The Canadian Securities Administrators have now approved proposals from the Investment Industry Regulatory Organization of Canada that will implement the rules and guidance of the client relationship model related to retail client accounts of IIROC registrants. The CRM will help ensure a consistent standard of conduct in the investing process, transform the way the investment industry sees itself and enhance the investing public’s respect for the advisory business.
The rules have been a long time coming, having their roots in the Ontario Securities Commission‘s Fair Dealing Model concept paper released in January 2004. The reforms have been reshaped in form and content by regulators and self-regulatory bodies, and influenced through extensive consultation with investment dealer firms and with the investing public. While the process has been lengthy, the CRM is ahead of its time. Core principles were developed even before the 2008 financial crash and well ahead of similar reforms now taking place in foreign jurisdictions.
The CRM has four components. Two relate to disclosure, including mandated information for clients on the investing process (such as the nature of the account relationship, products and services offered, investment suitability process, nature of account supervision, fees and charges), and rules for reporting client account performance. The third component is the management of conflicts through either avoidance or disclosure. The fourth component enhances requirements for “know your client” and suitability assessment.
The proposals for enhanced suitability begin with bedrock KYC information, including basic facts such as age, net worth, marital and employment status, and more complex information requiring discussion with the client. Areas covered include investment objectives, interpretation of risk, risk tolerance, investment time horizon, etc. This client/advisor interaction requires an understanding of financial risk, the dynamic nature of risk and “risk tolerance.” How much risk is reasonable, given the client’s objectives and status? How much money is he or she prepared to lose? And how much risk of financial loss should be balanced against the potential for incremental return?
These are difficult questions. Advisor and client must have a mutual understanding of these terms. This assessment measures suitability, not just in terms of the specific transaction but also holistically in terms of its impact on the investment portfolio.
Until now, the suitability assessment was transaction-oriented, initiated when a client trade was accepted or an investment recommendation made. (This remains the U.S. standard for suitability.) The new CRM, however, increases the trigger points for suitability assessment. Two of the conditions are relatively easily defined: the transfer of additional securities into the client account and the replacement of the advisor.
The third is a more frequent condition but more difficult to measure: a material change in the client’s personal and financial status. While the advisor should make reasonable efforts to identify such changes, the client also has an obligation to inform the advisor.
The mandated suitability assessment now moves along the spectrum from the trigger point of a client transaction to other specific events that can be clearly delineated for compliance purposes. The new rule moves even further along the spectrum to suggest, as an industry best practice, that advisors should consider reviewing client suitability when there has been: i) a “significant” market event; or ii) a material change in an issuer of securities held by the client. The suitability rule moves from transaction-focused to event-focused, and the advisor moves to having a continuous role in the client’s financial welfare.
CRM does several positive things. It brings all advisors and member firms to the same higher minimum standard of suitability review, establishes more rigour in the client communication process and raises the professional bar for managing the welfare of the client’s portfolio. Many advisors and their firms already take a pro-active role monitoring the welfare of their client’s portfolio investments.
Client contact has become more frequent, for exchanging views on market conditions, providing needed reassurance and, sometimes, to recommend defensive portfolio strategies. Conversations that don’t involve a portfolio transaction may still require a formal suitability assessment. The new rule also impresses upon the client the need to be forthright and timely in informing advisors of material changes in circumstances.
The regulators have been rightly cautious in imposing the conditions for enhanced suitability review, recognizing the practical need for dealers to establish workable procedures and policies. However, as firms adapt, suitability reviews and related client communication will become more frequent. Advisors will be recognized as diligent professionals who put their clients first.
Ian Russell is president and CEO of the Investment Industry Association of Canada.
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