Category: Client-Focused Reforms (CFRs)
On September 2, 2021, the Ontario Securities Commission (OSC) published its 2021 Annual Report – Promoting Confidence, Fostering Innovation (Report), along with its financial statements for the year ended March 31, 2021 and the accompanying MD&A. The Report highlights a busy year at the OSC.
There were 1,319 registered firms and 67,758 registered individuals in Ontario as noted in the Report. In the past year, the OSC reviewed 645 public company prospectuses, up more than 67% from the previous fiscal year, and a further 280 prospectuses from investment funds and structured products. The OSC Enforcement Branch assessed a record 807 cases and 164 tips were received under the Whistleblower Program. It issued 42 administrative sanctions, up from 22 in the previous fiscal year, handing down $11.1 million in monetary sanctions. The Quasi-criminal Serious Offences Team completed 11 cases, with two charges laid against 4 respondents.
The OSC continues to implement the Ontario government’s five-point capital markets plan focused on strengthening investment in Ontario, promoting competition, and facilitating innovation. In addition, following recommendations of the Capital Markets Modernization Taskforce, the Ontario government announced in its spring budget that it plans to move forward with legislative amendments to expand the mandate of the OSC and modernize its governance structure. The OSC is working to embed the new mandates to promote competition and foster capital formation into its work and is moving forward with key structure changes, including greater separation of its Tribunal under the OSC umbrella.
The Report included a 2020-2021 Report Card setting out how the OSC has fulfilled the obligations set out in its 2020-2021 OSC Statement of Priorities. The OSC sought to promote confidence in Ontario’s capital markets, reduce regulatory burden, facilitate financial innovation, and strengthen its organizational foundation. In furtherance of these goals, the Client Focused Reforms (CFRs) remain on schedule for implementation by the end of 2021. The OSC views these as fundamental reforms that provide retail investors with greater confidence that they are receiving investment products that are right for them and advice that puts their interests first.
Additionally, the OSC adopted final rules that prohibit order-execution-only (OEO) dealers from receiving trailing commissions from fund organizations where advice is not provided. Ontario joined other CSA jurisdictions to harmonize the ban on deferred sales charges taking effect on June 1, 2022.
The Report notes that activity in the crypto asset sector has accelerated, with global crypto asset market capitalization doubling from January to April 2021 to reach US$2 trillion. Along with its Canadian Securities Administrators partners and the Investment Industry Regulatory Organization of Canada (IIROC), the OSC announced steps that crypto asset trading platforms must take to comply with securities legislation. The OSC issued a deadline for platforms operating in Ontario to engage with it to start compliance discussions or face potential enforcement action.
Furthermore, the Report notes that the OSC has completed 62 of the initiatives set out in its 2019 report on reducing regulatory burden, with more than 20 on track to be completed by the end of 2021. The Report states that the OSC is embedding a culture of burden reduction across the OSC, which includes providing a detailed cost-benefit analysis of proposed rules, ten of which were published this year. In addition, following a comprehensive review of best practices in leading jurisdictions, the OSC published an updated service commitment that provides investors, registrants, and other market participants with added transparency on the standards and timelines to expect when interacting with the OSC.
With respect to facilitating financial innovation, the Report notes that the Office of Economic Growth and Innovation, first announced in 2019, is now fully staffed, including experts in capital raising and new financial intermediation technologies, allowing the OSC to support and encourage innovative business models. The OSC has also established a new Digital Solutions Branch (DSB) to lead the OSC’s data-driven transformation by building the data capabilities needed to support all aspects of its work.
If you would like to discuss the items highlighted in this summary or any aspect of the Report and its relevance to your business, please do not hesitate to contact us.
September 30, 2021
On September 13, 2021, the Canadian Securities Administrators (CSA) announced the launch of its newly refreshed website as part of its continued efforts to streamline and enhance the information and resources available to market participants. The website is intended to be easier to navigate, be mobile friendly and includes an expanded search feature. In addition, the site has been optimized to meet web accessibility guidelines and lays the groundwork needed for the transition of a number of CSA databases to SEDAR+.
The refreshed website contains a helpful Resources section under which one can easily find useful information including rules and policies, frequently asked questions regarding the client focused reforms as well as the CSA Guide to Monthly Suppression of Terrorism and Canadian Sanctions Reporting.
September 30, 2021
Answer: While a firm is not required to approve securities that are held in an account as a result of a client-directed trade if they do not otherwise make those securities available to clients, the firm is required to: (a) inform the client of the basis for the firm’s determination that the trade is not suitable for the client, (b) recommend to the client an alternative action that would be suitable for the client, and (c) receive recorded confirmation of the client’s instruction to proceed with the trade despite the determination that has been made by the firm.
In respect to suitability, the Canadian Securities Administrators (CSA) have stated that all securities in a client’s account are subject to the registrant’s obligation to make a suitability determination, including required periodic suitability determinations. This is subject to a permitted client’s ability to waive suitability. Otherwise, a firm cannot get an explicit acknowledgement in writing in respect of a client-directed trade that the investment will not be considered to be part of the account and will not be part of any suitability assessment.
In respect to the know-your-product obligation, the CSA have stated that they expect registrants to take reasonable steps to assess and understand securities that form part of an account as a result of a client-directed trade, within a reasonable time after the trade, and, specifically with respect to registered individuals, that they will have an understanding of all securities held in a client’s account, including those that are held as a result of a client-directed trade in order to make the required periodic suitability determination. The CSA have acknowledged that the depth of the understanding required may vary depending on the nature of the securities, the client’s circumstances and investment objectives, and the relationship between the client and the registrant. Lastly, it should be noted that even where a permitted client has waived suitability, the CSA have provided that they still expect firms and their registered individuals to have an understanding of the securities in those situations.
September 30, 2021
Answer: While some are breathing a (small) sigh of relief as the deadline for complying with the conflict-of-interest provisions of the Client Focused Reforms has passed, it is time to consider how prepared your firm is for the next phase of the CFR amendments, coming into effect on December 31, 2021.
Some questions to ask yourself include whether:
- Any employee titles need to be changed to comply with the misleading communication requirements;
- Your firm’s current KYP policies and procedures have been documented appropriately;
- You have formalized a system to monitor the securities products on your firm’s shelf as part of the new KYP obligations;
- Your firm’s suitability determination policies and procedures have been updated to the new standard;
- Your KYC forms are compliant with the new standard (and the requirement to get the information for a trusted contact person!);
- Your Relationship Disclosure Information (RDI) contains all the required new information;
- You have a plan / deadline to provide your clients with updated RDI;
- Your Compliance Manual will include all the new policies and procedures relating to the CFRs; and
- You have scheduled employee training on the new KYC, KYP and suitability determination obligations.
We know it’s a long list, but it does not need to be an overwhelming one. AUM Law would be pleased to assist you with any or all of the above, please reach out to your usual AUM lawyer to discuss further.
August 31, 2021
On July 15, 2021, the Canadian Securities Administrators (CSA) published final amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations that are intended to improve the protection of older and vulnerable clients, with effect as of December 31, 2021. We first described the proposed amendments in our bulletin here.
There are two main components of the amendments:
- Registrants will be required to take reasonable steps to obtain the name and contact information of a trusted contact person from individual clients and written consent for the trusted contact person to be contacted in specified circumstances.
- The creation of a regulatory framework for registrants who place a temporary hold on transactions, withdrawals or transfers in circumstances where the registrant has a reasonable belief that there is financial exploitation of a vulnerable client or where there are concerns about a client’s mental capacity to make decisions involving financial matters.
Registrants that have not already taken measures to enhance the protection of their older and vulnerable clients should ensure that they have taken the following measures by the end of the year:
- Implement written policies and procedures to identify senior and vulnerable clients, collect trusted contact person information and address how such information will be used and describe if and when a temporary hold can be placed.
- Provide relevant employees with training on the new rules and internal policies.
- Revise account opening forms (IMAs, subscription documentation) to collect trusted contact person information and obtain consent to contact such person in the enumerated circumstances.
- Consider how enhanced KYC information from older and vulnerable clients will be collected.
- Consider how trusted contact person information will be kept current (g., through the normal-course KYC information update process).
The CSA clarified that there is no expectation that registrants take reasonable steps to collect trusted contact person information from existing clients as of the effective date of the amendments. Rather, the CSA would expect registrants to take reasonable steps to collect that information from existing clients the first time they update the client’s KYC information after December 31, 2021 (i.e., pursuant to the CFR requirements). However, we encourage registered firms to start revising their policies and procedures now if they have not already done so, as a prudent practice and given existing CSA guidance setting out regulatory expectations regarding engaging with older and vulnerable clients. Many of our clients are revising their documentation for these requirements together with all the changes required by the client-focused reforms, and we can help with both sets of amendments. Please contact us for assistance.
August 31, 2020
On August 10, 2021, staff of the Compliance and Registrant Regulation (CRR) Branch at the Ontario Securities Commission (OSC) published OSC Staff Notice 33-752 Summary Report for Dealers, Advisers and Investment Fund Managers (Report). The Report provides an overview of the CRR’s work for the 2020-2021 fiscal year and is a must-read for all registrants. The OSC encourages registrants to use the Report to learn more about recent and proposed regulatory initiatives, the OSC’s expectations for registrants and how staff interpret initial and ongoing requirements for registration and compliance.
1. Focus Areas for 2021-2022 Compliance Reviews
The OSC identified the following as focus areas:
- Firms identified as high-risk through the Risk Assessment Questionnaire (RAQ) process;
- Client Focused Reforms review, which will commence after the key implementation dates of June 30, 2021 and December 31, 2021;
- Firms offering online advice or online dealer platforms; and
- “Registration as the First Compliance Review” for crypto-asset trading platforms.
AUM Law’s focused and general compliance risk assessments can save you time and money by enabling you to proactively identify and address issues before they flare up into problems or you are audited by the OSC. Please contact us to learn more about these services.
2. Compliance Initiatives
- COVID-19 Survey: In July 2020, the OSC issued a COVID-19 Survey to gather information from registrants to better understand the initial impacts of the COVID-19 pandemic on registrants’ operations. Overall, the information gathered from the survey demonstrated that registrants adapted well.
- Remote Work and Business Location Registration Considerations: Questions on whether individuals working remotely are required to identify their personal residence as a “business location” in accordance with NI 33-109 have popped up. The Report notes that the OSC continues to take a flexible and practical approach on this issue considering many firms have established work-from-home (WFH) arrangements with their registered individuals. However, registered firms that allow staff to work remotely must have compliance systems in place, including appropriate policies and procedures related to supervision, that adequately address the WFH arrangements.
- Business Continuity Planning: The operational challenges arising out of the COVID-19 pandemic demonstrated the importance of business continuity plans (BCPs). It is important that senior management is involved in the creation and approval of the firm’s BCP. Senior management’s ongoing communication and participation regarding the firm’s BCP will demonstrate a positive and strong tone at the top.
- 2020 Risk Assessment Questionnaire: In June 2020, the OSC issued the 2020 RAQ to over 1,000 firms. The RAQ is the OSC’s primary tool to obtain information about a registrant’s business operations, which supports the OSC’s risk-based approach to select firms for compliance reviews or targeted reviews. Registrants can expect to receive the next version in April 2022.
3. Compliance Deficiencies
What follows are highlighted topics we think will be of particular interest to our readers.
- Representatives servicing clients without required registration: The Report notes instances of representatives of registered firms conducting registerable activities in Ontario without being registered as either ARs, AARs or dealing representatives. If a firm is not in compliance with the registration requirements in Ontario, this may raise concerns regarding the adequacy of the firm’s compliance system and may reflect poorly on the firm’s continued fitness for registration. This may also raise concerns that the firm is not adequately supervising its representatives.
- Policies and procedures not tailored to the firm’s operations: For instance, (a) written policies and procedures did not address Ontario regulatory requirements, such as CRM2 guidelines for client account reporting and minimum timelines for retention of books and records, (b) the annual compliance report to the Board of Directors (or equivalent) did not address the firm’s compliance with Ontario securities regulatory standards or was signed by someone other than the firm’s CCO, and (c) confidentiality provision language in employment agreements, such as non-disclosure agreements and whistleblower policies, did not permit exceptions for voluntary communication with Ontario regulatory authorities.
- Inadequate disclosure when using benchmarks: Staff noted instances of registered firms presenting benchmarks in marketing materials to compare to the performance of their investment strategies, without adequate accompanying disclosure for a client to draw correct conclusions from the comparisons.
- Misleading marketing material: Several firms included claims in marketing material that were misleading. Registrants must ensure that all claims included in marketing material can be substantiated, are factually correct and are up to date to ensure that existing and prospective clients are not misled.
- Prohibited representations: The Report identifies instances where firms made prohibited representations in their marketing material that (a) implied the OSC had passed upon the financial standing, fitness or conduct of the firm, (b) resulted in the registration of the firm being improperly marketed, or (c) suggested the firm or an individual employed by the firm is holding out as being registered through the use of misleading titles.
- Outside business activities: OBAs are a regulatory concern for a number of reasons, including when the OBA (a) creates a material conflict of interest for the representative that must be addressed in the best interest of the client, (b) places the representative in a position of influence over clients, especially vulnerable clients, (c) creates the risk for client confusion, or (d) limits the ability of the representative to properly service clients. As such, firms must supervise their representatives’ OBAs as part of their compliance system and respond to material conflicts of interest which include OBAs. Firms are also required to report their representatives’ OBAs on each individual’s registration application, and report changes on the NRD within ten days.
- Complaint handling processes: Staff identified a number of issues, including a failure to clearly set out a client’s right to immediately access OBSI if they are not satisfied with the firm’s response. In some cases, clients were instead directed to the firm’s internal ombudsperson. Staff found this to be problematic as it may mislead clients to believe that they are required to contact an internal ombudsperson first before escalating their complaints to OBSI, or that the internal ombudsperson is an alternative to OBSI. The Report reminds firms that both the UDP and CCO have responsibility for establishing an effective compliance system, which includes maintaining a complaint handling process that is consistent with the firm’s obligations to deal fairly, honestly and in good faith with their clients.
- Net asset value adjustments: Section 12.14 of NI 31-103 requires an IFM to deliver no later than the 90th day after the end of its financial year and no later than the 30th day after the end of its first, second and third interim period, a completed Form 31- 103F4 Net Asset Value Adjustments (Form 31-103F4), if any net asset value (NAV) adjustment has been made in respect of an investment fund managed by the IFM during the financial year, including any interim period. A NAV adjustment is necessary when there has been a material error and the NAV per unit does not accurately reflect the actual NAV per unit at the time of computation. The Report notes instances where the error was identified by sub-advisers, auditors, or third-party fund administrators. Staff’s review found that most of the errors were identified and rectified in a timely manner, however, there were instances where inadequate controls resulted in the error remaining undetected for an extended period of time (e.g., greater than one month).
- Wholesaling securities requiring registration: Market participants who engage in wholesaling activities should (a) not communicate with end-purchasers when relying on section 8.5 of NI 31-103, including through written communications and marketing and registered firms should have procedures to prevent their employees from doing so, (b) seek registration as a dealer if they are not able to rely on section 8.5 of NI 31-103, and (c) have procedures to prevent their registered individuals from engaging in wholesaling outside of the registered firm.
- Ownership changes: The Report notes firms are not filing the notice of proposed ownership changes in, or asset acquisitions of, registered firms required under sections 11.9 or 11.10 of NI 31-103. Also noted were instances where, in addition to the registered firm missing the notice under sections 11.9 or 11.10 of NI 31-103, the firm did not make the required filings under NI 33-109, in particular the filing of Form 33-109F5 to reflect the change in share ownership or the acquisition of its assets. A registered firm has 30 days to file any changes to information previously reported in Part 3 of Form 33-109F6, which includes Item 3.12 Ownership Chart. A registered individual or permitted individual must also update information previously provided under Item 17 Ownership of Securities and Derivatives Firms of Form 33-109F4 within 10 days of such change. Failure to provide notice of ownership changes or asset acquisitions may also result in the issuance of a warning letter or further regulatory action.
- Incomplete Form 33-109 submissions: Registrants need to provide blacklines showing the amended sections of the form when making an update to information previously provided under Form 33-109F6. Furthermore, an update to information about a registered firm previously filed using Form 33-109F6 requires that the title of an authorized signing officer or partner be specified in the certification section in Form 33-109F5.
- Exemptive relief applications: The Reports reminds market participants engaging in at-will financings facilities/equity lines that both the issuer and the purchaser generally require registration relief. In addition, market participants are reminded that other requirements of Ontario securities law, including prospectus exemptions, early warning and insider reporting requirements, the prohibition on trading in securities of a reporting issuer while in possession of material undisclosed information and the prohibition on market manipulation, may also apply to market participants involved in equity line arrangements.
4. Additional Items of Note
- Voluntary Surrender Process: The OSC expects a registered firm to file an application to surrender its registration (a voluntary surrender application) when it ceases (or intends to cease) conducting registerable activities. To initiate the voluntary surrender process, registered firms must submit an application letter and an officer’s/director’s certificate. There is no prescribed format for the application letter or officer’s/director’s certificate. The application letter and certificate must be filed through the OSC’s Electronic Filing Portal.
- Registration of Client Relationship Managers: Last year, the Canadian Securities Administrators (CSA) updated its expectations for the assessment of Relevant Investment Management Experience (RIME) for advising representatives (ARs) wishing to act as client relationship managers (CRMs). Associate advising representatives (AARs) that act as CRMs typically will not have accumulated sufficient securities-selection RIME to become ARs. However, an AAR or other individual who can demonstrate that they have all of the other proficiencies required for registration as an AR, in addition to significant experience relevant to CRM activity, can be registered as an AR who will specialize in CRM activity (a CRM AR). In any case, terms and conditions will be applied to the registration of CRM ARs to restrict their registerable activities to things that do not involve the selection of securities.
5. Policy Initiatives
As usual, the Report summarizes certain policy initiatives affecting registrants and provides links to the relevant publications. This year, the Report covers:
- Burden reduction;
- Crypto-asset trading platforms;
- Client focused reforms; and
- Exemption from underwriting conflicts disclosure requirements.
If you would like to discuss the issues highlighted in this article or any aspect of the Report and its relevance to your business, please do not hesitate to contact us.
August 31, 2021
On June 21, both IIROC and the MFDA published proposed guidance regarding suitability that relate to the CSA’s client-focused reforms. IIROC’s Proposed Guidance on Know-your-client and Suitability Determination, applicable to investment dealers and their representatives, would replace its existing KYC and suitability guidance in its entirety, and is intended to conform in all material respects to the CFRs. The new guidance details IIROC’s expectations on the collection of KYC information, its interpretation of certain terms, its expectations on how dealers can in fact “put the client’s interest first” and confirms that KYC requirements are not one-size fits all but depend on a member’s business model, service offerings and clients. The requisite KYC information is divided into “essential facts” about an order, client and account which dealers must collect as gatekeepers to the capital markets (such as client ID), and KYC information needed for the suitability determination obligation (e.g. financial circumstances, risk profile, investment knowledge and investment time horizon). IIROC states that dealers should apply the guidance and the suitability determination requirement to all investment products offered, and not just securities. With respect to specific dealer models, the guidance notes that while the KYC obligation is generally the same for all accounts, some limited exceptions exist for accounts such as OEO or DEA accounts. The notice also addresses when it would be acceptable to collect and maintain one set of KYC information for multiple accounts (spoiler alert: the account beneficial owner must be the identical individual for all the accounts, for starters) and when separate account applications would be required. The suitability determination obligation not only applies before taking or recommending an investment action for a retail client, but notes that the order type, trading strategy, fee structure and method of financing must also be suitable (and put the client’s interests first). In the draft guidance, IIROC clarifies that it will not review suitability determinations in hindsight, but rather on the basis of what a reasonable dealer or registered individual would have done in the same circumstances.
For mutual fund dealers, the MFDA has published CFR Conforming Changes to MSN-0069 (Know-Your-Client and Suitability). The new draft guidance has been combined with prior guidance to ensure that it reflects the business models of MFDA members while still being consistent with new CSA guidance. The staff notice sets out the various types of KYC information that must be collected such as personal circumstances, investment knowledge, financial circumstances, investment needs and objectives, investment time horizon and risk profile, and explains how each can support a suitability determination. The draft updates its description of the situations where certain KYC information can be collected jointly for joint accounts. The guidance also focuses on the timing of suitability determinations, including with respect to bulk account transfers, and the meaning of an “investment action”. The inputs into a suitability determination have been updated, to include items such as a comparison of KYC information to the characteristics of the investments in the accounts, as well as KYP information, concentration and liquidity factors, and the potential and actual impact of costs. The guidance also confirms that members must have policies and procedures for both branch and head office staff relating to the opening of new accounts and updating of KYC information, which can not be solely an administrative exercise but a review of the information’s adequacy, reasonableness, consistency and uniformity. Specific guidance is reiterated with respect to the MFDA’s suggestion for supervisory policies and procedures to flag specific concentration limits (at 25% of a client’s total investments with the member and an additional limit of 10% of a client’s total investable assets) relating to any one security, sector or industry. Other changes to MSN-0069 include its scope, to ensure it applies to all business conducted through the facilities of a member (e.g. non-securities related investment products), removal of KYP guidance (which is now addressed by another staff notice) and other content found in other compliance bulletins, and the removal of examples of a KYC and suitability review on the basis that the requirements are well understood by members. The changes to the staff notice all support the requirement to ensure that before a member or approved person opens an account, makes a recommendation or takes any other investment action for a client it is suitable for the client and puts the client’s interests first, as required by the CFRs.
Comments on both proposals are due on August 20. If you have any questions or wish to comment on the proposals, please reach out to your usual lawyer at AUM Law.
June 30, 2021
As the June 30th deadline for the “part one” of the Client Focused Reforms passes us in the rear-view window and we go and enjoy our long weekend, we wanted to highlight some high-level considerations for “part two”. This “part two” mainly deals with the KYC/KYP and suitability requirements and changes to comply with the requirements must be made by December 31, 2021. The following are some high-level points/reminders for you to consider as we work towards that December deadline.
- Don’t Wait Until the Fall
Depending on your business model, “part two” may require some thoughtful planning and advance work. The earlier you start in mapping out how your firm will deal with the KYC/KYP and suitability requirements, the less stress you and your team may feel when the leaves start to change colour.
- Know Your Product – Documentation is King
At a high level, there will be an expectation that prior to investing in any position on behalf of a client, your firm will have completed documented due diligence on that investment. This due diligence documentation should include relevant structure, features, risks, initial and ongoing costs. The level of detail of your due diligence may vary depending on the nature of the product and your business model. Your firm will also have to monitor each investment product for significant changes. When significant changes in the investment product do occur, your firm may need to update your due diligence record. Your firm should be exploring or developing tools to ensure a due diligence standard is followed across your company.
- KYC – Knowing (more about) Your Client
You will need to have an updated KYC document ready for December 31, 2021. Each KYC document can be tailored based on the business model of your firm. You will also need to be able to evidence that your client has agreed that the collected KYC information is accurate (e.g. through the client signing the KYC form or a registered individual’s notes capturing the client interaction). Some items that may be changing on your KYC form include:
- Outside Investment Information:
Certain business models may need to start asking clients about investments the client holds outside of your firm to create a better understanding of a client’s financial circumstances. This outside investment information gathering could be expected to be heightened for discretionary investment managers. Additionally, it could be expected where your firm may need to assess whether a proposed investment would lead to over-concentration in a security or sector.
In addition to asking what your client’s risk tolerance is, as your firm likely has been doing for years, your firm will now be expected to professionally assess the client’s risk capacity. Put another way, risk tolerance speaks to the client’s preference for risk. Risk capacity is your firm’s assessment of how much risk a client should take on. Where there is a mismatch between a client’s risk tolerance and your firm’s risk capacity assessment, the client’s preference can prevail but only after you have a detailed and documented conversation with the client explaining your thought process and exploring alternative investment approaches.
The new rules specify minimum intervals when a client’s KYC information must be reviewed:
- 12 months for managed accounts;
- 12 months before making a trade or recommendation for exempt market dealers; and
- 36 months for other cases.
- Suitability – Documentation is King (Part 2):
Prior to taking any investment action on behalf of a client, your firm will need to document that this action is suitable for the client. In determining suitability, you will need to consider and assess the client’s KYC information, a reasonable range of alternatives available through your firm and the potential impact the investment action will have on the client. Please note that the inclusion of the language “of a reasonable range of alternatives available through your firm” dovetails with the need to have a standardized due diligence process throughout your firm as each registered individual will need to understand all products on your firm’s “shelf”.
Our experience thus far is that there are practical approaches and tailored solutions for each of the new “part 2” requirements. If you have any questions, please feel free to reach out to your usual lawyer at AUM Law.
June 30, 2021
Answer: Registrants are often asked by their clients, as trusted advisors, to act as their trustee under family trusts, executors under their will or as powers of attorney. The potential issue with accepting any of these roles for a registrant is that they may present a material conflict of interest. For instance, if a client is deceased and the advisor takes on the role of the executor of the estate, he or she will be required to review the registrant’s work and decide if the investments are still appropriate, and potentially whether the executor should even keep the assets with the advisor or the advisor’s firm. The conflict becomes most obvious if the registrant is responsible for reviewing his or her own work.
While the CSA chose not to explicitly prohibit such relationships in the Client Focused Reforms, personal financial dealings are referenced in certain IIROC and MFDA rules. For example, in IIROC rule 3115. Personal financial dealings, there is a prohibition on acting as a power of attorney, trustee, executor or otherwise having full or partial control or authority over the financial affairs of a client except in limited circumstances, such as when the client is a related person as defined in the Income Tax Act (Canada) and control is exercised in accordance with firm policies and procedures, or in the case of certain control granted in a discretionary account. The CSA is also of the view that a registrant having full control or authority over the financial affairs of a client may create a material conflict of interest. So, if a firm is not going to avoid this conflict, it should create a specific procedure to ensure that these conflicts are identified and are addressed in the client’s best interest. For example, specific pre-approval from the CCO could be obtained, based on a justification of why such activity would be in the best interests of the client in the specific instance, and procedures to manage the potential conflict such as having the individual advisor recuse himself or herself on matters involving the appointment of an investment manager could be implemented, where possible.
We understand that simply being appointed an executor in a will does not currently amount to a disclosable OBA in Form 31-103F4, and will only become disclosable once a registrant steps into that role and is vested with the powers of the office of an executor. We believe the same logic could apply to other powers of attorney as well, depending on the type of powers granted.
May 31, 2021
Our friends at BLG invite you to scan information from their CFR Communication Series – Surging through 2021 to 2022, starting with a conflicts of interest summary and the new rules relating to titles and misleading communications that are coming into force on December 31, 2021. For more information, please visit the following links:
BLG is hosting a webinar on June 24, 2021 “Understanding the Green Regulatory Landscape” – please use this link to locate the registration details. For more information on regulatory activities in this space, see Canadian Securities Regulators Conduct a “Green Sweep” of ESG Products and Practices.
May 31, 2021
A number of new regulatory requirements regarding conflicts of interest, including referral arrangements, come into effect on June 30. These requirements are part of the Client Focused Reforms initiative and require new internal processes and disclosure to clients. If you have not started working on these changes, please contact your usual lawyer at AUM Law as soon as possible to discuss how we can assist you.
May 31, 2021
Richard Roskies, Senior Counsel at AUM Law, recently sat down with Parham Nasseri from InvestorCOM to discuss the Client Focused Reforms and practical approaches for investment dealers and advisors to meet their KYP obligations.
Parham: What are your thoughts on how investment dealers have generally responded to the CFR requirements and their state of readiness?
Richard: By now, the CFRs should be on every dealer and advisors’ radar. I’d say about 60% of the clients I work with are at least knee deep into the conflict-of-interest requirements that are due in June. When it comes to the KYP, KYC and Enhanced suitability segments, I believe most people have started to think about it, but they haven’t yet weighed in with full focus. For example, these topics have not been a huge topic on the implementation committees I sit on.
That being said, depending on the size of the dealer’s product shelf, the KYP piece requires a fair amount of work and now is the time to start thinking about implementation strategy.
In terms of materials coming out of the final SRO rules-based comments, there wasn’t much to be concerned about. While the rules are close to baked, the interpretation will be ongoing through implementation guidance and FAQs. In short, this will be an ongoing iterative process for our industry.
Parham: At a high level, are there any outstanding areas for clarification or is the implementation goal quite clear?
Richard: I believe we are going to get ongoing implementation guidance and FAQs throughout this year.
The Canadian Securities Administrators (CSA) has done a lot of work in setting out what the goals, principals and expectations of the CFRs are. When it comes to KYP, it is clear that the regulators now expect documented KYP evidence for all traded products. However, when you drill down to the details of what is a reasonable way for firms to achieve these goals, I believe CSA guidance defers to industry by using the term use your “professional judgement” about ten times.
The regulators have definitely given us enough guardrails about what reasonable KYP should look like, but the last details will be determined by the ongoing interaction between regulatory Staff and industry. In short, you should absolutely start working on the CFRs, including KYP, but it will be important to follow the clarifications that come out over the course of at least this coming year.
Parham: Given the Dealer’s new KYP obligations, can you comment on what it means to monitor for significant changes and what needs to happen when a significant change is detected?
Richard: First it is important that the CSA guidance explicitly narrowed the requirement here from general monitoring to monitoring for significant changes. We don’t get an explicit definition of “significant change”, as the guidance indicates that it will vary depending on your firm’s operations and the type of security. However, I think a generally safe litmus test is that you are looking for any event that may significantly affect market price.
To that end, for most securities, I would be thinking about creating proactive alerts for any news stories related to the issuer (including earnings calls). Where we are talking about private funds, there will still usually be certain disclosure events that you can use as triggers for reviews. These are the kinds of triggers that you would want to consider. You also would want to have policies on reviewing your shelf if a sector or broad market downturn arises as companies are likely change in those times of stress. I read into the guidance that the higher the risk profile of the security, the more often you should be “checking in”.
Parham: Can you discuss the requirement to assess products on your shelf, how frequently, is this the regulator’s way of reducing shelf sizes, how does this requirement differ for dealers that have a proprietary shelf or have proprietary products on their shelves?
Richard: I think industry’s major comment to regulators over the course of the discussion about KYP is that some of these changes may have the unintended consequence of reducing shelf size. Whether that occurs in actuality will have to be determined over the course of the next few years.
In terms of different KYP approaches, that term “professional judgement” comes back into play. The guidance is clear that you are indeed allowed to simplify the due diligence required as the product trends towards the lower risk/well understood end of the scale. In fact, we are talking to our clients and regulators have confirmed that for certain lower risk/public securities, you could even do KYP by sector (e.g. draft a KYP document for the “public banking sector in Canada”). As you trend towards higher risk, private and more complex securities, the diligence will need to become more detailed. Private proprietary products are likely much closer to the highly detailed side of the scale.
Parham: Clearly, the new KYP requirements are raising some questions in the industry. What are some practical approaches in your view for tackling this new requirement?
Richard: When it comes to what is practical and reasonable, I always come back to two rules:
- Effort counts. When it comes to compliance, the goal cannot be absolute perfection. The goal has to be creating a strong and demonstrable “culture of compliance”. This is a key term regulatory auditors look for. Basically, as long as you are adequately protecting clients, effort counts. Where compliance departments can show that they have taken the CFRs seriously and have built up processes that reasonably resemble those of their competitor firms, then in an audit, regulators may dispute interpretation or approach but you are not going to fall below that dangerous red line. Where thoughtful effort is not shown, that is where you start to get into trouble.
- “If it is not documented, it does not exist.” If you boil down the CFRs into one concept, it is that most of what they mandate are things that dealers and advisers have generally been doing in their heads. The CFRs ask that you better evidence your existing process. To that end, their needs to be a good paper trail for each of the tasks the CFRs are asking you to do. I get that creating a paper trail for each KYP review is onerous, and there are tech solutions that can help with that. However, the papering aspect of these CFRs cannot be understated.
Finally, tackling the CFRs from scratch are going to be hard. You need tools.
Parham: Did the comment letters (and any of the responses you’ve seen – introduce or raise any substantive items, or do you feel like what Advisor KYP is and what is required is fairly clear here?
Richard: The current round of comments for the IIROC/MFDA rules that ended January 18 was relatively sparse. I believe there were about a handful of letters and while they were thoughtful they were relatively short. As mentioned earlier, the implementation guidance/FAQs will be more informative over the coming year.
Parham: In your respective view, do the requirements raise the bar for advisors when it comes to meeting their KYP requirements?
Richard: I think that the requirements codify a lot of the best practices that Commission Staff have been recommending for a number of years. In short, most of what is in the CFRs are not “net new” from a substantive standpoint. What is new and onerous is that dealer/adviser activity will now need to be evidenced in a written and formal manner.
Parham: What are the challenges a dealer and advisors needs to consider with respect to their KYP obligation and considering a reasonable range of alternatives when making recommendations?
Richard: The first and main challenge is trying to determine what this phrase means for different firm models. While this specific phrase is drawn from the suitability requirement, there are a number of instances within the KYP requirement where you may have to look at comparator products as part of your due diligence requirements.
Understanding the “why” of this requirement will help inform when and how you should be including comparator product analysis in your KYP diligence.
The first “why” is conflicts of interest – If you are a dealer or adviser that is recommending a product (both proprietary and third party) where you are getting direct or indirect compensation for that recommendation, there is a (reasonable or otherwise) perception that you are only recommending this product because you are getting paid for it. Regulators have struggled with this issue for years. Where this conflict is identified for your firm, it is helpful to do a comparator product review so that you can show that the product you are recommending is being recommended because it is a good product, not because you are getting paid to sell it. This will give your firm additional protection as this area evolves.
The second “why” is based around some recent OSC decisions. Regulators have found that there is a client expectation that when they go to a firm, they are getting access to all the products the firm sells not just the products that an individual dealer sells. To the extent that you can show that a dealer considered all of the firm’s shelf when recommending a product to a client, you are avoiding a client expectation issue that has come up in the past.
Notwithstanding the above, I think this area will be an ongoing topic of discussion throughout the year through implementation guidance and FAQs.
February 26, 2021
On September 28, the Canadian Securities Administrators (CSA) published guidance in the form of responses to frequently asked questions (FAQs) about how to interpret and implement the client-focused reforms (CFRs) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103). As our readers already know, the conflicts-related CFRs must be implemented by June 30, 2021 and the remaining CFRs must be implemented by December 31, 2021. If you need a refresher on the CFRs, you can download our recently updated publication In a Nutshell: Implementing the Client-Focused Reforms.
The CSA recently released additional FAQs on December 18, 2020. We have noted with interest the following topics:
- KYC 2.0 Timing: In what can only help alleviate registrant stress, CSA Staff have made it explicitly clear that registrants do not need to both: (i) update their KYC and suitability process; and (ii) re-paper all their client accounts by December 2021. Registrants must only update their KYC and suitability process based on the CFR requirements by December 2021. Re-papering client accounts can occur after that date based on when a specific registrant is obligated to conduct a KYC update.
- Conflicts of Interest and Disclosure: The CFRs require registrant firms to compile an inventory of all their material conflicts and how they will mitigate those conflicts. Subsequently, the registrant firm must then disclose those conflicts in their relationship disclosure. CSA Staff have now clarified that where a registrant firm addresses a conflict by avoiding the conflict altogether, they do not need to include this conflict in their relationship disclosure. This clarification gives registrant firms some control over their required disclosure to clients and makes their choice of approach to conflict mitigation all that more important.
- Registrant Employee Oversight: For registrant firms that seek to provide a multi-discipline offering to their clients (e.g. a family office that provides services such as financial planning, securities advisory and insurance), CSA Staff have clarified that registrants have a broader due diligence obligation that just securities law oversight. CSA Staff have indicated that if a registrant employee holds themselves out as appropriately registered with another regulator, registrant firms have an ongoing obligation to ensure that this license is appropriate and that the registrant employee is in good standing with that regulator. This expectation may broaden existing due diligence procedures for registrant firms.
Implementing the CFRs will require changes to your policies, procedures, internal controls, record-keeping protocols, client-facing documentation and compliance training. Giving our clients practical advice on compliance with NI 31-103 is one of our core services. We can help you develop a project plan, work with you to systematically review and make any needed changes, and train your employees so that you are ready as the CFRs are phased in. In fact, our very own Richard Roskies is part of the Portfolio Management Association of Canada (PMAC) CFRs implementation committee. If you have any questions about the Guidance, please do not hesitate to contact us.
January 29, 2021
As a proud member of the Canadian Association of Alternative Strategies and Assets (CAASA), AUM Law is pleased to contribute to CAASA’s ongoing educational programming. On November 23, our very own Jason Streicher contributed his expertise to CAASA’s webinar Client Focused Reform – A Closer look at KYP. The webinar shared discussions of changes to KYP coming from the Canadian regulators, with new rules taking effect in 2021.
December 11, 2020
The Mutual Fund Dealers Association of Canada (MFDA) and the Investment Industry Regulatory Organization of Canada (IIROC) have both published a set of proposed changes to self-regulatory rules designed to conform to the provisions of the Canadian Securities Administrators’ (CSA) effort to enhance investor protection.
As we have reported previously, on October 3, 2019, the CSA published, in final form, the client-focused reforms (CFRs) which require the industry to put their clients’ interests before their own. The CFRs include a number of changes to investor protection rules, including conflicts of interest, suitability, KYC/KYP and disclosure obligations. IIROC has now published its own proposed rule amendments for public comment intended to make its requirements uniform in all material respects with the CFRs. In a notice published on November 19, IIROC stated that the objectives of the rule changes is to better align the interests of industry firms and reps with their clients, to improve client outcomes and to enhance clients’ understanding of the terms of their relationship with the industry. IIROC has published two sets of proposals: measures that are out for public comment until January 18, 2021, as well as a set of so-called housekeeping amendments which are required to conform with the CSA’s amendments but don’t add further material requirements on industry participants. The more substantive amendments subject to public comments include enhancements to IIROC’s suitability rules and changes to its account appropriateness requirement to ensure that client’s interests come first, along with measures setting out CFR exemptions from the core regulatory obligations of account appropriateness, KYC, suitability determination, product due diligence and KYP for certain account types, client types or service arrangements, as well as other changes of a consequential nature.
Similar to the approach taken by IIROC, on November 19, the MFDA published two sets of amendments. One set addresses housekeeping changes that are relatively minor and the other is a more significant set of proposals that must go out for public comment before they can be approved. The public comment proposals include changes to the MFDA’s rules on suitability, KYC/KYP and account supervision, as well as covering the guidance set out in various MFDA staff notices. The MFDA proposals are out for comment until January 18, 2021. The MFDA has indicated that it is seeking comments on the drafting of its own amendments to ensure that they are clear and properly applied to the business model of fund dealers. As with the CSA’s reforms, the proposed changes will, among other things, require that fund dealers resolve all conflicts of interest in the best interests of clients and provide conflicts disclosure to clients.
The CFRs are to be fully implemented by the end of 2021, with the conflicts of interest provisions taking effect as of June 30, 2021. It is expected that IIROC and MFDA rule changes will be implemented along the same timeline.
December 11, 2020