Issues with respect to CSA and Expert Committee Best Standard Proposals

A recent e mail exchange allowed me to briefly raise again some of my issues with the current proposed best interest standards; one of the held within the recent CSA consultation and the other in the recently released Expert Committee report .  I note my comments here mainly because they raise important issues that I have not previously emphasised.

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I do not believe that there is an existing Best Interest Standard for personalised investment advice in Canada; the personalised investment advice relationship under dealing representative categories is not recognised under the securities act and regulation. 

If there is a best interest standard it applies to the responsibilities of the broker relationship with respect to the scope of the transaction relationship as per agency law.  A best interest standard for the provision of personalised investment advice should be a fiduciary standard and I note that there are many academic and legal references to the fiduciary duties of agents with regard to the lesser common law scope of agency.

To gain a better understanding of the scope of the current best interest standard, as stated by regulators like IIROC, you need to understand the historical legal precedents and regulation applying.

I elucidate here with respect to an element of my understanding: http://blog.moneymanagedproperly.com/?p=5831 with respect to the historic of regulation and legislation.

There is nothing specific in the securities act, possibly because the basic common law duties of an agent are already covered and the act has its roots in regulating primarily transaction based relationships (Prof Deborah DeMott: “Basic unit of interaction in an agency relationship is not contract but instruction...”). 

Determining whether duties extend to the provision of personalised financial advice has hitherto been the realm of the courts, but the introduction of a best interest standard should have acknowledged, IMO, this duty for advisors (who represent themselves as providing these services) in statute (note no other jurisdiction that I have read has specifically attempted to distance their best interest standard from a fiduciary responsibility, indeed legislative intent has been that the best interest standard is a fiduciary duty – i.e. UK/Australia).  Instead regulators and expert committee have spent some time eviscerating these standards/principles of such responsibility.  

The best interest standard IIROC et al are confusing, I believe, is with respect to the scope of the traditional client/broker relationship and other activities of the dealing registration and not that of the provision of personalised investment advice.

From Arthur Laby’s Fiduciary Obligations of Broker-Dealers and Investment Advisers

“under agency principles, one’s fiduciary duties are tied to the scope of one’s responsibilities…Under agency law, the extent of one’s fiduciary duty is limited by the scope of one’s agency. The scope of one’s agency depends in turn on the power that the principal has accorded the agent over the principal’s interests. Thus, in determining the nature of a broker’s fiduciary duty, one must analyze the broker’s power over the assets or affairs of the customer. This principle often is stated in the language of trust: a broker’s fiduciary duty is limited to matters relevant to the affairs entrusted to him or her”

“The court stated that the fiduciary relationship between a broker and its customer is limited to the narrow task of executing the transaction…generally speaking, in the case of a non-discretionary account, brokers are not held to fiduciary standards, except perhaps in the narrow task of executing a trade…Why then did some nineteenth and early twentieth century courts hold that brokers were fiduciaries? The reason had little to do with the advisory function performed today. Cases that labeled brokers as fiduciaries centered more on execution or custody-non-advisory-related services-than on the provision of advice. Today, however, cases addressing whether brokers are fiduciaries focus heavily on the broker’s advisory function. The question often presented is whether an investor has placed sufficient trust and confidence in the brokerage firm to justify the imposition of fiduciary obligations. The trust and confidence referred to, however, is trust and confidence in the broker’s advice.”

But, as we know the nature and scope of the actual relationship has changed, and thus has the fiduciary duty implied likewise shifted to the wider scope.  As Laby says, fiduciary duties are defined by the scope of the relationship, so to say that fiduciary duties are impractical with respect to Canadian retail financial services to a certain extent ignores the fact that they already likely apply but are restricted in scope.  This restriction in scope is to the benefit of the industry and to the detriment of the individual investor. 

I am not a legal expert, but it would seem to me that the current regulation of the transaction has effectively allowed advisors to carve out exclusions from the fundamental duties of agency law with respect to the impact of commissions on fund selection, for example, re performance and loyalty.  The best interest standards proposed by the CSA and possibly the expert committee (I have not thoroughly reviewed this yet) seem primarily focused on reemphasizing these duties via a focus on what is really the best product, the transaction, as opposed to the best outcome, the personalised investment advice from which the transaction emerges. 

From Arthur Laby’s Fiduciary Obligations of Broker-Dealers and Investment Advisers ; “Although the scope of activity can be altered by contract, in the case of non-discretionary accounts, a broker’s activity generally is limited to conduct surrounding a particular transaction, whereas the scope of an adviser’s activity extends beyond a particular trade. The different scope of activity yields different duties….. If an adviser has agreed to provide continuous supervisory services, the scope of the adviser’s fiduciary duty entails a continuous, ongoing duty to supervise the client’s account, regardless of whether any trading occurs. This feature of the adviser’s duty, even in a non-discretionary account, contrasts sharply with the duty of a broker administering a non-discretionary account, where no duty to monitor is required.  The two accounts in this example are similar in nature-both the broker and the adviser hold themselves out as providing non-discretionary investment advice-yet the adviser’s duty entails ongoing diligence while the broker’s duty is episodic”

From “DISLOYAL AGENTS” Deborah A. DeMott: “The (US) common law defines agency as the “fiduciary relationship that arises when one person (a ‘principal’) manifests assent to another person (an ‘agent’) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to act…Moreover, agency law, at least in the United States, requires explicitly that an agent act “loyally for the principal’s benefit” in all matters connected with the agency relationship. A principal may reasonably expect loyal service, not simply the due performance of the agent’s other duties.

Someone obligated to act in their client’s best interests with respect to personalised investment advice has a different set of responsibilities to someone obligated to act in the best interests of their client with respect to the transaction within the scope of the traditional brokerage relationship.

The OSC BIS is not, IMO, a best interest standard for personalised investment advice, it is a best product standard (a de facto best interest standard for a transactional relationship) because its focus is on the end point of a process that is still attached to its fair dealing (transactional) root; in other words, paraphrasing Demott, a response to the basic unit of interaction of the agency relationship, the instruction.  

I believe the CSA consultation and quite likely the Expert Committee have muddied the water with respect to the best interest standard. 

Re the BIS/SBIS: what are its roots and where does it fit within agency law (does it reinforce, refresh or replace existing duties and if so which?) and what are the scope of the relationships being considered?  If the fiduciary duty is not being assigned to the provision of personalised investment advice then why not?  Is it through difficulty defining scope, in which case if the definition of scope and duty is being left to the courts what on earth is the standard itself and its weight and why risk defining a duty at all if not to aid clarity with respect to the duty at common law?  We know that courts take note of regulatory declarations of duties and their accountability.

The Expert Committee’s BIS wishes to keep out undesirable elements of fiduciary duty with respect to loyalty and conflicts.  Yet, if we look at US commentary, fiduciary duties would already appear to exist at common law with respect to the narrower scope of agency, so just what are these undesirable elements and what components of these elements are they excluding?  

Andrew 

Fiduciary Obligations of Broker-Dealers and Investment Advisers – http://digitalcommons.law.villanova.edu/cgi/viewcontent.cgi?article=1050&context=vlr

CURRENT ISSUES IN FIDUCIARY LAW SEC v. CAPITAL GAINS RESEARCH BUREAU AND THE INVESTMENT ADVISERS ACT OF 1940 – http://www.bu.edu/law/journals-archive/bulr/documents/laby.pdf

The Fiduciary Character of Agency and the Interpretation of Instructions By Deborah A. DeMott* http://www.law.harvard.edu/programs/olin_center/papers/pdf/323.pdf

DISLOYAL AGENTS Deborah A. DeMott – http://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=2481&context=faculty_scholarship

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