Fiduciary Facts

Participants:
Peter Rusheleau, PGR Financial, member of the board of the Toronto CFA Society and a chair of the advocacy and external relations committee.
Jim Allen, head of Capital Markets Policy at CFA institute.
Michelle Alexander, director, policy, Investment Industry Association of Canada.
Thomas Trainor, managing director, Hanover Private Client Corporation.

One of the most contentious issues in the world of financial advice is the concept of fiduciary duty.

Not only are there differing interpretations of it, there also appears to be some confusion about the timing and the length of its application.

AER spoke to some industry experts, the head of the CFA institute, two Canadian charter holders, and a policy expert on the regulator side, who shared their views on the correct rules of client–advisor engagement, and the role of the governing regulators. Their conclusion: the duty to act as a client’s fiduciary starts early, perhaps even before the client rings the advisor’s doorbell. But it’s also a two-way street on which clients are required to keep advisors informed of major life events in order to ensure service levels are maintained.

We also discussed the nexus between education and training and the ability of advisors to view themselves as true fiduciaries for their clients.

AER: How many CFA holders are there in Canada and how is that number trending?

Jim: It’s about 11,000 right now. It’s up about 10% over the last few years. And I’ve watched over the exams they have here in Toronto. There’s a significant interest, and continuing interest in the CFA credential in Canada. I don’t see that waning at all.

[Outside North America] the growth has been particularly strong in recent years. There’s significant growth in the European region. I think it’s 20%, which is only dwarfed by the growth rates in Asia, which I think are north of 30%.

Peter: Actually, the better metric of this is the number of people who are actually writing the exams as opposed to how many CFAs there are. It’s almost like a growth industry by itself. People are trying to obtain their CFAs—whether it’s seasoned veterans who are just continuing education, or people who are coming out of university. They are trying to basically broaden and deepen their academic knowledge.

The CFA designation is not a U.S. designation or a Canadian designation, it is increasingly becoming an international designation.

AER: In terms of demographics, are you seeing more people out of university going into this as a way of continuing their education and actually moving very seriously from academic disciplines into financial services and wealth management?

Jim: I did it right out of school.

I think these days it seems to be a little bit of a delayed reaction.

A couple years ago, they changed the bylaws of the organization. So now it takes two-and-a-half years to pass the exam. But you have to have four years of practical experience to be able to actually claim the charter. You might be able to finish it in two-and-a-half years, but you have to wait another year- and-a-half before you can actually claim it.

Peter: In terms of the academic presentation to the students, the course material is very much akin to the reading list that the student would work through in preparation for writing their exams.

AER: How do CFAs define the concept of fiduciary duty, and how does that definition compare with those of other accrediting bodies and regulators?

Jim: Well, it’s in the code and standards that you put your clients’ interests first. And one of the standards specifically gets to the elements of fiduciary duty, which is that the members are bound by a duty of loyalty, care, and prudence. Prudence doesn’t mean perfection, it just means prudence; that you’re doing your due diligence and making reasoned recommendations. Probably another thing that makes us a little bit different from other accrediting organizations is the worldwide application of this [standard].

But regardless of what the local laws are, we’re bound by that higher duty.

Tom: Generally, most of the other professions come across with the duty to put your clients’ interests first. But there are technical interpretations from all the different bodies in terms of how to do that. And certainly the CFA one is probably one of the most rigorous.

I think it’s putting your clients as a group first, followed by the individual interests of clients that is probably one of the CFA’s most distinguishing factors.

Michelle: There are differing interpretations as to what the definition of fiduciary duty actually means. And certainly that’s going to be something we may be struggling with in Canada if the time comes when there is a discussion about imposing the fiduciary duty on broker dealer firms. There is no fiduciary duty. There is a duty of care. There certainly is fiduciary duty that does exist under common law.

But there is some confusion out there in the industry as to what it actually means.

I think the fiduciary issue has just become a recent issue based on what’s been going on in the U.S., and the whole discussion about broadening the fiduciary duty to apply not just to investment advisors in the U.S. but [also to] broker dealers. That is the ongoing debate right now, and the House and Senate are looking at the regulatory reform bill, and making some amendments to deal with that issue.

Certainly from the Canadian regulator, and from trade associations’ standpoint, we’ve learned from history that often the debates and issues that happen in the U.S. eventually trickle down here. So it’s best to look at the issues now and understand what our position is before we’re faced with having to deal with it head-on.

Peter: It depends on how you define fiduciary duty. It’s defined in law, common law, based on precedents. And that’s significantly different than the concept of the standard of care that the CFA institute is basically living by. Because not only is it talking about a standard of care, it’s also talking about a code of ethics. And the code of ethics says that when you’re working for an employer you have a fiduciary duty to basically respect and to be diligent in your activities for your employer. If your employer is trying to provide services to clients, you have a duty to provide those services.

The client is looking for that same level of care and diligence, and of course, that’s a conflict by its very nature.

What the CFA institute, with the standard of care and the ethics would say, is clear: The client must come first. It’s the higher standard that you must go to. And in order to get to that you have to have a certain base level of education.

AER: Where does the fiduciary duty start, is it when the client sits down in front of an advisor, or is it when the financial planning process gets under way?
Peter: The moment there’s contact, there is a duty of care. There is a duty of care in your treatment of the account and how you hold yourself out to represent or look after the needs of the account.

So I say right at the very beginning, if you’re getting ready to ring the doorbell, then that’s it, that’s the very point.

Tom: I think it actually starts even before you meet the client in terms of how they find out about you. In a formal sense, it starts at your marketing material or however you’re promoting yourself. Your duty of care, from the CFA’s perspective, starts long before the first contact with the client.

Michelle: That’s from the very beginning of the relationship. And I just want to clarify, duty of care is different from fiduciary duty.

AER: How does the fiduciary duty evolve over the course of a relationship?

Peter: The very first tenet of the relationship model that IIROC is working with is "know your client."

Know your client means having to continually be updating the files and looking for a change of circumstances.

And it’s not a one-way street—it is the client’s duty to come and advise the advisor of the change in circumstances. Maybe you just won a million and nobody knows about it. Your circumstances are a lot different, and it’s your responsibility to notify your advisor. [The] same thing goes if you are in a divorce and you’re going to lose all your assets. Your circumstances have changed and your lifestyle has to change.

Michelle: [And it’s] not just that the advisor is supposed to be asking you, but you have responsibilities in this relationship as a client as well. You can’t put it all on the advisor. So it’s up to you to make sure the advisor is informed of all changes going forward, otherwise you’re not going to get the best advice.

Jim: The advisor has to go back at regular intervals, but also at critical points, changes in the markets, or maybe when you find out that the client has made a big deposit. You have to go back and reassess what’s going on.

Tom: It also comes back to the problem of full disclosure with the client. We have quite a number of clients who have money managed elsewhere. But we simply won’t deal with clients unless there’s full disclosure from them.

AER: When a client requests an inappropriate path, do you try to work with the client and get them on the right track, or do you determine the relationship isn’t right?

Tom: It depends on the advisor and the client, the nature of the advisor’s practice. We spend a tremendous amount of time educating clients, and doing a lot of detailed financial work with them to figure out what the appropriate circumstance is. Others may just say, "I’m a small-cap growth manager, I don’t think you fit what I do, it’s just not appropriate."

AER: What if a client has a couple of advisors and you feel that the other advisor’s investment philosophy is questionable? Do you tell the client?

Tom: In our circumstances, we would know about that, and we would ask them [about] the reasoning behind it. Why they’re doing this, the nature and philosophy behind it. And then we would just go back and research what the end result of all this is.

Peter: It’s everybody’s obligation though, if you see impropriety, you report it. You have a fiduciary role in a firm and if you see something, are you not complicit in not reporting it? Sometimes you are, and sometimes maybe you’re not.

Jim: And it does go back to what everybody’s saying: you need to know your advisor. Now more than ever, just because of some of the things that have gone on in recent years.

Michelle: The amount of disciplinary action for [IIROC] members is quite small, and it’s usually those who are not registered who are the ones with the problems.

Although no matter what you do, there’s always going to be those rogue advisors out there.

AER: Do people who go through the CFA course of study have a predisposition to take on fiduciary standards, or is this a learned behaviour?

Jim: I think the process weeds people out. I know when I started it I was asking myself, "why am I doing this ethical stuff?" And yet by the time I finished it I had completely bought into it. By the time you get done with it you understand the rationale behind it. Second, when you’ve spent three of your springs studying while everyone else is out enjoying themselves, you’re not willing to give it up very easily. So as for whether they come in that way and leave, I’d say you mostly come in with it; but you learn it nonetheless.

Tom: I think there’s a lot of enhancement. And they go through innumerable examples in the CFA material, which really helps to focus your thinking on the whole subject.

The fundamental premise is that the vast majority of people who start the CFA program are inherently honest, well-meaning people. And I think what the CFA is trying to do is really just enhance and focus that thinking in this area.

In our business everything is word of mouth, and your reputation is everything; so even the faintest slight has to be defended rigorously.

Michelle: And wouldn’t you agree, in addition to the ethical standpoint, you also get a better understanding of the reputational risk that’s involved if you do not follow the standard? That can cost you your livelihood.

Peter: Unlike other professional standards, you do this at your own peril, at your own cost, on your own time, and basically at the end, it doesn’t say that you are a better advisor than others.

AER: If advisors were to truly embrace fiduciary responsibility, is regulation necessary beyond surveying the markets for outliers and dismissing them from the securities business? In other words, can the setting of standards create a world in which regulation effectively goes away?

Peter: You’re on the issue of principles-based versus rules- based. And the simple facts are, in my personal belief, without a minimum set of rules principles- based is a race to the basement. The regulator has to set a minimum standard, if nothing else to catch those few outliers.

You need principles, you need minimum rules, but in the final analysis you must find a way to enforce the rules.

Tom: It’s important to have a firm set of principles, and a regulator who’s prudent in terms of the way they look at things. They must have conversations with the appropriate people, as opposed to [saying], "We’ve got this rule, and here it is, and follow it blindly."

Michelle: Principles are usually based on what end result you want to achieve. And while that’s important, I think the industry has [indicated] that they need more than that. They need some kind of guidance as to how you get to that result. And so some proscriptive rules behind the principles are important.