Financial advisors face a tangled regulatory web, as the Canadian Securities Administrators (CSA) and the self-regulatory organizations look to make the investing process more transparent for retail investors. With requirements and rules overlapping in several key areas, the results can appear to be a befuddling, rule-bound maze.

Such is the case with the relationship between Fund Facts and Phases 1 and 2 of the client relationship model (CRM1/CRM2). Although both initiatives are aimed at greatly improving disclosure and transparency for investors, they are separate, albeit related regimes, with separate rules and deadlines.

The regulatory onslaught has not occurred in a vacuum. Susan Silma, one of the architects of CRM when she was director, compliance and registrant regulation with the Ontario Securities Commission (OSC) from 2003 to 2012, notes that OSC research found investors want clear disclosure of fees and performance. “There are really only two questions they care about: how are they doing; and what is it costing them?” says Silma, co-founder of CRM2 Navigator, a Guelph, Ont.-based consulting firm that advises on regulatory change. Many clients, she adds, find it difficult to obtain that information.

It’s that lack of understanding about fees that underpins not only CRM2, but also Fund Facts, the mutual fund disclosure document that now replaces simplified prospectuses. Rebecca Cowdery, partner and lawyer with Borden Ladner Gervais LLP in Toronto, notes that it’s not surprising that confusion sometimes arises over how these two regimes work together because they are “very related, even though the regulators haven’t connected the dots.”

As of this year, CRM2 requires advisors to engage in a pre-trade discussion about fees. On the other hand, Fund Facts, which was first proposed in 2009, requires that investors be provided with disclosure about standard cost and performance details about a fund in language that is clear and easy to understand. Currently, Fund Facts must be delivered within two days of the investment purchase. Mutual fund companies also must make the document available on their websites, although many fund firms have buried Fund Facts deep in their websites.

In March, the CSA announced the third phase of Fund Facts, slated for 2015, which involves the pre-sale delivery of the document. The goal is to provide investors with key information about a mutual fund when they are making their investment decision rather than after a purchase.

The timing of the two initiatives owes something to history. Originally, the CSA wanted Fund Facts provided at the time of a sale, but the industry pushed back, citing costs and operational issues. As a result, the CSA introduced a phased-in approach. The CSA also cites CRM2 as justification for moving to pre-sale disclosure, noting that the industry has already had to develop programs and systems to comply with CRM2-related pre-trade disclosure requirements. So, the costs to implement pre-sale delivery of Fund Facts will be “incremental in nature,” according to the CSA.

Silma says it would have been helpful to have the CRM2 fee disclosure deadline, which was in July 2014, accord with the pre-sale delivery disclosure requirement for Fund Facts in 2015. The good news for advisors, she adds, is that “Fund Facts contains information about all the disclosures that advisors are required to make pre-trade under CRM2.” Notes Silma: “One of the things I am recommending companies do is adopt pre-sale Fund Facts delivery now and incorporate that as part of their CRM2 disclosure. It’s nice to tackle those two different regulatory initiatives in one fell swoop.” (See story on page 10.)

While CRM2 seeks to make retail investors more informed, the Byzantine nature of the regulatory environment still leaves gaps, notes Mario Frankovich, CEO of Toronto-based Burgeonvest Bick Securities Ltd. He welcomes CRM2 because he thinks it provides a better standard of care. He adds that advisors supervised by the Mutual Fund Dealers Association of Canaada (MFDA) and the Investment Industry Regulatory Organization of Canada (IIROC), “are going to be providing very fulsome disclosure.”

That’s not the case for advisors governed under legislation for other industries within the financial services sector, such as the Insurance Act or the Bank Act, for example, Frankovich notes: “None of those have CRM of any sort, to the best of my knowledge, and most definitely don’t have CRM the way we have it.”

The result, says Frankovich, is that an investor might walk into one side of a financial services institution and receive no pre-transaction disclosure, while an IIROC- or MFDA-regulated advisor working on the other side of same firm will give pre-trade transaction disclosure of the same product. (See story, page 20.) As a result, he adds, “A client may be totally confused. Our policy is that we disclose on a level playing field. You have to wonder if all companies have the same kind of policy.”

In the end, Silma says, advisors need to embrace rather than fear the CRM2 changes and get in front of them, especially prior to the 2016 requirements for enhanced compensation and performance accounting. “This is the big shoe to drop,” she says. “People believe this will have a very significant impact on the industry.” However, she adds, it’s also an opportunity to get closer to clients and engage in discussion: “A better informed client is a better client.”

Investor protection may ramp up even further

CRM2 will be fully implemented by July 2016, but regulators aren’t stopping there. As with Phases 1 and 2 of the client relationship model (CRM1/CRM2), securities commissions are continuing to target greater transparency and accountability on the part of financial advisors, investment dealers and their firms.

This drive for ever more oversight may seem overwhelming at times, but financial services regulators in the U.K. and Australia are much further along in this process, having introduced a range of new reforms – from banning embedded fees to the creation of a statutory “best interest” test for advisors. According to a recent report from Toronto-based Advocis, such reforms have resulted in an estimated 25% of British advisors closing down their practices.

What does the reform discussion look like in Canada? In December 2013, the Canadian Securities Administrators (CSA), on behalf of securities commissions across the country, issued summaries of its proposals on the issues of embedded fees and a statutory best interest test. Those summaries included feedback from the investment industry, which called for more review and harmonization in any new regulations. For now, these proposals appear to be on hold, as regulators continue to solicit industry feedback.

Regulators are also ramping up their focus on services to seniors, with new guidance and commentary on this issue coming from several quarters, including the Ombudsman for Banking Services and Investments, the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada. So, whatever the future holds for advisors, it is likely to include more regulation in these areas.

“The CSA tends to follow what’s going on in other jurisdictions,” says Garth Foster, partner with Fasken Martineau DuMoulin LLP in Toronto. Regarding embedded fees, Foster notes that they have been banned in some other jurisdictions. “The reality is that they do cause, arguably, a bit of a conflict of interest. It’s possible the CSA would ban such fees at some point.”

However, he adds, such fees have been around for ages and are “already disclosed in the prospectus and Fund Facts. One could argue that there isn’t the need to ban them if they are properly disclosed.” Foster adds that if regulators ban embedded fees, “it will obviously have an income impact for advisors.” That might result in advisors having to charge their clients higher fees.

As for implementing a statutory best interest test, Foster says it is unnecessary. Fund managers already have a fiduciary duty under the [Ontario] Securities Act, while advisors are required to “deal honestly and in good faith with their clients. Pragmatically, there’s not that much difference [between the two standards].” If regulators do move to a best interest standard, he adds: “Most clients would not notice any difference.”

But whether or not embedded fees and a best interest standard get served up as another regulatory meal for advisors to swallow could very well depend on the success of the CRM initiative.

“Some would say that the implementation of CRM, both one and two, provides very prescriptive safeguards such that the fiduciary standard isn’t needed anymore,” observes Janice Wright, partner with Wright Temelini LLP in Toronto. “You can’t avoid the discussion of CRM and its impact on any other issues. It will be interesting to see how the advocates of one side or the other use CRM to their advantage.”

One thing that won’t deviate in the coming years is the regulatory focus on seniors. IIROC’s 2013 enforcement report noted that,”…37% of complaints reviewed by IIROC involved seniors. In response, approximately 40% of IIROC’s prosecutions against individual registrants related to misconduct against seniors, making it one of IIROC’s top matters prosecuted in 2013.”

Richard Corner, IIROC’s chief policy advisor, member regulation, says, “The changes are about improving continuous care to clients, improving relations with clients and addressing the challenges faced by all clients, including seniors. The vast majority of the wealth today is with senior investors, so that’s where the focus should be from a regulatory standpoint. Seniors, as a proportion of clients as a whole, are increasing over time. Naturally, there is going to be more focus on senior clients on all fronts, whether it’s examination or enforcement.”

That will create challenges for advisors, who are being told to speak more plainly and better disclose information about the investing process. When it comes to elderly investors, their ability to comprehend might be diminishing, a challenge likely to require more guidance and training for advisors in the future.

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