggests, the solution may be to have advisors do more to explain – and justify – the costs of investing: “Make advisors disclose exactly what the fees are. Make advisors, if they are recommending a product that has a higher fee, explain to clients why, in their view – notwithstanding the higher fee – this is a better product for [the client].

Changes in the U.K. not having detrimental impact

One of the financial services industry’s central worries about significant investor protection reforms is that this could drive many financial advisors out of the business, as has happened in the U.K. However, new data show that this fear may well be unjustified.

Among the various objections put forth by the members of the Canadian industry against fundamental reforms to retail investment regulation – such as curbing the use of third-party commissions or introducing a statutory fiduciary requirement – one that the regulators may take seriously is the fear that such reforms could lead to reduced access to financial advice for investors who want it.

Of course, the industry already rations access to its services on its own. But there’s a legitimate worry that regulation could amplify that trend. Critics of the proposed reforms often point to the U.K., in which a slate of major reforms took effect at the start of this year, which was preceded by a notable drop in the advisor population.

However, the latest data from the U.K.’s Financial Conduct Authority (FCA) indicate that advisor numbers now are rebounding; and, more important, the resulting advisor population is notably better qualified. In mid-August, the FCA reported that the advisory population has increased by about 1,500 advisors since the start of the year through to the end of July to about 32,690 advisors. The increase, the FCA suggests, is due to advisors re-entering the market after having achieved the necessary qualifications.

Not only did the reforms in the U.K. that took effect at the start of this year, known as the Retail Distribution Review, outlaw embedded commissions, they also boosted industry proficiency requirements and require advisors to: adhere to certain ethical standards; undertake continuing education; and provide independent verification that they’re meeting these tougher standards.

In 2010, the FCA reports, fewer than 50% of advisors would have met the current qualifications. Now, 97% of advisors do so, and the other 3% are on their way to meeting the new standards within the deadlines set by the new rules.

As a result, the FCA concludes, there still are plenty of advisors to serve the market and these advisors are notably more proficient than would’ve been the case a couple of years ago, which boosts the industry.

“By establishing standards across the industry,” says Clive Adamson, director of supervision at the FCA, “we are helping to build confidence by reassuring consumers and raising the profile of the advisor profession.”

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