Investment advisors may eventually be held to a fiduciary standard when dealing with clients, James Douglas, National Leader, securities litigation group, at Bordner, Ladner Gervais warned financial advisors attending a recent Advocis Symposium.
“I would suggest that, regardless of how it is labelled, we are moving closer and closer to a world where advisors, securities dealers and others who are engaged in the sale of investment products are going to be held to a standard of strict liability and that has been where the world has been moving for quite some time,” said Mr. Douglas who was a member of the Regulators’ Outlook panel at the symposium held in Toronto Nov. 22.
Mr. Douglas says that in his experience as a litigator, “all investors who have lost money are instantly unsophisticated. They also instantly have a risk tolerance of zero.” He suggested that advisors ask their clients one question before they invest their money. The question is ‘how much of this money are you willing to lose?’ “Ninety-eight per cent of your clients will say zero,” he says adding, “They are only interested in more risky investments if more risky investments mean I make more money, not that I am going to lose any money. So bear that in mind as you’re dealing with a retail client.”
Mr. Douglas adds that if the client answers zero, than that is their risk tolerance. With respect to clients and their level of sophistication, he warns that it is generally lower than an advisor might think. “They all come in sounding terribly sophisticated until a problem arises. But, if you gave them a quiz as they came in the door I think you’d be somewhat surprised. If you asked them what’s an option, most of them wouldn’t have the faintest idea. If you asked them, what’s a futures contract, most of them wouldn’t have the faintest idea…”
Mr. Douglas has been involved in a case in Nova Scotia in which investors claimed to misunderstand the concept of margin. It seemed that to these investors “margin was free money that you got from the dealer that you could use to buy houses and sailboats. And, if the stock actually fell in value, then the dealer would actually suffer the loss and shoulder the responsibility.”
He added that the courts in Nova Scotia seemed “incredibly sympathetic to investors who lose money because they borrow on margin accounts and they’re not unique. Courts in every province are plaintiff sympathetic, are investor sympathetic. Regulators are investor sympathetic.”
Mr. Douglas says that in common law, a fiduciary standard is linked to vulnerability and reliance. “These are the hallmarks of fiduciary.” Traditionally in the securities industry, there was a simple agency relationship between the investment advisor and the client, but this is changing, he warns. “As time has gone on, you’ve seen it both in judge-made law and movements by regulators to push you closer to something akin to a fiduciary standard.”
A fiduciary standard means that advisors will have to treat their clients’ money as if it is their own, he says. “So you will have to have an extraordinarily comprehensive understanding of your client, your client’s needs, your client’s risk tolerances, your client’s objectives.”
And, if indeed advisors are someday held to a fiduciary standard, Mr. Douglas warns that this would mean that the client would be relieved of almost all responsibility. Short of fraud on the part of the client, it would not matter what the client does. “If you are held to a fiduciary standard, you will be held responsible for the losses in that account.”
He says he recognizes that advisors in Canada are currently not held to such a standard, but he sees movement in this direction, especially when observing developments south of the border with the Dodd-Frank Act.
Mr. Douglas believes Canadian regulators tag along with U.S. regulation. “I can’t think of an instance where the U.S. has moved in a direction where Canada didn’t move along shortly thereafter in the same direction.”
“Not true,” disagreed panellist Susan Wolburgh Jenah, President and Chief Executive Officer of the Investment Industry Regulatory Organization of Canada. “I think we do have an opportunity in Canada to do things differently,” she said. She added that she could think of a number of examples where Canada has not followed the United States. “I think the reality is that things have changed also for international regulators. There was a time when everyone looked to see what the U.S. was doing and there was more of a tendency to follow suit…I think that is less true today.”
Another interesting shift is that the U.S. has started to look outward to see what other regulators are doing, Ms. Wolburgh Jenah observes. She sees this in her relationships with her colleagues in the United States who are very interested in knowing Canada’s approach to various issues, such as fiduciary duty, suitability requirements and so forth. “We have a lot of discussions and share our proposals with them. I think that it is moving to more of a dialogue between the two.”
Panellist Bill Rice, Chair and Chief Executive Officer of the Alberta Securities Commission responded to Mr. Douglas’ remark about courts and regulators being plaintiff sympathetic. “It should be understood that the job of securities regulators in this country is to protect investors and the integrity of the market, so however you see our sympathies, our job is to protect investors. That is fundamentally what securities regulations are all about.”
He adds that as a regulator he doesn’t take the view that “investors are lambs to the slaughter and that advisors are in anyway the bad people”, but he does see some problems with the current system, in particular with respect to disclosure. “There has to be a better way of utilizing that disclosure…” What is important, he says, is to find a way “where we can be more comfortable about the level of intelligence that goes into investing decisions,” he remarked.
Mr. Rice says he expects regulatory change to come but it will be evolutionary in Canada, not dramatic and revolutionary as some may fear. “From my own standpoint, we’re in an evolutionary process in Canada. We have had the luxury to sit back and watch what goes on in other jurisdictions…I would suggest to you that I’m not aware of pending, dramatic changes…I’m not aware of things that you should be particularly frightened of that are going to fall on you tomorrow, but that is not to say that things are not changing…”
Ms. Wolburgh Jenah agrees. In the aftermath of the financial crisis, the regulatory context has changed dramatically in some jurisdictions, particularly in the U.S. with the passing of the Dodd-Frank bill. But, because it held up better during the crisis, Canada’s regulatory system is not experiencing the same level of urgency to change. “The advantage we have in Canada is not having that proverbial gun to the head. We can, in Canada, take the approach we’ve always taken, which is an evolutionary, deliberative, careful consultative approach to regulation and change.”