Fostering a culture of compliance, an alignment of regulation and incentives, through best interests standards.

Whether he realises it or not, Bill Rice has unwittingly argued for the introduction of best interests standards as a solution to the regulatory burden.

I wanted to make a further comment on a topic that spins nicely off Bill Rice’s Keynote speech, that applies to everyone who opposes the introduction of a best interests standard. 

“It is important to securities regulators that intermediaries are as effective as possible and, in that regard, that they be as skilled and experienced as possible, and are motivated by incentives to do as good a job as possible.”

That topic is compliance and the benefits of encouraging a culture of compliance.  At the moment the focus is on balancing the opposites of advice based service requirements and transaction based remuneration.   Compliance and incentives are in conflict and the hammer and the nail will always be needed to keep the two together. 

Unfortunately, and to a certain extent understandably, today’s Canadian regulators appear to be overly focussed on supporting imbalances when they should be looking to foster naturally harmonious regimes where compliance and incentives are synonymous with the client outcome.  Regulators need to be looking through the problem and not at the problem. 

If you read industry best interests standard submissions many already claim that they are acting in their clients’ best interests.  But their resistance to the introduction of a best interests standard suggests they are not willing to comply with the niceties of such a standard.   Clearly this implies conflict between service and compliance with the service contract.  At one fundamental level regulators need to make sure that service processes are as closely aligned to service contracts, because the closer the alignment the smaller the regulatory cost and the smaller the regulatory involvement in the retail financial services market place.

I believe that best interests standards will enforce a culture of compliance, not just for compliance sake, but because it would become in the industry’s best interests to sell their compliance with such a standard to the general public.  Service outcomes, service returns, service process and compliance all become part of the same machine, as opposed to competing objectives.  

“…it occurs to me that a much greater degree of self-policing would go a long way to reducing regulator burden. It is not just that the regulators might have less work to do in the enforcement area if industry was doing more of its own culling, but there might be far less need for prescriptive rule making and standard setting if it was observed that problem areas were being dealt with by the peers of those who do not meet standards.

The best way towards enforcing and encouraging a culture of compliance and to a certain extent, greater levels of self regulation at the firm and the peer group level, would be to introduce best interests standards.   If we align service returns with compliance we create a fundamental incentive which is lacking in current transaction service standards.  

In other words Bill Rice’s arguments, if they are to be effectively implemented, are arguments for better process orientated standards, which can be more easily policed (both by firms and regulators) and better able to highlight offensive breaches of regulation.   These are best interest standards.

With best interest standards incentives and standards would become one.   At the moment incentives are in conflict with standards, which means greater need for rules, compliance oversight and ultimately enforcement.

In fact, Bill Rice hit the nail on the head when he said…

“When I interviewed for the position as Chair and CEO of the Alberta Securities Commission now close to nine years ago, I was asked about my views on self-regulation. Being a lawyer and having enjoyed the privilege of the self-regulation of the legal profession for some 32 years, I did not have much difficulty in quickly expressing my support.”

In the legal profession the existence of a fiduciary standard aligns both the incentive and the standard.   Whether he realises it or not, Bill Rice has unwittingly argued for the introduction of best interests standards as a solution to the regulatory burden.

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