Best ways to report on non-securities investments

CRM2 implementation is still underway, but regulators are already considering how to push for more transparency.

Regulators could crack down on how non-securities investments are reported, including insurance offerings, GICs, annuities and segregated funds. They haven’t been dealt with yet under new disclosure requirements, but industry watchdogs have been monitoring how advisors recommend and sell such products since 2012.

“The policy of CRM2 was set by CSA but handed off to the SROs so they could work with the industry to implement it,” says Joanne De Laurentiis, president and CEO of IFIC. And SROs, in turn, have urged members to meet the highest reporting standards for all investments. For example, along with reporting on securities, “many MFDA firms are reporting on investments other than securities.” That means they’re taking steps to exceed current reporting requirements (see “MFDA and IIROC on non-securities” on our tablet edition).

Getting ahead of regulators

Non-securities investments have different features than traditional investments, so help clients understand how they work. For instance, segregated funds have insurance components, GICs can be market-linked and annuities can have underlying invested capital. So it’s key to treat non-securities transactional business the same way as securities business, “both from a compliance and disclosure point of view,” says Daniel Popescu, president and CEO of Harbourfront Wealth Management, which has its head office in Vancouver.

One way to achieve this is to educate clients equally about all of your firm’s services and products from the start. Wayne Bolton, chief compliance officer at Edward Jones in Toronto, says his firm offers a six-page document that helps clients understand how the firm is compensated for its financial services. That document outlines the costs involved in investing in stocks and bonds, as well as non-securities such as GICs.

Further, “we are reporting on non-securities, including segregated funds and annuities,” Bolton explains. “On the trade confirmation side, we disclose any compensation that we receive from issuers directly. So, if a seg fund is sold on a deferred sales-charge basis, we include the dollar amount that we receive from the issuer for that charge—the client isn’t paying for that charge directly, but we include it. And going forward, where you have annual reports, seg funds and GICs will be included in those.”

To further exceed CRM2 requirements, says Popescu, advisors can take these three steps.

1. Use a series of custom KYC forms.

Standard forms tend to be one long questionnaire that ask for the same information as new account forms. “Designing [new] forms wasn’t an IIROC requirement,” says Popescu. But his firm’s advisors now use a series of 10 short forms over an average of four to six meetings. The process encourages advisors to collect clients’ financial details during the first meeting. In subsequent meetings, they discuss clients’ goals and histories, the firm’s services and a variety of products and fees, including non-securities transactions. Only then do clients invest.

When discussing non-securities investments with clients, talk about alternatives. Offer other options and clarify how securities and non-securities compare. For example, a seg fund could be compared to a mutual fund.

Once all 10 forms are completed, his firm recommends that “advisors get signed acknowledgements from clients that [all] disclosures have been made.”

There are also note-taking sheets that include lists of recommended discussion points attached to all KYC forms. These sheets allow advisors to add details about clients’ situations. In comparison, most industry forms only require notes when a client’s information changes, says Popescu.

2. Take extra steps for insurance sales.

For insurance products, Popescu’s firm has developed an internal suitability checklist, which advisors have to satisfy before they’re compensated for insurance sales. “Before we release commissions, there are a number of documents that [compliance] needs to see, with various disclosures. If we feel these documents are satisfactory and in the best interests of clients, [we] compensate advisors. We also have an advisor disclosure form that stipulates the compensation advisors receive. [Advisors] must reference this information [before] giving advice,” or they’ll have to go back to the client to complete missed steps. So far, his firm hasn’t had a problem releasing commissions, he adds.

3. Disclose non-securities performance.

In new disclosure documents, firms and advisors will have to “indicate the performance of securities for the year and since inception. At our firm, [performance] will be indicated through time-weighted and money-weighted calculations,” says Popescu.

For non-securities, his advisors can use a performance tracker to help clients better understand these products. “For both securities and non-securities, we have a spreadsheet that includes initial investment amounts, and any additions or redemptions from products.” If you take a GIC, for example, “You calculate the internal rate of return based on the income and any income distribution, plus any capital appreciation, depending on [whether] the product is market-linked.” Popescu adds that his firm’s advisors explain the structure and embedded fees of these products before clients invest in them.

To go over performance spreadsheets with clients properly, advisors must understand how to explain the “rundown [of] how the value of the non-security was calculated” for each investment, he says. Also, offer updates on performance metrics “from both a dollar and percentage point of view.”