Canada: CSA Registrant Proposals Have Far-Reaching Effects On Dealers And Advisers In Canada

Recently, the Canadian Securities Administrators (CSA) released an important Consultation Paper that proposes to significantly increase the obligations of all advisers, dealers and representatives, including IIROC and MFDA members (Registrants). Comments on the Consultation Paper can be made until August 26.

The CSA is proposing two distinct categories of changes that, if adopted, will significantly impact the economics of existing Registrant business models and Registrant compliance costs:

1. Best Interest Standard: A "client best interest" standard against which all Registrant-client obligations would be interpreted.

2. "Targeted Reforms": A comprehensive set of so-called "targeted reforms" will affect how the following key areas are addressed:

  • Conflicts of interest
  • Know you client procedures (KYC)
  • Know your product procedures (KYP)
  • Suitability
  • Relationship disclosure
  • Proficiency
  • Business titles
  • Use of professional designations
  • Role of the ultimate designated person (UDP) and chief compliance officer (CCO)
  • Statutory fiduciary duty when client grants Registrant discretionary authority.

The CSA sets out numerous consultation questions in respect of the Best Interest Standard and for each of the Targeted Reforms.

"Best Interest" Standard

The Consultation Paper is the latest in a series of CSA publications since 2012 which have studied the Registrant-client relationship and the possible introduction of a "best interest" standard for Registrants.

The Consultation Paper reveals that CSA jurisdictions are split on the wisdom of introducing a Best Interest Standard. British Columbia is opposed to the Best Interest Standard and is not even soliciting comments on it; Quebec, Alberta, Manitoba and Nova Scotia have strong reservations about it but are interested in receiving and reviewing the comments on the "Best Interest" Standard.

Only Ontario and New Brunswick are in favour and Saskatchewan is open to further consultations.

A regulatory Best Interest Standard would require that a Registrant:

  • deal fairly, honestly and in good faith with its clients and act in its clients' best interests
  • adopt the standard of care of a prudent and unbiased firm or representative, acting reasonably
  • be guided by the following principles:
    • act in the best interest of the client
    • avoid or control conflicts of interest in a manner that prioritizes the client's best interests
    • provide full, clear, meaningful and timely disclosure
    • interpret law and agreements with clients in a manner favourable to the client's interest where reasonably conflicting interpretations arise
    • act with care.

Opponents of the Best Interest Standard believe it would create more legal uncertainty and investor confusion and may actually exacerbate the expectation gap between clients and Registrants because business models with some fundamental conflicts of interest would continue to be permitted to operate, even as investors would come to believe a true "best interest" standard is in place.

In general, an overarching best interest standard could also impact civil liability of Registrants as it relates to negligence claims. Registered dealers would be most affected by the Best Interest Standard. Investment fund managers and portfolio managers are already subject to fiduciary duties by statute or at common law.

The Targeted Reforms

The Targeted Reforms are presented in the Consultation Paper as a set of proposals separate from the Best Interest Standard. This decoupling is significant as it could allow the Targeted Reforms to advance and be adopted even if CSA members fail to ultimately agree on the more controversial Best Interest Standard.

While the CSA states that elements of the Targeted Reforms are simply meant as an explicit articulation of expectations that the CSA already has for compliance with the current regulatory regime, the Targeted Reforms would nonetheless greatly increase the obligations of Registrants in a number of areas:

  • Conflicts of interest. Registrants would be required to respond to all material conflicts of interest in a manner that prioritizes the interests of the client ahead of the interests of the firm and representative. If this is not possible, the Registrant must avoid the conflict by ceasing to provide the service or product, or ending the relationship with the client. Simply disclosing the conflict to clients and getting their consent would not necessarily be sufficient. Under the current regime, a Registrant must avoid a conflict altogether only when the conflict is prohibited by law or when no other "reasonable response" is available.
  • KYC and KYP. Both KYC and KYP requirements would be made explicit and enhanced. For KYC, registrants would be required to gather, and regularly update, more client-centered information regarding investment needs and objectives, financial circumstances and client risk profile. For KYP, firms that have a product list that includes both proprietary and non-proprietary products (or non-proprietary products only), would be required to conduct a market investigation and product comparison as to ensure the range of products offered is representative of a broad range of products suitable for their client base.
  • Suitability. Suitability obligations would be significantly enhanced. Registrants would be required to consider basic financial strategies which would be more likely to achieve the client's investment needs and objectives than a transaction in securities. Registrants would also need to identify a basic asset allocation strategy for the client. A targeted rate of return needed to achieve client objectives would need to be identified and any mismatches between the target rate and the client's risk profile would need to be resolved. Registrants would have to ensure that the purchase, sale, hold or exchange of a security (or the decision not to purchase, sell, hold or exchange a security) was both suitable and "most likely to achieve the client's investment needs and objectives". Under the current regime, suitability is primarily a "trade-based" obligation with no explicit requirement to conduct a suitability analysis for a recommendation or decision to hold or exchange securities.
  • Relationship disclosure. In addition to the prescribed information that Registrants must currently deliver to clients regarding the Registrant-client relationship, firms would also be required to disclose the actual nature of the client-Registrant relationship in easy-to-understand terms. New disclosure obligations at the time of account opening would also be imposed on Registrants with restricted registration categories, such as mutual fund dealers or exempt market dealers. Registrants would be required to disclose whether they offer proprietary products only, or a mix of proprietary and non-proprietary products and make related disclosures to clients.
  • Proficiency. Explicit and increased proficiency requirements for representatives would be introduced.
  • Business titles. All client-facing business titles for representatives will be prescribed.
  • Use of professional designations. Specific rules would be introduced on the permitted use of professional and educational designations.
  • UDP and CCO roles. The roles and obligations of the UDP and CCO would be further clarified by amendments to NI 31-103.
  • Statutory fiduciary duty for discretionary accounts. Registrants that manage the investment portfolio of a client through discretionary authority granted by the client would become subject to a new statutory fiduciary duty.

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