Category: News

Reminder: OSC Participation Fee Calculation and Payment

It’s time for Ontario-registered firms, unregistered exempt international dealer/adviser firms, and unregistered investment fund managers to get ready to file their annual participation fee calculations with the Ontario Securities Commission (OSC) by December 1 and pay the prescribed fees by December 31.

Filing and Payment

  • How and when: Firms must complete and file Form 13-502F4 Capital Markets Participation Fee Calculation (Form 13-502F4) or Form 13-503F1 (Commodity Futures Act) Participation Fee Calculation (Form 13-503F1), as appropriate, by December 1.
  • Certification: Your firm’s chief financial officer (CFO) or another specified officer, such as the chief compliance officer (CCO), can certify and submit the required forms to the OSC.
  • Amount: According to the information that your firm provides in Form 13-502F4 or Form 13-503F1, the National Registration Database (NRD) generates a preliminary annual fee summary in early December. The participation fee in Form 13-502F4 or Form 13-503F1, as well as the annual fees payable in other jurisdictions (if applicable), will be withdrawn from your firm’s NRD account on December 31. Ensure that your NRD account has the necessary funds on December 31 to allow these withdrawals.
  • If you do not pay: Failure to pay annual participation fees will result in automatic suspension of a firm and its individuals. Furthermore, late fees will apply for forms and participation fees submitted after the due dates.

AUM Law Can Help: Please contact Gordana Beric or Rachel Palozzi if you would like our help in preparing and filing Form 13-502F4 or Form 13-503F1, or if you have any questions about the requirements.

October 30, 2020

Get Your Copy of AUM Law’s Updated Guide to the Client-Focused Reforms

In October 2019, the Canadian Securities Administrators (CSA) finalized their client-focused reforms to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) (CFRs or Amendments). The CFRs are the most sweeping changes to NI 31-103’s ongoing registrant obligations since the rule was adopted over ten years ago. These reforms represent a fundamental shift towards a best interest standard.

Implementing the CFRs will require changes to your policies, procedures, internal controls, record-keeping protocols, client-facing documentation and compliance training, but there’s no need to panic. AUM Law is here to help. 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.

 

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’s CRR Branch Publishes Its Annual Report on Registrants

On September 14, staff of the Compliance and Registrant Regulation (CRR) Branch at the Ontario Securities Commission (OSC) published their Annual Summary Report for Dealers, Advisers and Investment Fund Managers (Report). 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. Although we hope you find our takeaways from the Report useful, the discussion below doesn’t replace the Report or consultation with your counsel about the Report’s implications for your business.

A. Focus Areas for 2020-21 Compliance Reviews

Staff expect their upcoming compliance reviews to prioritize the following areas:

  • COVID-19 impact on registrants;
  • Complaint-handling processes;
  • Suitability assessments, including concentration;
  • Review of some firms to confirm their level of operational activities; and
  • Marketing practices, including environmental, social and governance (ESG) offerings.

During the Portfolio Management Association of Canada’s Fall Regulatory and Compliance Webcast on September 24, a CRR staff member indicated that they expect the marketing practices sweep to begin shortly, either in late October or in November.

AUM Law’s focused and general compliance risk assessments can save you time and money by enabling you to pro-actively identify and address issues before they flare up into problems or you are audited by the OSC. But if the OSC calls you for an audit before you call us, we can conduct a strategic and expedited “911” review, so that you can begin identifying and addressing any material issues and are better-positioned to make a good first impression with OSC staff in the initial meeting. Contact us to learn more about these services.

B. Spotlight on Compliance Deficiencies

In 2019-20, CRR staff conducted compliance reviews in the following areas, among others:

  • A suitability sweep of exempt market dealers (EMDs) and portfolio managers (PMs);
  • High-risk firms identified through the 2018 Risk Assessment Questionnaire (RAQ) or the “Registration as a First Compliance Review Program”;
  • Desk reviews of firms reporting financial statement losses in their 2017 and 2018 audited annual financial statements;
  • Desk reviews of U.S.-based firms relying on the international dealer, international adviser, and/or non-resident investment fund manager registration exemptions (International Exemptions Review);
  • Investment fund managers (IFMs) that had recently acquired or purchased assets of another IFM; and
  • IFMs that are members of a self-regulatory organization (SRO).

As usual, the Report includes aggregate data on the type and severity of compliance deficiencies identified during last year’s reviews. The largest number of deficiencies related to compliance systems (40%, up 2% from 2018-19), and there was a tie for second place. Know-your-client (KYC), know-your-product (KYP) and suitability matters tied with client reporting matters, with each category representing 13% of deficiencies identified during the past year’s reviews. The largest number of significant deficiencies in 2019-20 concerned compliance systems (9%), KYC/KYP/suitability (8%), and conflicts of interest/referral arrangements (7%).

As they have in the past few years, staff organized their discussion of compliance deficiencies by theme. Below, we have highlighted topics that we think will be of particular interest to our readers.

1) Compliance Function

Some Annual Compliance Reports Got “Needs Improvement” Grades: Staff noted that chief compliance officers (CCOs) at some firms failed to prepare annual compliance reports, as required by section 5.2 of National Instrument 31-103 Registration Requirements, Exemptions and  Ongoing Registrant Obligations (NI 31-103) or prepared cursory reports that didn’t contain enough detail to support the CCO’s assessment of the firm’s compliance function and/or the firm’s and employees’ compliance with securities legislation.

Service Provider Oversight: CRR staff are continuing to see situations where IFMs are performing little to no oversight of their outsourced fund administration and portfolio functions, or of their custodian. Common deficiencies included failures to:

  • Obtain and evaluate a Service Organization Controls (SOC) report, when one was available from the service provider;
  • Document and maintain evidence of the specific monitoring activities performed;
  • Periodically validate the accuracy of prices used by the service provider in portfolio valuation; and
  • Review material and complex corporate actions to confirm they were accurately processed and recorded by the service provider.

2) KYC, KYP and Suitability Obligations (EMDs / PMs / SPDs)

The good news is that, in this year’s suitability sweep, CRR staff generally saw improvements in firms’ KYC and suitability processes, compared with prior years’ reviews. However, they are continuing to see deficiencies in some areas, including:

  • Inadequate collection and documentation of up-to-date KYC information;
  • Inadequate documentation of suitability assessments (e.g. failure to document how a product that did not align with the client’s investment objectives nevertheless was suitable when other components of a client’s profile were considered);
  • Managed accounts with portfolios that didn’t align with the client’s target asset mix reflected in their KYC documentation;
  • Clients over-concentrated in a single issuer/issuer group or industry/asset class;
  • Advisers and dealers not considering a clients’ total holdings of illiquid securities when assessing concentration risk;
  • Inappropriate use of client-directed trade instructions (e.g. firms requesting such an instruction instead of conducting a suitability assessment first);
  • Non-compliance with investment limits under the offering memorandum (OM) prospectus exemption;
  • Inadequate documentation to support the determination that investors qualified as “accredited investors”; and/or
  • Relying on third parties to collect KYC information for some clients without an advising representative (AR) or dealing representative (DR) of the firm meeting or speaking with such clients directly.

KYC and suitability obligations remain an area of ongoing concern for securities regulators. AUM Law can conduct a focused review of your client-facing documentation, policies and procedures and then help your firm can make any changes needed to comply with existing laws and implement the changes required by the client-focused reforms (CFRs) by the December 31, 2021 deadline. Please contact us to discuss how we can help.

3) NOT Now – Internal Firm Suspensions Require a Notice of Termination (All)

A firm that internally suspends a registered or permitted individual must file a Notice of Termination (NOT), so that the regulators and the public (through the NRD database). Firms that do not file a NOT, as required, run the risk of being held responsible for any registerable activity the individual conducts, even while under a firm-imposed suspension.

Staff indicated in the Report that some firms have been reluctant to file a NOT due to concerns that having the individual reinstated will be time-consuming. To address that concern and encourage firms to file NOTs as required, CRR staff have committed to a streamlined review process for assessing an individual’s suitability for registration after a firm-imposed suspension. In particular, CRR staff will permit firms to file Form 33-109F7 Reinstatement of Registered Individuals and Permitted Individuals (instead of Form 33-109F4) and will not require a new application fee, if certain criteria are met, including the following:

  • The firm notifies staff in advance of the issue that led to the suspension;
  • Staff is satisfied with the remedial actions that the firm has indicated it will take;
  • The firm files a timely NOT;
  • The firm notifies staff at least five business days in advance of its intention to reinstate the individual;
  • There is no new detrimental information from the time the NOT was submitted; and
  • There are no changes to information previously submitted in items 13 through 16 of Form 33-109F4.

AUM Law can advise you on, prepare and complete registration-related filings such as NOTs, as required. Please contact us if you have questions about or need assistance with matters like these.

4) Cross-Jurisdictional Registration Issues

Servicing Non-Ontario Clients without Required Registration (PMs / EMDs): According to the Report, Staff continue to see firms and representatives who do not have the required registrations in the relevant jurisdictions to trade in, or advise on, securities for clients outside Ontario. For example, some firms and/or their representatives are purporting to rely on the client mobility exemptions for Canadian clients without satisfying the criteria for those exemptions. Staff encourage firms to, among other things:

  • Take an inventory of the residency of the firm’s existing clients;
  • If the firm determines that any of its clients are located in jurisdictions where the firm and/or its registered individuals are not registered and do not have a valid exemption to rely upon, take immediate steps to come into compliance or discontinue the offering of any advisory or dealing services to the relevant clients;
  • Train employees on the limitations of conducting dealing or advising activities in other jurisdictions;
  • If applicable, take adequate steps to confirm that all requirements to rely upon the client mobility exemption are met (including verifying that the individual and firm do not exceed the allowable number of eligible clients in each jurisdiction and submitting Form 31-103F3 Use of Mobility Exemption to the regulator in the relevant jurisdiction); and
  • Maintain adequate records for all of the above.

International Firms with Canadian Clients (EMDs / IFMs / PMs): During its International Exemptions Review, staff found that some firms had not filed up-to-date forms with the OSC to properly rely on the exemption and/or did not always provide clients with the required disclosure (or maintain evidence that the disclosure was provided). In addition, some international advisers had not maintained sufficient evidence to demonstrate that the advice being provided to Canadian clients with respect to Canadian securities was incidental to the advice being provided on foreign securities. Also, CRR staff noted that some firms, who were providing advisory services to permitted clients registered as advisers in Canada, were improperly purporting to rely on the international adviser exemption in section 8.26 of NI 31-103, instead of complying with the exemption criteria for international sub-advisers in section 8.26.1.

Please do not hesitate to contact us if you need advice or assistance regarding the application of Canadian registrant regulation requirements to your cross-border activities.

5) Distribution of a Registered Firm’s Own Shares (EMDs / PMs)

The Report discusses two compliance issues arising from situations where registered firms distribute their own shares to investors. First, staff reiterated that, even where the firm is relying upon a prospectus exemption to effect the distribution, the firm still must comply with its registrant obligations (e.g. relating to KYC and suitability) in connection with the distribution.

Second, staff emphasized that when firms distribute their own shares to existing and prospective clients, the resulting relationship is one that presents the highest degree of conflict of interest recognized by National Instrument 33-105CP Underwriting Conflicts (NI 33-105). In such situations, it is unclear if the firm is acting in the capacity of an issuer or, as a registered firm, by advising or recommending an investment in the firm’s shares to its existing clients (either as a PM through a managed account or as an EMD). In addition, this business model could create the perception that investors who are clients might be favoured over non-investor clients (e.g. with respect to access to proprietary information or the allocation of investment opportunities). The Report outlines steps that firms can take to respond to this conflict. Among other things, staff recommend that firms:

  • Disclose and explain the conflict to potential investors and obtain an appropriate acknowledgement from them;
  • Disclose all risk factors relating to the investment in the firm;
  • Advise potential investors to seek independent advice regarding the investment and provide all information needed for such advice; and
  • Develop and implement appropriate policies and procedures to, among other things:
    • Identify and address all related conflicts of interest;
    • Address the fair allocation of investment opportunities among clients; and
    • Prohibit sharing of the registered firm’s business information with shareholders of the firm that are also clients, in a manner that might prejudice other clients.

6) Captive Dealers (EMDs)

Staff reminded EMD-only firms that distribute securities of a related or connected issuer with common mind and management (Captive Dealers) that they must adequately respond to the material conflicts that arise in this business model. The EMD’s financial incentives to sell its related or connected issuer’s securities may come into conflict with its regulatory obligations, such as those concerning suitability and fair dealing. Staff recommend that Captive Dealers, among other things, to assign a responsible individual, such as the CCO or ultimate designated person (UDP), who has not been directly involved with the trade in question, to confirm that investors understand:

  • The relationship between the Captive Dealer and the related or connected issuer;
  • The investment’s key features; and
  • The concentration risks associated with investing in a limited number of related or connected issuers.

Staff also encourage Captive Dealers to ensure that the relevant employees have been trained to explain the nature of the material conflicts of interest inherent in the business model and the importance of avoiding, managing and/or disclosing them and understand their KYC, KYP and suitability obligations.

7) Financial Conflicts of Interest (All)

Staff identified certain financial conflict of interest situations such as the payment of consulting fees or placement fees to registered firms by companies that the firms’ funds or managed accounts invested in and where the conflict of disclosure to clients was non-existent or inadequate. According to staff, if a registered firm is paid by issuers of securities that it recommends to its clients, it should:

  • Structurally segregate its corporate finance business from its advisory business and implement internal information barriers;
  • Enhance its monitoring controls over clients’ suitability assessments;
  • Fully disclose the issuer relationships and compensation arrangements in offering documents and account opening documents;
  • Disclose all conflicts of interest in the relationship disclosure information (RDI) required by section 14.2 of NI 31-103;
  • Provide clear and meaningful disclosure in plain language about the nature and impact of each conflict; and
  • Obtain the client’s written acknowledgment that they understand the nature and impact of each disclosed financial conflict of interest before selling the product or service to them.

8) Inappropriate Reliance on Custodian to Satisfy Account Statement Delivery Obligations (PMs)

Staff reminded PMs that they cannot meet their statement delivery obligations by relying solely upon their custodian to deliver position and transactional information to clients. If a PM has entered into a service arrangement with a dealer member (DM) of the Investment Industry Regulatory Organization of Canada (IIROC), the PM can satisfy its obligation to deliver statements to a client if that client’s DM, acting as custodian, sends a DM statement to the client, provided that the PM:

  • Does not hold any of the investments it manages for the client;
  • Verifies that the investments it manages for the client are held in a separate account for the client where the DM knows the client’s name and address;
  • Discloses the service arrangement to the client in accordance as called for by Section 3 of CSA Staff Notice 31-347 Guidance for Portfolio Managers for Service Arrangements with IIROC Dealer Members;
  • Confirms that for each of the client’s accounts at the DM, a DM statement is delivered to client at the required frequency with the required content;
  • Takes reasonable steps to verify that the DM statements are complete and accurate;
  • Complies with client requests or agreements to receive PM statements from the PM, supplemental to the DM statement; and
  • Verifies that the market value data it uses to prepare the client’s annual investment performance report is consistent with the data in the relevant DM statement delivered to the client.

Staff also note that PMs should maintain their own records of clients’ investment positions and trades, including evidence to support reconciliations between their records and the DM’s statements and establish policies and procedures to verify that DM statements are complete, accurate and delivered on a timely basis.

9) Trade Confirmations for Managed Accounts (PM / EMD)

The Report addresses a frequently asked question about whether a firm registered as an EMD, IFM and PM must send trade confirmations to its managed account clients for each purchase or sale of a security of a proprietary fund where the firm also acted as the registered dealer for the trade. According to staff, since the firm is already subject to obligations as a PM when it purchases the security on behalf of the managed account, there are no additional obligations that apply if it conducts the trades through its dealer registration. Provided that the managed account client consented not to receive trade confirmations for each transaction in the account, staff would not expect the firm to provide real time trade confirmations.

10) Other Deficiencies

We’ve briefly summarized below some additional staff recommendations and commentary that we think our readers may find relevant.

Custodial and Prime Brokerage Agreements (IFMs): CRR staff reminded IFMs that they need to have written agreements in place between the prospectus-exempt funds managed by them and the funds’ custodian and/or prime broker.

Funds Purchasing Securities from “Responsible Persons” (IFMs / PMs): According to staff, some registered advisers have been selling securities owned by the adviser’s firm to an investment fund managed by the adviser, contrary to the prohibition in paragraph 13.5(2)(b) of NI 31-103 on advisers knowingly causing investment funds they manage to purchase securities from a “responsible person”. Staff emphasized that firms should have policies, procedures and pre-trade controls to identify prohibited transactions like these and prevent them from occurring.

Impact of IFRS 16 on Working Capital (All): Some firms are not applying IFRS 16 Leases correctly, or at all, which has resulted in some firms incorrectly calculating their excess working capital balances. In some cases, this resulted in the firm being capital-deficient.

Insurance Coverage (All): Firms should check that their coverage is adequate, that bonding policies provide for a double aggregate limit or full reinstatement of coverage, that claims of other entities covered under a global policy do not reduce limits or coverage available to the registered firm, and that the registered firm should have the right to claim directly against the insurer for losses under a global policy.

Personal Trading (All): CRR staff are continuing to see deficiencies in firms’ personal trading policies and procedures. Identified deficiencies included inadequate policies and procedures, failures to enforce the firm’s policy, failing to maintain complete information on the person trading accounts of all “Access Persons”, and failing to require written pre-approval of Access Persons’ trades.

C. Regulatory Actions – Conduct Concerns During the Registration Process

The Report also includes data on CRR regulatory actions, including data comparing the different kinds of regulatory actions taken in the past five fiscal years. In addition to providing an overview of all regulatory actions concerning registrants, this year the Report highlights CRR staff’s approach to handling conduct concerns that arise during the registration process.

CSA Guidance Has Helped: Staff discussed the decrease since fiscal 2018 in the number of regulatory actions involving denial of registration. They believe that the 2017 publication by the Canadian Securities Administrators (CSA) of Staff Notice 33-320 The Requirement for True and Complete Applications for Registration (SN 33-320) has provided helpful guidance to firms conducting due diligence on the individuals they’re sponsoring and deterred some non-disclosure by registrants. Staff have also been conducting early-stage conference calls with firms where concerns have been identified, which has led to firms reviewing and, in seventeen cases in fiscal 2020, withdrawing applications that otherwise might have resulted in denial of registration.

Non-Disclosure in Registration Applications Is Still a Problem. Nevertheless, CRR staff are continuing to identify material non-disclosure of regulatory, criminal and/or financial information in registration applications, and this concern still constitutes a substantial number of the cases reviewed by CRR where registration is ultimately denied.

How Staff Handle Conduct Concerns in Registration Process: The Report includes a flow chart outlining the typical process CRR staff follow if a Registration Team refers a matter to the Registrant Conduct Team for investigation. According to the flow chart:

  • CRR management will share their initial regulatory concerns with the firm.
  • The Registrant Conduct Team will take steps that may include interviewing third parties who may have relevant information, as well as the individual applicant.
  • If the Registrant Conduct Team recommends that an application be granted subject to terms and conditions or that the application be refused, the applicant will be given an opportunity to be heard (OTBH), except in the rare situation where the matter is referred to the OSC’s Enforcement Branch.
  • Before an OTBH commences, the applicant can accept the proposed terms and conditions if the sponsoring firm agrees. If the OTBH goes forward, the Director of CRR will make a decision and give written reasons. If the Director refuses the application or grants it subject to terms and conditions, the applicant can ask an OSC panel to review the Director’s decision.

AUM Law has extensive experience helping firms get their employees prepare a strong application package and engage with regulators should any challenging situations arise. Please contact us to discuss how we can help.

D. 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 initiatives (see our bulletin article here);
  • A status update on the client-focused reforms (see our bulletin article here and our recently updated publication In a Nutshell: Implementing the Client-Focused Reforms);
  • Crowdfunding (see our bulletin article here); and
  • Syndicated mortgages (see our article on the most recent developments here).

If you would like to discuss the themes highlighted in our article above or any other aspect of the Report and its relevance for your business, please do not hesitate to contact us.

September 30, 2020

OSC Issues Interim Prospectus and Registration Exemptions to Facilitate Crowdfunding

In our February 2020 bulletin, we reported on proposed National Instrument 45-110 Start-up Crowdfunding and Registration Exemptions (NI 45-110), which is intended to create a nationally harmonized regime. The comment period for that proposal ended on July 13. On July 30, the Ontario Securities Commission (OSC) adopted an interim class order (Order) that provides prospectus and registration exemptions for start-up crowdfunding that are substantially similar to the local exemptions already in place in Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia, Québec, and Saskatchewan (collectively, the Crowdfunding Orders).

In the news release accompanying the Order, the Canadian Securities Administrators (CSA) noted that start-ups and other small businesses are facing significant funding challenges due to COVID-19 and might benefit from more unified regulatory requirements to expand their access to capital. The Order will remain in place until the earlier of the date that NI 45-110 is adopted or January 31, 2022. If you wish to learn more about the Crowdfunding Orders and their potential usefulness for your business, please contact us.

July 31, 2020

How does a registered firm’s UDP certify their firm’s 2020 RAQ responses if the UDP doesn’t have online access to the survey?

As we mentioned in our May 2020 bulletin, Ontario-registered firms must submit online their 2020 Risk Assessment Questionnaire (RAQ) responses and supplementary COVID-19 survey responses to the Ontario Securities Commission (OSC) by August 6. The OSC introduced additional security measures this year for the RAQ process, including a requirement that each firm’s chief compliance officer (CCO) register and create an online account before accessing the firm’s 2020 RAQ.

Since many people are working remotely, it might not be possible for the firm’s ultimate designated person (UDP) to access their firm’s 2020 RAQ responses online and provide the required certification. OSC staff, therefore, sent an email in mid-July to UDPs describing the steps that they and the CCO should take in such circumstances. In particular:

  • The UDP should certify the firm’s 2020 RAQ by sending an email to the ComplianceSurvey@osc.gov.on.ca and copy the CCO on this email.
  • The email must include the specific language set out in the email that the firm’s CCO should have received from the OSC in mid-July.
  • The CCO must copy that same email into the Final Overall Feedback section at the end of each section of the 2020 RAQ.

If you have any questions about the certification process described above or want us to review your draft responses to the 2020 RAQ or COVID-19 Survey, please contact us as soon as possible, so that we help you get your responses submitted by the August 6 deadline.

July 31, 2020

OSC Staff Share Compliance Program Updates during PMAC’s Spring Regulatory and Compliance Webcast

During the Spring Regulatory and Compliance Webinar organized by the Portfolio Management Association of Canada (PMAC) on May 27, a member of the Compliance and Registrant Regulation Branch (Branch) at the Ontario Securities Commission (OSC) updated attendees on the Branch’s programs and what registrants can expect in the coming months. We think that our readers will be interested in the following:

  • Compliance audits re-booted:The Branch is re-starting regulatory compliance audits this week. They will be conducted remotely, and firms can expect to have more time (e.g. 45 days as opposed to 30 days) to respond to deficiencies.
  • Privacy and cyber security risks arising from the shift to remote work during the pandemic will be an area of regulatory focus in compliance audits. (See our March 2020 and April 2020 bulletin articles, which discussed these risks.) Among other things, if firms haven’t already done so, they should consider arranging for secure document removal from employees’ homes and destruction of files as appropriate.
  • Working capital: Registered firms should stay on top of their working capital. If there are potential issues resulting from COVID-19, firms should engage proactively with their regulators.
  • Are you registered everywhere you need to be? Branch staff have observed an uptick in registrable activity by registrants in jurisdictions where the firms and relevant individuals are not registered. OSC staff will report such activity to the local regulator.
  • Some CCO reports need improvement: Branch staff have observed that some chief compliance officers (CCOs) are not complying with the requirement in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Requirements to provide the registrant’s board of directors with an annual compliance report (CCO Report) or are preparing only a cursory report. Branch staff expect all firms, even one-person firms, to produce comprehensive CCO Reports every year describing how their firms are meeting their securities law obligations.
  • Registration of client relationship managers: We expect the OSC to announce very soon a protocol for registering client relationship managers as Associate Advising Representatives subject to certain terms and conditions.

Post-COVID work arrangements: Although the topic did not come up during the PMAC conference, it is our understanding that, to date, registered firms have not been expected to register any remote work locations (such as home offices) that have been set up in response to the authorities’ COVID 19-related restrictions or recommendations for workplaces. As COVID-19 goes on for an extended period, as well as Post-COVID-19, if any of a firm’s individuals make working from home, or another location that isn’t already approved as a branch office, more permanent, the firm should consider whether it needs to register new branch offices.

As the OSC moves toward a “business almost as usual” state, AUM Law stands ready to help registered firms meet their existing obligations and address emerging risks and evolving regulatory expectations. For example, we can conduct focused compliance risk assessments in areas of interest to the regulators and help draft (or improve) your CCO Report. We are also helping firms and individuals with registration applications, and we can help you, too. Please do not hesitate to contact us.

Correction: The paragraph on Post-COVID work arrangements reflects our understanding of expectations for registered firms on this topic. However, in an earlier version of this article (published on May 29), we incorrectly attributed those views to the OSC representative who spoke at the webinar.

June 9, 2020

The RAQ is Back on Track

In March, the Ontario Securities Commission (OSC) announced that due to COVID-19, it was postponing the 2020 Risk Assessment Questionnaire (RAQ) cycle until further notice. On May 28, chief compliance officers (CCOs) of registrants were notified that they will receive the RAQ on June 11, with responses due on August 6. The 2020 RAQ will ask for information for the periods ending December 31, 2018 and December 31, 2019.

In our January 2020 bulletin, we highlighted a number of changes that the OSC is introducing for the 2020 RAQ, including pre-population of the questionnaire with some of the answers from firms’ 2018 RAQ responses and data security enhancements.

But wait, there’s more: Because the 2020 RAQ will not cover the period when registrants were dealing with COVID-19, the OSC also will send out a short survey (Survey) on July 9, 2020 to gather information from January 1 to June 30, 2020 regarding COVID-19’s impact on each registered firm. The Survey will be sent to firms domiciled in Ontario, as well as to some firms where the OSC is not the principal regulator because the OSC is collecting the information for those other regulators. The deadline for completion also will be August 6, 2020.

We encourage firms to re-start their planning for this exercise now, if they haven’t already done so, and to schedule time with key individuals including the ultimate designated person (UDP) to review and sign off on the completed questionnaire. AUM Law has had extensive experience helping firms prepare their RAQs. If you would like us to help you complete this year’s RAQ and the Survey, please contact us for a fixed-fee quote.

May 29, 2020

AUM Law Participates in CAASA Webinar and Podcast

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 April 21, our very own Stacey Long contributed her expertise to CAASA’s webinar Marketing Your Liquid Alternative Fund. And our very own Chris von Boetticher teamed up with Jason Russell, ReSolve Asset Management’s Chief Operating Officer and Chief Compliance Officer, and CAASA President James Burron for a podcast discussing regulatory compliance and operational issues for asset managers to consider while operating remotely during this “new normal” of the COVID-19 pandemic. The podcast is part of CAASA’s ongoing series Alternative Thinking: Both Sides of the Investment Coin, available on Spotify and Apple.

Lexology Award

We are pleased to have been recognized once again by Lexology as the exclusive Legal Influencer for financial services commentary in Canada for the first quarter of 2020. These awards are designed to recognize law firms that provide subscribers with relevant, high-quality legal updates and are determined based on an algorithm that takes into account reader engagement with the law firm’s publications on Lexology. This is the fifth time that AUM Law has received the award, which has existed for seven quarters.