FIDUCIARY - TO BE OR NOT TO BE

Federation of Mutual Fund Dealers3rd Annual Federation of Mutual Fund Dealers’

ConferenceApril 29, 2014

David Di Paolo, BLG LLP

Today’s discussion

1. Fiduciary or No Fiduciary

2. Overview of the CSA’s proposal for a Best Interest Standard

3. Response from industry participants

4. What is the experience in Other Jurisdictions

5. Impact of a Fiduciary Standard - Examples

6. What does this mean for the Sale of Insurance Products – Will Advisors Jump Ship

7. Next Steps

1. Fiduciary or No Fiduciary

• CSA Staff Notice 33-316

2. Overview of the CSA’s proposal for a Best Interest Standard

• A fiduciary is a legal concept wherein an agent or trustee has an absolute obligation to act for the sole benefit of the principal or beneficiary.

Common Law Fiduciary Obligation

Hunt v TD Securities, 66 OR (3d) 481•Five factors to consider when determining if a financial advisor owes a fiduciary duty to their client:

• 1. Vulnerability- the degree of vulnerability of the client that exists due to such things as age or lack of language skills, investment knowledge, education or experience in the stock market

• 2. Trust- the degree of trust and confidence that a client reposes in the advisor and the extent to which the advisor accepts that trust

• 3. Reliance- whether there is a long history of relying on the advisor’s judgment and advice and whether the advisor holds him or herself out as having special skills and knowledge upon which the client can rely

Common Law Fiduciary Obligations

Hunt v TD Securities, 66 OR (3d) 481•4. Discretion- the extent to which the advisor has power or discretion over the client’s account

•5. Professional Rules of Conduct- help to establish the duties of the advisor and the standards to which the advisor will be held

Current Duty for Dealers

There is no current statutory fiduciary obligation in Ontario.

Whether a dealer owes a fiduciary duty to a client is determined at common law on a case by case basis.

The existence of a fiduciary duty will depend on the circumstances of the dealer/client relationship.

Professional standards

IIROC• not engage in unbecoming business conduct or practice

• be of good character and business repute

• observe high standards of ethics and conduct in business

MFDA• same as IIROC

• deal fairly, honestly and in good faith with clients

OSC• firms/individuals - deal fairly, honestly and in good faith with clients

• investment funds mangers – exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in the circumstances – discharge duties honestly, in good faith

and in best interests of fund

The CSA’s Proposal

The CSA released a consultation paper which proposed introducing the following statutory “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,

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

The CSA’s Proposal – Why now?

The CSA has identified the following concerns they hope a statutory standard would address1.The current standard of conduct does not recognize that the securities industry is not like other business transactions that rely on “buyer beware”

2.Many investors do not have the financial knowledge that their advisors do

3.There is a gap between what standard of conduct currently exists and what clients expect of their advisors

4.Suitable investments may not necessarily result in investments in the client’s best interests

5.Current conflict of interest rules are not implemented effectively

3. Industry Reaction

Investor/investor advocates• Supportive of proposal

• Best interest standard would benefit investors

Registrants/industry associations• Supportive of investor protection objectives

• Support direction of current regime and changes are not required

• Further research/analysis needed

The CSA/OSC has acknowledged that the feedback received has been divided between the views of investors/investor advocates on the one hand and industry on the other

Industry Reaction, cont’d

• CSA Status Report on the consultations with investors/investor advocates and industry participants summarized four key themes:

• Significant disagreement about whether the current regulatory framework adequately protects investors and whether any regulatory response is required

• If a best interest standard is adopted, it must be clear (is an objective standard possible? will low cost would be determinative factor? will investors understand that perfect advice/positive returns are not guaranteed? are firms required to know the entire universe of products in order to recommend the “best”?)

• Potential negative impact on investors and capital markets must be carefully assessed (will advice become more expensive, less accessible and too conservative? will the traditional retail dealer be eliminated?)

• More work is needed

4. International Experience – Aus and UK

Australia and the U.K. have both passed laws imposing a fiduciary obligation upon dealers

U.K. reforms have resulted in:• Two tiers of advice which can be given: independent and restricted

• Commissions and payments must be disclosed at the outset of any client relationship and product providers can no longer provide pre-determined commissions to dealers

• Codified code of professionalism

International Experience – Aus and UK

• Australia• Future of Financial Advice (“FoFA”) reforms came into effect July 2013

(was voluntary from July 2012)

• The previous professional standard in Australia was “appropriateness” as opposed to “suitability” in Canada

• Many have concerns that the new standard is vaguely worded and creates uncertainty on the part of firms and advisors as to their new responsibilities

• “Conflicted Remuneration” is prohibited under the new set of reforms

• On December 20, 2013, the new coalition government announced changes to FoFA to reduce compliance costs and regulatory burden (which was an election commitment)

International Experience – Aus and UK

• Australia, cont’d• “The Government supports the principles of FoFA, however the previous

Government’s reforms went too far, creating unnecessary complexity, imposing significant burdens on industry and reducing the availability and increasing the cost of advice to consumers.”

• Amendments were introduced into Parliament on March 19, 2014 intended to address these concerns:

• Removing the “opt-in” requirement, which required clients to agree to continue their relationship with their adviser every two years

• Amend the requirement to provide fee disclosure statements so that it applies only to new clients

• Amend the best interests duty to allow for the provision of “scaled advice”, permitting advisers and client to agree on the scope of advice to be provided

• Exempting general advice (as opposed to personal financial advice) from conflicted remuneration prohibition

International Experience - US

In the United States, SEC Staff proposed the adoption of a statutory “best interest” standard for broker-dealers and investment advisors in 2011.

SEC Staff recognized that clients often do not know the difference between the obligations of investment advisors and broker-dealers.

In March, 2013, the SEC requested further comments and data concerning the consequences such a standard would have on the industry.

International Experience - US

In its request for comments, the SEC set out possible alternative approaches to a statutory standard:

• Adopt a uniform rule requiring investment advisors and dealer-brokers to disclose material conflicts of interest

• Create a uniform standard of conduct that does not reach to the level of a fiduciary duty for broker-dealers

• Apply a “best interest” standard for broker-dealers which does not raise the standard of conduct to the level applicable to investment advisors

• Provide greater specificity of professional obligations for broker-dealers which take into account fiduciary principles

• Follow the model set by the UK and Australia which sets limits on how advisors charge for their services and includes obligations to put the client’s interest ahead of their own.

5. Impact of a Statutory Fiduciary Duty

A statutory fiduciary duty invites the use of ambiguous terms which have not been clearly defined by the CSA

• “conflict of interest”• “best interests”• “full disclosure”• “ongoing” obligation

Impact of a Best Interest Standard

Suitability

•Suitability of investments would no longer be the standard for a dealer/advisor

•The new standard would be whether you acted in the “best interests” of the client

•“Best interest” has not clearly been defined by the CSA – does it mean the cheapest option?

•This may result in liability even if the investments were suitable

Impact of a Best Interest Standard

Compensation

•Does an advisor recommend only the cheapest option or else be placed in a conflict of interest?•What if the cheapest option is not the most suitable for the client?•What impact would a new standard have on commissions?•Australia and the UK have set limits on how advisors and dealers can profit from their advice

Impact of a Best Interest Standard

Legal

•Would take away defence of client individuality•If there is found to be a breach of fiduciary duty, damages may not be reduced for contributory negligence •Easier for a plaintiff to be awarded punitive damages if they are in a fiduciary relationship with the dealer or advisor•May result in an increase in class actions for Know-Your-Client claims if every client is treated as being owed a fiduciary duty•Likely to increase the cost of litigation•Will registrants become liable for market losses?

Complaint Handling

• A premium will be put upon early resolution of client complaints

Examples

• Unapproved OBA• Class Actions• Sale of Proprietary Products

6. Will advisors jump ship?

• There is no current proposal to apply a “best interest” standard to insurance brokers

• The costs associated with a new standard and the legal uncertainty surrounding an advisor’s responsibilities towards their client may cause some advisors to look elsewhere

• This may result in advisors leaving the investment industry for the insurance industry due to the lack of burdensome regulations (regulatory arbitrage is a risk raised by some)

• Alternatively, will the industry see the elimination of retail dealers, leaving discount brokerages (to whom a best interest standard may not apply) on one end of the spectrum and portfolio managers (who already owe a fiduciary duty to their clients) on the other?

7. Next Steps

• Interestingly, many of those in favour of a best interest standard were of the view that it would be insufficient to adequately address investor protection concerns and would need to be supplemented by targeted reforms in areas such as:

• Creating two categories of advisor similar to the UK model

• Improving rules relating to conflicts of interest and in particular conflicted compensation models

• Regulating advisor titles to ensure they are not misleading

• Raising proficiency and designations

• Improving suitability (including by permitting certain restricted dealers, such as mutual fund dealers, to offer a broader range of products

• Prohibiting or standardizing embedded commissions so that they are neutral to the type of product being distributed

Next Steps, cont’d

• The consultation process has clarified that more work needs to be done.

• There is a recognized connection between the work being done on the best interest standard and the work being done on mutual fund fee structures and as such the CSA intends to coordinate its policy considerations on these initiatives going forward: “… in collaboration with the Mutual Fund Fees Consultation initiative, CSA staff continue to consider and discuss the information gathered throughout consultation process with a view to determining next steps. We anticipate communicating in the coming months what, if any, regulatory actions and/or research we intend to pursue.”

CSA Staff Notice 33-316 – Status Report on Consultation under CSA 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 (December 19, 2013)

Next Steps, cont’d

• In its draft 2014-2015 Statement of Priorities (Request for Comments), the OSC indicates that it intends to take specific steps to move the best interest duty debate forward and to better understand the impacts on dealers, advisers and investors, including:

• Completing a joint OSC/IIROC/MFDA mystery shop research sweep of advisers to gauge the suitability of advice currently being provided to investors;

• Reporting on mystery shop findings, including issuing guidance on what constitutes non-compliant advice, compliant advice and good advice – findings will inform best interest duty policy development;

• Completing research that will inform its decision on the application of a best interest duty and publishing recommendations.

Thank You!