Special Feature

CRM2 Guide 2015

At the midpoint of the three-year implementation of the second phase of the client relationship model (CRM2) project, some of the most challenging reforms are yet to come. Prepare your practice for regulatory change with CRM2 Guide 2015, a supplement to the October 2015 issue of Investment Executive.

The new cost and performance reports mark a fundamental shift

By Jade Hemeon | October 2015

The implementation of the second phase of the client relationship model (CRM2) continues over the next few years, allowing financial services firms the time to adjust to the new information about how much clients are paying to invest and the performance of those investments - and to do the all-important arithmetic for how these two items compare.

Although the CRM2 journey to fuller disclosure began with basic pre-trade disclosures in July 2014, the thornier parts of the path lie ahead as financial advisors reveal details of their compensation. July 15, 2016, is an important date, marking the deadline for the beginning of the third and final stage of CRM2, which requires specific reporting on fees and compensation, as well as on investment performance, with the mandatory 12-month reporting period commencing on that date.

Under these new rules, investors must receive a customized annual report with details of how their investments have performed, in both dollar terms and percentage terms. Investment dealers will have one year from the 2016 deadline to begin sending these reports to their clients. From 2017 onward, investors must receive individually tailored reports every year, showing percentage returns for the previous one-, three-, five- and 10-year periods.

Firms also will need to provide an annual report on all charges and other compensation, showing in dollars what the dealer was paid for each of the products and services provided, as well as an aggregate amount. This report will itemize the cost of everything from embedded trailer-fee commissions, to redemption fees, point-of-sale commissions, switching fees, referral fees and RRSP/RRIF administration fees - and include an explanation of each type of payment.

The report on charges and compensation will provide details about the money received by the dealer firm during the previous year, a portion of which will be paid to the financial advisor. The report won't include disclosure of the management expense ratio (MER) on mutual fund products, which typically includes the trailer fee paid to advisors and other costs and expenses incurred by the fund-management firm all lumped together. Information on the MER is available through the Fund Facts document provided by fund companies, while CRM2 disclosures identify only the component of the MER that is paid as a commission to dealer firms. Charges and compensation reports do not show a breakdown of the amounts paid to the advisor and the dealer.

Advisors are faced with the challenge of communicating these explicit cost and performance numbers and educating their clients about what and how the advisor is being paid, as well as about the value being provided in exchange for the fees paid. One of the benefits of CRM2 is that all mutual fund and securities dealers are required to make the same disclosures of fees and performance, allowing for more consistency and making it easier for clients to compare individual advisors.

The specific account performance reporting must include:

- The market value of securities at the beginning and end of the annual reporting period, and the market value of cash and securities moved in or out of the account. Also required is the annual change in value and the cumulative change in value since the securities have been owned in the account.

- Annualized total percentage return - net of charges - for one-, three-, five- and 10-year periods, or since inception if the period is less than 10 years.

The report on investment performance will not provide benchmarks, but will focus on the individual client's personal rate of return, and this rate of return cannot be compared directly with a benchmark. This return figure will be based on the individual client's specific deposits into and withdrawals out of the account, as well as dividends and interest earned and changes in the value of securities. Under CRM2 rules that came into effect in 2014, dealers are required to provide clients with a general explanation of relevant benchmarks.

Firms may decide to issue the newly required reports on a calendar year basis or choose another date for annual measurements. For firms that have chosen to report on a calendar year basis (which many have decided to do), the first reports will cover the period from Jan. 1, 2016, to Dec. 31, 2016, and include market value information since Jan. 1, 2016, or an earlier date chosen by the firm that is the same for all similar clients. When the firm has decided not to report on a calendar year basis, its first reports will likely cover the period from July 15, 2016 to July 14, 2017. The reporting must include market value information as at July 15, 2015 or an earlier date chosen by the firm that is similar for all clients.

Investment performance reports must include annualized total percentage return information since inception - or for the period since Jan. 1, 2016, when reporting on a calendar year basis. If a firm has decided to report on a calendar year basis, that firm must provide information for the 12-month period ending Dec. 31, 2016, but it is not required to provide the information for any earlier period. Nor is the firm required to provide information for earlier periods in any subsequent performance reports covering the 12-month periods ending Dec. 31, 2017, and every year thereafter.

If a firm has decided not to report on a calendar year basis, it must provide information either: (A) for the period since the account was opened, if the account was opened at least a year before the date of the report; or (B) for the period since July 15, 2015, or an earlier date chosen by the firm that is the same for all similar clients.

Sticker Shock

The detailed disclosure of fees and commissions that comes with the second phase of the client relationship model (CRM2) will lead many clients to question the value they are receiving. Financial advisors should be prepared with answers.

"Transparency will be good for the professionalism of the industry," says William Charles, senior vice president in Toronto with Winnipeg-based Investors Group Inc. "If you're simply flogging funds, it's going to be difficult to prove you offer much value. But CRM2 will not be a problem for advisors providing services that are worth more than the fees being paid."

Advisors need to get in front of the disclosure train that's coming, and begin educating their clients now, Charles says. One way to do this is to expand the range of services an advisor offers; an advisor who helps a client save taxes, manage insurance needs and do complex estate planning offers more value than an advisor whose services are mostly confined to allocating assets and an annual review. The latter type of practice is going to look more and more like the services offered by the bargain-priced robo-advisor firms now on the rise.

Another challenge for advisors is in differentiating themselves from other advisors. Dan Richards, president of Toronto-based Clientinsights, says some services, such as financial planning, aren't regarded by clients as a true differentiator and are no more impressive than a restaurant offering clean cutlery. Thus, he says, advisors need to focus on outcomes for each client and demonstrate in concrete terms - with case histories and examples - how the client is better off as a result of the advisor's expertise.

Many clients do not realize the full range of services their advisor offers, and it's important to remind them, says Tina Tehranchian, certified financial planner and branch manager with Assante Capital Management Ltd. in Richmond Hill, Ont. Her list of client services is long, including tax planning, risk management and life insurance. She also offers critical illness and disability insurance, evaluation of corporate pension plans and stock options, cash flow management, charitable giving, and trusts and estate planning.

Tehranchian advocates providing written information to clients regarding such services along with the new reports on fees and performance, "so that fees are not disclosed in a vacuum but are seen in relationship to the services received." Information about an advisor's professional credentials also should be provided, showing that the advisor, like other professionals, is entitled to proper compensation.

A comprehensive, written financial plan is one of the most enduring ways that advisors can showcase their value, Charles says. Advisors can help clients with their behaviour, setting long-term goals and helping with saving and spending strategies. Notes Charles: "Advisors can help clients by not letting them react emotionally to ups and downs, and prevent them from making big mistakes."

Tehranchian is ahead of the new rules. "At every client meeting, I go over the fees, explaining what portion goes to the fund company, the dealer and to me, and what services those fees are designed to cover," she says. "I calculate the dollar value myself and make sure [clients] hear what it is, so that in the next year or so, when they see the amount on their statement, it won't be a shock. I'm putting it on the table right now."

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