see-saw with king chess piece and pawns

Merging the investment industry’s self-regulatory organizations was meant to level the field between investment dealers and mutual fund dealers while curbing regulatory arbitrage. That process could now upend the industry’s competitive balance.

In the first phase of its consultation to consolidate two sets of dealer rules, the Canadian Investment Regulatory Organization (CIRO) examined the idea of opening certain practices to fund dealers that have traditionally been the preserve of investment dealers. Those practices include allowing fund dealers to offer order-execution only accounts (a fund dealer version of discount brokerage) and, on the other end of the advice spectrum, allowing fund dealers to offer managed accounts.

The latter proposition — not included in Phase 1 of the rule proposals but posed as a possible idea for future stages of the project — sparked divergent reactions from the investment industry.

The Federation of Mutual Fund Dealers (FMFD) endorsed the proposal in its submission to CIRO: “This extension would promote a level playing field, enhance competition, and offer more robust and comparable services to clients across the different licensing channels.”

The Investment Funds Institute of Canada (IFIC) also said fund dealers should be able to expand into these areas, as long as they’re subject to the same supervisory, capital and proficiency requirements as investment dealers.

Conversely, the Portfolio Management Association of Canada (PMAC) opposed allowing fund dealers to offer managed accounts. “From an investor protection point of view, PMAC is concerned about [fund dealers] and their [reps] not having the same proficiency and regulatory obligations of [portfolio managers] if they are permitted to manage client assets on a discretionary basis,” PMAC’s submission stated.

The trade group argued that any firm allowed to manage client assets on a discretionary basis owes those clients a fiduciary duty. It called on CIRO and the Canadian Securities Administrators (CSA) to consider how a fiduciary duty could be imposed on fund dealers.

The Canadian Advocacy Council of CFA Societies Canada’s (CAC) submission also expressed concerns regarding “registrant proficiency and account oversight” if fund dealers were able to offer managed accounts.

PMAC asked the CSA to consider whether allowing fund dealers to engage in discretionary management could lead to regulatory arbitrage, potentially driving firms to register as SRO dealers rather than as portfolio managers, the latter of which are directly regulated by the provincial securities commissions.

“We strongly caution against creating back-door channels for providing discretionary investment management to these investors without comparable duties of care, proficiency, compliance, and regulatory oversight requirements,” PMAC stated.

The trade group suggested the CSA subject all discretionary asset management to the regulator’s direct oversight, regardless of whether the management is being provided by an SRO dealer or by a firm directly regulated by the CSA.

While the CAC rejected the idea of allowing fund dealers to provide managed accounts, it supported enabling them to offer discount brokerage-style accounts, which, it said, would help meet investors’ diverse needs.

“Mutual funds also tend to have more inherent safeguards that would make them particularly suited for order-execution only accounts and mitigate the potential for investor harm,” the CAC submission said.

The Investment Industry Association of Canada (IIAC) took no position on fund dealers offering managed accounts and order-execution only accounts.

Temporary discretionary accounts

Another policy in Phase 1 — eliminating temporary discretionary accounts — also attracted sharply divergent views.

CIRO proposed doing away with accounts that give investment advisors temporary discretionary authority over a client’s account — for example, when the client is travelling. The SRO said advances in communications have reduced the need for these kinds of accounts, which haven’t been available in the fund dealer world.

The proposal received strong pushback from the FMFD, which said temporary discretionary accounts “offer a crucial service for certain investor segments, and their elimination will undoubtedly disadvantage these clients, cause undue hardship, and diminish the competitive edge of independent dealerships in the market.”

The FMFD said compliance concerns should be addressed “specifically and surgically, and not with such a broad and crude brush” as eliminating the accounts altogether.

The IIAC also pushed back, arguing that investors may not always be able to communicate with their financial advisor. Temporary discretionary accounts let clients choose how their accounts are handled during temporary absences, IIAC’s submission said.

IFIC also said the accounts should be preserved, and that they should be available to fund dealers too.

However, the CAC agreed with eliminating temporary discretionary accounts. Using fully managed accounts makes more sense for clients who are intermittently out of touch, the CAC argued, as managed accounts provide greater certainty about the terms of the client-advisor relationship and have more appropriate oversight and conduct standards.

PMAC also favoured eliminating temporary discretionary accounts.

Personal corporations for investment dealers?

A separate consultation considered a coveted reform for investment dealers: expanding the use of personal corporations. CIRO proposed a path to eliminate the long-standing disparity that allows fund reps to funnel a portion of their revenue through personal corporations, a business structure prohibited to investment dealer reps.

The inconsistency is a legacy of the pre-SRO world that enabled fund dealers to take advantage of tax rates for that are lower for businesses than for individuals.

In January, CIRO published three options for resolving this regulatory incongruity and detailed its preferred approach: allowing both investment dealer and fund dealer reps to use personal corporations approved by the SRO and under its oversight.

Alternatively, reps could use personal corporations registered with the provincial regulators; or reps could direct a portion of their revenue (the share that isn’t derived from registrable activities) through unregistered personal corporations (as fund dealer reps can do now).

That paper is out for comment until March 25, although any solution to this long-running problem would still have to go through the regulatory rule-making process.

This article appears in the February issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.