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Jun 30, 2016

The Best Interests Advice Standard

by Ken Kivenko

Ken KivenkoUnder prevailing rules and regulations, investment “advisors” need only provide you recommendations that are suitable. Imagine this for a moment: You would never ask a lawyer, an accountant or a doctor if the advice they were giving you was in your best interest or merely suitable. You rightfully assume it. But sadly, investors are being asked to make this distinction today with their financial advisors. And sadly, most retail investors don’t have the tools to evaluate the differences between suitable and best interest. Many wrongly believe the Best Interests duty is in place.

A report, Lack Of Truth In Advertising Deceives Investors from Small Investor Protection Association, deftly illustrates the divergence of the advisory services promoted by industry versus the actual services delivered.

Under a suitability standard, certain products like mutual funds can and do compete by offering generous remuneration to the sellers, and that’s the problem. Investors end up paying high costs, suffering substandard performance, being exposed to unnecessary risks and subjected to exploitive behaviours as a direct result. Suitability does not require advice to be in the best interest of a client or to be the lowest priced or least risky option available; it simply requires advice to be suitable, which is, of course, a very broad definition that benefits the advisor and the dealer at the expense of the consumer. That has a huge impact on the ability of Canadians to afford a decent standard of living in retirement or fund other long-term financial goals. Retail investors need and deserve advice which is competent, objective, transparent, and understandable.

In a 2011 Financial Post comment piece, former OSC Chairman Ed Waitzer noted that, as one commentator to a published SEC staff study noted: “If the product sold is that of advice, then that advice should be in the best interest of the client. Anything else is fraud, because the seller is delivering a service different from what the consumer thinks he or she is buying.” Read the full article Make Advisors Work For Investors

If you visit the website of the Canadian Securities Administrators you can check the registration status of individuals offering advice. What you will find is that the vast majority of “advisors” are in fact registered as salespersons or dealing representatives. Most of the titles used on business cards are just marketing ploys. They do not provide advice under a Best Interests regime. There is a small number of registrants identified as Portfolio Managers; these do have a fiduciary duty to clients but their clients typically are high net worth individuals. Also, investment fund managers (IFM) are subject to a statutory best interest standard or fiduciary duty. Every IFM must (i) exercise the powers and discharge the duties of their office honestly, in good faith and in the best interests of the investment fund, and (ii) exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in the circumstances.

With the decline of Defined Benefit Pension plans, more volatile markets, technological change, an aging population and complex investment products, investor risks and vulnerabilities are much greater than ever before. Canadian investors are highly vulnerable due to low financial literacy, information asymmetry versus dealers/dealing Reps (“advisors”), overconfidence in their investing skills, blind trust in advice givers incented by commissions and a desperate search for yield in a low interest environment. Whatever savings they have must be protected with trusted financial advice. The industry has evolved from a transaction industry to wealth management—it's time for regulations and standards to catch up.

Holding financial advisors to a fiduciary standard would require them to act solely in the best interests of their clients, and avoid or disclose all conflicts of interest/self-dealing that arise in the advisor-client relationship. Currently, financial advisors in Canada are held to a “suitability” standard that does not require them to act in the best interests of their clients, instead, they must simply ensure that any investment recommendations are suitable given a client’s personal profile and objectives. The implementation of a fiduciary standard would have widespread implications for the financial industry, as advisors would be required to ensure that all recommendations were in the best interest of their clients, including the optimization of all fees and expenses, which is typically at odds with the dealer representative’s goal of maximizing revenue from a client account.

The key change needed is to raise the standard of care that financial advisors owe their clients to a fiduciary standard (referred to as “Best Interests”). There has simply been too much investor exploitation under the lowly suitability standard. This change has already occurred in the UK, Australia and elsewhere. Under a separate initiative, the U.S. Department of Labor recently released a finalized fiduciary rule defining who is a "fiduciary" of an employee benefit plan under the Employee Retirement Income Security Act of 1974 (ERISA). A change to Best Interests is disruptive and the road has been bumpy loaded with vigorous industry opposition along the way wherever it has been introduced. However, it is a journey that Canada must take to better protect the life savings of investors who more than ever, are responsible for their own retirement income security.

In a 2013 Consultation Paper, the Canadian Securities Administrators (CSA) proposed for comment the standard that every advisor 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,

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

In the latest consultation , the CSA state it is not their intention for the Standard of Care to automatically result in firms and representatives owing a common law fiduciary duty to their clients.

Two critical elements of a fiduciary duty are:

  • A duty of loyalty—fiduciaries should act in good faith, in the best interests of their client or beneficiaries. They should avoid conflicts of interest, and should not act for the benefit of themselves or another third party
  • A duty of prudence—fiduciaries should act with due care, skill, and diligence, investing as a “prudent man” would do.

Best interests means no conflicts-of-interest or at a minimum mitigating conflicts of interest. It implies that appropriate professional tools such as an investment policy statement will be routinely used. Best interests implies no game playing—unduly expensive products, unnecessary leveraging, misleading ads, with-holding of important decision making information, misrepresentation, made up titles and designations, no account churning etc. It means working to a publicly available Code of Ethics and Code of Conduct. A Best Interests duty implies the obligation to provide full disclosure on portfolio fees / expenses and account performance .

Specifically, for Kenmar, Best Interests means a process including these elements:

  • Distilling the objectives, financial situation and needs of the client that were identified through forms, tests and discussion;
  • Identifying the subject matter of the advice sought by the client (whether explicitly or implicitly);
  • Clearly identifying the objective(s), financial situation and needs of the client that would reasonably be considered relevant to the advice sought on that subject matter;
  • If it is reasonably apparent that information relating to the client’s relevant circumstances is incomplete or inaccurate, make reasonable inquiries to obtain complete and accurate information;
  • The Representative must assess whether he/she has the expertise to provide the advice sought and, if not, decline to give the advice or refer to a subject matter professional;
  • If it would be reasonable to consider recommending a financial product (or investment strategy like leveraging), conduct a reasonable investigation into the financial products that might achieve the objectives and meet the needs of the client that would reasonably be considered relevant advice on the subject matter and assess the information gathered in the investigation ( choose the lowest cost product that meets minimum requirements);
  • Disclosing why proprietary products are more appropriate to the client’s objectives, constraints, risk profile than products from third parties available from the advisor;
  • Base all judgments on the client’s prevailing relevant circumstances and solely on their best interests;
  • Take any other step that, at the time the advice is provided, would reasonably be regarded as being in the best interests of the client, given the client’s relevant circumstances at the time. This could include for example not to make an investment if high credit card interest is being incurred or insurance coverage is inadequate.

Being a fiduciary is not about the types of service offered, it’s about the quality of service. The big issue here is the definition of Best Interests in the context of investing. Some regulators have hinted that the Best Interests " standard is an objective standard for assessing the processes used when delivering investment advice and accordingly will not examine investment performance retrospectively. Dealers must ensure that they have the infrastructure to support the provision of trusted advice. This includes but is not limited to information systems, personnel selection and training programs, administrative processes, policies, procedures and rules, product research, supervisory oversight, compliance monitoring and timely and fair client complaint handling.

A Best Interest standard does not impose a “perfect advice” standard. In certain situations, advice that the client “do nothing” will satisfy the best interests duty, if a reasonable advice provider would believe that the client is likely to be in a better position if the client follows the advice.

Ultimately, we anticipate regulators will expect advisors to exercise judgment in acting in the best interests of the client .They will likely regard a “one-size-fits-all” advice model to be insufficient.

After many consultations and much research, Ontario and the Canadian Securities Administrators (CSA) seem ready to introduce some sort of Best Interests standard for personalized advice to better protect retail investors.

On April 28th the CSA released a consultation paper that includes proposed targeted reforms to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, as well as potential guidance in a number of areas that would work together to better align the interests of registrants to the interests of their clients, better define the client-registrant relationship for clients and enhance various specific obligations that registrants owe to their clients. Several provincial regulators have significantly different approaches. At the far end of the spectrum, the British Columbia Securities Commission (BCSC) has ruled out the proposed standard. It is not even prepared to consult on the idea. It remains to be seen how all this shakes out.

We are probably years away from seeing any real reforms put in place. Even when introduced, a lot will depend on the definition of “Best Interests” and the applicable rules. The success of a Best Interests standard will also depend on regulatory enforcement, enhanced KYC/risk profiling processes, how dual licensed advisors are treated, the type of fee structures put in place and how complaints are handled.

Until a meaningful Best Interests standard is invoked, it's CAVEAT EMPTOR.

Ken Kivenko, PEng, President , Kenmar Associates, Etobicoke, ON (416) 244-5803,,