Brokerage firms, banks, and insurance companies often create their own in-house product, referred to as proprietary products. They are proprietary because they can only be sold by the firm that created it. These products can come in various forms such as a special class of mutual fund or structured products such as a market linked GIC.
These proprietary products have become popular by the firms offering them because they are only available from the one underlying firm and their advisors can recommend this product to their clients. Even if it is the most suitable investment option for the client, it could create a potential conflict of interest.
Historically, a client may not even know that they own a proprietary product. Recent client-focused reforms by the regulators have been made that require firms to disclose any conflicts arising from selling proprietary products, and/or incentives given for selling these products. These disclosures are often enclosed within the terms and conditions document and/or monthly account statements.
Even with these reforms it can be difficult for some clients to know if the funds they have in their portfolio are proprietary or not. Sometimes it is easy, as the name of the financial institution is within the name of the investment (i.e. regular class of mutual funds offered by all the large Canadian banks). Sometimes it is not as easy for investors to determine if the investment is proprietary just by looking at the name.
Some proprietary products can be transferred to other firms, others can not. We are most concerned about proprietary products that cannot be transferred to another firm — let’s refer to these as “firm-only proprietary products.”
One way to find out is to ask the advisor managing the position: “If I ever wanted to switch to another institution, can this investment be transferred in-kind (as is) or would I have to sell it first?” If the answer is that you have to sell the investment, then you may have a firm-only proprietary product.
Our experience with new clients is that they may have purchased a special class of mutual fund as a preferred client of their firm — often a firm-only proprietary product.
Initially, you may wish to determine if you are also simultaneously committing long-term to one financial institution — for better or worse. Over time, you will have hopefully generated gains; however, you may have materially underperformed the markets or not received the service offering you expected. Changing financial institutions can become paralyzing from the standpoint of having to sell everything to make a change and realize 100 per cent of the gain in one year. The best solution is to be aware when investing only in proprietary products.
New Regulation — Know Your Product (KYP)
Know Your Product Obligations
The Investment Industry Regulatory Organization of sa国际传媒 (IIROC) has recently issued various client-focused reforms. Know Your Product (KYP) obligations have been communicated to all firms and approved persons (i.e. Wealth Advisors). Per information on the IIROC website:
We do not expect all Approved Persons to be fully proficient in all securities made available by their Dealer. However, an Approved Person should have a general understanding of the securities available on their Dealer’s product shelf to meet its suitability obligation; Under the product due diligence requirement, Approved Persons must not purchase for, or recommend securities to, a client unless the Dealer has approved those securities. The fact that a security has been “approved” by the Dealer in fulfilment of the Dealer’s product due diligence obligation does not discharge the Approved Person from KYP. KYP is a separate and distinct obligation on an Approved Person that is in addition to the product due diligence obligation on Dealers.
The inspiration to write this article stems from the above new regulations. As mentioned earlier, regulators have been putting into action client-focused reforms to address conflicts of interest.
Another part of the client-focused reforms is focused on know your product. KYP states that registrants must understand the structure and features of each investment product they recommend. This includes costs, risks, and eligibility requirements.
The KYP requirement applies to both the firm and the individual. There is a requirement for advisors to become more familiar with all the product offerings of their firm per the new IIROC rules coming into effect at the end of 2021.
Flexibility is key for peace of mind
We have never been a fan of structured products in general and even less of a fan of proprietary products. We believe that when one invests in proprietary products, they are significantly reducing their investment options, especially if it is a firm only proprietary product.
Some advisors impacted more than others
The above regulation changes will affect some financial professionals more than others.
For example, a mutual fund representative who works at the bank level is already limited to selling the proprietary funds offered by that bank. In most cases, these mutual funds can be transferred to other financial institutions.
Certain financial firms have a division between the bank division and full-service brokerage — this division is often referred to as the financial planning division. The financial planning division advisors may be impacted the most.
As noted in a recent , “Royal Bank of sa国际传媒, Toronto Dominion Bank and Canadian Imperial Bank of Commerce have all notified clients in their financial planning businesses that advisers will no longer be selling third-party funds for any investment portfolios.” The full-service investment division likely will continue to offer third-party funds; however, heightened compliance on KYP will be required.
Portfolio Manager has fiduciary responsibility
As a Portfolio Manager, we have a fiduciary responsibility to our clients. We are able to offer all the suitable investment options available and we are not told to favour one over another.
Our preference has always been to own some of the best companies in the world and focus on getting the right asset allocation for clients. We don’t believe in selling propriety products, or any structured product for that matter. One of the focuses of the new regulations deals with advisors not understanding the products they are selling (i.e. features, risks, costs, liquidity, ability to transfer).
Flexibility and peace of mind
Flexibility is the key to having peace of mind. You should always have the option to transfer your investments between financial firms without having to liquidate your holdings. In our opinion, every investor should be in a position of being able to change financial institutions without having to change their investments. When we look at an investment statement, we are able to identify those holdings that are transferrable (hopefully all) and those that are not transferrable. We would be happy to provide assistance with this analysis.
Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email [email protected] or visit greenardgroup.com/secondopinion.
