Investment industry firms are reviewing their client relationship policies and procedures to ensure their financial advisors comply with new investor-protection rules that come into effect at the end of the year.
In October, the Canadian Securities Administrators (CSA) introduced the final version of the client-focused reforms, with some amendments. The rules, which were first introduced in June 2018, put the onus on investment firms and advisors to ensure clients’ interests come first when determining suitable investments for their portfolios. The rules also do more to help clarify what investors should expect from their advisors.
The reforms introduce “new obligations on registrants” and “codify best practices,” including increasing the amount of information compiled for the know-your-client (KYC) and know-your-product (KYP) documents.
Although many advisors already have internal policies and procedures around client relationships, the new rules will ensure they meet industry standards and are well documented, says Lori Stein, partner in the investment funds and asset-management group at Osler, Hoskin & Harcourt LLP in Toronto.
“For many advisors, the status quo is unlikely to be sufficient,” Ms. Stein says. “There are going to have to be enhancements. Even if, at the end of the day, the actual process doesn’t change that much, there has to be thought given to all of it ... especially on the conflict of interest side. If your practices don’t change at all, you’re going to have to explain and justify why that is.”
She says the amendments acknowledge the level of detail that needs to be provided will depend on the firm’s business model, the type of clients it has, the services it offers and its relationship with clients. Still, most firms will most likely need to tweak what they have in place, at least.
“I would expect most advisors, unless they have an extremely simple business model, are going to have to look at each item ... and document why it is relevant to their ‘know your client’ and suitability analysis,” she says.
An example of where the rules may force some advisors to improve their processes and get more information from clients is around recommending investments that are “illiquid or highly risky,” according to the CSA document.
“Risk is an area that, historically, clients haven’t really understood, and the know-your-client process has been a bit superficial ... outside of the more in-depth [client-advisor] relationships,” Ms. Stein says. “It gives the clients a better understanding of risk. For advisors, it gets them to think about risk in a different way, what it’s going to mean to a client’s portfolio and whether the investment is suitable.”
The conflict of interest section is where many firms will need to do some work, Ms. Stein says. The reforms introduce a new requirement that says, “material conflicts must be addressed in the best interest of the client.” She says advisors will need to ensure they have the proper documentation in areas such as referral arrangements, sales practices, compensation arrangements and incentive practices.
“That’s new, more specific guidance than what’s been there in the past about which conflicts are heightened,” she says. “While it’s true a good advisor is already managing these things in the best interest of the client, now the level of documentation and support that’s going to be required to demonstrate that the advisor is doing this is higher.”
Firms may also need to review the titles they give to advisors to ensure they’re appropriate and not misleading to clients. Ms. Stein says individual advisors can’t create titles for themselves that may make them appear more senior than they are. For example, the “vice-president” title will only be permitted for an individual who holds the corporate office of vice president of the firm.
She says there’s a requirement now for firms to adopt policies and procedures, including guidance on what titles and designations are allowed to be used, as well as restrictions.
The KYP requirement is also more explicit in the new rules. Although many large firms have a detailed process and record-keeping in place, Ms. Stein says smaller ones may need to formalize and document their policies.
“Firms will have to enhance their documentation of their know-your-product process in terms of what steps an advisor will have to take and know about that product ... before recommending it to a client,” she says.
Michael Stanley, president of Sterling Mutuals Inc., a Windsor, Ont.-based mutual-fund dealer, says many firms like his already have in place policies and procedures that address the new rules, but some enhancements and tweaks will be made in the months and years ahead to comply.
A key change, he says, is around suitability, which is being taken “to a higher level” in the client-focused reforms. An example is the assessment and impact of costs on clients’ returns.
“Suitability today is tied tightly to risk ratings and investment objectives, and we think there will be another element of suitability that brings in a pricing element in a more formal way. It’s currently being done, but it’s implicit instead of explicit,” he says.
Sterling Mutuals has communicated that changes are coming to its branch managers and advisors, Mr. Stanley says. But the firm is waiting for more specific guidance from its self-regulatory organization, the Mutual Fund Dealers Association of Canada, in the coming months.
Although he says the changes may be subtle for firms like Sterling Mutuals, he hopes the industry, overall, is proactive in ensuring the amendments are adhered to.
“It would be best if the industry didn’t underestimate the impact of the change and think that there is no change. There is a change, for sure,” Mr. Stanley says.
Norm Trainor, founder and chief executive officer of the Covenant Group in Toronto, which provides coaching for advisors, says the changes shouldn’t be a surprise to advisors who work to meet clients’ changing needs proactively .
“Regulators react to what’s going on in the marketplace. They’re very rarely ahead,” he says. “If your business is being impacted by regulation – shame on you. It says you’re behind the curve, not ahead of it.”
In terms of process and procedures, Mr. Trainor recommends advisors look at all ways to make their businesses more transparent to not only comply with the changes, but also anticipate what might be next.
“That way, you aren’t just protecting yourself, but differentiating yourself – you’re getting ahead,” he says.