Industry calls for safe harbour protections to accompany vulnerable client rules

Industry calls for safe harbour protections to accompany vulnerable client rules

If your firm has no processes for establishing trusted contact persons or placing a temporary hold on a client’s account when financial abuse or diminished capacity is suspected, it soon will.

Earlier this year, regulators published a proposal to use those two tools. However, the proposal as written may fail in its objective to protect vulnerable investors and may even have negative consequences, according to comment letters for the Canadian Securities Administrators (CSA) consultation.

In March the CSA published proposed amendments to NI 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, and its companion policy, aiming to enhance protection of vulnerable clients. The comment period ended in July.

The amendments require advisors and firms to take reasonable steps to have clients name a trusted contact person (TCP) and provide written consent to contact the TCP in certain circumstances, such as when concerns arise about financial exploitation or mental capacity.

Account holds on withdrawals, transactions and transfers wouldn’t be prohibited if the advisor or firm “reasonably believes” a vulnerable client is being financially exploited or the client doesn’t have mental capacity to make financial decisions.

The proposal defines “vulnerable client” as someone with an illness, impairment, disability or “aging process limitation” that places the client at risk of financial exploitation.

While industry participants supported the proposed amendments, comment letters overwhelmingly urged the addition of safe harbour legal protection for advisors and firms as they use TCPs and temporary holds.

Safe harbour, along with TCPs and temporary holds, is among six recommendations in a 2017 report on vulnerable investors by the Canadian Foundation for the Advancement of Investor Rights (FAIR Canada) and the Canadian Centre for Elder Law.

The paper recommends safe harbour for advisors and firms from regulatory and civil liability when they make disclosures to TCPs or designated reporting bodies, or place temporary holds on accounts (so long as they meet regulatory requirements as they do so).

Safe harbour is part of the Financial Industry Regulatory Authority’s financial exploitation rule in the U.S., applicable to temporary holds, as well as the North American Securities Administrators Association’s model act for vulnerable investors. NASAA found increased reports of suspected exploitation in jurisdictions that use its model act.

Absent safe harbour protections, Advocis said in a comment letter, advisors “lack adequate protection from the risks of regulatory and legal action when acting in good faith to discharge these new professional obligations or when conscientiously refusing to act when, in their judgment, a situation falls outside their area of expertise.”

A key example of civil liability exposure is when an advisor places an account on a temporary hold and assets subsequently decline, motivating the client to pursue a liability claim should the hold prove unjustified.

While that’s a real risk for advisors, independent brokerage Leede Jones Gable Inc. highlighted the risk for clients.

“Considering the market volatility, a hold could have significant negative impact on a client,” CEO Jim Dale said in a comment letter. “The companion policy notes that firms worry putting temporary holds will cause regulatory repercussions. A far bigger risk is that a temporary hold will result in the client losing money.”

The firm, along with Advocis and many others who submitted comments, noted that advisors don’t have the skill set to identify financial exploitation or incapacity.

In the proposal, regulators say they don’t expect advisors and firms to “be the final arbiter in matters of vulnerability, financial exploitation or mental capacity.” Rather, the regulators say they “believe that [advisors and firms] may want to place temporary holds in these circumstances so that they can take steps to protect their clients.”

A firm’s policies and procedures “may assist” in demonstrating the advisor/firm acted fairly, honestly and in good faith in placing a temporary hold, the regulators say.

Still, that reassurance doesn’t allay concerns about protection from civil liability.

To address liability, the Portfolio Management Association of Canada suggested in a comment letter that a regulatory safe harbour be established in the short term, and a legal safe harbour be established in the longer term (legislative changes would be required for a safe harbour from civil liability, including privacy breaches).

Advisory relationship at risk

While comments discussed the technical details of the amendments, an overarching concern was potential damage to the advisor-client relationship.

A client could resent an advisor’s assessment of financial exploitation and cut off communication with the advisor or move their assets, Leede Jones Gable said.

The Canadian Advocacy Council of CFA Societies Canada (CAC) warned of the consequences of relationship breakdown when advisors make erroneous assessments: the client could be left even more vulnerable.

“Placing a hold or contacting a trusted contact person with concerns could be an irreversible action that will alter or sever the client relationship and could permanently damage a vulnerable client’s trust in the financial system overall,” the CAC said in a comment letter. “If clients lose trust in their advisor and pull their own accounts, it may lead to a situation where they forego advice to their own detriment.”

An investor’s comment letter highlighted the importance of advisors and firms effectively explaining TCPs and holds, so as not to give rise to investor complaints.

The investor was concerned seniors could be unfairly targeted by the proposal, and frustration with ageism was palpable in the letter. Indignantly, the investor asked: Would Warren Buffett be forced to provide a TCP?

Leede Jones Gable warned that unintended consequences could arise from the proposal, such as firms refusing to serve clients based on age or perceived mental capacity.

The firm didn’t support the proposed amendments based on a cost-benefit analysis, and suggested instead increased training and education for both advisors and clients. For example, regulators could require training on financial exploitation before licensing advisors, the firm said.

While the Investment Funds Institute of Canada supported the proposed amendments, it suggested (among other things, such as safe harbour) that the CSA develop a national training course on financial exploitation and diminished capacity, in partnership with elder law experts.

The CAC suggested the CSA work with government agencies specializing in vulnerable people to create a larger framework to address abuse and incapacity. (The recommendation aligns with the 2017 report on vulnerable investors.)

“Advisors could be required to report concerns to an overriding agency with the staff, medical expertise, data and resources to genuinely assist an individual in need, as well as provide guidance to registrants,” the council said.

A larger framework could also include such things as enhanced internal controls to identify appropriate investment strategies and supervisory spot checks of advisors with many retiree clients, the CAC said.

The council also offered suggestions to support the advisor-client relationship and the amendments’ objectives, such as educating clients on the purpose of TCPs and holds, and discussing fraud with them.

Over time, such things will “help build a relationship where a vulnerable client will hopefully call their advisor for a second opinion if approached with ‘too good to be true’ investment opportunities or if someone is trying to otherwise exploit them financially,” the CAC said.

More ideas to serve, identify vulnerable clients

Many respondents provided ideas to improve the proposal and client protection.

IG Wealth Management suggested holds apply to client instructions beyond transactions.

“A change of account ownership, beneficiary, power of attorney, or banking instructions, for example, can equally put clients at risk,” the firm said in a comment letter. “We strongly encourage the CSA to expand the permitted circumstances to extend to all client instructions generally.”

IG also suggested a more comprehensive definition of vulnerability. The proposal’s definition excludes clients who are vulnerable because they’re dependent on another person, socially isolated or lonely, or otherwise prone to being taken advantage of, IG said.

Investor advocate Kenmar Associates said in a comment letter that the definition should incorporate personal circumstances such as low savings, bereavement and poor digital skills — like the definition used by the U.K.’s Financial Conduct Authority.

The CAC also suggested expanding the definition of vulnerable — to include such things as ignorance, illiteracy or inability to understand the language, which are part of the Alberta Securities Act.

PMAC had practical suggestions to update the CSA’s registration database to help investors understand to whom they’re trusting their assets. These included using plain language for registrant categories and providing information across regulatory bodies, such as insurance regulators.

In the end, the proposal represents only a start to protecting vulnerable clients, Kenmar Associates said. (The regulators themselves describe the proposed amendments as “a step” toward protecting vulnerable clients.)

Kenmar’s letter maintained more needs to be done to protect clients from those providing financial advice: “It is our firm conviction that the harm done to vulnerable clients by registrants is at least equal to the harm done by outside parties interfering with investment accounts.”

That harm included exploitative transactions against the vulnerable, such as the “far-too-common” liquidation of an elderly client’s income-producing investments for a hot stock or off-book investment, and decades of early redemption penalties on mutual funds.

Kenmar provided two laundry lists of action items to protect investors — one for regulators, and one for advisors and firms.

The latter included detection and prevention of off-book transactions and personal financial dealings; improved recruitment practices and conduct standards for advisors facing vulnerable clients; a crackdown on misleading titles such as “seniors specialist”; and fraud seminars.

For full details, read the comment letters to the proposed amendments.

Source: Investment Executive

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