- BCSC Annual Report Card Illuminates Issues with Conflicts
The British Columbia Securities Commission (BCSC) released its Annual Compliance Report Card (Report Card) on May 25th summarizing the findings from its 2022 compliance program review of B.C. based portfolio managers, investment fund managers, and exempt market dealers. They conducted 27 reviews, of which 17 were part of the CSA Client Focused Reforms – Conflicts of Interest sweep. Our summary below focuses on the compliance deficiencies relating to conflicts of interest (COI).
- Top Conflict of Interest Deficiencies
The top COI deficiencies found by staff at the BCSC related to referral arrangements, compensation practices and gifting. In each situation, the conflict created an incentive for the registrant (firm or individual) to put their interest ahead of their clients’ interests and therefore the conflict was almost always material.
- Referral arrangements
- Failure to identify material COI. Some firms failed to identify any material COIs arising from their paid referral arrangements and incorrectly disclosed to clients that no material COIs existed. Remember, material COIs almost always exist in paid referral arrangements as firms have an incentive to accept referred clients (to grow their assets under management and management fee revenue) and referral agents have an incentive to refer clients (to receive referral fees).
- Failure to identify that a service fee collection arrangement is a referral. Some firms failed to recognize a service fee collection arrangement as a referral arrangement. Under this arrangement, a financial planner refers a client to a registered firm for its portfolio management services, and the firm deducts both financial planning fees and portfolio management fees from the client’s account, with the former being remitted to the financial planner. While the monetary payment is not by the registrant, the firm benefits from increased assets under management and management fees and the financial planner benefits from receiving fees.
- Failure to provide meaningful disclosure. While most firms disclose their referral arrangements to their clients, some failed to describe:
- the nature and extent of the conflict when the registrant’s interests (firm or individual) do not align with the client’s interests,
- the potential impact on and risk of harm to the client that the conflict could pose if the registrant (firm or individual) placed their interests before their client’s interests, and
- the controls that the firm uses to address the conflicts.
- Compensation practices
- Failure to identify material COI. Some firms failed to identify the following as material COIs relating to compensation for registered employees:
- incentives that are based on revenue generation, sales and revenue targets (including annual awards, promotions, and opportunities to become a partner of the firm),
- negative consequences for failing to meet sales or revenue targets,
- different commission rates for certain products and/or certain clients, for example, depending on the source of the clients (such as referred clients), and
- repayment of commission advances when a quarterly sales target is not met.
It is important to remember that the existence of different commission rates for products or client source also creates an opportunity to favour clients who provide the highest percentage commissions.
- Failure to provide meaningful disclosure. Some firms failed to disclose the material COIs in their compensation practices to clients. Other firms provided disclosure but lacked details as to how the conflicts relating to compensation would impact the clients’ interests. Remember, while providing disclosure is necessary when a firm has material compensation conflicts, it may be insufficient to address these conflicts by disclosure only.
- Gifting
- Failure to identify material COI. Some firms failed to identify that gifts to and from clients can result in a material COI.
- Failure to address material COIs. Some firms failed to address material COIs from gifting because they did not monitor and track the gifts and entertainment that registered employees receive from or provide to their clients. If gifts to clients are allowed, firms should monitor and track them to ensure gifts are not material and frequent.
- Inadequate policies and procedures. Policies and procedures on gifts to clients were either missing or insufficient.
- Common mistakes – process for dealing with COIs
Approximately 50% of the COI deficiencies relate to the firms’ process in dealing with COIs, which include mechanisms to adequately identify, assess, address, and/or disclose material COIs. These are the most common mistakes discussed in the Report Card.
- Failure to identify COI. Some firms responded that they had no material COIs in their business as they failed to recognize that personal trading, outside activities, and fair allocation of investment opportunities represent material COIs.
- Failure to adequately assess and address COIs. Some firms identified COIs but incorrectly assessed them as immaterial and therefore did not institute controls to manage them.
- Failure to adequately disclose COIs. Firms did not clearly describe: (i) the nature and extent of the COI, (ii) the potential impact on and risk that the COI could pose to the client, and (iii) how the COI has been, or will be, addressed.
In addition, some firms:
- included material conflicts in their internal COI documents but failed to disclose them to clients,
- provided boiler plate COI disclosure to clients that included conflicts that did not exist at the firm, or
- provided disclosure that was not meaningful to clients.
- Common mistakes – inadequate policies and procedures and COI records
Approximately 50% of the COI deficiencies relate to the lack of policies and procedures for specific conflicts, such as gifting and referral arrangements. Some firms:
- had no written policies and procedures to identify, assess, and respond to COIs,
- appropriately identified material COIs when responding to the sweep but did not address the COIs that were identified in their policies and procedures manual, or
- had a COI matrix but failed to provide the information to their employees.
Next steps
If you would like assistance assessing whether your policies and procedures address the issues identified in the Report Card, which are also of concern to other members of the CSA, we would be happy to help. We can also assist with training your employees on specific aspects of the COI requirements that apply to your firm.
May 31, 2023