What the CSA’s bombshell proposals mean for you

Many thought it was only a matter of time, and at the end of April it happened: CSA moved on the best interest standard with Consultation Paper 33-404 – Proposals to Enhance the Obligations of Advisers, Dealers and Representatives toward Their Clients.

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The paper also includes 10 categories of proposed targeted reforms, covering areas such as conflicts of interest, KYC, KYP, suitability, relationship disclosure, proficiency and titles of client-facing reps. If adopted, the proposed reforms will amend NI 31-103 – Registration Requirements, Exemptions and Ongoing Registrant Obligations.

Referring to the client-registrant relationship, CSA bluntly states in the paper’s introduction that “[t]he status quo must change.”

Says Prema Thiele, partner at Borden Ladner Gervais in Toronto: “[CSA has] embarked on proposed changes that would touch virtually every aspect of business carried on by registered dealers and advisors and their representatives.”

Darin Renton, a partner at Stikeman Elliott in Toronto, agrees: “If the proposals go through as drafted, there could be a significant additional due diligence and record-keeping burden on all market participants across the board.”

But debate continues on the best way to close gaps in the client-registrant relationship.

“You can achieve what the regulators are trying to achieve with investors by simply imposing a standard,” Thiele says. “Or you can […] look at conduct, compensation [and] various areas of regulation, and you can reform all those areas,” as CSA has done with CRM2 and POS initiatives and, now, with these proposed reforms.

Lacking consensus

Ontario and New Brunswick support the proposed best interest standard, but agreement ends there. Other provincial commissions are taking a wait-and-see approach; Saskatchewan is interested in receiving and reviewing comments; and B.C. isn’t biting at all.

“We’ve got major divergence on a major initiative,” says Thiele, “which is never a positive for registrants [nor] ultimately [for] investors.”

The idea behind the standard, explains Thiele, is that regulators can’t “prescriptively go through every single requirement that exists in […] securities legislation; they’ve gone through a lot here [with the proposed reforms], but they’re not going to go through every single inch. […] According to Ontario and New Brunswick, we still need to statutorily provide for that regulatory duty [to non-discretionary clients].”

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However, Thiele points out, the proposal states the duty is not actually a fiduciary one. The best interest standard, notes the paper, would be “formulated as a regulatory conduct standard.”

Time will tell, says Thiele, what the best interest standard actually means.

Gillian Dingle, counsel at Torys in Toronto, concurs: “There will likely be growing pains in the interim as courts and regulators figure out how to properly apply [a best interest standard] to scenarios that perhaps nobody was anticipating.”

Renton compares the proposed standard to what investment fund managers must meet.

The proposed standard “will ultimately level the playing ground in securities legislation,” he says, “since those registered as investment fund managers already have the [standard of care] duty—in Ontario it’s [sec.] 116 of the Securities Act, for example.”

The uncertainty introduced by the proposed standard concerns Thiele. She thinks—as does the B.C. Securities Commission—that the proposed reforms would achieve a similar outcome to applying a best interest standard, and that both are not needed.

Bernard Pinsky, a partner at Clark Wilson LLP in Vancouver, recalls being on the securities advisory committee years ago for a principles-based securities act in B.C., which was eventually scrapped.

Principles-based regulation, such as the proposed standard, is a noble goal, says Pinsky, but “people want bright-line tests. They want to know exactly what the law says, and exactly what they can do, and exactly what they can’t do.”

Thiele counsels caution. “The regulatory landscape [may not be as] static as is suggested by CSA,” she says, noting CRM2 and POS initiatives aren’t yet in effect. “Let’s look at the other 10 proposals and see […] what comments there are on those before we [implement] this best interest standard.”

Highlight reel

Renton says the reforms reflect CSA’s view that a best interest standard raises suitability and KYC issues. Further, CSA’s approach is holistic, addressing issues for both clients and firms.

KYP

Proposed KYP reforms include having sufficient product knowledge together with KYC information to support a suitability analysis. Again, advisors might consider such an analysis as basic, but legislating the proposal increases obligations, says Thiele.

“Firms’ compliance departments are going to have to document—and supervisors are going to have to document—to their satisfaction that representatives are in fact conducting the suitability analysis, that they are using various elements of each security on a firm’s product list and comparing it to the recommended products. The key is, there’s going to be more that needs to be substantiated.”

For firms, those with mixed/non-proprietary product lists must know their suite of products relative to the competition. Renton notes the requirements set out in the paper to determine whether a firm’s list meets clients’ needs: “Going through a market investigation, product comparisons, benchmarking, and then maybe even having to rejig your product mix depending on what you find. That’s significant and invasive in a business model.”

Thiele agrees: “Those firms are going to have a significant burden in ensuring that the[ir] range of products are appropriately representative of the products most likely to meet the investment needs and objectives of their clients. That is the biggest concern coming out of this part of the proposals.”

She cautions that proprietary list disclosure depends on how regulators expect it to be disseminated, and how the proposed best interest standard comes into play.

Renton adds the proposal affects everyone with a proprietary list: “All the non-banks. […] Hedge fund managers, individuals that are offering mortgage investment entities and the like—they’re really going to be challenged by this.”

Titles and proficiency

The proliferation of advisor titles, and these questionable accuracy of many of them, has long been a regulatory pet peeve. Some of the options CSA’s floating read like an investor-advocate wish list:

Option 1

• securities advisor—portfolio management for discretionary advisors who work for a firm registered as a portfolio manager or investment dealer that has a mixed/non-proprietary product list;
• securities advisor for reps who aren’t discretionary and work for a firm registered as a portfolio manager or investment dealer that has a mixed/non-proprietary product list;
• restricted securities advisor for reps who work for a firm that isn’t an investment dealer or portfolio manager but has a mixed/non-proprietary product list;
• securities salesperson for reps who work at any firm that has a proprietary product list.

Option 2

• advisor for reps working at IIROC-registered portfolio managers and investment dealers and managing clients with discretionary accounts;
• salesperson for representatives of any other firm.

Option 3

• representatives could only use their category of registration (e.g., dealing representative and/or advising representative).

“Those revised titles, to the extent they are adopted, [will] flow through the entire system,” says Renton, adding they would have to appear on websites, client documentation and business cards. “Wherever you’re client-facing, the title will have to conform to the new standard.”

He also highlights the proposal requiring continuing education for reps. “For the MFDA, CE is going to be a brand new item […]. If this proposal comes in, there will be a continuing education requirement right off the top.”

Suitability and KYC

How reps handle clients with debt is a major concern for CSA. “They want advisors and representatives to know more about that debt and factor [it] into decision-making—a level of analysis [they] haven’t had to do in the past. It would maybe be part of a net asset statement or a net investment statement, but they now want the advisor community to take more ownership of client debt.”

Similarly, a new level of tax planning may be required, says Thiele, highlighting the obligation to understand clients’ tax positions. Some advisors may already do that, but she questions what the obligation will look like in practice.

Further, the reforms propose a yearly KYC update requirement. “The KYC obligation and the update requirement were all over the place,” says Renton. “Sometimes you saw a one-year standard; sometimes it was within two years. This is clear: They want to see it on an annual basis.”

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Another new obligation is ongoing suitability analysis. “[CSA’s] talking about an analysis being done anytime you’re getting instruction to buy, hold or sell,” Renton explains. “That’s pretty broad, […] and we’ll need more detail to figure out when they think a suitability analysis is required.”

Industry effects

Pinsky says the proposals may hurt investors and advisors.

“All these things […] increase the costs of investment advisor services […], and that leaves less [return] for the investor.” He says this may heighten the lure of cheaper online investing, especially for conservative investors looking to keep more of their relatively small returns.

Thiele says, regardless of how the proposals play out, they will “expand the expectations, proficiency and experience needed to be a representative.”

The comment period closes August 26.

by Michelle Schriver, assistant editor of Advisor Group.

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