Are advisors acting in clients' best interests? The tussle over terminology

It would seem to be common sense that companies and people who sell financial products and give advice should be required to act in their clients’ best interest. Most investors believe they do, surveys show.

Securities regulators have been mulling an overarching “best interest” standard since 2012, but the investment industry has been fighting them tooth and nail. What is it about a best-interest standard that evokes such a response? Where do the sales people – the advisors – stand?

From the industry’s perspective, best interest is a “catch-all phrase that could have unintended consequences,” says Michelle Alexander, vice-president of the Investment Industry Association of Canada. The Canadian Securities Administrators – the umbrella organization of Canada’s provincial and territorial securities regulators – "did not define the best-interest standard,” Ms. Alexander said in an interview.

One of the concerns, she says, is that the courts might interpret best interest as a fiduciary duty, which is clearly spelled out in law as having a duty of trust to act for the benefit of the client.

Advisors who hope to survive and prosper in the investment business need to keep a close eye on how best interest and fiduciary duty evolve for a number of reasons, experts say, including:

• Best interest is often used synonymously with fiduciary duty. In certain circumstances, advisors already are held to the fiduciary standard.
• While an overarching best-interest standard appears to be off the table, regulators have tried to incorporate best-interest principles in the revised rules governing how firms and advisors deal with clients. Ontario and New Brunswick, which support an overarching best-interest standard, say they may break from other provinces and impose one if the proposed rules prove ineffective. 
• Some advisors may find they are at odds with their employers on this issue, especially if the firm’s business model – and method of compensation – is fraught with potential conflicts of interest. Understanding the best-interest principles will help advisors figure out how and where they want to be employed.

Indeed, a survey last year showed the vast majority of advisors polled supported an overarching best-interest standard, either because they already met such a standard or because they welcomed efforts to make their role more professional, according to the trade publication Investment Executive.

It might be useful to step back and look at where the proposals stand.

Last June, securities regulators abandoned the idea of an overarching best-interests standard, focusing instead on spelling out in detail rules designed to clarify the relationship between sales people and their clients. Regulators also dropped proposals to do away with hidden or embedded commissions on mutual funds.

Comments on this latest version of the proposed regulatory changes – known as Client Focused Reforms, Proposed Amendments to National Instrument 31-103 and Companion Policy NI 31-103CP – closed on Oct. 19.

Judging from some of the responses, regulators may well have to go back to the drawing board. Especially irked are the portfolio managers, who already are held to the highest fiduciary standard.

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“We would like everyone to use fiduciary duty” as a standard, Katie Walmsley, president of the Portfolio Management Association of Canada, said in an interview. The association is not in favour of layering the proposed rules over the ones to which portfolio managers already are held, and it has asked the regulators to restate fiduciary duty as it applies to portfolio managers.

If fiduciary duty is spelled out in law, the meaning of best interest, as the regulators see it, would be established over time as situations came before regulators or the courts. The industry wants it spelled out so it can’t be confused with fiduciary duty.

For advisors, this prescriptive approach may prove less favourable than an overarching principle because the changes could raise the standards in an industry that many people view with some skepticism. The rules-based approach, rather than raising the bar, conjures up images of compliance officers peering intrusively over advisors’ shoulders looking for potential infractions.

It’s not unusual for best interest and fiduciary duty to be used interchangeably. Journalists and investor advocates often use them in the same sentence, as in: “Advisors should have a fiduciary duty to act in the best interests of their clients.” Even regulators occasionally swap one term for the other.

Does calling it a best-interest standard imply a fiduciary duty?

“Our view is that it does not," the Canadian Securities Administrators said in a consultation paper in August of 2016, "since our express intention is not to establish a statutory fiduciary duty for registrants, and although the phrase ‘best interest’ has been interpreted in some contexts as a fiduciary duty, in others it has not.”

In disputes involving the elderly or the vulnerable, though, regulators and courts tend to hold advisors to the higher fiduciary standard.

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“The law of fiduciary duty is quite well developed in Canada, including the law’s application to investment advisors,” says Neil Gross, a securities lawyer and former head of the Foundation for the Advancement of Investor Rights (FAIR Canada). A fiduciary is someone who agrees to act for another’s benefit while having some sort of power over their property or interests, Mr. Gross said in an e-mail. Trustees, for example, are fiduciaries. The law requires fiduciaries to safeguard that other person’s property or interests, he adds.

“Investment advisors owe all their clients a duty to act with reasonable care and skill, but in some situations the advisor’s duty rises to a fiduciary level,” Mr. Gross says. “Those situations are ones where the advisor has discretionary authority over the client’s account, or where the client is acutely vulnerable to suasion and the advisor thus effectively has control over the client’s investments.

“In cases of this type, Canadian courts often have held investment advisors to the fiduciary standard.”

According to the Ontario Securities Commission (OSC), the changes that the Canadian Securities Administrators are proposing would result in client portfolios that are more diversified, lower in costs and likely to generate higher risk-adjusted returns in the long run. They would also force the industry to re-evaluate its business models and practices and enhance the ability of new entrants and smaller players to compete in the market.

Firms that sell third-party investment products and proprietary ones side-by-side would either have to enhance the competitiveness of their in-house products or stop using them, the OSC says. There would also be a shift to fee-based compensation.

“It would force significant change upon the investment industry,” Mr. Gross said in his e-mail. “Investment advisors and their firms would be required to avoid placing themselves in a position where their commercial interests interfere with their ability to provide objective advice to clients,” he says. “Conflicts of interest are rife in the investment business, but regulators allow many of them to be managed through disclosure. Under a best-interest duty (or a fiduciary duty), that would be insufficient.”

Standing outside the fray are portfolio managers and financial planners who work on a fee-only basis and are held to the higher standard either because they are chartered financial analysts (CFAs) or registered financial planners (RFPs). Both professional associations include fiduciary duty in their code of ethics.

Jason Pereira, a fee-only financial planner at Woodgate & IPC Securities Corp. of Toronto, strongly supports an overarching best-interest standard and a proposed ban on embedded commissions. The industry, he says, is worried about having to do more for less over time. As an RFP, Mr. Pereira already operates under the higher standard.

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“Any time you change the way people operate or make money, there will be resistance,” Mr. Pereira said. “The tragedy is that investors believe their financial advisors already are obliged to act in their best interests.”

The gap between what investors expect from advisors, and what they get, is summed up in a 2016 submission to the regulators from former OSC chairman Ed Waitzer and Keith Ambachtsheer, director emeritus of the International Centre for Pension Management at the University of Toronto’s Rotman School of Management. In it, Mr. Waitzer quotes from a submission made to U.S. securities regulators:

“If the product sold is that of advice, then that advice should be in the best interest of the client. Anything else is fraud, because the seller is delivering a service different from what the consumer thinks he or she is buying.”