Regulation: Tackling CRM2

The securities industry’s resistance to the client relationship model (CRM) reforms has faded from a defiant roar into a resigned whimper. Now, the industry is eager to get the final rules nailed down – and the lobbying for changes is coming largely from the investor side.

Since the Canadian Securities Administrators (CSA) finalized Phase 2 of the CRM rules (CRM2), the industry seemingly has given up any hope of meaningful modifications. The self-regulatory organizations (SROs) – the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) – still need final approval for their own versions of the rules, which are tailored to their respective industries, but it has become clear that there is little room to deviate from the CSA’s requirements.

In mid-September, IIROC republished its package of CRM2 rules for a second comment period after the CSA found that IIROC’s first edition didn’t quite match the CSA’s rules closely enough. The reissue of IIROC’s rules stems from a specific concern about the SRO’s proposed approach to reporting certain “off-book” positions to clients.

The CSA’s rules require firms to provide reporting to clients on any off-book securities for which the dealer receives ongoing compensation, along with any off-book holdings of securities issued by a scholarship plan, mutual fund or labour-sponsored investment fund. IIROC’s proposed rules require reporting on only off-book positions in which the firm receives ongoing compensation.

Although the difference between the two approaches seemingly is minor, it was enough for the CSA to require that IIROC’s proposals, which since have been revised to follow the CSA’s design on this topic – as have numerous other small changes – now must be subject to a second comment period. That comment period ends Nov. 17.

The MFDA is not expecting to run into a similar quandary with its CRM2 proposals. Karen McGuinness, senior vice president, member regulation, compliance, with the MFDA, says that the SRO has not received any indication that the CSA staff have any material objections to the MFDA’s proposals: “And I do not anticipate any, given [that] our CRM2 rule proposals meet and, in some areas, exceed requirements under [the CSA’s rules]. We do not anticipate another public comment period.”

At this point, the investment industry appears to have relatively few objections to the MFDA’s proposals. The only item that appears to need clarification is the proposed requirement that firms use July 15, 2015, as the inception date in performance reporting for accounts that were created before that date but for which a firm doesn’t have reliable data on the accounts’ holdings. A couple of comments point out that the use of this date may seem arbitrary to clients.

The Investment Funds Institute of Canada’s (IFIC) comment says that July 15, 2015, is not a “client-friendly” date because most clients are used to reports as of the end of a month. IFIC’s comment recommends that firms be given the option of using either Jan. 1, 2016, or the date of their most recent systems build prior to July 15, 2015, as an inception date.

The comment from Tangerine Investment Funds Ltd. suggests using Jan. 1, 2015, as the inception date for these accounts: “We support ensuring the performance reporting initiatives are implemented in Canada in as smooth a manner as possible, and enacting an intuitive implementation date for the consumer will play a part in this rollout.”

Apart from this technical issue, the investment industry appears to have accepted the MFDA’s CRM2 proposals. Rather, it’s investor advocates that are calling for changes.

The comment from the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) recommends that mutual fund dealers be required to give clients upfront disclosure of the trailer commissions the dealers will receive in dollars because investors understand dollars better than they do percentages.

FAIR Canada’s comment also says that the MFDA’s proposals will narrow certain disclosure requirements so that they apply only to securities and not to all of a client’s investments. While the comment acknowledges that the MFDA must harmonize its requirements with the CSA’s rules, it adds: “This does not mean that the MFDA should lessen the disclosure that is already occurring on those investments that are not securities.”

FAIR Canada’s comment suggests that limiting the scope of reporting “goes against the spirit of the CRM2 initiative.” And the comment calls upon the MFDA to reverse its course on that point. Similarly, the comment says, firms should be required to report on the compensation they receive for all the investments they sell, not just securities.

In addition, the investor advocacy group’s comment recommends that the MFDA consolidate the key account opening requirements into a single rule for easy reference and also suggests a variety of other tweaks to make this disclosure “more meaningful to the investor.”

The Small Investor Protection Association‘s (SIPA) comment to the MFDA echoes many of FAIR Canada’s recommendations. SIPA’s comment also suggests, among other things, that the SRO work toward make the upgraded disclosure more useful to clients by launching an investor education initiative. This initiative would ensure that clients understand the significance of the new investment cost and performance reporting information that will be provided under CRM2.

Several investor advocates insist that the regulators should not be satisfied with merely improving disclosure. Their comments propose that regulators be prepared to tackle deeply entrenched issues – such as industry conflicts of interest and high product costs – by pursuing reforms to mutual fund fee structures and introducing a “best interests” duty for financial advice.

Although those reforms may materialize, the priority for both SROs and the investment industry right now is finalizing the SROs’ versions of the CRM2 rules and implementing them as efficiently as possible.

For IIROC-member dealers, that means going through another comment period and hoping for the CSA’s approval this time around.

Barbara Amsden, managing director with the Investment Industry Association of Canada, says that the association is pleased to see IIROC’s revised rules back out for comment: “Just as there are differences between a blueprint and the final house, a project as all-encompassing as CRM2 can be expected to require some changes as details become clearer and plans are implemented.”

These changes ultimately will lead to better outcomes when the rules are implemented, Amsden suggests: “The IIROC rule changes address concerns, for instance, that might have led a dealer to cease offering clients certain investment vehicles due to the cost of building new systems for a handful of accounts.”

An IIROC notice explains the decision to amend the SRO’s proposals and publish them for comment again: IIROC revised its original proposals to follow the CSA’s approach to reporting off-book positions in order to avoid the prospect of firms being required to comply with two sets of the same rules.

However, IIROC may allow firms to gain an exemption from these reporting requirements if they “can demonstrate that the costs of building and administering this new client reporting capability significantly outweigh the benefits to the client of also receiving off-book position information.”

This exemption may allow dealers that have either a small number of clients with off-book holdings or accounts holding a small dollar amount in such positions to avoid building a costly new reporting capability to cover some relatively minor off-book investments.

IIROC’s proposals indicate that in order to receive an exemption, a dealer would need to satisfy IIROC staff that the dealer: tried to get a client to convert the off-book holdings into on-book positions; isn’t promoting the use of off-book holdings; isn’t receiving any ongoing compensation from these off-book holdings; and the overall quantity of these positions is not significant.