Investor protection body asks for clarity around conflict of interest proposals
FAIR Canada has challenged the Canadian Securities Administrators to clarify its conflict of interest reforms.
In June, the CSA published a series of industry proposals around best interest and embedded commissions, which also detailed major changes to know-your-client requirements and suitability obligations. The consultation period is ongoing.
In an open letter, FAIR said it has long advocated for a statutory best interest standard so that Canadians receive objective, professional financial advice.
It read: “Of key importance to successful implementation of a best interest standard is the adoption of rules that prohibit embedded commissions and other advisor compensation arrangements that foster the misalignment of client and advisor interests (‘conflicted remuneration’).
“This is necessary to ensure that registrants provide their services in a manner that does not actively jeopardize or subvert the interests and well-being of their clients since an abundance of evidence has clearly demonstrated that compensation drives behaviour.”
FAIR also asked the CSA to explain how firms are supposed to address conflicts of interest between itself, or individuals acting on its behalf, and the client while the “firm continues to utilize embedded commissions or employs incentive programs or sales targets or only sells products from a related issuer”.
The investor watchdog said that the CSA had listed various controls which place an onus on individual firms and their registrants to address the conflicts of interest even though such firms profit from these conflicts.
It requested that the CSA take a look at a number of potential situations to explain how, in reality, firms can address these conflicts in an effective manner.
The scenarios detailed in the open letter are as follows:
1. Embedded Commission Only MFDA Dealer
Client works with a MFDA dealer who recommends only proprietary mutual funds with embedded commissions and recommends the client invest in a fund-of-fund mutual fund product with a 1%
trailing commission and a MER of 2.04%. Client is provided with disclosure at time of account opening and before the trade but the suitability analysis does not consider the larger market of nonproprietary products or whether those non-proprietary products would be better, worse, or equal in meeting the client’s investment needs and objectives. The mutual fund cannot be transferred in kind to any other firm.
2. Commute the Value of a Pension
An individual has recently retired and is deciding whether to keep her money with her employer’s pension provider or move it. She is approached by an advisor at an IIROC dealer owned by a major financial institution who recommends that the person move their funds out of her workplace pension to be invested by the advisor on the basis that the firm offers a wider selection of products even though the investment costs at the pension firm are lower.
3. Leveraged Investing
Advisor recommends that a 50 year old client borrow $100,000 to invest in equity mutual funds in order to meet their financial goals as current rate of savings and investment is not on target absent a leveraging strategy and that the loan be taken out against the equity of her jointly owned home. The client has two children in high school, a $325,000 mortgage on her Toronto home which is currently valued at $1.1 million, a $100,000 available line of credit (balance paid off on periodic basis as a result of bonus income received) and $200,000 in RRSP assets. The advisor will receive a 5% referral fee from the lender and will have more assets under management from which to earn commissions from the embedded commissions. Both conflicts are disclosed.
4. Exempt Market Dealer
This dealer offers prospectus exempt products of only related or connected issuers to its clients. It recommends, pursuant to the OM exemption, that John Adams, who meets the test of an eligible investor, invest $100,000 in a mortgage investment corporation. Mr Singh, who also meets the test of an eligible investor, is advised to invest in promissory notes in the amount of $100,000. The conflict of interest in investing in a related party was disclosed.
