Category: Client-Focused Reforms (CFRs)

CSA FAQ Guidance on Client-Focused Reforms – Part 2

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.

On September 30, we published an article sharing our first look at some of the FAQs. In this article, we’ll highlight additional FAQs that we think our readers will find relevant as they work on their implementation plans.

Know-Your-Client (KYC) and Suitability Requirements

  • Collecting Information about Outside Holdings: In their response to FAQ 2, CSA staff provide guidance on how they expect registrants to handle situations where they do not have access to information about a client’s outside holdings, which may be relevant to the registrant’s assessment of the client’s capacity for loss. In particular, CSA staff expect dealers to obtain a breakdown of the client’s financial assets and net assets to ensure that the information collected accurately reflects the client’s financial circumstances and to assist the registrant in determining the availability of prospectus exemptions the suitability of any investment made. Outside investments may be particularly important to an assessment of whether a particular investment could lead a client to become over-concentrated in a security. Staff indicated, however, that if a client refuses to provide or update the requested information, that refusal does not automatically prevent the registrant from servicing the client. The registrant should use professional judgment in deciding whether it has sufficient information to meet its suitability determination requirement and whether that information is sufficiently current. Furthermore, staff expect dealers to make further inquiries where there is a reasonable doubt about the accuracy of information provided by the client or the validity of the client’s claim to be an accredited investor or eligible investor.
  • Unsolicited Orders: In their response to FAQ 2, CSA staff also remind registrants of the new requirement, set out in section 13.3(2.1) of NI 31-103, regarding unsolicited orders. If the registrant believes that a client order or instruction isn’t suitable, it’s insufficient to mark the order as unsolicited. The registrant must advise the client in a timely manner against proceeding, indicate the basis for that determination, and recommend an alternative that satisfies the suitability requirement in subsection 13.3(1). In order to provide such advice, the registrant must have sufficient KYC information.
  • Evidencing Compliance with KYC Update Requirements: In their response to FAQ 3, CSA staff emphasize that they have not prescribed how registrants must evidence their compliance with obligations to keep KYC information current. They note that methods for documenting a client’s confirmation of the accuracy of information, including significant changes, may include maintaining notes in the client’s file or more formal methods such as obtaining the client’s digital or handwritten signature. In some cases, notes of a phone call will be enough but in other situations (e.g. where there are significant changes in KYC information), staff expect that information to be repapered. Also, when a periodic review takes place, CSA staff expect all KYC elements to be reviewed. It wouldn’t be reasonable to update a client’s income or employment without asking questions to revisit their risk tolerance and time horizon.
  • Reassessing Suitability When Team Membership Changes: Section 13.3.(2)(a) of revised NI 31-103 (the Revised Rule) requires a registrant to review a client’s account and reassess the suitability of the securities in that account if, among other things, a registered individual is designated as responsible for the client’s account. In FAQ 26, CSA staff provide guidance on how that requirement can be interpreted where a firm assigns teams, rather than specific individuals, to client accounts. They indicate that professional judgment must be exercised in deciding whether a change in team membership triggers a suitability review. For example, a change of one registered individual will not necessarily trigger the requirement but individual team members’ roles and responsibilities, to the extent they differ, should be considered. For example, if there is a team leader who approves other team members’ recommendations and that team leader changes, it is likely that a review would be appropriate because that individual is effectively designated as responsible for the client’s account.

Best Interests Standard: In FAQ 4, market participants sought more guidance on how they can ensure that they are addressing material conflicts of interest in the best interests of their client. CSA staff’s response, however, does not provide much additional information. Staff reiterate their prior statements that determining best interests is a facts and circumstances-specific exercise, point to their guidance in NI 31-103CP regarding conflicts, and stress that a registrant’s conflicts analysis should take into account materiality, reasonability and professional judgment, taking into account the client-registrant relationship and the registrant’s business model.

Conflicts Disclosure: FAQ 15 asks whether conflicts can be grouped for disclosure purposes or whether they must be specifically enumerated. In their response, CSA staff stress that they do not want the disclosure to overwhelm clients but that some specificity is needed to help clients evaluate their relationship with the registrant. Registrants should use their professional judgment in deciding whether grouping certain conflicts together will result in the client being able to more easily understand the disclosure.

Relationship Disclosure Information (RDI) Requirements

  • Timeline: Now that the deadline for implementing the revised RDI requirements has been extended to December 31, 2021, CSA staff expect all new and existing clients to receive updated RDI in line with that deadline (FAQ 21).
  • Delivery Mechanisms and Content: CSA staff’s response to FAQ 21 also emphasizes that registrants have flexibility about how they deliver the revised RDI. For example, the information could be provided to a new client during onboarding, while an existing client could receive the information when the registrant first interacts with that client after the implementation date. If an existing client has opted to receive correspondence electronically, firms should provide the s. 14.2 disclosure to that client by December 31, 2021 to the extent feasible. Staff also stress that, to satisfy s. 14.2, registered individuals must spend enough time with the client to adequately explain the information being delivered to the client, including an explanation of any changes to the RDI being delivered to the client. Finally, CSA staff encourage registrants to assess the effectiveness of the disclosure they provide to clients by considering behavioural economics principles and tactics to simplify the content.
  • Standalone Conflicts Disclosure: FAQ 22 doesn’t expressly incorporate a question, but it seems to seek the CSA’s confirmation that firms will not have to mail out a separate disclosure document disclosing material conflicts of interest by June 30, 2021. In their response, CSA staff point out that the required conflicts disclosure to new and existing clients cannot be delayed past the June 30, 2021 deadline. However, the disclosure can be provided electronically or on paper, provided that it meets the CFRs’ plain language requirements. In addition, registrants that are not required to be members of the Investment Industry Regulatory Organization of Canada (IIROC) do not have use a prescribed RDI document to deliver the account opening conflict of interest disclosure.
  • Disclosure about Fees, Expenses and Operating Charges: CSA staff’s responses to FAQs 23 and 24 go beyond the guidance in revised NI 31-103CP to set out some additional factors and principles to consider in crafting RDI to meet the requirements in sections 14.2(2)(b)(ii) and 14.2(2)(o). Among other things, staff state the following:
    • Since fee models and products and services offered to clients vary widely, registered firms will have to exercise professional judgment as to the extent they can standardize disclosure, how client-specific it can be, and how much detail is needed. They also will need to strike the right balance between providing “enough information” and not overwhelming the investor.
    • Subparagraph 14.2(2)(b)(ii) of NI 31-103 does not require the firm to provide the client with a list of all investment funds and other products with ongoing fees and expenses. Rather, it is to inform clients who may be invested in such products or services that those investments have ongoing fees and expenses. For example, staff would expect disclosure in plain language about how fees and expenses are taken from the fund as a percentage of its total assets, how the fees and expenses will be deducted from the fund’s returns (and therefore will affect the client’s returns on their investment for as long as they hold the fund), and that when the client gets information about the value of their investment in the fund, the fees and expenses have already been taken into consideration.
    • The requirements for transaction charge disclosures in RDI are for “a general description” of the types of transaction charges that the client might be required to pay. This means that types of fees that the firm does not currently use for clients like the individual receiving the RDI should be excluded. It also means that the details of the amounts relating to a specific security should not be included in RDI.
    • The requirement to disclose operating charges is not qualified as a “general description”. It is specific to what the firm might charge the client related to the account. This is because RDI is deliverable at account opening and the specific details about the cost of having the account are therefore relevant at that time.
    • The requirement relating to the potential impact of fees and charges is for a “general description” but it is specific to the types of transaction charges and the actual operating charges (if any), as well as the investment fund management fees or other ongoing fees the client may incur in connection with a security or service, applicable to the client’s account. The most evident impact is that investment returns will be reduced in proportion to the fees and charges.
    • Firms should not provide generic summaries of the kinds of charges that are used in the industry or a sector of it.
    • A firm with a simple AUM-based fee model can be much more specific and more readily use numerical examples than one that relies on a mix of transaction fees and trailing commissions paid on products that it sells to clients.
    • Firms are encouraged to use graphics as well as text in order to make the information understandable to as many clients as possible.

Training: In their response to FAQ 1 regarding training on conflicts of interest, CSA staff indicated that registrants should exercise professional judgment in developing training materials and determining which staff require the training. They also said that:

  • They expect firms to train “all appropriate staff” on conflicts of interest generally, and this would include all registered individuals, all supervisory staff, and additional staff (including compliance staff) depending on their roles and responsibilities.
  • Training on the firm’s code of conduct, which generally includes training on conflicts of interest policies, procedures and controls may be sufficient to evidence training of staff on conflicts of interest generally.
  • Specific training modules for certain material conflicts also may be required for certain staff (e.g. training on compensation-related conflicts may be needed for all registered individuals and compliance/supervisory staff).

If/When Updates to Guidance Can Be Expected: FAQ 27 asks whether there is a comprehensive list of guidance and staff notices that the CSA and/or the self-regulatory organizations (SROs) expect to revise or rescind. In particular, market participants asked if guidance published by IIRCO and the Mutual Fund Dealers Association of Canada (MFDA) regarding personal financial dealings will be revised or rescinded. CSA staff state that:

  • If there is an inconsistency between language included in prior CSA guidance and the CFRs, the CFRs prevail to the extent they impose requirements or set out more current guidance.
  • The CSA proposes to review earlier guidance and may revise it or rescind it at a later stage. The FAQ guidance does not provide any specifics about what will be reviewed or when such a review will take place.
  • IIROC does not expect to issue new guidance on personal financial dealings.
  • The MFDA intends to revise “all [presumably relevant] guidance”. In particular, MSN-0047 Personal Financial Dealings with Clients will be revised but no changes to MSN-0031 Control or Authority over the Financial Affairs of a Client are expected.

If you would like to discuss the FAQ Guidance and its relevance to your business, or if you have other questions about the CFRs or would like our assistance on implementation matters, please do not hesitate to contact us. Please contact your usual lawyer at AUM Law for assistance, or if you’re new to the firm, please contact us for a free consultation.

October 9, 2020

CSA Publishes FAQ Guidance on the Client-Focused Reforms

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.

In our first look at the 34 just-published FAQs, we noted with interest the following topics:

Closed-Shelf Firms: Several FAQs address issues relevant for firms that only sell proprietary products (Closed-Shelf Firms):

  • Comparative Analysis of Competing Products Encouraged but Not Required: In their response to FAQ 9, CSA staff indicate that Closed-Shelf Firms do not have to compare their proprietary products to similar securities available in the market. However, CSA staff also suggest that periodically evaluating whether the firm’s proprietary products are competitive with alternatives in the market is one way a firm can demonstrate that its product shelf development and client recommendations are based on the quality of the proprietary products that it makes available to clients. This does not mean, however, that the firm must use the information gained from such an analysis either to change the products it makes available to clients or perform a shelf optimization. However, the information gained from such an assessment might inform the firm’s analysis of whether its controls to address the conflict of interest inherent in its business model are sufficient.
  • Assessing Competitors’ Prospectus-Exempt Products: CSA staff’s response to FAQ 11 acknowledges that it can be difficult to compare proprietary products to alternative products offered on a prospectus-exempt basis due to limits on publicly available information. They also stated, however, that most registrants and issuers have a general knowledge of the competitive space in which they operate and are able to gather enough information to understand how they or their offerings compare with others in that space. Staff also emphasized that if there are specific limitations to the information registrants can obtain, or necessary assumptions or caveats registrants have to make in their comparative analysis (for example, because competitive products are materially different), these limitations and assumptions should be documented. Staff also indicated that generally they will expect firms to be familiar with its competitors’ products at least at a high level.
  • Know-Your-Product (KYP) for Non-Proprietary Products Offered on an Incidental Basis: FAQ 11 also asks what level of due diligence is expected where a registered firm mostly offers proprietary products but may recommend certain non-proprietary products on an ancillary basis. In their guidance, CSA staff emphasize that firms operating under a 100% proprietary model do not have to include non-proprietary products on their shelf or recommend them. However, if a firm incidentally recommends non-proprietary products, then the incidental nature of the recommendation doesn’t reduce the firm’s KYP obligations for that product. Also, the firm should document its due diligence and, from a conflicts and suitability perspective, document why it has chosen to recommend a particular non-proprietary product over others.

Consent (or Disclosure + Consent) Aren’t Enough: In their responses to several FAQs, CSA staff emphasized that once the CFRs are in effect, consent (or disclosure plus consent) without other action by a registrant will be insufficient to address a material conflict of interest in a client’s best interest. (FAQs 6, 7 and 11) Additional controls (such as pre-trade controls and/or post-trade reviews) must be used. In FAQ 7, CSA staff also indicate that if a client opens an account after receiving clear disclosure that the dealer or adviser will be using proprietary products, it is reasonable to assume that the client agreed to a client-registrant relationship on that basis. However, the dealer must also take other steps to address the conflict before it can proceed, and it cannot rely solely on the issuer or an affiliate for its product due diligence.

Referral Arrangements: The response to FAQ 17 reiterates that when a firm refers a client to a service provider, the firm is responsible for conducting oversight over that service provider. The response also outlines steps that registrants can take to conduct due diligence on prospective referral parties and then supervise any referral arrangements they enter into. CSA staff expect registrants to consult publicly available databases and search engines, and make inquiries of the other party (whether registered or not) to ascertain, for example:

  • The referral party’s status (including licensing or registration status), financial health, professional qualifications and history;
  • Whether the referral party has been the subject of any investigation by a securities or financial sector regulator, any disciplinary action relating to their professional activities under their governing body or organization; and
  • Whether there have been complaints, civil claims and/or arbitration notices filed against them in relation to their professional activities.

Due diligence records must be maintained. CSA staff also list examples of controls that can be used to monitor referral arrangements, including:

  • Ongoing assessment of compensation received by registrants under referral arrangements;
  • Ongoing compliance calls to investors who have been referred to or by the firm to assess how the process is being conducted by each referral party;
  • Annual questionnaires sent to registrants receiving referral fees regarding the nature and extent of their involvement in referral arrangements;
  • Interviews of registrants receiving referral fees during the branch review process;
  • Requiring unregistered referral agents who make referrals to the firm to: (1) attend training on how to conduct referrals; and (2) use only pre-approved marketing materials and social media content in relation to their referral business; and
  • Assessing complaints and other information received in connection with referral arrangements to ensure compliance by all referral parties.

When is a Conflict Material? CSA staff’s response to FAQ 5 asking for further guidance on the concept of “material conflicts” does not provide any new information. Staff reiterated the guidance expressed in the revised Companion Policy to NI 31-103 (Revised Policy) that, in determining whether a conflict is material, registrants should consider whether the conflict may reasonably be expected to affect, in the circumstances, the client’s decisions and/or the registrant’s recommendations or decisions. They also pointed to their guidance in the Revised Policy listing the conflicts that they consider to be “almost always material”.

Conflict of Interest Records: FAQ 12 asked the CSA for more guidance on the level of detail required in conflict of interest records. CSA staff’s response emphasizes several points:

  • As the materiality of the conflict increases, there should be greater detail in the records maintained to demonstrate compliance.
  • The CSA has not prescribed a specific format for such records. However, staff expect firms to, at a minimum, document their identification, review and analysis of conflicts of interest, their determination as to whether a conflict is material, and the controls used by the firm to ensure that material conflicts have been addressed in the client’s best interest.
  • The firm’s documentation can be part of its risk assessment or conflicts of interest assessment, and it can include cross-references to the firm’s policies, procedures and controls.
  • Paragraph 11.5(2)(q) of NI 31-103 will require firms to create a complete record that documents sales practices, compensation arrangements, and incentive practices, and the guidance in section 11.5 of the Revised Policy describes what must be documented.

Supervisory Staff Compensation: CSA staff discuss approaches to supervisory compensation in their response to FAQ 10. They state, among other things, that they expect the majority of the compensation of supervisory staff to not be tied to the revenue generation of representatives, the branch, or the business line that supervisory staff oversee. If, however, a portion of supervisory staff compensation is tied to branch or business line profitability, CSA staff expect that:

  • The other compensation factors should be sufficient to outweigh any bias that supervisory staff might have toward profitability over the clients’ best interest;
  • Controls such as multiple level supervision should be in place to ensure head office or an otherwise independent review of the supervisory process; and
  • Compensating controls should be tested periodically for effectiveness.

Staff also recommend that firms consider compensating controls such as setting a low level of bonus relative to base salary combined with strict measures that penalize non-compliance, such as tying supervisory staff’s bonuses (or even salaries) to:

  • Branch and direct reports not receiving valid investor complaints; and
  • Results from independent quality assurance calls to investors to assess compliance and sales practices.

Other FAQ Topics: Before the Thanksgiving Holiday, we expect to publish a second article on our website discussing other FAQs, such as staff’s responses to questions about the collection and maintenance of up-to-date know-your-client (KYC) information and questions about the revised relationship disclosure information (RDI) requirements. We also will monitor the CSA’s CFRs Resource page and update our readers when new FAQs are added.

AUM Law is helping firms make steady progress toward the CFRs’ compliance deadlines and we can help you, too. We can help you develop a project plan, systemically review and make any needed changes to your policies, procedures and operations, and train your employees so that they understand the revised rules and your firm’s updated protocols. And along the way, we’ll stay on top of regulatory updates like the just-published FAQs so that our advice to you keeps pace with regulatory expectations. Please contact your usual lawyer at AUM Law for assistance, or if you’re new to the firm, please contact us for a free consultation.

September 30, 2020

OSC Publishes 2020-2021 Statement of Priorities and Its 2019-2020 Report Card

A.  Priorities for the Coming Year

On June 25, the Ontario Securities Commission (OSC) published its annual Statement of Priorities (SOP). As we mentioned in our April bulletin, COVID-19 and the related market uncertainty caused the OSC to forego its usual substantive consultation on priorities. Instead, the OSC used last year’s SOP, its plans flowing from its burden reduction initiative and its routine engagements with stakeholders to develop its 2020-21 priorities. Consequently, there are very few surprises in this year’s final SOP. We’ve summarized below key initiatives that we believe will be of interest to our readers.

Client-focused Reforms: The OSC will work with other members of the Canadian Securities Administrators (CSA) and the self-regulatory organizations (SROs) to help registrants operationalize the amendments.

Seniors Strategy: The OSC will continue to implement its Seniors Strategy, including continuing with its consultation on proposed changes to the regulatory framework to address financial exploitation and cognitive decline among older and vulnerable investors. (See our March 2020 article on this consultation.)

Leverage in the Asset Management Industry: Working with other members of the International Organization of Securities Commissions (IOSCO), the OSC plans to design and implement enhanced data collection to monitor vulnerabilities associated with the asset management industry’s use of leverage.

OTC Derivatives: The OSC plans to:

  • Publish (with Ministry pre-approval) amendments to the business conduct rule for over-the-counter (OTC) derivatives, limiting the rule’s scope and outlining jurisdictions that will be granted equivalency;
  • Work with the CSA on the next version of the proposed OTC derivatives dealer registration rule;
  • Conduct compliance reviews of the OTC derivatives rules on trade reporting, clearing, segregation and portability; and
  • Develop and implement a framework to analyze OTC derivatives data for systemic risk and market conduct purposes.

Continue Policy Work on Embedded Commissions: The OSC will continue working within the CSA and on its own regarding rule reforms affecting mutual fund deferred sales charges (DSCs) and order execution-only embedded commissions.

Retrospective Reviews of Rulemaking: As part of its efforts to enhance its economically-focused rulemaking, the OSC plans to conduct restrospective reviews of past regulatory changes to see if the intended objectives were achieved.

Re-Consider the SRO Framework: As discussed elsewhere in this bulletin, the CSA has launched a consultation on the SRO framework. The OSC also plans to work on clarifying and streamlining the SROs’ recognition orders and memoranda of understanding.

Office of Economic Growth and Innovation (OEGI): The OSC plans to have the OEGI fully operational and delivering on its mandate by fiscal year-end 2021. This includes having the OEGI conduct outreach with market participants to identify further, potential burden reduction opportunities.

CSA National Systems: The OSC will support the CSA in its implementation of revised national systems (i.e. SEDAR, SEDI and NRD) under the name SEDAR+. It also will work with CSA members to amend the operational and fee rules governing CSA systems.

Modernize the OSC’s Technology Platform: The OSC will continue redeveloping its website, implementing its information security program, and adding more tools and technology to enable to staff to work more effectively and efficiently from home.

B.  2019-2020 Report Card

The OSC also published its 2019-2020 OSC Statement of Priorities Report Card (Report Card). Chief Compliance Officers (CCOs) may find it useful to skim the Report Card because it consolidates into a single document status reports on the OSC’s regulatory and operational initiatives from the past fiscal year. It also highlights some “in progress” initiatives that the OSC expects to deliver in the coming year. Notably, the Report Card indicates that the OSC expects proposed reforms to the regulatory framework governing registrants’ other business activities (OBAs) to be published for comment in the fall of 2020.

C.   Be Prepared for the OSC to Shift Its Stated Priorities

Market participants should always be prepared for the OSC to adjust its priorities in light of significant emerging issues. This year more than ever, however, market participants should be prepared for surprises. The OSC has also indicated that it expects to adjust and re-align its priorities throughout the coming year to accommodate changes resulting from the impact of COVID-19 as well as the outcomes of the Ontario Government’s Capital Markets Modernization Task Force.

Please contact us if you would like to discuss how the OSC’s priorities and goals for the coming year might affect your business.

June 30, 2020

CSA Extends Deadline to Implement Conflicts-Related Client-Focused Reforms by 6 Months

As we discussed in our October 2019 special bulletin, the Canadian Securities Administrators (CSA) have finalized their client-focused reforms (CFRs) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103). The CSA initially set an implementation deadline of December 31, 2020 for the conflict of interest provisions and related relationship disclosure information (RDI) requirements in the CFRs.

On April 16, CSA members announced that they are shifting that implementation deadline to June 30, 2021. Registrants will have to comply in the interim period with the comparable provisions in NI 31-103, as they read on December 20, 2020.

Although we expect registrants to welcome this extension of the deadline, we encourage firms to continue making steady progress toward implementation of the new requirements. In the current environment, where so many registrants and their service providers have their employees working remotely and are dealing with emerging risks resulting from the COVID-19 pandemic, projects like these may take longer than expected to complete. AUM Law is already helping many of our clients systematically prepare for the new regime and we can help you, too. Please do not hesitate to contact us.

April 30, 2020

Our Client-Focused Reforms in a Nutshell Publication Is Ready

To make your life easier, we have consolidated the articles we’ve written to date on the client-focused reforms (CFRs) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations into a snappy, little(ish) guide, Client-Focused Reforms in a Nutshell. If you would like to receive a copy, please contact us and we’ll subscribe you to our publications (if you haven’t already signed up).

February 28, 2020

OSC Goes Its Own Way as CSA Finalizes Rule on Embedded Commissions

On February 20, the Canadian Securities Administrators except the Ontario Securities Commission (Participating Jurisdictions) published a notice (Multilateral Notice) announcing amendments to National Instrument 81-105 Mutual Fund Sales Practices and related instruments to prohibit deferred sales charges (DSCs) for investment funds (Amendments). The OSC, like somebody who someone in Fleetwood Mac was dating unhappily, has decided to go its own way and restrict rather than ban DSCs outright. We’ve set out below the key features of the Participating Jurisdictions’ ban, and the OSC’s proposed restrictions, on DSCs.

A.  Participating Jurisdictions

  • In the Participating Jurisdictions, the Amendments will prohibit fund organizations from paying upfront sales commissions to dealers, which will result in the discontinuation of all DSC options.
  • The Amendments will take effect on June 1, 2022 (Effective Date). The redemption schedules for mutual fund investments purchased under a DSC option before the Effective Date will be allowed to run their course until their scheduled expiry.
  • As we discussed in our October 2019 bulletin, the conflict of interest provisions in the client-focused reforms (CFRs) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) come into effect on December 31, 2020. Regulators in the Participating Jurisdictions will exempt dealers from these new requirements as they apply to DSC options until the Effective Date. Instead, dealers will be required to comply with the conflict of interest provisions that are currently in effect under NI 31-103 in relation to DSC options.
  • Regulators in the Participating Jurisdictions view the discontinuance of the DSC option as a material change. So, for prospectuses that contemplate a DSC option, are receipted before the Effective Date, and lapse after the Effective Date, disclosure can be handled in one of two ways.
    • Option 1: Amend the simplified prospectus and fund facts documents as of the Effective Date to remove references to the DSC option.
    • Option 2: Include disclosure in simplified prospectus and fund facts documents indicating that the DSC option will not be available in the Participating Jurisdictions after the Effective Date.

B.  Proposed OSC Rule 81-502 – Restrictions on the Use of the Deferred Sale Charge Option for Mutual Funds

  • Proposed OSC Rule 81-502 is intended to address the “lock-in” effect associated with the DSC option and reduce the potential for miss-selling while continuing to allow dealers to offer the DSC option to clients with smaller accounts. Restrictions will be imposed at the investment fund manager (IFM) and dealer levels.
  • IFM-level restrictions: OSC Rule 81-502 will limit the redemption schedule to three years. Clients will be permitted to redeem up to 10% of their investment annually without redemption fees (on a cumulative basis). IFMs will have to create a separate DSC series so that investors who purchase funds on a no-load or front-end charge basis do not incur any costs related to financing the upfront commissions typically associated with the DSC option.
  • Dealer-level restrictions: Dealers won’t be able to sell funds with a DSC option to clients who are either aged 60 or over or have an investment horizon that is shorter than the DSC schedule. In addition, DSC option funds can only be sold to clients with accounts not exceeding $50,000, and clients will not be able to use borrowed money to buy mutual funds with a DSC option. Upfront commissions will be permitted only for new contributions to client accounts and no such commissions will be payable on reinvested distributions. Finally, no redemption fees will be payable in connection with investor redemptions in specified circumstances (g. involuntary loss of full-time employment, permanent disability, critical illness, or death).
  • Effective date: OSC Rule 81-502 is expected come into effect when the DSC ban comes into effect in the Participating Jurisdictions.
  • Conflict of interest: The OSC considers it a conflict of interest for registrants to accept upfront commissions associated with the sale of securities under a DSC option. Therefore, it expects registrants to address that conflict consistent with their obligations under NI 31-103, in its current state, and as amended by the CFRs, when those amendments take effect at the end of this year.
  • Deadline for comments: Comments are due on proposed OSC Rule 81-502 by May 21, 2020.

In light of the forthcoming ban on DSC options in most jurisdictions and the narrowly defined scope for them contemplated in OSC Rule 81-502, we imagine that fund organizations and dealers are assessing whether it will be worth it to continue DSC option funds in Ontario once the ban in the Participating Jurisdictions takes effect. If you would like to discuss how the Amendments and OSC Rule 81-502 might affect your business, please contact us.

February 28, 2020

Bulletin | Year of the Rat Edition | January 2020

In this bulletin:

  1. Client-Focused Reforms: A Closer Look at the Misleading Communications, RDI, Compliance Training and Record-Keeping Rules
  2. IIROC and FINRA Publish Their Compliance Priorities for 2020
  3. Get Ready to RAQ and Roll
  4. IIROC Fines Registered Representative for His Shoulda Woulda Could KYC
  5. ASC Schools Registrants on Compliance with OM Exemption
  6. Like Rats in a Maze: Navigating the Application of Securities Laws to Crypto Assets

FAQ Corner: Can an advising representative act as the executor of an estate on behalf of a client?

In Brief: CSA Consults on Access Equals Delivery Model for Disclosure Documents

News and Events: Lexology Recognizes AUM Law Again for Thought Leadership in Our Publications

Click the link to access a PDF of our full, monthly bulletin summarizing these recent developments. >> Monthly Bulletin | Year of the Rat | January 2020

Client-Focused Reforms: A Closer Look at the Misleading Communications, RDI, Compliance Training and Record-Keeping Rules

As we reported in our October 2019 special bulletin, the Canadian Securities Administrators (CSA) have finalized their client-focused reforms (CFRs) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) and its related Companion Policy (NI 31-103CP) (Policy). These provisions came into force late last year and will take effect in two phases, beginning on December 31, 2019.

This month, we highlight the new prohibitions on misleading communications as well as the relationship disclosure information (RDI), compliance training and record-keeping requirements. The RDI requirements will come into effect on December 31, 2020 and the other provisions discussed in this article will come into effect on December 31, 2021. To streamline our discussion, we refer to NI 31-103 and NI 31-103CP in their current form as the Current Rules and Policy and to the amended versions as the Revised Rules and Policy.

This article is the third in our series of closer looks at the CFRs. We discussed the conflict of interest provisions in our October 2019 bulletin and the know-your-client (KYC), know-your-product (KYP) and suitability provisions in our November 2019 bulletin.

A.  Misleading Communications

Securities regulators and investor advocates have been concerned for years that some registered firms and individuals use confusing or misleading titles, designations, awards and/or other descriptions of themselves and their services. The securities regulatory framework already incorporates prohibitions that are broad enough to capture at least some of this conduct. For example, subsection 44(1) of the Ontario Securities Act prohibits people and companies from making statements that a reasonable investor would consider relevant in deciding whether to enter into or maintain a trading or advising relationship with that person or company if that statement is untrue or omits information necessary to prevent the statement from being false or misleading. Section 2.1 of National Instrument 31-505 Conditions of Registration requires registered dealers, advisers and representatives to deal fairly, honestly and in good faith with clients. And in 2011, the Canadian Securities Administrators (CSA) outlined their specific concerns and provided guidance to portfolio managers regarding the use of trade names and individual titles in marketing materials in Staff Notice 31-325 Marketing Practices of Portfolio Managers.

New section 13.18 of NI 31-103 reflects the securities regulators’ conclusions that this principles-based approach is inadequate. The new rule, scheduled to come into effect on December 31, 2021, will prohibit registrants from holding out their services in any manner that could reasonably be expected to deceive or mislead any person as to:

  • Their proficiency, experience or qualifications;
  • The nature of the person’s relationship or potential relationship with the registrant; or
  • The products or services provided or that might be provided.

It also will prohibit registered individuals who interact with clients from using from any title or designation without their sponsoring firm’s approval. In addition, they will be prohibited from using corporate officer titles unless appointed to that office under corporate law, and they will not be able to use any title, designation, award or recognition based on their sales activity or revenue generation.

The Revised Policy emphasizes that particular scrutiny should be given to titles that may convey an expertise in seniors’ issues or retirement planning. It also recommends that firms consider whether a particular designation has a rigorous curriculum, examination process and experience requirements issued by a reputable or accredited organization when deciding whether to approve the designation’s use.

As registrants develop their project plan for implementing these new requirements, they should also take into account the following:

  • The CSA has indicated that there is potential for further rulemaking on the use of titles and designations. And in 2020, the Financial Services Regulatory Agency of Ontario (FSRA) intends to consult stakeholders and publish draft rules to implement the Financial Professionals Title Protection Act, which will regulate individuals’ use of “financial planner” and “financial advisor” titles in Ontario. AUM Law will monitor these developments and keep you informed.
  • As noted above, there are principles-based laws already on the books that could support enforcement action against a firm or individual for misleading communications. Therefore, although the official effective date for the new rules is December 31, 2021, we encourage firms to review their policies, procedures and practices in this area sooner rather than later.

B.  Updated RDI Requirements

Section 14.2 of NI 31-103 has been amended to reflect changes with other CFRs (e.g. relating to conflicts of interest, KYC, KYP and suitability determination requirements) and, according to the CSA, to “better implement” the principle in subsection 14.2(1) that a registrant must deliver to the client “all information that a reasonable investor would consider important about the client’s relationship with the registrant.” Among other things, when revised section 14.2 comes into effect it will:

  • Expand the existing requirement for registrants to provide a general description of the products and services that the firm offers to the client to include, as applicable, descriptions of any restrictions on the client’s ability to liquidate or resell a security and any investment fund management expense fees or other ongoing fees the client may incur;
  • Require registered firms to describe generally any limits on the selection of products or services that the registrant will offer to the client, including whether the firm will primarily or exclusively use proprietary products in the client’s account;
  • Require registered firms to explain generally the potential impact of operating charges, transaction charges, investment fund management fees, and any other ongoing fees the client might occur; and
  • Expand the requirement for pre-trade disclosure to expressly require disclosure of investment fund management expense fees or other ongoing fees that the client may incur.

Also, the existing requirement to describe compensation paid to the registered firm in relation to the types of products a client might purchase will be broadened. It will require a general description of any benefits received or expected to be received by the registrant from anyone other than the registrant’s client, in connection with the client’s purchase or ownership of a security through the registrant.

The Revised Policy includes expanded sections on:

  • Information to be included in the description of the nature or type of a client’s account;
  • Factors to consider in describing limits on the selection of products or services, including guidance emphasizing that a registrant is required to tell a client if it does not have products or services suitable for them; and
  • When a firm is expected to provide a client with the KYC information it has collected (i.e. at the time of account opening and when the firm collects updated information).

The new RDI rules will take effect on December 31, 2020. AUM Law can help you prepare for the new regime by reviewing and updating your existing disclosure materials for clients, as well as the related policies, procedures and controls.

C.  Compliance Training

Under the Current Rules and Policy, training is specifically addressed through:

  • Prohibitions on registered individuals performing registrable activities, and chief compliance officers (CCOs) performing their responsibilities as CCOs, without having the education, training and experience that a reasonable person would consider necessary to perform the activity competently; and
  • Language in the Current Policy indicating that registered firms should provide training, including ongoing communication and training on changes in regulatory requirements or the firm’s policies and procedures, to ensure that everyone at the firm understands the standards of conduct and their role in the compliance system.

Section 11.1 of NI 31-103 has been amended to introduce a broadly worded requirement for registered firms to provide training to their registered individuals on compliance with securities legislation, including without limitation the KYC, KYP, suitability determination and conflicts of interest requirements. This new rule is supplemented with guidance in the Revised Policy, which emphasizes the following concepts:

  • A firm’s compliance training will depend on the nature, size and complexity of its business. For some small firms, a formal compliance training program or written training materials might be unnecessary. However, the CSA will expect firms to exercise professional judgment in determining what training is appropriate for their operations.
  • Although Section 11.1 of the Revised Rules speaks only to the need for firms to train registered individuals, the Revised Policy retain the concept that CSA members expect firms’ training programs to ensure that everyone at the firm understands the standards of conduct when dealing with clients and understands their role in the compliance system. In our view, this broader definition of the firm’s training responsibility can be seen as flowing from the existing requirement in section 11.1 for registered firms to have a system of controls and supervision sufficient to provide reasonable assurance that the firm and every individual acting on its behalf complies with securities legislation.
  • Although the Revised Rule calls for compliance training on securities legislation generally, it and the Revised Policy specifically highlight the need for compliance training on the KYC, KYP, suitability, and conflicts of interest provisions. According to the Revised Policy, training should provide examples of how to:
  • Identify existing and reasonably foreseeable, material conflicts of interests between registered individuals and their clients;
  • Address material conflicts of interest in the client’s best interest; and
  • Put the client’s interest first when making suitability determinations.
  • Consistent with the KYP requirements, firms also will be expected to assess whether any additional training or proficiency requirements are needed so that their registered individuals understand the securities and can make appropriate determinations.
  • Firms can outsource elements of their training programs but remain responsible for demonstrating that their registered individuals have been trained on the firm’s policies and procedures.
  • Training programs should include “ongoing” communication and training on changes in regulatory requirements or the firm’s policies and procedures.
  • Firms will need to document their compliance training programs.

Although these specific, new compliance training requirements won’t come into effect until December 31, 2021, we recommend that firms begin enhancing their compliance training programs in 2020, so that your employees become familiar with the CFRs. AUM Law offers compliance training programs tailored to your firm’s needs. We can help you identify compliance gaps or topics that need reinforcement, determine who needs to be trained and when, develop the content for training sessions, update your compliance manual to reflect the new training requirements, and prepare the needed documentation to show that the compliance training requirements have been met.

D.  Record-Keeping Requirements

Section 11.5 of NI 31-103 has been expanded so that registered firms will have to maintain records that:

  • Demonstrate compliance with the new KYP and suitability determination requirements;
  • Demonstrate compliance with the conflict of interest provisions in Part 13, Division 2;
  • Demonstrate compliance with the requirements relating to misleading communications;
  • Document training actions conducted by the firm; and
  • Document the firm’s sales practices, compensation arrangements and incentive practices as well as any other compensation arrangements and incentive practices from which the firm, any of its registered individuals or any of its affiliates or associates, benefit.

The Revised Policy provides detailed guidance on the kinds of records that it expects registered firms to keep. It also stresses the importance of firms maintaining adequate documentation to support the firm’s supervision of its compliance processes in these areas. We expect that some of the more challenging aspects of these new requirements will include:

  • Documenting suitability determinations and related supervisory measures (e.g. to address patterns of unsuitable trades); and
  • Documenting the KYP process, including where the firm concludes that using proprietary products and services as opposed to a third party’s products and services puts the client’s interests first.

In addition to presenting some conceptual challenges, some of the new record-keeping requirements (such as those documentation of conflicts of interest, sales practices, compensation arrangements, incentive practices) will require a substantial deployment of firm resources to design and maintain.

AUM Law can help you implement these new requirements by, for example, assessing your existing record-keeping practices, identifying any gaps and developing new protocols and record types to cover the elements listed above.

E.  Now What?

This is the last article in our introductory series highlighting the CFRs. Giving registered firms practical advice on compliance with NI 31-103 is one of AUM Law’s core services, and we have already started with working with some of our clients on implementation. We can help you understand the implications of the CFRs for your business, develop a pragmatic implementation plan, revise any of your policies and client-facing documentation that are looking a little “ratty” in light of the recent reforms, update your record-keeping protocols, and train your employees on the new requirements. Please contact your usual lawyer at AUM Law for assistance or, if you’re not already a client, request a free consultation.

January 31, 2020