1. INTRODUCTION
As we look forward in our crystal ball to looming issues on the horizon for 2018 and onwards, one that certainly comes to the fore is the regulation of those who provide financial advice and financial planning services, often offered under the nomenclature of "estate planning" or "retirement planning" advice.
There is a lot of movement afoot as many jurisdictions grapple with how best to regulate those who offer financial advice and financial planning services given the lack in many jurisdictions of a comprehensive legal framework to do so. One of the burning issues is whether a "best interests" standard should apply. Presently, in most jurisdictions there is no express obligation for those who provide financial product sales and advice (as opposed to portfolio managers) and financial planning advice to act in the client's best interests. In many jurisdictions, financial planning as an activity is not subject to a general regulatory framework, and the provision of financial product sales and advice is often subject only to know-your-client and suitability requirements.
However, several major jurisdictions, including the U.K., Australia, and the U.S. have in place or in the process of adopting the best interest standard, referred to as the "fiduciary rule". In Canada, the provinces of Ontario and New Brunswick are considering adoption of the rule, which has created significant controversy in the financial industry.
The primary concern that is the genesis for the rule is that many clients believe, and have the expectation, that the financial advice and financial planning services they receive are based on their best interests with a lack of understanding that their advisor may, in fact, have a conflict and not be providing objective advice, in particular where his or her compensation is a commission or other financial reward based on sales.
2. WHAT IS THE FIDUCIARY RULE?
The fiduciary rule is grounded in the law of fiduciary relations. Professionals such as lawyers, accountants, and others who act as advisors are well-steeped in the obligation to put the interests of their client first, and to ensure there are no conflicts of interest.
One of the fundamental legal requirements of a fiduciary is that he or she not place himself or herself in a position where his or her self-interest might conflict with his or her duty of loyalty to act in the best interests of his or her client, or other person to whom the duty is owed.
Arguably, the societal basis for creating the professions, who enjoy special privileges but also have special obligations, is to place important and essential work into a protected class where the interests of the person receiving the advice must always come first, and the rough and tumble buyer-beware profit-focus rules of the marketplace should not interfere.
Within the context of financial advisory and financial planning services, the fiduciary rule can be seen as a standard to protect investors and those receiving financial advice and financial planning services in fulfilment of an ever-more important need, as ageing baby-boomers are in, or fast-approaching, their retirement years. The need for independent, objective financial advice given its profound impact on important life decisions is seen as a compelling societal objective.
In the U.S., the practical application of the rule would be to ensure the fiduciary rule applies to a broad range of brokers who presently operate under a less strict standard of "suitability".
In Canada, there is a plethora of bodies which regulate financial services and financial planning. Financial advisors provide investment advice and may also be involved in selling life insurance, mutual funds and other investments and may be licensed by several bodies. The term "financial advisor" is not for the most part regulated and many persons, whether bank tellers, financial planners, life insurance agents, brokers and others refer to themselves as a "financial advisor".
Recent controversy erupted for several major Canadian banks when allegations were made by employees that they were subject to strict targets to sell financial products to clients, for products they did not need, including some who held themselves out as "advisors".
In the U.K., investment advice is provided by stockbrokers and financial advisors, and financial planners can be Chartered Financial Planners, considered the "gold standard" qualification.
New standards and changes were adopted in 2013, including a ban on commissions, and creating two categories for advisors: restricted; and independent. Independent advisors must ensure the full range of appropriate products are explained to their clients, and all advisors must follow a code of ethics and act honestly, fairly, and professionally in accordance with the best interests of their clients.
Australia is a leader in the application of the fiduciary rule. Reforms effective from July 1, 2013 have resulted in a ban on commissions for investment products, subject to certain exceptions. As well, financial advisors have a statutory fiduciary duty to place the best interests of their clients ahead of their own when providing advice to clients. A more detailed review of these reforms and comments on the guidance which has been created by the Australia Securities & Investments Commission follows below.
In the EU, the Markets in Financial Instruments Directive II ("MiFID II") will come into effect on January 3, 2018. It is wide-ranging and contains significant investor protection measures, including higher standards for suitability and appropriateness of investments and a complete ban on independent advisors accepting or retaining payments or inducements, including commissions.
Movement for Reform and Impact of Reform
U.S.
In the U.S., the Department of Labour introduced the "Fiduciary Rule" which would apply only to financial advice in respect of certain retirement plans, including defined contribution plans, defined benefit plans, and Individual Retirement Accounts (IRAs). Originally proposed by President Obama in 2015, new regulations to create a best interests standard were introduced in April 2016, with a phase-in to begin in June, 2017. The Trump Administration then proposed to delay the start date for the rule until further review could be done. At the time of writing, it appears a further delay will occur to change the final deadline for compliance from January 1, 2018 to July 1, 2019. At this point, a broader application of the rule has not been advanced by U.S. securities regulators.
Under the Department of Labour's proposals, advisors would be required to act in the best interests of their clients, and disclose fees and commissions to clients by way of a disclosure agreement when a commission structure is used.
There has been strong opposition to these proposals from certain segments of the financial industry, including brokers and financial planners. They argue that commissions will essentially be eliminated, resulting in a shift of fees onto clients, including those who are not high-net-worth but are of modest means, pricing them out of the market. In addition, it is argued it will result in higher compliance costs, which will adversely impact smaller firms, broker dealers and financial advisors, and result in consolidation among the bigger players.
The U.K. experience supports some of this argument, where after it introduced the fiduciary rule in 2011, the number of financial advisors dropped dramatically by almost 25%.
Canada
The Canadian Securities Administrators led a consultation in 2016 to review proposals to increase the obligations of those who provide financial advice, including its proposal to introduce a best interests standard.
In Canada, the government response to adoption of the fiduciary rule has been varied and the issue falls under provincial jurisdiction. A majority of Canadian provinces (including Alberta, British Columbia, Manitoba, and Quebec) have decided to abandon it, and pursue other targeted reforms. Both Ontario and New Brunswick continue through their securities regulators to support the fiduciary rule. Concerns have been expressed that without a uniform standard, there will be a patchwork of varying standards across the country, and resulting confusion in the industry and for clients.
The Ontario government has continued to review recommendations to introduce a statutory best interests standard, as well as to regulate financial planners, including what titles can be used for those who provide financial advice, but there is a long way to go before recommendations might actually result in legislative reform.
U.K.
In the U.K., a qualified best interest standard has been in place since 2007.
The Financial Conduct Authority, or FCA, is the chief U.K. financial regulatory body. It operates independently of the U.K. government, and is financially supported by the financial industry. As a result of the retail distribution review ("RDR") introduced in 2013, the qualifications for advisors were increased, transparency of fees and services was enhanced, and commissions to advisors and embedded commissions in financial products were removed. And as noted above, two categories of advisors were introduced: restricted; and independent.
The U.K. is now trying to remedy the advice gap, given that a significant sector of the population cannot afford professional advice, in order to make advice more accessible and affordable. The initial introduction of RDR resulted in a decline in the number of advisors, but numbers are on the increase. It is generally considered that the bold reforms made in the U.K. have improved the professionalism and quality of financial advice for clients in the U.K.
Australia
Australia introduced a statutory best interests standard for advisors in 2013 that requires advisors to act in a client's best interests, to provide advice that is appropriate, and to put a client's interests ahead of the advisor's where there is a conflict of interest. As well, it placed a ban on conflicted remuneration, including commissions and volume-based payments in the distribution of, and advice on, a range of retail investment products.
The Australian Securities & Investments Commission has provided detailed guidance with regard to the application of the best interests standard and conflicts of interest, including helpful, practical examples for everyday use in many client situations.
Some of the factual examples provide scenarios to illustrate what a reasonable advice provider would believe are likely to leave the client in a better position if the client follows the advice, providing advice that is not product-specific, switching advice, remuneration conflicts, as well as concrete examples where the advice has not complied with the best interests duly, including case examples.
A review of this extensive guidance gives a much deeper appreciation for how the fiduciary rule can operate in practice, and acts as a rebuttal to industry skeptics, including in other jurisdictions who have questioned the ability to realistically apply such a standard.
EU
MiFID II will have far-reaching consequences for the investment industry and deals with the conflict of interest issue by a direct ban on third-party inducements for portfolio managers and those who provide independent investment advice. It also introduces new requirements for disclosure of costs and charges. Investment advice will be classified as independent or not, and independent advice is subject to higher standards, including providing a sufficient range of different product providers to clients in providing investment advice.
Conclusions and the Way Forward in the Evolution of the Role of the Advisor
The developments outlined above with regard to regulation of financial advisors demonstrate further refinement in contemporary society of the meaning of who is an advisor, and who is not.
The need for objective, independent financial advice in an aging demographic where clients need a secure retirement and unbiased investment advice to achieve it cannot be questioned. There is a broad-based lack of understanding within the public of conflicted advice, hidden commissions, the amount of fees charged and that their advisor may not have any obligation to put their interests first. In fact, many investors believe their advisors are required to give advice based on their best interests, which is encouraged by the financial industry, and prominent in their marketing strategies which hold out trusted, objective, reliable advice is provided to the client.
It seems that in an era of strong consumer protection for most products and services, the area of financial advice is one of the last strongholds where contemporary standards still, surprisingly do not apply.
The extensive reforms that have been introduced in several leading jurisdictions, including in particular the U.K. and Australia, and which still may see their way through in the U.S. to some degree for retirement plans – a first step, and at least in two Canadian provinces, hold out hope that these reforms will continue as a broad-based reform movement to other jurisdictions as well.
If they do, it is good news for clients but as well for all advisors, in whatever profession they may be, and a boon to the nature of the advisory relationship in such a key and important sector of modern life.
Originally published by The International Comparative Legal Guide to: Private Client 2018, Global Legal Group.
Margaret has been an expert columnist for Advisor.ca and Advisor's Edge magazine since 2011. You may read her columns here.
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