CRM2 creates legal risk, but honest efforts to adapt to the full range of changes makes it less likely that regulators will flex their enforcement muscles
When it comes to complying with the new disclosure rules for commissions, fees and account performance under Phase 2 of the client relationship model (CRM2), financial advisors need to tread carefully. That’s because penalties for failing to toe the line can range from a slap on the wrist to being fined and kicked out of the profession.
Most advisors and their firms are likely to hear first from their self-regulatory organization (SRO) if they are offside: the Investment Industry Regulatory Organization of Canada (IIROC) or the Mutual Fund Dealers Association of Canada (MFDA). The SROs will be using their usual toolkit to enforce their rules. “The penalties are not going to be unique,” says Janice Wright, partner with Wright Temelini LLP in Toronto. “You’re looking at the same type of penalty regime as for other IIROC matters.”
For example, advisors and their firms could face reprimands, fines, implementation of conditions, suspensions and, says Wright, for “catastrophic violations, a permanent ban.”
Advisors can take some comfort in knowing that IIROC will grant some leniency early in the game. “It’s not our intention from Day 1 to open an enforcement file if everything is not done 100% to the letter of the law,” says Richard Corner, IIROC’s chief policy advisor, member regulation. “The intention is to make sure everyone in the community collectively has his or her shoulder to the wheel and is pushing forward as aggressively as possible to get this stuff in place.”
Nonetheless, advisors need to appreciate that IIROC and the MFDA mean business. That’s evident already, based on the implementation of Phase 1 of the client relationship model (CRM1), which began in 2012 and dealt primarily with suitability and conflict-of-interest issues. Wright says suitability has played a big role in many cases before the regulators: “It’s hard to tell whether the focus has been heightened because of CRM1 or whether the cases would have arisen in any event.”
However, Wright notes, regulators have tipped their hand by indicating “they are going to be looking at CRM implementation issues through business compliance audits and trying to assess how dealers are complying.” That suggests, she adds, that regulators’ efforts will be “more through the compliance route, rather than the enforcement route.”
Still, CRM2 can become something of a quagmire if sufficient care is not taken to adhere to its principles. What needs to be avoided is a rote response to the rules that fails to get through to clients.
“I don’t think people really understand the implications of what’s coming at them,” says Rebecca Cowdery, an expert on CRM compliance at law firm Borden Ladner Gervais LLP in Toronto. “[CRM2] is real cultural change. To me, the biggest challenge is at the advisor level, changing behaviour and making sure people understand [CRM2].”
Cowdery says the objective is simple: making sure investors understand the cost of what they are investing in and how their accounts have performed. However, she adds, “The rules are so prescriptive, you really have to go beyond the mere objective and understand the detailed rules.” That, in itself, can be a problem “because you have to pay attention to all the details – you are looking at the trees and losing sight of the forest.”
However, while the rules are detailed, they do provide latitude in how the requirements can be met. For example, charts and graphs can be used to help tell the story. When it comes to things like discussing fees or performance, advisors are better off by speaking in terms of dollars rather than nebulous percentages.
On the other hand, advisors will not be expected to work miracles. Advisors, Cowdery says, can “make information more inviting and more informative, but you can’t force somebody to understand it.”
Cowdery observes that despite the efforts around Fund Facts (see story on page 18) and disclosing information about costs, studies show that “people still don’t understand what the cost of a mutual fund is.”
Any time there are new regulatory initiatives, legal risks are created and the CRM initiative is no exception. As the new rules take hold and the standard of care required around disclosure on fees, performance, suitability and conflicts evolves, more discipline cases and lawsuits, including arbitration hearings before the Ombudsman for Banking Services and Investment (OBSI), are expected to crop up.
How often, remains to be seen. A spokesman for OBSI says the ombudservice will be monitoring complaint volumes as CRM2 is implemented. In 2013, OBSI heard 434 cases, with suitability and fee disclosure being the top issues; poor product disclosure ranked tenth. Complaints about suitability, fees and commissions also ranked among the top complaints made to the MFDA. Suitability was one of the top three complaints made to IIROC.
Advisors who are honestly working toward compliance with CRM2, Wright says, and doing their best to adapt should have little reason to worry: “I don’t anticipate they are going to have enforcement jumping down their throats anytime soon.” It will be a different story, however, for those “flagrantly violating” the rules.
In that case, expect the full wrath of enforcement.
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