Client Suitability Compliance: A Comparative Review Of The USA, UK, Canada and Australia

We can learn a lot from our neighbours, including how to manage a client’s suitability for a certain investments. The U.S., U.K, Canada, Australia and a number of other countries have produced guidelines around client suitability including the use of risk tolerance questionnaires. Below is an overview of where each country stands.

U.S.A. – Financial Industry Regulatory Authority (FINRA) and Securities Exchange Commission (SEC)

FINRA Rule 2111 discusses client suitability when advisors recommend investments. It states advisors must…

“have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [firm] or associated person to ascertain the customer’s investment profile. In general, a customer’s investment profile would include the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance.“

FINRA defines risk tolerance as a client’s “ability and willingness to lose some or all of [the] original investment in exchange for greater potential returns”. This what we would call risk tolerance and risk capacity. With regards to questions and questionnaires FINRA states they must not be “confusing or misleading“. Advisors are not forced to use a risk questionnaire but FINRA recognizes advisors use such tools as a best practice.

Financial Advisors regulated by the SEC are held to the fiduciary standard, meaning they must legally and ethically act in people’s best interest. The SEC provides little specifics on risk questionnaires. However, they do say any presentation of data must be clear and not misleading.

U.K. – Financial Conduct Authority (Formerly the Financial Services Authority)

The UK has the most prescriptive suitability rules in the world. In 2011 the FSA released “Assessing Suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection“. The assessment found that most advisors were not properly assessing client suitability for investment. Their main findings were that…

• Advisors were not diligently assessing risk tolerance AND risk capacity
• Advisors were not assessing clients’ investment knowledge and experience
• Advisors were using poorly constructed questionnaires that could sway clients too far into aggressive risks. Questionnaires did not have enough granularity.

Since this paper was released standards for suitability investment have increased. All UK advisors now have to provide a Suitability Report when recommending investments to clients.

Canada – Investment Industry Regulatory Organization of Canada (IIROC) and Mutual Fund Dealers Association of Canada (MFDA)

Canada has a complex financial regulatory system due it’s decentralized government. Financial regulation happens at the national level and at the provence level. However, the responsibility for client suitability has been led by the IIROC and the MFDA.

The IIROC has a series of KYC (Know Your Client) regulations including the requirement to demonstrate a client’s risk willingness, financial ability, time horizon and investment objectives. There is no specific mention of using a risk appetite questionnaire but KYC forms are encouraged.

MFDA has been significantly more prescriptive and even provided a basic “safe harbor” risk questionnaire for financial advisors. They are the first regulator to talk about the need to measure a client’s risk tolerance, risk capacity and risk needs. Jointly these represent a person’s overall risk profile.

Australia – Australian Securities and Investments Commission

The focus for Australian regulators is that best interests have been applied by the Financial Services Professional (FSPs). Professionals must “ensure the financial products they recommend are suitable having regard to each client’s objectives, financial situation and needs. An important part of an FSP’s assessment of a client’s objectives, financial situation and needs is the knowledge of the client’s tolerance to risk.“

The regulator goes a step further and states FSPs should “educate their clients about risk and reward” and ensure couples are assessed individually.

ASIC and the Financial Ombudsman are supportive of risk tolerance quizzes but state FSPs should not be 100% dependent on their results. They should use their judgement in conjunction with a questionnaire.

Conclusion

Regulators support and acknowledge the concepts of risk tolerance, risk capacity and risk need. They are increasingly prescriptive about measuring these constructs however, they don’t want a client assessment to become a “check the box” exercise and have thus shied away from developing detailed questionnaires. What they are looking for is consistency, objectivity and diligence when advisors recommend investments to clients.