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Comments on proposed statutory best interest duty

June 25, 2013  
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Source: Originally published in Exempt Market Update, Issue 3 - the leading national magazine for the exempt market professionals.

By: Marsha Gerhart, EMDA Director, Counsel, Borden Ladner Gervais LLP

Following reforms underway in the U.S., the U.K., Australia and the E.U., the Canadian Securities Administrators (CSA) have released their long awaited Consultation Paper 33-403 – The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty When Advice is Provided to Retail Clients (the CSA Paper) on fiduciary obligations of investment advisers and dealers. The CSA is seeking comment on the desirability and feasibility of a "statutory best interest standard” for advisers and dealers when providing investment advice to retail clients. Comments are due by February 22, 2013.

For purposes of the consultation, the CSA suggests the following as one possible way of phrasing the proposed best interest standard:

Every adviser and dealer (and each of their representatives) that provides advice to a retail client with respect to investing in, buying or selling securities or derivatives shall, when providing such advice:

(a) act in the best interests of the retail client, and
(b) exercise the degree of care, diligence and skill that a reasonably prudent person or company would exercise in the circumstances.

The CSA is explicit that this duty to "act in the best interests” of clients constitutes a fiduciary duty that is not open to contractual variation. Constituent elements of this duty include ensuring that: (1) clients’ interests are paramount, (2) conflicts of interests are avoided, (3) clients are not exploited, (4) clients are provided with full disclosure, and (5) services are performed reasonably prudently.

The CSA contemplates that this duty only applies when giving dealing "advice” to a retail client, and thus would not apply to discount brokers who only take orders from clients. Existing suitability requirements will continue to apply to advisers and dealers.While jurisdictions currently have different articulations of fiduciary standard, the CSA hopes to harmonize the standard across all jurisdictions.

"Retail client” is defined to mean any person or company that is not a "permitted client” (as defined in section 1.1 of NI 31-103). This encompasses individuals that have net financial assets of $5 million or less and companies that have net assets of less than $25 million. This definition of retail client is broader than the definitions proposed by the U.S. and Australia, and would include some accredited investors.

Canadian securities legislation currently requires registered advisers and dealers to deal fairly, honestly and in good faith with their clients. While industry participants debate whether this imposes a fiduciary standard, no court or regulatory body has yet come to this conclusion. There are other additional principle-based and rule-based requirements under securities law currently applicable to adviser and dealers that directly affect the client relationship including suitability obligations, conflicts of interest responsibilities and relationship disclosure information.

The CSA highlights what they believe to be five principal concerns with the current standard of conduct in Canada:

(1) The current standard of conduct is not based on the most principled foundation;
(2) The current standard does not address the problems associated with asymmetry in investment knowledge between advisers/dealers and their clients;
(3) Investors mistakenly believe that advisers and dealers already have a duty to act in their best interest, creating a gap between expectations and legal requirements;
(4) The suitability standard is not functioning to provide investors with the best investments; and
(5) The conflict of interest disclosure requirements are not being employed effectively.

While no decision to adopt a statutory best interest standard has been made, the CSA suggests that a fiduciary duty my be the best mechanism for addressing the above cited concerns, while providing enough flexibility to accommodate the concerns raised by some stakeholders, like those highlighted below.

Increased Costs - the increased due diligence likely to accompany a higher fiduciary standard has the potential to increase costs for advisers and dealers, which could negatively impact the choice, access, and affordability of advisory services for investors

Impact on Differing Business Models – a uniform standard could negatively impact advisers and dealers whose business involves advice that is specialized or restricted in some way (for example, some mutual fund dealers, exempt market dealers and scholarship plan dealers). Similarly, there is concern about the impact that this best interest duty will have on capital raising, namely, the effect on exempt market dealers and their role in raising venture capital for smaller Canadian issuers. The concern is that one universal duty is impractical and too restrictive for these widely differing business models.

Compensation Structures - stakeholders are concerned that some compensation structures, like volume based payments or embedded commissions paid by third parties to advisers and dealers, may be inconsistent with the proposed standard. While the reforms in the U.K. and Australia are moving toward banning embedded compensation practices, the SEC is taking a different approach and evaluating each broker-dealer compensation practice to determine whether they meet the test.

The EMDA submitted a comment letter on the CSA Paper, which you can review here.

For more information contact: Marsha Gerhart

For more articles, please download the Exempt Market Update, Issue 3 - the leading national magazine for the exempt market professionals