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This article appears in the November 2021 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.

New suitability requirements that take effect at the end of the year will require advisors to take additional steps when recommending products, transferring securities — and even when standing pat.

The changes are part of the client-focused reforms (CFRs) effective on Dec. 31 and include enhanced know-your-client (KYC) and know-your-product (KYP) obligations. Together, the reforms aim to better align registrant and client interests and to improve client outcomes.

The requirement to put clients’ interests first “reinforces the importance of suitability,” said Rebecca Cowdery, a partner with Borden Ladner Gervais LLP. Advisors should be able to explain how they put a client’s interest first when making a recommendation, she said.

In addition to putting clients’ interests first and fulfilling KYC and KYP obligations, the rules list various factors to consider when making a suitability determination: the impact on the account, including concentration and liquidity; a reasonable range of alternatives; and the potential and actual impact of costs on the client’s returns.

But suitability is about more than product purchases. The reforms use the broad term “investment action,” defining it to include such things as opening an account, transferring securities and holding securities — or, as Susan Silma, head of regulatory business practices with Sun Life Financial Investment Services (Canada) Inc., put it: doing nothing.

Previously, “it wasn’t clear that advisors needed to assess suitability if they were recommending no change to a client’s holdings,” she said. With the CFRs, advisors must “make a suitability determination and put the client’s interest first, and make sure the product continues to be appropriate for the client’s circumstances,” she said.

Costs are only one factor in the suitability reforms, said Cowdery. The key is “to demonstrate that you considered all of these factors when you either made a recommendation or considered the suitability of all the securities in a client’s account,” she said. Good advisors probably already do this, she added, and the reforms “make sure that everybody is doing the same sort of thing.”

Product costs

Regulators want clients to understand costs, Silma said: “An educated client is an engaged client, so being transparent about costs should be a positive for client relationships.”

In practice, the discussion can provide general education and doesn’t always need to be specific to a security, she said. Further, the advisor can explain their approach to fees generally, and some advisors may want to explain that the cheaper alternative isn’t always the better one, she said.

Cowdery cited conflicted compensation as an example of an “obvious outlier” to the client-first standard: “If another security would be demonstrably suitable for the client, but the advisor is getting additional compensation because they’re putting the client in another option, I’m not sure that is demonstrably putting the client’s interest first.”

If two products are generally suitable for a client and one pays more compensation, the advisor should ignore the extra compensation “and instead only consider which product is really better for the client,” Silma said. “That is what the regulators believe would put the client’s interest first.”

While “the lowest-cost product won’t always put the client’s interest first,” Silma said, the advisor must document why the more expensive product is better for the client.

More than purchases

Putting clients’ interests first means more than increased documentation alongside product recommendations. The standard can mean recommending the client pay down their debt before making an investment or informing the client you can’t offer the product that best serves their needs, Silma said.

The CFRs also clarify transfers in, which will require fulfilling the obligations associated with KYP, product comparison and suitability, Silma noted. (The reforms say a suitability determination for a transfer can be completed within “a reasonable time period” after account opening.)

Another example of an investment action is a redemption. When deciding how to structure a redemption, advisors should consider implications such as the impact of fees and taxes, she said.

An advisor could need to reassess suitability when updating a client’s KYC or when a product a client owns has a change that would affect suitability.

The latter “comes back to KYP,” Cowdery said. “The firm should be monitoring for those kinds of changes to the securities that are on their approved list. And there needs to be some sort of process or system to disseminate that information to advisors.”

In addition to reacting to the firm’s notifications about product changes, advisors have their own KYP obligations. “I would expect advisors to conduct their own ongoing monitoring of products on their personal product shelf,” Silma said. “In doing that monitoring, they would react to product changes as and when they consider best.”

For KYC updates, “you’ve got to reach out,” as opposed to merely suggesting on a statement that the client provide information about changes, Cowdery said (see “Reviewing KYC”). “There need to be some proactive measures taken to contact the client — and I would suggest more than once.”

Advisors should also document those contact attempts, Cowdery said. In addition to understanding the new rules, she said her best advice to prepare for the reforms was to “start taking notes.”

Silma described the suitability changes as “subtle but not insignificant.” To understand both what the CFRs mean and how advisors and firms can meet their obligations “will be a journey for us as an industry,” she said.

A reasonable range

Considering a reasonable range of alternatives depends on circumstances, according to the self-regulatory organizations — including the investments and services offered to the client, advisor skill and proficiency, and the client’s circumstances. For example, IIROC says “where a dealer offers only a limited range of model portfolios, we would not expect the [advisor] to conduct an in-depth consideration of alternatives if it is clear that only a limited number of options, or a single option, would be suitable.”

Reviewing KYC

KYC reviews should generally occur no less than every three years, and every year for discretionary and managed accounts. All KYC elements should be reviewed during updates, says the Mutual Fund Dealers Association of Canada: “For example, it would not be reasonable to only update a client’s income or employment information and not also ask them questions to revisit their risk tolerance and time horizon.”

Regulatory reviews

There’s often no single best suitability determination, regulators say: “There could be several decisions or recommendations that the registrant has a reasonable basis for concluding are equally suitable and that put the interest of the client first.” Further, a regulatory review of a suitability determination will be done “without hindsight” to events that occurred after the determination. (Source: Client-Focused Reforms’ companion policy, pp. 11, 212)

Correction: Due to an editing error, the print version of this article (“Reviewing KYC” section) incorrectly stated that IIROC doesn’t require all KYC elements to be reviewed during an update.