compliance-regulation

01 IIROC compensation review

In April, IIROC published guidance on managing compensation-related conflicts after reviewing 20 firms. The review identified three concerns:

  • disclosure gaps,
  • a lack of oversight of compensation grids and policies, and
  • a shift to fee-based accounts without supervision or risk monitoring.

The guidance, along with CSA’s proposal on banning embedded commissions, indicates a trend “toward greater clarity, greater and better disclosure, and fewer conflicts,” says John Fabello, a partner at Torys in Toronto. Though not new, the guidance indicates regulators will be “more exacting in their standards,” he says.

For example, the guidance says conflicts can’t be addressed through disclosure alone.

“The regulators are signalling that the way in which the industry has dealt with conflicts through disclosure is not satisfactory,” says Fabello. “Reps are going to have to work a lot harder to satisfy themselves that conflicts are understood and accepted by clients.”

Julie Mansi, a partner at Borden Ladner Gervais (BLG) in Toronto, says, “CCOs are going to have to go back to the starting point to see what their disclosure actually says.” She describes the guidance as “broad rules and very prescriptive interpretations.”

For example, in reference to fee-based accounts, the guidance says dealers must monitor client account activity and assess appropriateness on an ongoing basis. The review found that few firms could provide evidence of this monitoring.

Mansi says monitoring would be resource-intensive, especially for mid-market firms. She wonders if dealers are expected to contact clients who are in a temporary buy-and-hold stage.

IIROC also highlights potential conflicts with fee-based accounts. Mansi notes this comes just as some dealers switched to fee-based to avoid conflicts associated with trailing fees and churning. Dealers are “racing to keep up with this ever-evolving regulatory landscape,” she says.

Additional resources will also be required to address conflicted supervision. Though Dealer Member Rule 2500 requires independent supervision of all retail accounts, the guidance says that “the rule speaks to the need for genuinely independent supervision.”

For example, the guidance says it’s understandable to base compensation for a supervisor who’s also a branch manager partly on the branch’s profitability. But, “the dealer should consider other factors in determining supervisor compensation that would offset any undue bias toward branch profitability at the expense of client best interest.”

“Do we need new [independent] supervisors?” asks Mansi, noting few firms have the resources to comply. “We could face a human resources problem.”

Unintended consequences

Challenged by the cost of managing regulatory risk, firms might be motivated to provide fewer products, potentially resulting in shorter shelves, says Mansi. Bank-owned dealers, with proprietary shelves, might more easily comply with the guidance. “To maintain or meet these regulatory expectations,” says Mansi, “I think it would be difficult to do with a broad shelf.”

However, the guidance says that firms with proprietary shelves have additional conflicts, including “the possibility that the client suitability analysis will be based on what products are available, versus what is actually in the client’s best interest.” The limitations of proprietary shelves “must be disclosed in clear and plain language at the outset of the client relationship.”

IIROC’s review didn’t identify any cases where there was a preferential grid payout for proprietary mutual funds, but it did find that two dealers provided higher payouts for managed-account programs than for comparable third-party managed programs, because the former have lower dealer costs. The rationale for the higher payout doesn’t hold, says the guidance, because the cost savings aren’t passed on to clients.

Mid-market dealers are “expending resources to build these programs for broader use,” counters Mansi, adding that the programs are arguably in the best interests of clients and are generally offered at a lower cost. “There’s no negative impact on client[s], and it could be argued that they’re getting access to these programs that they may not have otherwise.”

On the other hand, if the guidance motivates dealers to move to managed accounts to better avoid compensation-related conflicts, some clients could lose out. “The price point on a fully managed account is not necessarily acceptable to the retail client,” says Mansi.

She also notes that dealers will be asked to explain the rationale behind sales targets and controls implemented to guard against inappropriate sales activity, which affects both bank-owned and non-bank-owned dealers alike.

For example, the guidance says inappropriate sales activity could result from a dealer setting overly aggressive sales targets, but how dealers will be asked to explain those targets is unclear. Mansi says she’s never seen such a requirement in guidance before.

Practically, the guidance is the result of a best interest standard “already seeping through to market participants,” she concludes.

02 Ontario’s big plans for financial services regulation

Ontario’s 2017 budget, also released in April, reveals how the province plans to regulate financial planning and advisory services.

Proposed changes are part of the province’s regulatory transformation, which includes support for the Cooperative Capital Markets Regulatory System and the creation of a new Financial Services Regulatory Authority to replace the Financial Services Commission of Ontario.

Based on recommendations from an expert committee report, initiatives include:

  • developing oversight and proficiency requirements for financial planners, regardless of current registration or licence;
  • regulating titles for financial planners;
  • responding to the recommendation to develop a central registry of financial planning and advisory services;
  • considering the recommendation to require those providing financial planning or financial advice, and who make referral arrangements, to adhere to Part 13 (Division 3) of National Instrument 31-103 (e.g., referral arrangements must be set out in writing); and
  • examining the feasibility of a statutory best interest duty.

The initiatives help ensure people operating outside securities regulation can’t escape oversight. “There are financial planners out there [who] are operating in a regulatory vacuum,” says Sarah Gardiner, partner at BLG in Toronto. “They’re not subject to any regulation of any kind of credential requirements, which obviously is not in the public interest.”

The expert committee report further recommends those outside the regulatory framework for insurance and mortgage brokering also have their financial advice and planning activities regulated.

On the other end of the continuum, Gardiner says the recommendations “would capture even a portfolio manager who’s providing discretionary advice to clients.”

The report makes clear, however, that the recommendations seek to avoid duplicative regulation. Says Gardiner: “If you are currently regulated by the OSC and subject to oversight by an SRO like IIROC or the MFDA, there wouldn’t be an expectation that you would be subject to further regulatory oversight by another body.”

But advisors would be subject to any new regulatory requirements for financial planning and advisory services.

When asked about both CSA and the Ontario government working on the regulation of titles, Gardiner says, “This is all coming down from the Ontario government, trickling through to the OSC, so I think certainly there will have to be some consistency.”

Fabello notes the fractious nature of national regulation, with only Ontario and New Brunswick pursuing a best interest standard. Such lack of harmonization casts a poor image globally and presents challenges to dealers as they attempt to establish policies and procedures. It wouldn’t be fair or efficient to expect dealers to impose Ontario’s standard across the country, he says. Further, “a statutory best interest/fiduciary duty in one province but not in others creates uncertainty in the law.”

Exactly when the initiatives will be implemented is also uncertain, but the budget provides a clue: regulation of financial planners will occur “over the coming year.”

Michelle Schriver is assistant editor of Advisor Group.

Originally published in Advisor's Edge Report

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