Regulatory Responses in a Rapidly Evolving Industry Susan Wolburgh Jenah President and CEO Investment Industry Regulatory Organization of Canada At the Investment Industry Association of Canada (IIAC) 2009 Annual Conference Le Meridien King Edward Hotel, Toronto September 24, 2009 Check against delivery 1
Thank you, Ian, for that kind introduction. Events like today s conference provide valuable opportunities for industry participants and regulators to engage in dialogue about emerging issues and how best to respond to them. We ve all been through a period of unprecedented volatility and turmoil. Changes in the industry are inevitable. In this environment, regulators must be prepared to take new approaches to emerging domestic and international developments to enhance our regulatory effectiveness. Greater information sharing, coordination with other regulators, and the strategic use of research and risk analysis are important tools. Over the past year, we have strengthened our ties with domestic and international regulators to share information and intelligence, benchmark our regulatory practices and enhance our understanding of industry trends. This year we signed a formal cooperation agreement with FINRA that will enhance the effectiveness of both organizations through the exchange of information and other cross-border assistance. In addition to information sharing on compliance and enforcement related matters, we plan to work together on issues related to firm oversight and examinations of dealer/broker members which are subsidiaries of IIROC- or FINRA-registered firms. Internally, I established an Emerging Regulatory Issues Committee to help us identify and address issues that are important to investors, industry, and the integrity of our markets. The Committee s first area of focus was the US Rand Study on Investor and Industry Perspectives on Investment Advisors and Broker-Dealers. We have also been monitoring regulatory proposals in the United States, the UK and Australia that focus on the advisor-client relationship. Firms have introduced new business lines, and are increasingly focused on wealth management. There appears to be a shift away from a transactional focus to a more advice-based relationship. In their Winter 2009 Retail Brokerage Report, Investor Economics describes this trend as follows: Advisors, both those new to the industry and those with considerable experience, are moving away from the traditional commission-based business model that focused on trading to a model that is more focused on the planning and management of wealth and the exercising of discretion by either individual advisors or a selective group of external managers. Client expectations and needs are also changing. Many investors place considerable reliance on their financial advisors to ensure adequate retirement income. Faced with enormous choice among increasingly complex 2
financial instruments they are, not surprisingly, relying on their advisors for information and advice. IIROC and our regulatory partners in the Joint Standing Committee on Retail Investor Issues recently commissioned independent research, surveying one thousand Canadian investors about the information they receive from advisors and other sources, and how they use this information in making investment decisions. The survey yielded some results that should be of interest to this audience: 91 per cent of respondents said their investment advisor was among their top sources of investment information; Most respondents said experience is the top quality they look for when choosing an advisor; When it comes to making investment decisions, 60 per cent said they use their advisor all or most of the time; When assessing an investment product, investors say they are far more likely to consider their advisor s knowledge of the product than their own knowledge, and Most investors want to receive information from their advisor prior to making a decision and say they would postpone this decision until information is available. Survey participants also indicated that they don t feel they are provided with sufficient information to be made aware of the potential conflicts of interest that exist between them and their advisor or firm. We recently hosted a Roundtable discussion on IIROC s Client Relationship Model proposal that provided us with additional insight into investors current concerns and expectations. Participants, consisting of both industry and investor representatives, called for higher standards of proficiency, ethics and professionalism. Some suggested the adoption of a fiduciary standard for advisors. Clearer disclosure about the different kinds of account relationships would, they said, help dispel investor confusion. There were also calls for addressing potential conflicts of interests in current compensation structures. Both the survey results and a summary of comments at the Roundtable are accessible on our website. Regulators in the US, UK, Australia and here in Canada have been responding to these changes in the marketplace and in investors expectations and perceived needs. We have recently seen proposals which focus on the following issues: The advisor s relationship with and responsibility to his/her client; Compensation: getting the incentives right so the client and advisor s interests are better aligned; and The training and proficiency of advisors. 3
Let me first comment briefly on proposals which address the nature of the client/advisor relationship. In the United States and Australia regulators are proposing changes which would see the introduction of a fiduciary standard for those offering financial advice. In the US today, the standard of care differs as between broker-dealers and investment advisors as they are governed by different legislation. This results in inconsistent standards as investment advisors are held to a fiduciary standard while broker-dealers are subject to a suitability standard. On July 10 th of this year, the US Department of the Treasury proposed legislative changes to strengthen the SEC s authority in a significant respect. The proposed amendments to the Securities Exchange Act of 1934 (Title IX- Additional Improvements to Financial Markets Regulation) would allow for the establishment of a fiduciary duty for brokers, dealers and investment advisors. They would authorize the SEC to promulgate rules to provide that the standards of conduct for all brokers, dealers and investment advisers, in providing investment advice about securities to retail customers and clients shall be to act solely in the interest of the customer or client without regard to the financial or other interest of the broker, dealer or investment adviser providing the advice. This proposal has received support from the SEC, FINRA and the industry trade association, the Securities Industry and Financial Markets Association. SIFMA President Tim Ryan, who will be speaking to you later today, stated as follows: Under this new federal fiduciary standard, it won t matter who is giving the advice broker or adviser investors will be protected by the exact same federal fiduciary standard when receiving the same services. There is a similar proposal on the table in Australia, where the Australian Securities and Investments Commission (ASIC) has called on the government to consider making a fiduciary standard mandatory when personal financial advice is held out to investors. It is premature to predict whether these proposals will be implemented. To date, the public debate has focussed on a very high-level discussion and general endorsement of a harmonized standard. In principle, this is compelling. However, legislative reform, changes in regulatory oversight as well as industry business practices would be necessary elements of any successful reform efforts and the public debate that would need to proceed them. Britain s regulator, the Financial Services Authority, has also been looking at ways to improve the interaction between consumers and industry participants. The FSA has already implemented a number of principles-based rules that address advisor/client relationship issues. These rules set out disclosure requirements regarding the nature of the account relationship and conflicts of interest. The FSA has recently published new proposals for public comment. Its Retail Distribution Review aims to improve the clarity with which firms describe their services 4
to consumers; increase the professional standards of advisers; and address the potential for adviser remuneration to distort consumer outcomes. While the FSA proposals do not revolve around introduction of a fiduciary standard they do call for changes in advice-giving practices and in compensation. Canada has also examined the client-advisor relationship. The Ontario Securities Commission s Fair Dealing Model Concept paper, first released in January 2004, envisioned extensive changes to the regulatory requirements applicable to retail client accounts. These covered negotiation and documentation of the relationship at account opening, as well as transactional information and account reporting to be provided to clients on an ongoing basis. In September 2004, the OSC Fair Dealing Model initiative was brought under the umbrella of the broader CSA Registration Reform Project. It was rebranded as the Client Relationship Model, and the focus was narrowed to three areas: account opening documentation; costs, conflicts and compensation transparency; and performance reporting. The SROs the IDA (now IIROC) and the MFDA took on the responsibility for taking these proposals forward. Under the current IIROC CRM proposal, firms would be required to disclose information that a client needs to know when opening an account. This includes the specific nature of the account, the services offered and fees charged. Firms must also provide account cost and activity reporting that will help clients assess the account performance and whether their objectives and expectations have been satisfied. CRM also addresses conflicts of interest and suitability of investments. While the Client Relationship Model proposal addresses similar issues to those the US, UK and Australian proposals are aimed at, it does so primarily through enhanced disclosure and increased transparency. Although the CRM does not expressly introduce a fiduciary standard, it would elevate the current standard of care. The proposed approach to managing conflicts of interest offers an example. To supplement existing IIROC requirements, the CRM proposes that where conflict situations cannot be avoided, all such conflicts must be disclosed and addressed in a manner that is consistent with the best interests of the client. As well, suitability requirements which currently involve assessing suitability at the time of transaction have been enhanced by requiring an account suitability review to be performed whenever certain trigger events occur (such as when securities are transferred or deposited into the account, there is a change of representative, or a material change to the know your client information). Let me turn now to regulatory proposals regarding compensation. 5
The US Treasury legislative proposal that I referred to earlier also addresses compensation issues. Under the proposed amendments, the SEC may examine and where appropriate, promulgate rules prohibiting sales practices, conflicts of interests and compensation schemes for financial intermediaries (including brokers, dealers and investment advisers) that it deems contrary to the public interest and the interests of advisors. In the accompanying press release, the Treasury Department made it clear that the SEC would be empowered to examine and ban forms of compensation that encourage financial intermediaries to steer investors into products that are profitable to the intermediary but are not in the investors best interest. The FSA has proposed changes to the compensation system which currently allows product manufacturers to directly compensate advisors. Instead, they are proposing that compensation be agreed to and paid directly between the client and the advisor. The stated rationale for this proposal is as follows: We do not believe that the potential for product provider commission to bias advice, or to undermine trust, can be properly dealt with while product providers continue to set commissions receivable by adviser firms. In Australia, ASIC has expressed concern that current remuneration structures create conflicts of interest which can distort the quality of advice. ASIC therefore has proposed that the Government consider banning remuneration for advice based on up-front commissions; trail commissions; soft-dollar incentives; volume bonuses; sales target achievement rewards; and fees based on percentage of funds under advice. IIROC s CRM proposal does not propose to prohibit current compensation practices. Instead it calls for enhanced transparency and disclosure to clients. We recognize that greater transparency may lead to changes in business practices and compensation arrangements. Finally, regulators are also looking at current proficiency standards for advisors. In Britain, the FSA is calling for higher minimum qualifications for investment advisors, while ASIC has noted the relatively low barrier to entry in Australia and is reviewing the applicable proficiency standards. When we look at proficiency requirements for IIROC-regulated firms, a recent study conducted by the International Council of Securities Administrators Working Group on Market Professionals suggests that our standards are broadly consistent with those in place in other international jurisdictions, including the US and UK. IIROC registrants are subject to pre-registration course requirements, on-the-job training and mandatory Continuing Education. That said, we believe it is important to review our proficiency standards, including experience and competency, in order to ensure that they properly reflect current marketplace realities and investor needs. 6
IIROC will continue to work with our industry committees, the CSI, and other stakeholders to ensure our proficiency requirements are appropriate, relevant and upto-date. During my time with you this morning, I have discussed some important regulatory proposals which are currently under consideration in Canada, the US, Britain and Australia. As proposals, they will be subject to consultation, discussion and debate. Markets are constantly changing. The shift to wealth management and the advice-based model appears poised to continue. Investor expectations and needs will also continue to evolve. It is our role as regulators and industry participants in Canada to begin to engage in dialogue about these significant issues. The foundation of self-regulation is a shared commitment to maintaining high industry standards. Today s challenge for regulators and industry working together is to realign incentives that will encourage the desired behaviour through compensation, enterprise-wide risk management and a longer-term focus on sound business practices and overall client satisfaction. We are committed to working with our regulatory partners, industry participants and the investing public to address these challenges and improve the efficiency of the regulatory system and the integrity of the Canadian capital markets. Thank you. -30-7