Along with the removal of embedded commissions, one of the most talked-about issues in the Canadian investment funds industry these days is the potential of changing the current standard of care financial advisors provide to their clients.The Canadian Securities Administrators (CSA) sent out a consultation paper on the standard of conduct for advisors and dealers last year exploring the appropriateness of introducing a statutory best interest – or fiduciary – duty when advice is provided to retail clients.

At the end of 2013, the CSA sent out two reports stating it required further consideration of the issues raised during its consultations on both fiduciary responsibility and changes to the mutual fund fee structure “to co-ordinate their policy considerations on these initiatives.”

“We anticipate communicating in the coming months what, if any, regulatory actions and/or research we intend to pursue,” the CSA said.

Duty of care

Right now in Canada, financial advisors have a duty of care to act fairly, honestly and in good faith. This includes knowing the client’s financial circumstances, objectives and risk tolerance. It also requires advisors understand the products they offer so they can recommend suitable products to each client.

But a key point is that currently – in most cases – the decision on which product to buy is up to the client, said Ralf Hensel, director of policy, fund manager issues at the Investment Funds Institute of Canada (IFIC).

However, there are some investors who want their advisor to make all the investment decisions for them.

“If a client says to you, ‘Here’s my money, invest it for me’ and the advisor says ‘Fine, I’ll do that’, they are putting themselves in a fiduciary relationship,” said Hensel. “But if the investor says, ‘I want you to recommend some products for me but I still reserve the right to make the decisions’, then that’s not a fiduciary duty, that’s the duty of care.”

Currently, there are “managed” accounts in which an advisor, with the client’s consent, makes investment decisions on behalf of the client, but doesn’t need to approve every decision. As well, Quebec has the duty of loyalty and duty of acting in the client’s best interests in some circumstances. But for the most part, the standard in Canada is duty of care via suitability, Jeff Scanlon, senior legal counsel at the Ontario Securities Commission (OSC) told a recent roundtable.

On July 1, 2013, Australia introduced a statutory best interest standard for its advisors so that advisors must act in their clients’ best interests and place these interests ahead of their own when developing and providing personal advice. The Australian Securities & Investments Commission says this means advisors “must make ‘reasonable inquiries’ to obtain accurate information from the client and conduct a ‘reasonable investigation’ into relevant financial products. This is designed to protect advisors from clients claiming that the advisor should have done something onerous or unreasonable in order to act in their best interests.”

“Best duty is probably the most welcomed part of the entire set of reforms,” said Dante De Gori, general manager policy and conduct with the Financial Planning Association of Australia (FPAA) Ltd., the main financial planners’ organization in Australia.

Tougher standards

However, De Gori said tougher standards mean increased costs of compliance that could get passed on to clients.

He also said advisors are concerned that if they put a client in, say, a growth fund and the markets fall, clients will lay all the blame on the advisor even if the market decline is international or in one particular segment.

The reform on duty to clients in Australia followed surveys that showed evidence of conflicts of interest, sub-par advice and the belief by about two-thirds of retail and institutional investors that advisors were not acting in their best interests.

In the United Kingdom, there has been a qualified best interest standard since 2007. However, as part of a more sweeping set of regulations called the Retail Distribution Review (RDR), regulators also banned commissions as of Jan. 1, 2013, required more robust proficiency requirements and made clearer the kinds of advice investors could receive from independent and restricted advisors – those who can advise on any product or service and those that have a limited list of products and providers they can advise on.

Fiduciary responsibilities

All three of these regulations help the advisor fulfil their fiduciary responsibilities, said Mike Gould, senior advisor, retail distribution with the Investment Management Association in London.

“With those rules already there what the regulator was trying to do is effectively make the retail financial advice market more professional so that these advisors are better equipped to exercise their fiduciary duty,” Gould said in an interview.

He said there is a definite move on the part of a number of countries in Europe to bring in regulations similar to RDR.

“So the UK may have jumped the gun a bit but that is certainly the direction. If in Canada, some version of RDR is adopted that seems to be in line with what’s happening in most Western economies. The objectives set out in RDR are difficult to argue against.”

IFIC’s Hensel says the term “fiduciary” may not mean exactly the same thing around the world, but has been well-defined by Canadian courts.

It is, in fact, in the advisor’s best interest to serve their clients well because they will keep coming back, he added.

If Canadian regulators decided to implement fiduciary duty for everyone, it will raise a number of questions.

“Does this mean that advisors have to guarantee the client’s results? I think that’s unrealistic to ask of the advisor community because it transfers responsibility for market outcomes to the advisor, but no one can predict the future,” said Hensel.

During a roundtable this past summer hosted by the OSC, Harold Geller, a lawyer with Doucet McBride LLP, said it is now up to regulators to ensure that any description about best interests includes the advisor’s responsibilities.

“Best interest is a …new statement,” said Geller. “And I think that the securities commission and the CSA, in issuing it, should make clear that this is a fundamental principle. It means that the client’s interest always must be put first and the advisor … if they’ve recommended something which arguably is not in the best interest [of the client], they’re going to have to justify it. I think that should be the standard because they’re the ones in the power position.”

And while some at the roundtable voiced the opinion that introducing fiduciary duty will change the entire business models of some companies, Lindsay Speed of FAIR Canada said the industry will adapt.

“It’s our expectation that new models will develop and that the industry, in its ability to innovate, will be able to deliver services, basic services that people need, at a lower cost and therefore have better outcomes for investors,” Speed said.

Other investor advocates raised their concerns that most clients already believe their advisors have a “best interest” standard of care and that regulators should ensure that investors are protected in whatever new proposals they bring forward.

The OSC’s Scanlon said during the roundtable that the rules put forward in Australia and the UK are “instructive” and “helpful” as the CSA reviews the prospect of introducing fiduciary responsibility into Canada.

“But I don’t think this is a situation where, because we see what’s going on there … that that’s necessarily the only solution for us,” Scanlon said. “I think we just need to ensure that we are doing what’s right for Canadian investors and Canada’s capital markets.”

See also: Banning embedded commissions - A series of three articles by Susan Yellin