More thoughts on best interest standards, regulation, common law and carve outs

Forgive me for posting less well prepared items, but time is short and the thoughts themselves are valid.  Noted below are some brief thoughts I sent in a recent e mail exchange (with some minor amendment) re the Ontario FINAL REPORT OF THE EXPERT COMMITTEE TO CONSIDER FINANCIAL ADVISORY AND FINANCIAL PLANNING POLICY ALTERNATIVES


One thing that has become increasingly clear to me over the years is that many securities regulations, that are supposedly there to protect Canadian investors, appear to operate as de facto carve outs from common law duties.  

Under agency law an advisor acting under instruction to buy a security would not I believe be allowed to sell you a product that is more expensive than another (and pocket the difference without your knowledge) because he gets paid more for doing so; he would owe a duty of loyalty to the principal and not to the third party to do otherwise.  

From Disloyal Agents, Demott D, 2007: “only the principal can assess how best to further the principal’s own interests and objectives. The prospect of acquiring a side benefit may distract the agent from focusing on accomplishing the principal’s objectives by biasing how the agent interprets instructions received from the principal and understands what the principal wishes to achieve. This is so even when the side benefit received by the agent does not come at an explicit cost to the principal. If the agent, in contrast, duly discloses the prospect of the side payment, in determining whether to consent, the principal may assess how the payment may compromise or aid the agent’s performance. “ p1055

Current regulations allow advisors to earn more on some products than others, thereby disadvantaging the investor and this is compliant with securities regulation.  The present best interest standard proposals via the CSA Consult appear to me to be attempting to right this carve out in an attempt to prevent advisors from recommending higher cost similar products – this is a best product standard and conforms to agency law with respect to duties of loyalty and performance.  It is not a best interest standard for advice.

At a fundamental level a fiduciary standard is a legal obligation attached to a common law duty, and in the case of advice, this common law duty is applied to advice.  Securities Acts allowed a carve out from a fiduciary duty for advice incidental to the transaction in the US in 1940 and Canadian Securities Law, I believe, is drawn from this root.    At present there are no material regulatory or statutory protections for advice provided by dealing representatives in Canada and this is affecting legal decisions in terms of establishing the relationship deemed to be at issue. 

The “Suitability standard“ is a half way house, a recognition that advice is being provided, that the typical agency relationship of instruction is actually one that includes advice and that regulation of the transaction on its own omits important liabilities associated with this non regulated duty.  But how to acknowledge and regulate without attaching fiduciary duties?  The suitability standard!

The SBIS from the expert committee appears to be a best interest standard applied to advice with carve outs from common law that weaken the duties and obligations of the fiduciary duty.  The expert committee should provide an explanation as to what the carve outs are exactly.  Its standard complements the CSA proposed standard in that it deals with different duties: one is the best product, the other the best advice.   But the SBIS, as I said, has critical carve outs that would not, I presume, be allowed at common law.  

Critically from page 52 of the Expert Committee’s report:

Historically, the common law relating to fiduciary duties carries strict rules relating to loyalty and conflicts. Importing these rules to the financial sector would likely cause confusion, especially because breach of fiduciary duty may give rise to equitable remedies which may be more generous than is appropriate. A SBID would insulate against the importation of undesirable or unnecessary elements of a fiduciary duty, and permit a customized articulation of the standard that is tailored to the financial advisory context.

These carve outs will weaken attempts by individuals to take complaints to court in that a determination has already been made, at a statutory level, that the duty to advice in a client’s best interests is not a fiduciary duty as such and not deserving of its protection.

Note the following taken from my submission to the CSA Consultation 33-404

The issue of how courts interpret regulatory rules is discussed in the UK Law Commission’s 1995 review of Fiduciary Duties and Regulatory rules

Should fiduciary law take account of rules made by regulatory bodies operating in the public – law sphere? Our provisional view is that it should: either because there is statutory authority for rules to modify common law and equitable obligations … or because the court should take account of reasonable regulatory rules in ascertaining the precise content of the common law or equitable duty…our provisional view that problems of mismatch between what is required or permitted by regulatory rules and the obligations imposed on fiduciaries by the common law and equity lie principally in the field of financial services.”

“the decision to use a particular form of regulation and a particular regulatory body was a legislative one, and the regulatory bodies to whom Parliament has delegated the achievement of the new statutory purposes are likely to have expertise in the areas remitted to them….Thus, although the new system is described as self-regulating, it is the product of legislation and is a form of public law regulation. It is, therefore, appropriate to take some account of regulatory rules when assessing liability for an alleged breach of a fiduciary obligation.”