When contemplating the range and severity of sanctions that back the new disclosure regimes, the word “thicket” comes to mind. Multiple regulators, from the Ontario Securities Commission (OSC) and various self-regulatory organizations (SROs) to the Ombudsman for Banking Services and Investments (OBSI) – not to mention a firm’s own compliance department – are all part of the equation.
Mix those components in with the client relationship model’s phases 1 and 2 (CRM1; CRM2), Fund Facts, point-of-sale requirements and new proposals to ban embedded commissions and implement a “best interest” standard, and it’s no wonder the enforcement landscape looks confusing.
So, what are the biggest risks for financial advisors?
A review of current complaint levels is illustrative. Issues that have long rankled clients will continue to rank near the top of the list. Suitability and leveraging remain the No. 1 client complaint to the Investment Industry Regulatory Organization of Canada (IIROC). According to that SRO’s 2015 annual enforcement report, suitability accounted for 33% of complaints vs 35% in 2014. At the Mutual Fund Dealers Association of Canada (MFDA), suitability accounted for 16% of complaints in 2015, followed by signing blank forms (14%) and misrepresentation (13%).
IIROC, the MFDA and the OSC wield the biggest sticks (short of the courts), with the power to levy stiff warnings, fines and trading bans and it seems likely that, as compliance duties rise, so too, will enforcement.
What is far from clear is the extent of that change. Johanna Braden, a litigator with Stockwoods LLP in Toronto who defends financial advisors, says that, at the least, an uptick in investors’ complaints can be expected. She adds that the biggest enforcement risk for advisors are the CRM2 changes, with their new annual reports on investing costs and portfolio performance: “[Clients] will see numbers in a way they haven’t seen before. Investment advisors should be ready to address more questions.”
However, Braden believes the new pre-trade disclosure rules will reduce the risk of client complaints. “It will be harder for investors to say, ‘I didn’t know what I was getting’,” she says. “Hopefully, investors will understand what the risks are before they agree.”
Joanne De Laurentiis, recently retired president and CEO of the Investment Funds Institute of Canada (IFIC), and an investment industry veteran, notes that both IIROC and the MFDA have been briefing their members extensively about the changes. “If you are doing what you are supposed to be doing, you shouldn’t be concerned,” she says.
For Fund Facts, Braden adds, a key requirement will be record-keeping. Advisors are “going to have to show they had a clear process in place” for ensuring that clients receive the required materials in advance of the trade, she says.
For the new reports mandated by CRM2, much will turn on ensuring that firms’ data systems produce the correct information and that it is displayed properly on clients’ account statements. “Everybody is trying to automate this as much as possible,” Braden explains.
She expects regulators will be diligent in checking that firms are complying with CRM2 requirements. Following the CRM1 changes, the OSC, the MFDA and IIROC collaborated in 2014 on a mystery-shopping venture to test suitability and “know your client” (KYC) rules – the core of CRM1. People masquerading as clients visited investment firms to assess how those firms collected information. The exercise revealed that 29% of firms failed to comply with KYC rules.
However, Braden doesn’t think that mystery shopping will be an appropriate tool for enforcement of CRM2 reforms, which involve producing reports based on an existing relationship and a history of providing information to clients. “It’s hard to see how [mystery shopping] works for this initiative.” Still, she doesn’t rule out more mystery shops.
Another enforcement tool to watch for could be spot audits, which are used in the legal profession. IIROC has used them in overseeing members who are under a discipline sanction. Braden believes spot audits are one of the best ways to address oversight of ongoing client relationships.
Sarah Bradley, CEO of OBSI, notes that fee disclosure is the third-largest category of investor complaints at OBSI and could increase once investors start receiving their annual costs reports. (Product disclosure ranks fourth in complaints.)
Regarding remedies, investment firms still can choose to ignore OBSI’s recommendations. However, an independent review of OBSI suggested that the ombudservice be given the power to make its penalties binding. Bradley says the OBSI is consulting with its stakeholders about those recommendations. She adds that, in any case, only a small number of firms have balked at paying up.
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