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Investor group demands CSA clarify conflict of interest reforms

As part of its campaign to inform investors of the changes to the National Instrument 31-103 and its Companion Policy, the Canadian Foundation for Advancement of Investor Rights (FAIR Canada) has demanded the Canadian Securities Administration (CSA) clarify their position on conflict of interest.

In an open letter addressed to the regulator, FAIR Canada said the key to the successfully implementation of a best interest standard is the adoption of rules that ban embedded commissions and other advisor compensation arrangements that encourage the misalignment of client and advisor interests.

“This is necessary to ensure that registrants provide their services in a manner that does not actively jeopardize or subvert the interests and well-being of their clients since an abundance of evidence has clearly demonstrated that compensation drives behaviour,” the letter read.

The group questioned how firms will be expected to commit with the Client Focused Reforms while they “continue to utilize embedded commissions or employs incentive programs or sales targets or only sells product from a related issuer”

FAIR Canada illustrated four scenarios and asked the regulator to clarify how firms involved will be able to address conflicts of interest and to still uphold clients’ best interests. The scenarios are as follows:

  1. Embedded Commission Only MFDA Dealer

Client works with a MFDA dealer who recommends only proprietary mutual funds with embedded commissions and recommends the client invest in a fund-of-fund mutual fund product with a 1% trailing commission and a MER of 2.04%. Client is provided with disclosure at time of account opening and before the trade but the suitability analysis does not consider the larger market of non-proprietary products or whether those non-proprietary products would be better, worse, or equal in meeting the client’s investment needs and objectives. The mutual fund cannot be transferred in kind to any other firm.

  • Commute the Value of a Pension

An individual has recently retired and is deciding whether to keep her money with her employer’s pension provider or move it. She is approached by an advisor at an IIROC dealer owned by a major financial institution who recommends that the person move their funds out of her workplace pension to be invested by the advisor on the basis that the firm offers a wider selection of products even though the investment costs at the pension firm are lower.

  • Leveraged Investing

Advisor recommends that a 50 year old client borrow $100,000 to invest in equity mutual funds in order to meet their financial goals as current rate of savings and investment is not on target absent a leveraging strategy and that the loan be taken out against the equity of her jointly owned home. The client has two children in high school, a $325,000 mortgage on her Toronto home which is currently valued at $1.1 million, a $100,000 available line of credit (balance paid off on periodic basis as a result of bonus income received) and $200,000 in RRSP assets. The Advisor will receive a 5% referral fee from the lender and will have more assets under management from which to earn commissions from the embedded commissions. Both conflicts are disclosed.

  • Exempt Market Dealer

This dealer offers prospectus exempt products of only related or connected issuers to its clients. It recommends, pursuant to the OM exemption, that John Adams, who meets the test of an eligible investor, invest $100,000 in a mortgage investment corporation. Mr. Singh, who also meets the test of an eligible investor, is advised to invest in promissory notes in the amount of $100,000. The conflict of interest in investing in a related party was disclosed.

We also wish to know how CSA members will be able to ensure from a compliance and enforcement perspective that firms are complying with requirements to address conflicts in the best interest of the client.