In the days before brokerage firms called themselves wealth managers and the Internet allowed everyone to trade online, investment advice was often little more than stock-picking. The main job of securities regulators was to make sure that trades were fair. But, as the investment industry rapidly evolved from the basic stock brokerage business into providing a wide range of financial advice, regulators have struggled to keep up. With the second phase of the client relationship model (CRM2), they may have finally done so.

“Advisors are realizing they should show they offer more than just investment-picking skills, because there’s so much more they provide or offer access to,” says Barbara Amsden, managing director with the Investment Industry Association of Canada (IIAC) and a longtime participant in initiatives to bring new policies and practices to this field.

Amsden believes the time has come to accept the new era embodied in CRM2, one in which investors become well-informed customers with an active role in making decisions about their finances. As she points out: “Clients are understanding better what they get or can get for their money: monitoring, tax savings, financial education for kids, help with estate planning and with handling the estates of others, structuring retirement, savings discipline, and so on.”

Change was a long time coming. Regulators began grappling with the movement away from simple transactions and toward advice in the mid-1990s. At that time, Glorianne Stromberg, now a retired securities lawyer and former commissioner with the Ontario Securities Commission (OSC), produced a couple of groundbreaking reports that documented the shift in the investment business. Her reports also recommended a regulatory overhaul to cope with the change and ensure adequate investor protection. Although Stromberg’s proposals provoked much discussion, they led to few concrete results.

The industry, however, continued its transition. And by 2004, the OSC had decided to take action. In recognizing how fundamental the transformation had been, the OSC created a whole new regulatory model centred around the ongoing client/advisor relationship rather than transactions. But that proposal, known as the fair dealing model (FDM), struggled to gain traction, both within the industry and with securities regulators in the other provinces. Adopting a whole new regulatory approach in just one province wasn’t practical, so the FDM floundered.

There was, however, still interest across the country in incorporating some of the underlying principles of the FDM into other regulatory models. That led regulators to take some of the FDM’s concepts for enhancing transparency and toughening industry standards, and roll them into the ongoing efforts to reform the registration system. (Unlike certain areas of securities regulation, the rules governing registration of industry participants are national, so bundling some FDM concepts into registration reform meant that those concepts would be adopted in every province, avoiding the problem of one province going at it alone.)

At the same time, in order to win greater industry acceptance, securities regulators brought in the self-regulatory organizations (SROs) that oversee the investment industry – the Mutual Fund Dealers Association of Canada (MFDA) and the Investment Dealers Association of Canada, the latter of which has since become the Investment Industry Regulatory Organization of Canada (IIROC) – to adopt these principles. At this point, the reform initiative became known as the client relationship model (CRM).

The SROs’ rules are national, so this approach ensures that the requirements the SROs set down will be substantially the same across the country. Involving the SROs also gives the investing industry greater say in the rule-making process, allowing the CRM principles to be customized to some extent to fit the different business models and traditions of the investment dealer and mutual fund dealer businesses.

So, although the CRM has its roots in the Canadian Securities Administrators’ (CSA) long-standing deliberations regarding how best to protect investors amid the shift from transactions to advice, the SROs have produced their own versions of these rules, tailored to the firms under their supervision. (To avoid duplication, the CSA has exempted MFDA and IIROC firms from its CRM requirements.)

Of course, there’s a price to pay, in terms of delays, for using the CSA route to achieve national consensus. And involving the SROs further complicated and delayed the process. Making matters worse, the regulators did not always approach the reform initiative in a co-ordinated fashion. Following the launch of the FDM project in 2004, it was five years before the CSA introduced new rules to reform the registration system, a sweeping makeover designed to modernize the regime. Those changes, which included the CRM goals of greater transparency and disclosure of conflicts, took effect in 2009.

In a parallel initiative that began in 2008, the SROs began considering how to enshrine CRM principles in rules that would apply to their members. The MFDA finalized its initial set of CRM reforms in 2010; IIROC’s version came in 2012. IIROC’s new requirements were then phased in over a couple of years, meaning that some of them came into effect only this year – a full 10 years since the original FDM proposals made their début.

CRM2 represents the next chapter in this convoluted regulatory evolution. In 2011, after extensive industry consultation and new research commissioned by the CSA into investors’ understanding of the costs of investing and performance reporting, all regulators decided that disclosure in these critical areas needed to be much tougher. So, the existing proposals for improving cost transparency and enhancing performance reporting were shelved, and the regulators began considering a second wave of reforms that would require more explicit disclosure. This second wave of reforms has come to be known as CRM2.

CRM1 and CRM2, at their core, are designed to: ensure clients understand the terms of their relationship with their advisor; better manage and disclose conflicts of interest; step up the standard of care that advisors must adhere to; put numbers on the costs of investing; and do a better job of performance reporting. Specifically, there will have to be full disclosure of the fees and commissions that are charged, including spelling out the dollar cost of somewhat hidden charges such as trailer fees. And dealers will have to show clients more explicitly how their portfolios have performed.

“CRM represents significant regulatory reforms to enhance the client/advisor relationship,” says Paul Riccardi, senior vice president, enforcement, member policy and registration, with IIROC, “by improving transparency through the disclosure of fees, account performance and potential conflicts, and by strengthening suitability assessments.”

After initially resisting some of these measures and passionately debating the details of the new requirements, the industry is now trying to embrace these rules – accepting that there is likely to be advantages to improved disclosure along with the inevitable costs.

“CRM is making what is most often a good relationship [between clients and advisors] that much better,” says Amsden. The rules that have been implemented are starting to pay off, she adds, because they remind advisors to demonstrate their skills in several areas. And clients are getting a more complete understanding of the range of expertise that’s required to manage their finances. As a result, Amsden continues, what “was initially seen as overwhelming for clients and advisors is already showing benefits.”

After resisting some of the CRM2 measures and debating the details of the new requirements, the industry is now trying to embrace the changes

CRM, So far

Bssic changes are in Force already. Are they working?

The first phase of the client relationship model (CRM1), in force across Canada for all investment industry participants since the spring of 2014, lays the groundwork for overhauling the client/advisor relationship. The regime includes stepped-up account-opening duties, managing conflicts of interest, and more thorough and ongoing suitability assessments.

Perhaps the most important of these is the enhanced suitability obligation. Suitability, historically the fundamental standard of conduct in the investment industry, requires that advisors ensure that their recommendations are appropriate for a particular client, given that client’s individual financial circumstances, risk tolerance and time horizon, among other factors. CRM1 aims to heighten that obligation.

Under CRM1, advisors must consider the suitability of an investment within the client’s overall portfolio, not just the features of a specific investment. And rather than just considering suitability when an initial recommendation is made, CRM1 mandates that suitability can be triggered in a variety of situations – such as life events or when switching advisors.

This emphasis on suitability is not an arbitrary choice made by the regulators: suitability-related issues top the list of client complaints about their firms, an issue that the regulators are determined to address. The CRM1 reforms are designed to reduce these kinds of problems by adopting a more rigorous process to ensure that clients’ investments are suitable.

The CRM1 rules also boost the duties of dealers and advisors in managing and disclosing conflicts of interest, both actual and potential. Although there already were rules about dealing with such conflicts, the CRM1 rules spell out that dealers and advisors must deal with conflicts fairly and equitably. If that’s not possible, such conflicts must be avoided altogether. CRM1 also creates new supervisory obligations for dealers to ensure that conflicts are being identified properly, dealt with and disclosed.

Whether this new regime has brought about change is difficult to assess. “These initiatives are proactive measures, so it is hard to gauge what the impact has been on clients,” says Karen McGuinness, senior vice president, member regulation, compliance, with the Mutual Fund Dealers Association of Canada. “For example, it is hard to measure if providing the new disclosures has avoided a future complaint.”

It will also take time to adapt to the new rules and assess their impact in good times and bad. The Investment Industry Regulatory Organization of Canada (IIROC) is planning to issue further guidance on the rules this year.

“We know from our ongoing communication with members,” notes Paul Riccardi, senior vice president, enforcement, member policy and registration, with IIROC, “that they still have questions and operational challenges with some aspects of the first phase of CRM, and we are in the process of developing resource materials to assist them.”

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