There may be no better example of the dysfunction that afflicts the Canadian securities regulatory system than the tortured tale of the fair-dealing model — a project whose legacy lingers, continuing to tease investors and torment the financial services industry.
The latest chapter in this very long-running FDM saga began this past summer, when the Canadian Securities Administrators proposed a series of important new amendments to the registration rules that would both beef up the required cost disclosure that firms must make to clients and introduce new performance-reporting requirements.
The CSA initiative is certainly investor-friendly, because it aims to ensure that clients of all registered firms receive complete disclosure of all the fees, commissions and other charges they are paying for the products and services these clients buy — and that they receive meaningful performance reporting.
The CSA characterizes its proposals as a “significant investor-protection initiative,” noting that investors should be entitled to receive this sort of information. Yet, in many cases, either they aren’t receiving it or, if they are, it is not being delivered clearly and effectively. The hope is that by improving cost disclosure and ongoing performance reporting, clients will be in a better position to make more well-informed investing decisions.
In general, investor advocates seem to be strongly in favour of the initiative. In a comment on the proposed rules, the Ontario Securities Commission’s investor advisory panel indicates that it “wholeheartedly” supports the CSA’s proposals. Similarly, the Canadian Foun-dation for Advancement of Investor Rights (FAIR Canada) calls the proposals “an essential step” in fulfilling the obligation that financial services firms should be under in providing their clients with clear, unbiased information. Both groups urge the regulators to begin implementing the proposals sooner rather than later.
The industry however, has some major complaints with the proposals, as indicated by the large volume of comments generated over the comment period that ended in late September, the vast majority of them voicing similar concerns.
A large portion of the industry comment letters point to a submission from the Investment Funds Institute of Canada as capturing their thoughts about the rule.
IFIC’s letter argues, among other things, that the proposal is duplicative in a couple of important ways. For one, it says, the proposal places too much emphasis on disclosing fees and commissions that are already included in a mutual fund’s management expense ratio, which, it argues, will only serve to confuse investors.
More important, the IFIC comment points out, the amendments would trample on the extensive work already done by the self-regulatory organizations (the Mutual Fund Dealers Association of Canada and the Investment Industry Regulatory Organization of Canada) to bring in their own cost-disclosure and performance reporting rules.
And this is where the legacy of the FDM rears its ugly head. The FDM, which the OSC began working on back in 2000, was an ambitious project that had aimed to shift fundamentally the focus of regulation from products to advice, modernize regulation and enhance investor protection. However, after several years of consultation on just how to accomplish these bold goals, and after meeting with resistance to the project from both the industry and the rest of the CSA, the FDM was subsumed into an existing project to overhaul the registration system. Some of the FDM’s concepts about recasting the client/advisor relationship and improving cost disclosure and performance reporting were handed off to the SROs and turned into what became known as the client relationship model.
The MFDA and IIROC have since spent the past few years developing and refining their CRM proposals, which also have gone through several rounds of extensive industry comment. Late last year, MFDA members approved its proposed CRM rule, which is slated to take effect in July 2012. IIROC, for its part, had submitted the final version of its own CRM rules to the CSA this past summer and is awaiting approval, which is expected by the end of this year.
Now, the industry warns, all of that work would effectively be for naught if the CSA’s proposed new amendments are adopted in their current form, usurping the requirements already being adopted by the SROs. IFIC’s comment letter says that allowing this to happen would undermine all of the public consultation that has taken place over the past seven years on these issues and “would place at risk the credibility of the public consultation process itself.”
Moreover, bringing in two sets of rules on the same subject will likely cause firms to make two costly rounds of systems changes to ensure they are in compliance with both the SROs’ rules and the CSA’s rules — potentially confounding investors too.
IFIC’s comment letter requests that firms that belong to the SROs be exempt from the CSA’s proposals. (IIROC and MFDA firms already had an exemption from the relationship-disclosure requirements in the existing registration rule, which expired on Sept. 28 but was recently extended by the CSA until the end of 2013 in anticipation of the implementation of its new CRM rules).
The idea that SRO firms should be exempt from new CSA cost-disclosure and performance-reporting requirements does not sit well with investor advocates, however. FAIR Canada’s comment letter “urges the CSA not to succumb to IFIC’s request” to exempt SRO members from compliance with the CSA’s proposed requirements.
FAIR Canada’s comment letter calls IFIC’s argument for an SRO exemption “weak at best,” noting that the CSA’s proposed rules in this area would require more complete disclosure than some of the SRO rules.
And FAIR Canada’s comment letter stresses that all clients should receive the same level of disclosure — clients of SRO firms shouldn’t get less disclosure than clients of firms that are directly regulated by the CSA: “It is essential that all registrants, whether or not they are a member of IIROC or the MFDA, be required to provide the same information regarding costs and performance reporting to investors.”
FAIR Canada’s comment letter also takes on a couple of the other common objections to the amendments that are voiced in industry comment letters. Regarding mutual funds, some comment letters say, the requirements would duplicate disclosure now being provided in the new Fund Facts documents. Also, various comment letter add, the rules place the securities industry at a competitive disadvantage relative to the banking and insurance sectors, which enjoy weaker disclosure requirements.
In rebuttal, FAIR Canada’s comment letter says neither the existence of some cost disclosure in Fund Facts nor the absence of adequate disclosure in the insurance and banking industries should deter the CSA from imposing its new proposals: “The CSA should reject an argument [that] results in a ‘race to the bottom’ and [that] disregards the interests of investors. Furthermore, investors should not be expected always to have all of the information previously disclosed at their fingertips when making comparisons or assessing performance. This is unfair, unrealistic and investor-unfriendly.”
Similarly, the IAP’s comment letter calls on the CSA to lead the way and set the bar for regulators in the banking and insurance sectors regarding improved disclosure, and the IAP’s letter calls on regulators in those industries to follow the CSA’s example. The IAP’s letter also advises the CSA to resist the push to exempt products that may have a tougher time meeting the requirements, such as scholarship funds: “All performance reporting is complex. Complexity should not be a reason for depriving investors of crucial information to aid in their decision-making.”
But, most important, the IAP’s letter calls on the CSA to just get on with it and finally impose these requirements after years of debate: “We are struck by the lack of transparency that exists in cost disclosure and performance reporting…. Investors in Canada suffer from having much less information than their financial advisors.”
This inequity is particularly problematic, the IAP’s letter suggests, because advisors also are not subject to a fiduciary duty in Canada, which would require them to act in the best interests of clients.
Previously the IAP had called for the OSC to impose such a duty, and the OSC has said that it is studying the issue. In the meantime, the IAP’s letter says, absent this fiduciary duty, “full disclosure of performance returns and costs, in easily understood formats, is necessary all the more.”
Ultimately, it concludes, the proposals are “long overdue; any delay in [their] implementation would undermine investors’ interests.”
A one-year transition period should be sufficient, the IAP’s letter says, rather than the two-year period that’s contemplated in the proposals. (FAIR Canada’s letter suggests six months should be adequate.)
A number of the industry comments call for a three-year transition period if the CSA does insist on going ahead with these amendments. Of course, in that time, the CSA could well have changed tack on these rules several more times, leaving inves-tors waiting and the industry uncertain yet again. IE