The current suitability regime is a flag of convenience, a get out of jail card and it should no longer be relied upon by regulators to protect investor interests. FULL STOP/PERIOD.
I would like to comment on a recent Investment Executive article titled “Fiduciary duty costly for dealers, advisors suitability standard costly to investors”. The article drew on comments made by David Di Paolo, a partner of Borden Ladner Gervais and references the recent CSA consultation regarding the proposal to introduce a best interests standard.
“Imposing a fiduciary duty against financial advisors would have significant legal implications for advisors, and would substantially increase costs for dealers, ultimately forcing many small dealers out of the market, according to David Di Paolo, partner at Borden Ladner Gervais….”
First of all, the current transaction driven industry is incompatible with a fiduciary duty, and the liability structure of a transaction driven model within a fiduciary regulatory structure would, I agree, be insane. But this is no argument against its introduction!
These firms, or dealers, as they currently stand would not be able to function as is within a fiduciary model. Instead of relying on product distribution and other transaction initiation for their revenue, they would need to rely on revenue from advice, and would need to change their processes and systems to one capable of delivering well structured wealth management solutions.
No longer would the salespersons be deciding what and where to invest, how to assess risk, how risk profiles and investment objectives related to recommendations and structure, but these would all be centralised and formalised, considerably reducing the costs and the risks of delivering a fiduciary standard solution. The advisors would be the client relationship managers, delivering well structured investment solutions.
“The most significant impact for advisors, Di Paolo said, would be a diminished ability to defend themselves against liability in cases where clients have suffered investment losses.. one common defense available to advisors dealing with client losses under the existing regulations is suitability – proving that the investment they recommended was suitable for the client after having gathered the appropriate know your client (KYC) information. Under a fiduciary standard, this would no longer constitute a sufficient defense, Di Paolo. Suitability will no longer be the standard,” Di Paolo said. “Therefore, even a suitable recommendation – one consistent with the KYC – could result in liability.”"
If you are reliant on transacting, you would want to limit the constraints on the time it takes to transact and the costs of the transaction. The current suitability standard is limited for this very reason, and the information required to generate a suitable trade is different from the information and standards needed to provide a recommendation that fits into a well structured, planned and appropriately managed framework. The current suitability framework is a crude and quick parameter to parameter framework reliant on the investor taking responsibility for the transaction decision. It does not however match the representation of service being made and the expectation of service being assumed. This has been known for a while and it was the central focus of the OSC’s earlier FDM model.
But it is not just the limitations of a parameter to parameter framework, that make it difficult to ensure that recommendations are made in the client’s best interests and reflect their risk aversion/risk capacity, existing assets and financial needs (which is too complex a process for a back of the envelop suitability structure to deal with), that invalidate the process. The fact that the whole structure and operation is decentralised means there is considerable room for discretion amongst advisors as to how to interpret the framework and considerable room for abuse. This could not happen to anywhere near the same degree in a centralised, process driven structure with fiduciary responsibility for those processes – red flags would be waving immediately you stepped outside of its boundaries and the returns would not be influenced by the transaction, but by the service..
Hence, the true liability of a transaction regime, in terms of its failure to deal properly with the real environs of suitability, would be borne by the firms who benefit from those transactions. The current suitability regime is a flag of convenience, a get out of jail card and it should no longer be relied upon by regulators to protect investor interests. FULL STOP/PERIOD.
Another common defense is contributory negligence – the concept that the client bears some responsibility for his or her own decisions to invest. Under a fiduciary standard, however, that responsibility would essentially be transferred to the advisor. “The notion of client responsibility is turned completely on its head,” Di Paolo said. “The client bears absolutely no responsibility for his or her poor choices, even though the client is the ultimate decision maker.”
The problem with contributory negligence is that the risks and omissions of the process are not known to the investor. If they were they would likely not seek advice under the transaction framework. Again, I would like to reference the simplifying assumptions that need to be made in order for the investor to be realistically capable of taking responsibility for the investment recommendation under the current transaction system – please see Appendix A in my submission to the OSC on this matter.
With regard to the client bears no responsibility under a fiduciary framework, I would have to disagree. If the processes and structure and communication that underpin the advisory portfolio construction, planning and management process have integrity, the investor can take responsibility, while dependent on the integrity of the processes, for the generics of the decision, but they would have much more information on the risks of the approach and the rationale. In other words, the investor would have less leeway to place the liability on the advisor within a formalised best interests standard investment process. The problem with using the current limited standards is that there is limited definition, structure, communication, organisation and integrity. Relying on limited standard parameter to parameter suitability processes is just asking for trouble if you are intending to use that process to deliver advice.
Borden Ladner Gervais seeks only to defend a business model that could not survive with the higher standards that would be needed to deliver the promise of service that many make and without which the industry, likewise, could not survive. The industry wants to have their cake and eat it, which is possible only if the misrepresentation of the client/advisor relationship is allowed to continue as it is. This is the shocking and disturbing aspect of this article. Simple transaction based services are incompatible with best interest standards.