When is a tool not just a tool? When it’s a recommendation.
In November, IIROC published proposed guidance for order-execution only (OEO) services, or online discount brokers that take advantage of the OEO suitability exemption.
What’s the exemption? When one of these services accepts an order without providing a recommendation to the client, the broker isn’t required to comply with certain suitability rules related to the order.
But these OEO services, like RBC Direct Investing, Questrade or BMO InvestorLine, increasingly offer clients various tools, services, products and account types that provide information that may steer close to recommendations. It’s now unclear what constitutes a recommendation.
“The heart of the guidelines [is] the lengthy discussion about what is a recommendation,” says Bernard Pinsky, a partner at Clark Wilson in Vancouver. Currently, there’s no definition of “advice” or “recommendation” under Canadian securities law, effectively making these terms equivalent in the guidance.
Simon Romano, partner at Stikeman Elliott in Toronto, says IIROC has interpreted “advice” and “recommend” in enormous detail, probably in response to numerous queries from firms seeking to comply with the “no recommendation” condition.
What is and isn’t a recommendation
The details are needed to expand on IIROC’s broad definition of the term “recommendation.” The SRO says it is “any communication or statement of opinion sent or made available to an investor […] that could reasonably be expected to influence that investor […] to make an investment decision.” “Decision” includes both investment and transaction decisions.
Generally, IIROC views any tool that uses KYC information or that is pushed to clients as a recommendation. (But a recommendation doesn’t necessarily have to involve KYC info. For example, a tool could advise a client without assessing KYC info. Also, KYC info for opening a client account wouldn’t be considered a recommendation in the context of this guidance.)
The problem with pushed tools is that clients might consider them more relevant than pulled tools, which clients choose themselves. Plus, pushed tools are typically based on KYC info.
Tools that merely provide facts are acceptable, such as portfolio analyzer tools that inform clients of their current account breakdown. The information shows clients what their account is—not what it should be.
Although identifying recommendations can depend on particular circumstances, here’s IIROC’s short list of recommendations:
- trading tools, because they tell investors what trades to make (excludes automatic rebalancing tools)
- trade execution tools, because they tell investors how to make trades (OEO firms may offer clients the option of how to execute trades so long as the client makes the choice without firm input)
- model portfolios, because they influence investment decisions
IIROC is asking for comment on an exemption for “permitted model portfolios,” which would be available on OEO firm websites to be pulled by the client. The models would be based only on investor class, asset class, industry sector and/or time horizon.
“As a client trying to get a low-cost environment, it’d be helpful to […] get some form of model portfolio,” says Romano. “You can argue about the details, but […] it could help clients.”
Tools that may not necessarily be a recommendation but have the potential to be deemed so include:
- hyperlinks and portals offered by firms to third-party websites that, in turn, provide recommendations;
- social media activity, such as a firm’s likes;
- pricing incentives, such as those that favour proprietary products or a small number of securities; and
- educational tools and research reports that influence investment decisions, make predictions or promote products.
Pinsky imagines a client calling a brokerage firm looking for insight on a product. Depending on its nature, that insight could be a recommendation. “[Firms] will need to be vigilant not to make any recommendation[s] on OEO trades,” he says.
A growing advice gap?
While the proposal provides clarity to address OEO dealers’ increased product supply and technology use, “it’s putting an awful lot of meaning around the word ‘recommend,’” says Romano, who says the guidance limits discount brokerage services.
“When the OSC contemplates a discount broker who’s exempt from suitability, and says, ‘Don’t make recommendations,’ did [the OSC] have this broad view of recommendations in mind?” he asks, instead of, say, a one-on-one conversation about buying a specific investment.
He distinguishes between recommendations and help.
“Investors trying to run a low-fee model through the discount brokerage environment get less help,” he says. “If I want help, I have to go to a higher-cost environment.”
Of course, some clients can’t afford full-service firms, many of which have minimum asset thresholds. IIROC acknowledges that the OEO discount brokers may be providing tools to clients to reduce the advice gap, though the regulatory body suggests online advisors can help lessen this gap.
Full-service advisors could potentially differentiate themselves from OEO brokers by highlighting that those firms can’t give advice, says Romano.
On the plus side for OEO dealers, potential liability exposure is reduced, says Pinsky, although Romano says he’s not aware of any suitability cases against the discount brokers. (In an independent IIROC survey of OEO clients, most said they wouldn’t lodge a complaint in the event of a sizable loss; however, the clients believe OEO brokers should be held financially responsible if the loss results from the use of a tool.)
If implemented, the guidance would replace Member Regulation Notice MR-098.
Comments are requested by Dec. 19, 2016.