This article is the second in a series covering the changes taking place this year — some on June 30, others on Dec. 31 — as the Canadian Securities Administrators’ client-focused reforms are implemented. Read the first story on advisor compensation here.
This week, firms will provide new disclosures to clients about conflicts, including how they address the conflict of offering proprietary products.
The new disclosure statements due Wednesday are part of the client-focused reforms (CFRs). Dealers and advisors must identify and address material conflicts in clients’ best interests, and provide written disclosure to clients.
For firms, addressing the conflict of proprietary products means implementing controls. For example, the CFRs’ companion policy suggests that firms with only proprietary products could ensure their products are competitive by conducting periodic due diligence on comparable non-proprietary products. Firms with mixed shelves could demonstrate that proprietary products are subject to the same know-your-product (KYP) processes as non-proprietary ones.
Hand-in-hand with such controls, the reforms’ enhanced KYP requirements (effective on Dec. 31) call for firms to regularly review their product shelves to ensure a reasonable range of alternatives for clients.
“The main challenge is the scope of the obligation,” said Michael Taylor, a partner with Borden Ladner Gervais in Toronto, referring to enhanced KYP. “It is a significant undertaking to assess the products the firm offers on an ongoing basis,” as well as to continually inform advisors about product changes.
The KYP challenge may be even greater for a firm with a mixed shelf, which may have to justify to regulators why a client is invested in a proprietary product versus a non-proprietary one, Taylor said.
“You need to have a very robust KYP process in place,” as well as documentation, to show why your proprietary products are as suitable for clients as third-party products, he said.
The reforms could result in some firms shrinking their shelves in an effort to limit the required product analysis, or moving to only proprietary products, he said.
For firms with only proprietary products, the companion policy suggests explicit disclosure ahead of account opening, being clear that suitability “will not consider the larger market of non-proprietary products or whether those non-proprietary products would be better, worse or equal in meeting the client’s investment needs and objectives.”
That compliance requirements result in an increasing focus on proprietary products has been an industry concern. In its final report this year, Ontario’s Capital Markets Modernization Taskforce, which supports the CFRs, offered several suggestions to increase non-proprietary products at banks, including targeted shelf reviews and registrant titles specifically for the proprietary channel. If its various recommendations were implemented but proved ineffective, further reforms could include banning the channel, the report said.
Access to a broad product shelf helps advisors satisfy their KYP requirements before making a recommendation, said Richard Rizi, senior director of investment services with Worldsource Financial Management Inc. “If you’re really looking at clients’ best interests, you’re providing them with product choice,” he said.
The firm’s shelf includes ETFs and liquid alternatives for both IIROC and MFDA advisors, and Rizi said adding product types beyond traditional choices was a priority.
Regardless of shelf type, firms should be clear about their products and services, using plain language, Taylor said.
He also noted that firms’ disclosures direct clients with questions to ask their advisors, so advisors should be adept at answering questions about conflicts. The CFRs require firms to train advisors on conflicts, as well as KYP, KYC and suitability obligations.
Matthew Prew, director of advisor compliance with Canada Life in London, Ont., said the firm, which has a mixed shelf, is providing clients with the required enhanced disclosure with their Q2 statements. For advisors, the firm is providing a document on conflicts and how advisors can avoid or mitigate them. The firm is also implementing a mandatory learning module for advisors, which will include avoidance or mitigation strategies related to conflicts.
“It’s being communicated to advisors that simply providing [to] a client a disclosure document isn’t sufficient,” Prew said. “They need to have that conversation with the client.” The firm’s branch review programs will test for disclosure, he said.
Reggie Alvares, executive vice-president of Mississauga, Ont.–based Investment Planning Counsel, said the firm’s advisors were prepared to discuss disclosure about proprietary products.
“We coach our advisors to speak about [affiliate relationships], because people may not go through all the disclosures in detail,” he said. Alvares also said the firm’s shelf, which includes third-party funds and proprietary funds available to other dealers, has undergone no major changes as a result of the reforms.
Rizi said his firm has an ongoing CFR series that comprises white papers and webinars covering conflicts, KYP, KYC and suitability. One-on-one or group meetings with advisors will occur as needed, he said.
He said clients’ Q1 statements included a notice about upcoming conflicts disclosure, and Q2 statements will include the new disclosure. He doesn’t expect clients to raise concerns about the advisory relationship because of the new conflicts disclosure. The firm’s advisors have at least a decade of experience and are adept at explaining their investment choices to clients, he said.
As the CFRs are implemented, Taylor suggested that, in consideration of enhanced KYC and suitability requirements to put clients’ interests first, advisors at firms with mixed shelves may want to pay extra attention to clients’ investments during account reviews.
“A discussion with the client might make sense if the client is mostly in proprietary products,” Taylor said. The advisor should ensure suitability and document why the investments make sense, he said.
When asked if a discretionary advisor at a firm with a mixed shelf would have a greater regulatory burden under the CFRs when recommending a proprietary product, Taylor said the requirements held: “You still have to document why that particular product and that investment decision was suitable based on the client’s KYC.”
Were an advisor to persistently use only proprietary products for clients, suitability questions may arise, Taylor said. “That’s where documentation comes into play,” he said. “That’s the key regardless of the product.”
For firms with a mixed shelf, the reforms’ companion policy suggests controls such as prohibiting monetary or non-monetary benefits that could bias advisors’ recommendations toward proprietary products over non-proprietary products, and monitoring the use and level of proprietary products in client portfolios.
Rizi, Prew and Alvares said advisors receive no incentives at their firms to sell proprietary products.
Looking ahead, firms must document how they identify, address and disclose material conflicts as part of enhanced record-keeping requirements (effective Dec. 31).
Regulators expect records to be more detailed regarding such things as sales targets and revenue quotas for advisors for selling proprietary products.
Firms have so far been occupied with conflicts disclosure and KYP processes, which include assessments of product compensation, Taylor said. Record-keeping is on firms’ upcoming agendas.
As with the reforms overall, record-keeping presents firms with an opportunity to review what they do and make changes if necessary.
“Documentation of the steps is key to justify the ultimate decision — whatever it is — about what’s been decided on at the firm,” Taylor said.