Regulation And The Retail Investor
In the last few years, a lot of regulatory change has occurred that impacts the retail investor. Here's a summary of the most prominent reforms:
A New Self-Regulating Organization (CIRO) Is Now In Place
The consolidation of the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) formally took effect on 1 January 2023, with new nomenclature, the Canadian Investment Regulatory Organization (CIRO). The project to consolidate and enhance self-regulation was initiated by the Canadian Securities Administrators (CSA), which sought an overhaul of the Self-regulating Organization (SRO) framework. The new structure will benefit dual-platform Dealers, which will now combine compliance under CIRO. The new SRO enhances retail investor representation in the self-regulatory system with the creation of an independent Investor Advisory Panel (IAP), an Investor Office and increased regulatory oversight. It is anticipated that CIRO will be more investor-focused with more robust enforcement practices.
Trusted Contact Person (TCP) Option Introduced
As of 31 December 2021, an advisor now is required to take reasonable steps to see if a client would like to name a Trusted Contact Person (TCP) when opening an account and when updating a client's information. The TCP initiative provides an advisor with a tool to help protect clients should they suspect they are experiencing financial exploitation or diminished mental capacity. It allows the financial advisor to know who the client trusts and who they have permission to contact when they are concerned about the client's financial well-being. Appointing a TCP is encouraged but read the Dealer's appointment letter carefully.
New Rule On Temporary Transaction Holds
Under recent securities law amendments, Dealers may place a temporary hold on a transaction if they believe the client is being financially exploited or if they appear to be impacted by diminished mental capacity to make sound financial decisions. Upon placing a temporary hold, action must be taken to determine the next course of action. This might include contacting the TCP.
A temporary hold does not apply to the client's entire account, only to the suspicious transaction. Transactions that are unrelated to suspected financial exploitation or an apparent lack of mental capacity should not be held. For example, if a temporary hold were placed on a sale of securities, pre-authorized rent payments from the client's account would not be suspended or held. Where a temporary hold is placed, Dealers will have to document the reasons for doing so, provide notice of the hold and the reasons to the client, and, within 30 days of placing the hold, either revoke the hold or provide notice to the client regarding the decision and reasons for maintaining the hold. Where the temporary hold is maintained, the Dealer would have to provide subsequent notification to the client every 30 days.
Client Focused Reforms Are Being Deployed
Investment dealers are implementing new regulations intended to ensure financial advisors and their firms are providing a high standard of care for their clients. These rules, called Client Focused Reforms (CFR), are based on the concept that client interests should always come first in the client-advisor relationship. For example, the rules require that advisors address material conflicts of interest in the client's best interests. The CFRs outline how material conflicts are expected to be identified, documented, addressed, and disclosed. Conflicts arising from proprietary products and incentive and third-party compensation arrangements must be fully disclosed and documented, and a Firm must be able to substantiate how these products and arrangements are aligned with a client’s interests.
Advisors must put their clients' interests first when making a suitability determination. An ongoing suitability determination is required when assessing the suitability of the type of account, conducting periodic reviews of a client's account, acting in response to client instructions and liquidating securities. For more information on CFR, see Putting Investors First: How Client Focused Reforms Affect You. (https://www.securities-administrators.ca/investor-tools/putting-investors-first-how-client-focused-reforms-affect-you/)
SEDAR+ Is Finally Launched
The long-awaited System for Electronic Data Analysis and Retrieval + (SEDAR+) was launched on 25 July 2023. SEDAR+ is the new web-based technology platform that will be used by all market participants to file, disclose, and search for issuer information in Canada's capital markets. The new platform is designed to better support how issuers, SEDAR+ filing agents and data consumers file, disclose and access issuer financial data and information. The 24/7, web-based platform will simplify the disclosure process for issuers and was developed to improve the user navigation experience. This updated system should make it easier for retail investors to access company and investment fund disclosure documents.
Deferred Sales Charge (DSC) Mutual Funds Are Now Banned
The move away from DSCs is an important step forward in simplifying the mutual fund fee structures that investors simply do not understand. Large upfront DSC payments to salespersons incentivize them to sell the highest fee products and don't provide an incentive to provide ongoing advice and financial planning since the client is locked into the DSC mutual fund for six or more years. Ensure you are no longer being sold a DSC fund.
The bad news is that some Dealers have been able to subvert regulatory intent. A system called chargebacks has been introduced wherein salespersons are provided an upfront cash advance by the Dealer upon the sale of a mutual fund. The salesperson must compensate the Dealer in the event the investor redeems the fund within five years. This leads to the conflict of interest associated with outsized upfront payments and creates a disincentive for the salesperson to recommend a sale (redemption) even if the fund is not appropriate for clients.
Access Equals Delivery (AED) On The Horizon
Regulators have proposed rule changes that would allow issuers to meet their regulatory obligations for providing investors with disclosure—such as prospectuses and annual and quarterly financial statements—by uploading those documents to the regulator’s online system, SEDAR (and on their website), and issuing a news release alerting investors to their availability. Issuers would not, however, be able to rely on the AED model for materials that are time-sensitive and require immediate shareholder action, such as proxy circulars and takeover and issuer bid circulars. Investors would somehow have to become aware of the news releases applicable to them and then access SEDAR to find the document(s). This is NOT "delivery".
According to regulators, the so-called modernization is designed to reduce the costs of delivering physical documents, such as printing and mailing costs, while preserving the ability of investors to request paper documents. Investor advocates have vigorously resisted a shift to AED, citing concerns that the approach could reduce shareholder engagement and disenfranchise certain investors. Advocates recommend that SEDAR+ should provide a free subscription service wherein investors would receive an email notifying them of a disclosure and provide a direct link to it. There is a real concern that the regulators will ignore investor arguments and proceed with AED.
IIROC (Now Part Of CIRO) Proposes An Updated Arbitration Program
IIROC has had an arbitration program for years, but it attracted little usage. A proposal has been put forward to modernize it so it will meet more closely the needs of complainants. Some of the ideas are positive, such as reducing fees and streamlining the process. A major concern is that it could be used for dollar amounts that overlap with the free dispute resolution services offered by the Ombudsman for Banking Services and Investments (OBSI). CIRO is currently studying the comments received by stakeholders. The program does not apply to mutual fund dealers. See the Kenmar Associates comment letter from the retail investor perspective. (https://www.iiroc.ca/sites/default/files/2022-12/Kenmar%20Associates-December%2013%2C%202022.pdf)
OBSI Binding Decision Mandate Consultation To Be Held
As things stand today, investment Dealers are not required to comply with an Ombudsman compensation recommendation. A number of retail investor compensation claims have been low-balled, to their detriment. Regulators plan to conduct a consultation this year on a proposal that would grant the OBSI a binding decision mandate. 2024 might be the year we finally see this much-needed investor protection issue finally resolved.
Thousands Of Salespersons May Be Titled "Financial Advisors" In Ontario
The Ontario insurance regulator, the Financial Services Regulatory Authority of Ontario (FSRA), has approved several institutions (Credentialing Bodies) to grant qualifying members the use of the Financial Advisor (FA) title in Ontario. Investor advocates view this as misleading, given the relatively low proficiency profile needed to qualify for the Ontario FA title and the licensing restriction to only sell mutual funds. Titles are often used by Bay Street for marketing purposes and do not reflect the representative's proficiency. Check the registration of the person you are dealing with to better understand the true nature of the advice you can expect to receive.
Total Cost Reporting (TCR) Coming
The TCR enhancements will improve the transparency of total fees and costs to holders of investment funds and segregated funds. The changes will bolster investors' and policyholders' awareness of the ongoing embedded costs of owning investment funds and individual segregated fund contracts, including management fees and trading expenses. The new regulations will take effect on 1 January 2026.
Investors will see their 2026 costs in a statement they will receive in mid-January 2027. Slow industry response is the cause of the extended time period. To learn more, visit What is total cost reporting and how it will work?(https://www.getsmarteraboutmoney.ca/learning-path/rules-and-regulations/what-is-total-cost-reporting-and-how-it-will-work/#:~:text=Total%20cost%20reporting%20will%3A,%2Dtraded%20funds%20(ETFs).)
Single, Non-Profit External Complaint Body (ECB) For Banking On Horizon
It has taken years of consumer advocacy, but finally, the federal government has decided that a competitive External Complaint Body (ECB) system is not fair to consumers. Sometimes this year or early next year, the Financial Consumer Agency of Canada (FCAC) will recommend an entity as the sole independent, non-profit dispute resolver for banking complaints. Consumer advocates are hoping that OBSI is selected, given its experience and track record. This would be a step forward for Main Street financial consumer protection.
There's plenty of change going on in the securities sector. Stay tuned for updates.
Ken Kivenko, Peng (retired), President , Kenmar Associates, Etobicoke, ON, kenkiv@sympatico.ca, www.canadianfundwatch.com