The regulatory restructurings of the client-adviser relationship have not developed in a vacuum. The economic crisis of 2008, and ensuing recession, gave rise to a plethora of new financial services legislative initiatives around the world — and most common law countries, as well as the European Union, have now implemented a fiduciary standard for financial advisers and planners.
While many of the changes in the United Kingdom, Canada and Australia lack the political theater of the American experience, the imposition of a fiduciary standard has nevertheless been widely accepted as prudent consumer protection.
In 2006, the U.K.'s Financial Services Authority established a review of financial advice. In 2013 the rules came into effect, and securities firms, whether dealing or advising, became subject to a statutory requirement to act honestly, fairly and professionally in the best interests of their clients. These reforms imposed strict adherence to a code of ethics, requirements for appropriate qualification and for ongoing continuing education.
Australia followed with a more rigorous rule the same year: in addition to banning embedded commissions, it legislated an adviser payment regime. Australia’s qualified standard differentiates on the nature of financial advice and looks to client results as a measure of compliance.
QuoteCanada has moved to implement a qualified best-interest standard.
With marked similarities to the U.S. market, Canada has moved to implement a qualified best-interest standard as evidenced with the phased-in implementation of the Client Relationship Model (or CRM as it is known locally). With particular focus on avoiding conflicts of interest, the majority of reporting and disclosure requirements will take effect this July as phase two of the initiative, or CRM2.
Part of these new disclosure requirements will see all compensation paid to the adviser reported to the client, including any embedded commissions or trailer fees. Though the introduction of the CRM model has been met with some degree of trepidation by advisers, both its motivations and tenets have nevertheless been widely accepted in the advisory community at large.
For those countries which have introduced an escalated standard, the key elements of transparency, avoidance of conflict of interest and expanded disclosure have served to strengthen consumer protection. There have also been notable effects in these countries, including an initial reduction in the number of advisers.
In the Canadian experience in particular, advisers understand they must now justify the commissions they are paid. This new understanding has resulted in many advisers embracing a fee-for-service model, and expanding service offerings to their clients. Ultimately, the results of this gradual approach, based on extensive consultation with industry groups, have been positive — in part because it allows for the industry to accommodate the costs associated with the new protocol, including expansion of compliance and IT requirements.
In other common law jurisdictions, courts have also taken a much more measured stance and only imposed a fiduciary standard when a number of other criteria are fulfilled. Factors which might merit the imposition of a fiduciary standard include when the client is vulnerable (such as in respect of their investment knowledge or language skills).
At the same time, various U.S. states have already imposed the best interest standard statutorily and a number of money managers, such as pension fund managers, are currently defined as fiduciaries.
QuoteUltimately, the results of this gradual approach has been positive.
COMPLIANCE OR COMPLEXITY?
Around the world, the common law jurisdictions that have implemented the fiduciary standard have done so through a consultative, gradual and arguably objective process. When contemplating the coming restructuring in the U.S., one worries that the impetus for the current changes is, fundamentally, overarching political concerns and agendas.
While there can be no doubt that a client is best served when disclosure is comprehensive, conflicts are disclosed and avoided, and adviser compensation is understood; to what extent is this change seeking to improve problems that are best resolved by the market? By layering on further regulation, will the result be compliance or complexity? And when there are individuals and firms that seek to circumvent regulation, are client remedies best obtained through legislation, or via the courts?
Recall that courts, relying on precedent, are able to apply the law to a myriad of circumstances; but a nebulous or overly-expansive definition of a standard not supported by precedent may end up stifling activities that it merely sought to regulate and moderate.
Indeed, from an outsider’s viewpoint the American legislative experience is replete with examples of legislative and regulatory overkill. Take the response to the Enron debacle, when Congress imposed section 409A of the Internal Revenue Code which — rather than introduce sensible and understandable rules to govern executive compensation — instead fettered the practice with undue complexity that only specialized consultants welcomed.
The costs and complexities associated with implementing an expensive fiduciary standard may also see new and smaller investors denied meaningful financial advice. The British experience would suggest this may be a real consequence for America. The advent of the robo adviser is also problematic. A service offering that removes the human element, most notably of judgment and experience, and which is attractive on the basis of low cost by its very nature will minimize service in order to avoid exclusion.
A ravenous plaintiff’s bar is also worth contemplating. Advisers owe a duty to their clients to provide advice that is understandable and consistent with client goals. But if an adviser fulfills this standard, they should equally be able to rely on their clients to make informed decisions, and to accept the consequences of those decisions.
While focusing on consumer protection is laudable, it still must be matched by equivalent energies in aiding the client to expand their own financial literacy and understanding that mutual responsibility is at the heart of any relationship.