Some of CRM II’s initial requirements were implemented last year, but 2014 marks the first wave of major changes.

Susan Silma, a Toronto-based industry consultant and former OSC director who launched the CRM II and Fund Facts initiatives, walks us through what’s required this year and how to prepare for it.

01 Pre-trade disclosure

Beginning July 15, advisors must disclose the following to clients—orally or in writing—before accepting any instruction to buy or sell a security:

  1. the charges the client will be required to pay in respect of the purchase or sale, or a reasonable estimate if the actual amount of the charges is not known to the firm at the time of disclosure;
  2. in the case of a purchase to which deferred charges apply, that the client might be required to pay a deferred sales charge on the subsequent sale of the security and the fee schedule that will apply; and
  3. whether the firm will receive trailing commissions in respect of the security.
  4. Silma suggests firms and advisors need to ask and answer the following questions:
    1. Do we have all appropriate information on charges?
    2. Will disclosure be oral or in writing?
  5. If in writing, what form will it take? Will we send digital or paper copies?
  6. If oral, how do we ensure there’s an appropriate compliance trail?
  7. How much detail is appropriate? How can the information be presented to clients in a comprehendable way?
  8. How do we explain what clients get for these charges?
  9. How will these changes impact client relationships?

She adds the regulator doesn’t expect firms to quantify the DSC if clients drop a fund before the holding period’s up. “But there is an expectation that the advisor will tell the client that there is some fee that applies” and that it gets lower over time.

The trailing commissions conversation is going to be a bit tougher, she says. “It’s a fee that has been paid for quite some time and that in many cases clients were not aware of. I would suggest explaining the value your firm offers for the trailing commission. And you may or may not use that term. Perhaps there’s terminology that’s more plain-English and relevant to your customers.”

02 Trade confirmations

Starting July 15, 2014, trade confirmations will have to include new information for debt securities:

  • In the case of a purchase of a debt security, the security’s annual yield;
  • In the case of a purchase or sale of a debt security, either of the following:
  1. The total amount of any mark-up or mark-down, commission or other service charges the registered dealer applied to the transaction;
  2. The total amount of any commission charged to the client by the registered dealer and, if the dealer applied a mark-up or mark-down or any service charge other than a commission, the following notification or a notification that is substantially similar: “Dealer firm remuneration has been added to the price of this security (in the case of a purchase) or deducted from the price of this security (in the case of a sale). This amount was in addition to any commission this trade confirmation shows was charged to you.”

Silma notes that for most clients this will be the first time they receive this information. “And, depending on a firm’s business model, it’s not straightforward to determine exactly which figures need to be captured and about which securities.

“Talking to people about how they’re going to deal with this, my sense is—and the regulators acknowledge that they’re perfectly comfortable with this—a lot of people will go with the commission number and then some generic, boilerplate disclosure about possible additional costs.”

03 Benchmarks

Also beginning July 15, 2014, the Relationship Disclosure Information (RDI) given at account opening will need to provide “a general explanation of how investment performance benchmarks might be used to assess the performance of a client’s investments and any options for benchmark information that might be made available to clients by the registered firm.”

Silma notes that while there’s no requirement for firms to provide client-specific benchmark information, the regulator’s encouraging firms to do so as a best practice.

She adds the regulator struggled for years to determine how to handle benchmarks. The main issue is finding one that’s relevant. An actively managed small-cap fund can usefully be measured against a small-cap index, but most clients have a wide array of holdings with different capitalizations and from different sectors.

“It’s quite a challenge,” says Silma, “to get an apples-to-apples comparison for an entire account.” Firms in the managed account space have been doing it for years, but it may be more difficult for a retail client base.

She suggests client-specific benchmarks aren’t a priority for most firms. They’ll meet the requirement of explaining in account-opening documents how benchmarks can be useful, “but perhaps because of all the other requirements they’re struggling to meet, my sense is there’s not a great deal of focus on actually providing benchmarks at this stage.”

But don’t take it off your long-term agenda, Silma says.

“I suggest that when firms start thinking about statement design—quarterly [as well as] annual performance and cost statements—they give some thought to this because it may actually help them in [client] conversation[s]. A client might appreciate a bit more guidance around how they’re doing, in a graphical or pictorial way. My experience is that works better with clients than just having a conversation.”

An opportunity, not a burden, CRM II is different from most regulatory initiatives because it’s designed to have a direct impact on the advisor-client relationship. And that, says Silma, means firms need to respond differently.

She notes the typical firm’s response to most regulatory initiatives is to send advisors educational material that describes the new rule or statute and the associated requirements. But this mechanical approach won’t work with CRM II.

“If you do nothing other than tick the boxes,” Silma says, “there could be a very unhappy situation when clients start opening account statements and new cost and performance reports that include information they had no idea was coming and don’t have any context for.

“If firms and advisors take the view that CRM II is a way to strengthen the relationship with their clients through greater openness and transparency, I believe that they can turn this from just another regulatory burden into a significant opportunity to differentiate themselves from their competitors.”

She suggests informing clients of the new information they’ll be getting over the next three years, then developing plain-language disclosure, and finally tailoring the level of detail to the needs of different clients.

IIROC’s top audit targets in 2014

IIROC’s 2013/2014 compliance report reveals several key areas the regulator will focus on in the coming year. This includes the following three categories:

1. Firm operations

IIROC will focus on balance sheet leverage, liquidity and outsourcing.

2. Surveillance and trading conduct

The commission will assess how firms are dealing with unreasonable and erroneous trades, electronic trading requirements and best execution.

3. Business conduct

IIROC will review CRM implementation, members’ outside business activities and social media use at firms.

In the report, the regulator also discusses its part in the OSC mystery shop project. IIROC says its purpose is to evaluate the quality of investment advice being provided to Ontario retail investors. Both organizations want to “gain first-hand knowledge of investors’ experiences.”

IIROC also highlights the results of its targeted reviews over the past year. The regulator examined the use of items such as non-arm’s length products, advisor designations, third-party risk controls and stop-loss orders.

The SRO found deficiencies related to: books and records; margin requirements for dealers engaged in underwriting; internal controls related to risk-adjusted capital calculations and intra-day inventory trading limits; safekeeping and custody of assets; wash trades; monitoring of deceptive practices; client complaints; and the sale of private placements to accredited investors.