Best Interest Standards And Legislative Intent: a global view

In conclusion, Europe, Australasia and the US have all exhibited legislative intent with respect to implementing best interest/fiduciary standards for part or all of the investment advisory market place; Europe to date is set to implement best interest standards for the wider market place and much more restrictive and higher standards for those who wish to be seen to be delivering independent financial advice.

Canada is the odd one out! It neither has legislative interest in best interest standards nor does it have unified regulatory interest in best interest or fiduciary standards. Indeed, its best interest standard, as should become clear, is not a best interest standard per se but a best product standard, which places Canada’s regulation, in say UK regulatory time, somewhere in the mid 1980s.

I append a section from my submission to the CSA CONSULTATION PAPER 33‐404 PROPOSALS TO ENHANCE THE OBLIGATIONS OF ADVISERS, DEALERS, AND REPRESENTATIVES TOWARD THEIR CLIENTS, April 28, 2016

UK


 

In the UK there has been clear legislative intent behind a fiduciary standard for financial advice:

Note recommendation 7 of the UK Government response to the Kay review[1]: “Regulatory authorities at EU and domestic level should apply fiduciary standards to all relationships in the investment chain which involve discretion over the investments of others, or advice on investment decisions. These obligations should be independent of the classification of the client, and should not be capable of being contractually overridden.”

The reason why the term fiduciary is excluded from regulation and statute is also clearly explained:

“the Government accepts the view that there should be common minimum standards of behaviour required of all investment intermediaries, but believes that describing these standards as ‘fiduciary’ has the potential to cause some confusion, and has therefore defined these standards in the following principle: All participants in the equity investment chain should act:

• in good faith;

• in the best long-term interests of their clients or beneficiaries;

• in line with generally prevailing standards of decent behaviour.

This means ensuring the direct and indirect costs of services provided are reasonable and disclosed, and that conflicts of interest are avoided wherever possible, or else disclosed or otherwise managed to the satisfaction of the client or beneficiary. These obligations should be independent of the classification of the client. They should not be contractually overridden.

The best interest standard is noted as a specific rule, COBS 2.1.1 in UK regulations:

The client’s best interests rule

(1) A firm must act honestly, fairly and professionally in accordance with the best interests of its client (the client’s best interests rule).

(2) This rule applies in relation to designated investment business carried on:

(a) for a retail client; and

(b) in relation to MiFID or equivalent third country business, for any other client.

(3) For a management company, this rule applies in relation to any UCITS scheme or EEA UCITS scheme the firm manages.

[Note: article 19(1) of MiFID]and article 14(1)(a) and (b) of the UCITS Directive]

In the proposed CSA Consultation the best interest standard noted is only a principle.  This is also relevant.  In the UK the standard is a rule and according to the Law Commission review into the Fiduciary issue :

COBS 2.1.1R contains the regulatory equivalent of the “best interests” duty: A firm must act honestly, fairly and professionally in accordance with the best interests of its client.  As we explained in the Consultation Paper, a private person who has suffered loss as a result of a breach of this rule may bring an action for breach of statutory duty under section 138D of FSMA.

So in the UK we have a best interest standard with a legislative fiduciary intent supported by regulatory rule, whereas in Canada we have a best interest standard, without legislative support or intent, specifically designated by the regulators as a principle and not a rule.  Additionally we have had the removal of commission (transaction remuneration) and the institution of higher educational and professional standards supporting the ability to deliver fiduciary standards in the advisory market place.

Australia

In Australia, in the document “Future of Financial Advice: Best interests duty and related obligations”, December 2012, we again have a specific legislative intent with respect to fiduciary standards even though regulation specifies the duty as one of best interest standards.

“The PJC found that the law relating to how personal advice is provided could be improved, noting that: The committee supports the proposal for the introduction of an explicit legislative fiduciary duty on financial advisers requiring them to place their client’s interest ahead of their own. There is no reason why advisers should not be required to meet this professional standard, nor is there any justification for the current arrangement whereby advisers can provide advice not in their clients’ best interests, yet comply with section 945A of the Corporations Act. A legislative fiduciary duty would address this deficiency: paragraph 6.28.”

In Australia the best interest standard is not just codified in regulation but also in Statute, in the Corporations Act 2001, Sections 961B to J. As with the UK Australia has also removed embedded commission from products.

Europe & MIFID II

Europe will be introducing MIFID II in 2017. It has a specific Best Interest Standard in Article 19 (1).

“Member States shall require that, when providing investment services and/or, where appropriate, ancillary services to clients, an investment firm acts honestly, fairly and professionally in accordance with the best interests of its clients and comply, in particular, with the principles set out in paragraphs 2 to 8.”

MIFID is a legal directive meaning that it is a legal act of the European Union. Additionally MIFID also differentiates between tied and independent advice, with independent advice no longer being allowed to receive transaction based returns. The following is from Norton Rose Fullbright on the new MIFID regulations:

“firms providing independent investment advice or portfolio management are prohibited from receiving and retaining any fees, commission, or monetary or non-monetary benefits from third parties – these payments / benefits can be received but they must be passed on in full to clients as soon as possible following receipt”

The new MIFID rules complement recent legislation in Germany, the Fee Based Investment Act described below in an excerpt from a Department of Labor (US) report into Financial Advice Markets:

To increase transparency about adviser compensation and promote unconflicted advice, German lawmakers introduced the Fee-Based Investment Advice Act, effective August 1, 2014. The regulation introduces “fee-based investment advice” as a legally protected designation and imposes specific restrictions on those seeking to become fee-only advisers. As the name of the act suggests, fee-only advisers are prevented from receiving commissions or remuneration from third parties and must receive payment only from clients.

Also, fee-only advisers must consider a sufficiently broad set of financial products when issuing recommendations to clients (i.e., fee-only advisers cannot exclusively offer financial products from issuers with whom the adviser is associated). Advisers are not prevented from offering financial products issued by their institution, but they must consider other providers’ products when constructing advice. Should a fee-only adviser recommend a product from a firm the adviser is affiliated with, the adviser must disclose that affiliation.

To further promote the provision of investment advice in the clients’ interest, institutions providing fee-based investment advice must segregate fee-only advisers from conventional advisers to help ensure that fee-based investment advice is not influenced by commission-based investment advice. Moreover, firms are prevented from setting sales targets for their fee-only advisers that may conflict with the interests of clients.

Holland has also banned most commissions and introduced a statutory duty of care into their own Financial Supervision Act, “The Amendment Act 2014 provides for a statutory general duty of care for parties which provide financial services…The general duty of care shall apply in addition to the existing specific duty of care provisions…. The proposal introduces a new provision which contains the obligation for financial services providers to take into account the justifiable interests of the consumer or beneficiary in a prudent manner. For financial services providers that provide advice, the proposed provision further elaborates by stating that an adviser is required to act in accordance with the interests of the consumer or beneficiary” This statutory duty of care also notes that it is one that requires financial services providers to act in the interests of the consumer, effectively a best interest standard.

The US

Regulation, legal precedent and legislative intent in the US concerning the regulation of personalised advice, and otherwise, has had a much longer and clearer pedigree. Legislative intent with respect to fiduciary standards for the provision of personalised financial advice has been noted in the many US Supreme Court decisions that have helped establish the Federal Fiduciary Standard in Common Law. The legislative intent referred to is that which led to the development of the 1940 US Investment Advisor Act, even though the act itself did not mention the term fiduciary or specifically create the federal standard itself.

Note the following From Arthur B Laby’s SEC v. Capital Gains Research Bureau and the Investment Advisors Act of 1940 (2011), 91 B.U.I. Rev. 1051, 1088

“After quoting passages from legislative history, Justice Goldberg, quoting Louis Loss, concluded that the Advisers Act reflected a congressional recognition “of the delicate fiduciary nature” of the advisory relationship and a congressional intent to eliminate or expose conflicts of interest. Goldberg wrote that it would defeat the purpose of the Act to hold that Congress meant to require proof of intent to injure, and actual injury, as conditions of liability. Such requirements might be necessary in damages actions, but not in cases seeking equitable relief. Nor was it necessary in a case against a fiduciary – which, the Court wrote, Congress “recognized” an investment adviser to be – to establish the elements of fraud that would be necessary in an action stemming from an arm’s length transaction”

“The Capital Gains Court neither stated nor implied that the Investment Advisers Act created a fiduciary duty governing advisers – the Act merely recognized that a fiduciary duty existed between advisers and their clients”

The Advisers Act, the Court explained, “reflects a congressional recognition” of the fiduciary nature of the advisory relationship.161 Similarly, the Court wrote, “[it is not] necessary in a suit against a fiduciary, which Congress recognized the investment adviser to be, to establish all the elements required in . . . an arm’s-length transaction.”162 This passage plainly states that the Court believed Congress recognized that advisers had a fiduciary duty to clients, a duty which pre-dated passage of the Act. Finally, the Court described committee hearings leading up to passage of the Act and wrote that prominent investment advisers emphasized their relationship of “trust and confidence” with advisory clients.163 This testimony necessarily predated passage of the Act and therefore described a duty in existence before the Act was adopted.

“There is little doubt that an investment adviser covered by the Act is considered a fiduciary. Arguments bearing on the advent of a fiduciary relationship, such as sophistication of the parties or communications between them, will be unavailing.328 All advisers are broadly considered fiduciaries.”

The Dodd Frank Act provides specific legislative intent to raise the standard of care for broker dealers to that of fiduciaries. Note the following excerpt from the Arthur Laby’s Sec V Capital Gains Research:

Section 913(g), entitled Authority to Establish a Fiduciary Duty for Brokers and Dealers, amends the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 to authorize the SEC to establish enhanced duties for brokers.

Section 913(g)(2) of Dodd-Frank amends section 211 of the Investment Advisers Act to allow the SEC to adopt rules providing that the standard of care for brokers, dealers, and advisers, shall be to act in the “best interest” of their customers.

The Department of Labor (US) has now published its new rules, effective April 2017, with respect to retirement investment advice:

“The Department’s conflict of interest final rule and related exemptions will protect investors by requiring all who provide retirement investment advice to plans, plan fiduciaries and IRAs to abide by a “fiduciary” standard—putting their clients’ best interest before their own profits..

The final rule defines who is a fiduciary investment adviser, while accompanying prohibited transaction class exemptions allow certain broker-dealers, insurance agents and others that act as investment advice fiduciaries to continue to receive a variety of common forms of compensation as long as they are willing to adhere to standards aimed at ensuring that their advice is impartial and in the best interest of their customers.”

In the Securities Exchange Commission’s Study on Investment Advisors and Brokers (2011), they also supported the introduction of a uniform standard:

“Investors have a reasonable expectation that the advice that they are receiving is in their best interest. They should not have to parse through legal distinctions to determine whether the advice they receive was provided in accordance with their expectations. Therefore, in light of this confusion and lack of understanding, it is important that retail investors be protected uniformly when receiving personalized investment advice or recommendations about securities regardless of whether they choose to work with an investment adviser or a broker-dealer.

It also is important that the personalized securities advice to retail investors be given in their best interests, without regard to the financial or other interest of the financial professional, in accordance with a fiduciary standard.”

The CFA Insitute have also commented on the global move towards implementing uniform fiduciary standards for the provision of personalised investment advice

“In the US, we support a single fiduciary standard for those providing personalized investment advice to retail investors that is at least as stringent as that required by the Investment Advisers Act of 1940, and caution against excessive reliance on disclosure. We continue to urge the SEC to move forward with such a standard….We favor consistent descriptions for independent investment advice and those who provide it, and would require advisers not adhering to a best-interests duty to describe their services in a way that does not connote independent advice”

In conclusion, Europe, Australasia and the US have all exhibited legislative intent with respect to implementing best interest/fiduciary standards for part or all of the investment advisory market place; Europe to date is set to implement best interest standards for the wider market place and much more restrictive and higher standards for those who wish to be seen to be delivering independent financial advice.

Canada is the odd one out! It neither has legislative interest in best interest standards nor does it have unified regulatory interest in best interest or fiduciary standards. Indeed, its best interest standard, as should become clear, is not a best interest standard per se but a best product standard, which places Canada’s regulation, in say UK regulatory time, somewhere in the mid 1980s.


[1] The Government Response to the Kay Review, November 2012, https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/253457/bis-12-1188-equity-markets-support-growth-response-to-kay-review.pdf

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