Category: Regulatory Compliance

It’s Still Ongoing – OSC Continues with its Conflict of Interest Focused Reviews

In early March, a number of registrants were selected by staff at the Ontario Securities Commission (OSC) to undergo a focused review on their conflict of interest policies and procedures. The OSC is searching for information on how firms have operationalized the amendments introduced through the Client Focused Reforms initiative, the first part of which came into force on June 30, 2021. We plan to keep you updated on guidance and commentary that comes out of this focused review but, in the interim, the information request itself and the questions it contains may provide some helpful guidance in reviewing your own conflicts regime:

  • The OSC is going beyond confirming the existence of policies and procedures concerning conflicts of interest. They are looking for evidence of:
  • employee training;
  • client disclosure; and
  • the creation and maintenance of an inventory/matrix that identify, assess, and address material conflicts.
  • The OSC is specifically requesting information on conflicts that firms previously dealt with through disclosure and, post CFR implementation, now avoid outright. It is possible that the OSC may be looking to collect trend information to develop an industry standard on what conflicts should be avoided. We anticipate that staff will provide disclosure of any such trends in future guidance, and firms should look out for any such information if such guidance is released.
  • The OSC questions appear to focus around the two main thematic conflicts of: i) proprietary conflicts (i.e. selling related products); and ii) compensation arrangements. Firms should be reviewing their approaches to these conflicts to ensure they are robust.

As always, if you wish to better understand the questions contained in the OSC information request or want to generally discuss your conflict of interest compliance regime, please contact your usual lawyer at AUM Law.

April 29, 2022

Canadian Securities Regulators Reduce Regulatory Burden Related to the Interpretation of the Primary Business Requirements

On April 12, the Canadian Securities Administrators (CSA) published final changes to harmonize the interpretation of the financial statement requirements for a long form prospectus, such as in an issuer’s initial public offering. The changes come in the form of amendments to Companion Policy 41-101CP to National Instrument 41-101 General Prospectus Requirements (41-101CP) along with consequential amendments to Companion Policy 51-102CP to National Instrument 51-102 Continuous Disclosure Obligations (51-102CP) (the Changes).

Form 41-101F1 Information Required in a Prospectus (Form 41-101F1) requires an issuer that is not an investment fund to include certain financial statements in its long form prospectus. The required financial statements include the financial statements of the issuer and any business or businesses acquired, or proposed to be acquired, if a reasonable investor reading the prospectus would regard the primary business of the issuer to be the business or business acquired or proposed to be acquired (the Primary Business Requirements). The purpose of the Primary Business Requirements is to provide investors with financial history of the business of the issuer even if the financial history spanned several legal entities over the relevant time period.

The Changes attempt to reduce the regulatory burden on issuers by removing the uncertainty about the interpretation of the Primary Business Requirements.

The CSA previously consulted the industry on this topic and in April 2017 published CSA Consultation Paper 51-404 Consideration for Reducing Regulatory Burden for Non-Investment Fund Reporting Issuers. Comment letters received on that consultation were summarized in CSA Staff Notice 51-353. Then on August 12, 2021, the CSA published a Notice and Request for Comment proposing changes to 41-101CP, as we previously wrote about in our August 2021 bulletin. The CSA has not made any material amendments to the changes proposed in 2021.

If you have any questions regarding the Changes or the amendments to 41-101CP or 51-102CP please contact a member of our team.

April 29, 2022

OSC Finalizes Statement of Priorities – Going Green

In our November bulletin we wrote about the Ontario Securities Commission (OSC) draft Statement of Priorities (SoP), which helps inform its business planning for the year ended March 21, 2023. The 2022-2023 SoP has now been finalized, setting out the OSC’s four strategic goals and its priority initiatives for the upcoming fiscal year. As set out in the initial draft, one of the OSC’s goals remains promoting confidence in Ontario’s capital markets, which includes developing a rule setting out climate change-related disclosures for reporting issuers. It is noted in response to comments on the draft SoP that the CSA will continue to focus on these disclosures, with broader environmental factors and other sustainability topics to be considered in the future.

In addition, registrants will be interested to note that priorities under the first goal also include strengthening dispute resolution services for investors (such as OBSI) through policy and oversight activities, and developing a total cost reporting disclosure regime for investors (i.e. CRM 3). The latter proposals are being developed in collaboration with the self-regulatory organizations, the Canadian Council of Insurance Regulators (CCIR), and the regulatory bodies in the CCIR, and impact the disclosure for mutual fund investors and segregated fund holders. It is noted that the focus will be on requirements for dealers and advisers to provide periodic reporting to clients, which shows the total amount of fees (such as management fees) after the initial sale of the investment and is intended to be built up on existing disclosure documents. The approach under the securities and insurance regimes is intended to be as consistent as possible. We will have more to say about these proposals, released on April 28th, shortly.

Other goals in the SoP remain modernizing the regulatory environment, facilitating financial innovation, and strengthening the organizational foundation of the OSC. The SoP goes on to outline the other of the 23 priority areas that the OSC will focus on during the year. Based on comments received on the initial draft, a new priority has been added which addresses how the OSC balances the importance of each of its mandates (to provide protection to investors from unfair, improper or fraudulent practices, to foster fair, efficient and competitive capital markets and confidence in the capital markets, to foster capital formation and to contribute to the stability of the financial system and the reduction of systemic risk) in its decision-making and other work. In addition, there are new statements regarding more engagement with Indigenous communities and reflecting the spirit of reconciliation within the OSC’s internal culture in response to comments to the effect that Indigenous reconciliation was not specifically mentioned in connection with inclusion, equity and diversity initiatives. The response to comments also notes that the SoP now includes specific actions to engage in consultations, including with Indigenous organizations, as part of the climate-related disclosure rule development process.

Under the goal of modernizing the regulatory environment, the SoP continues to state that the OSC will implement annual surveys of both private and public investment funds about their portfolio exposure to assess relevant systemic risks, focusing on asset classes and leverage information.

The numerous priorities set out in the SoP, together with other regulatory initiatives underway (such as the consideration of the draft Ontario Capital Markets Act, which we also wrote about in our November bulletin, and the operationalization of the changes to the governance and organizational structure of the OSC as set out in the Securities Commission Act, 2021) mean a very busy year ahead for registrants and other market participants.

April 29, 2022

Save Those Exemption Requests – IIROC Proposes Amendments Respecting the Codification of Certain UMIR Exemptions

The Investment Industry Regulatory Organization of Canada (IIROC) has proposed amendments to codify existing exemptions provided through exemptive relief applications that allow IIROC dealer participants to trade listed securities off-marketplace during a statutory resale restriction if a prospectus exemption is available. The participant would have to continue to ensure that trades comply with securities legislation, including any applicable insider reporting requirements. The exemption would not apply to securities that are subject to contractual (i.e. private agreement) resale restrictions. A second codified exemption would also be available to allow trading on a foreign organized market if there is a regulatory halt in Canada because a cease trade order (CTO) is in effect and the specified conditions in the CTO are met. Many of these CTOs require that investors must have acquired the position before the date of the CTO, and they can not be insiders of the issuer. Participants would still be required to determine whether the security is subject to a CTO issued by more than one Canadian jurisdiction, and determine whether or not a specific trade can thus be executed. For both exemptions, IIROC reminds dealers of their record keeping obligations to demonstrate compliance with CSA and IIROC requirements. IIROC notes that these two exemptions accounted for 95.97% of all UMIR exemptions granted by IIROC in 2021, and thus codifying the exemptive relief should reduce the number of UMIR discretionary exemptions sought dramatically. The comment period closes on July 13.

April 29, 2022

Saving the World One Prospectus at a Time – Proposed Amendments to Implement an Access Equals Delivery Model for Non-Investment Fund Reporting Issuers

On April 7, the Canadian Securities Administrators (CSA) proposed amendments to a number of national instruments to implement an access equals delivery model for most types of prospectuses, annual and interim financial statements and related annual and interim MD&A for non-investment fund reporting issuers. The model is intended to be more cost-effective and environmentally friendly for issuers and dealers, particularly with respect to the current requirement to deliver paper copies of prospectuses. It is further noted that the model is more consistent with how investors are increasingly accessing information electronically.

Delivery will generally be deemed to have occurred when an issuer provides access to the document through SEDAR and notifies investors that the document is available through a press release (no press release would be required with respect to the availability of a preliminary prospectus). In British Columbia, it is proposed that an exemption be provided from the delivery requirements in the same circumstances to better deal with the wording in existing BC legislation. A press release would be required to indicate that the applicable document is available electronically and that a paper copy can be obtained on request. The proposals would not apply to rights offerings by way of prospectus or MTN programs or other continuous offerings under a shelf prospectus. The two day right to withdraw from an agreement to purchase securities would be amended to refer to the later of the date that access to the final prospectus (or amendment) has been provided and the date the purchaser has agreed to purchase the securities. The proposals would also require the front page of the prospectus to indicate where the withdrawal right period under the access equals delivery model is explained in detail in the prospectus.

With respect to delivery of financial statements and MD&A, the proposals include references to the current process of obtaining standing instructions from beneficial owners and the interaction of those instructions with an access equals delivery model. At this time, the CSA is not considering expanding the model to other types of documents such as proxy-related materials or take-over bid circulars, which require immediate shareholder action and participation. Comments on the proposal are due by July 6.

April 29, 2022

Additional Derivatives Proposals Taking Root

On April 21, the Investment Industry Regulatory Organization of Canada (IIROC) released another version of proposed amendments to its rules relating to the futures segregation and portability customer protection regime. As noted in our August 2021 bulletin, the changes are required as a result of expected changes to the rules of the Canadian Derivatives Clearing Corporation (CDCC) which themselves are changing to comply with international standards for the protection of clients in the event of a default by a clearing participant. The proposed amendments will make it easier to port client positions and the value of any posted collateral if there is such a default. The purpose of the amendments remains in part to reduce the linkages between a dealer’s futures business and securities business (i.e. which could otherwise force a dealer to use margin from other accounts to post the higher margin required under the new CDCC rules, which are based on a gross customer margin model). This republication aims to clarify the original amendments and increase the likelihood that client positions would be ported in a default situation.

Among other changes, the new proposed amendments would now require a dealer’s client to acknowledge the dealer’s porting disclosure document, which is to include disclosure on the risks, benefits, conditions and requirements of porting futures positions to another dealer member as well as a requirement for a client identification record. The acknowledgement requirement is intended to make clients aware of the need for them to pre-arrange a replacement clearing member. The proposed amendments include draft guidance as an appendix, with guidance on the information to be included in both the disclosure document and client identification record. IIROC is accepting comments on the proposed amendments until May 24, 2022.

IIROC also republished its Proposed Derivatives Rule Modernization, Stage 1 earlier in April. The purpose of the proposed rule changes remains to modernize and simplify IIROC’s derivatives related requirements such that there is a harmonized framework for securities and derivatives, whether they are listed or traded over-the-counter. Most the amendments have not changed from IIROC’s earlier proposal in November 2019, except to reflect updates to other IIROC rules (for example, changes that have been made to reflect the client-focused reforms). A few new changes have been proposed to address suggestions made in comment letters. For example, new risk factors will be added to a dealer’s risk disclosure statement, and dealer members offering order execution only accounts to trade OTC derivatives will now need to disclose the percentage of accounts that were profitable for clients for each of the 4 most recent quarters. In addition, dealer members will have a new requirement to have records indicating they have made an assessment of their clients’ qualifications as a hedger and an institutional client for purposes of the rules relating to derivatives trading. The comment period will end on June 13.

April 29, 2022

Important Reminders: Compliance Checkup – Is Your Investment Management Agreement Compliant?

A friendly reminder to portfolio managers that there are a number of regulatory expectations around investment management agreements. For example, each investment management agreement entered into with a client must be dated, signed in a timely manner by a member of senior management of the firm, contain accurate fees and contain certain baseline content. The agreement should set out the services to be provided, the roles and responsibilities of each party, and address all aspects of the investment advisory process. At minimum, an investment management agreement should usually contain the following:

  • The type of authority the PM has over the client’s assets;
  • A description of how the client’s assets will be held;
  • Any client instructions or restrictions;
  • Who is responsible for proxy voting and insider reporting;
  • A description of how any conflicts of interest impact the services to be provided;
  • A detailed provision for fee arrangements (i.e., calculation of payment, timing of payment, any sliding scales or most favoured nation clauses);
  • A statement that the PM is required to manage assets in accordance with the client’s know-your-client information; and
  • The notice period and process for terminating the agreement.

An investment management agreement is a “living” document. If the understanding or arrangement with a client changes over time (for example if fees change), the agreement should be kept current and amended accordingly. Any schedules to the agreement (explaining a firm’s privacy policy, for example) should also be checked periodically to ensure the client has access to the most recently applicable disclosure.

April 29, 2022

FAQ Corner: Records Retention – Do Firms Need to Keep Documents Forever?

Answer: Most registered firms are aware of the obligation to maintain records to demonstrate compliance with securities laws and anti-money laundering requirements and have policies and procedures to address these requirements. For example, National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations requires a registered firm to keep a record that it is required to keep under securities legislation for 7 years from the date the record is created, in a safe location and in a durable form and in a manner that permits it to be provided to the regulator in a reasonable period of time. FINTRAC regulations generally require registrants to maintain records for at least 5 years. However, once the statutory retention periods have been met, should a firm destroy the documents? What are the implications if a firm wants to retain documentation for longer periods? There are a number of considerations that are relevant to document retention and destruction including the nature of the document, applicable regulatory retention requirements, privacy law considerations (generally, personal information must not be retained longer than necessary), the firm’s operating needs and potential or actual litigation. Firms may wish to give some thought to their processes for destroying physical documents including whether electronic copies will be maintained, the method of destruction (taking care to safeguard personal and confidential information) and maintaining a record of the date and manner of destruction. AUM Law is pleased to assist firms with developing policies and procedures to address matters of records retention and destruction.

April 29, 2022

FAQ Corner: Fixing the Leaks: Common OSC Audit Questions

You just got a formal request from the Ontario Securities Commission (OSC) that they would like to come by for a visit, accompanied by a request for all the inner workings of your firm, what do you do?! First, respond. Second, get ready, any regulatory review will be much smoother if you are prepared. Below are a few frequently asked questions we receive from firms.

Question: Why Me? Why is the OSC Targeting Our Firm?

Answer: The OSC is required to review each registered firm on a regular basis. With more than 1000 registered firms, it is impossible to review all firms each year. To narrow their focus, one technique employed by the OSC is to send out risk assessment questionnaires (RAQ) to the industry, and firms are then risk ranked based on their responses. Selections are then made from each registration category. Registrants can also be subject to a targeted review or “sweep”, specific to an issue/trend in the industry. Over the last three years the OSC has focused their sweeps on issues such as the following: seniors/vulnerable investors, crypto currency use, continuous disclosures, marketing/sales practices, and derivatives use. Registrants could also be selected due to a complaint received, a referral from another regulatory body, or randomly.

Question: What Do They Typically Ask For and Do During a Compliance Review?

Answer: The OSC will send a written notice to the CCO requesting the firm’s Books and Records (lists per registration category are posted on the OSC website), for a specified period. The OSC will schedule a kick-off meeting with senior management. A typical OSC review can take six weeks to conclude (especially if the firm has branch offices) but in our experience can go on for even longer depending on the complexity of the organization. During the review the OSC will want to interview senior management and key employees, assess the firm’s compliance systems, disclosures, internal controls, marketing materials, and all policies and procedures, as well as any outstanding deficiencies noted during a previous review.

Question: What Happens After the Review?

Answer: Once the OSC has completed the assessment portion of the review, they will schedule an exit interview with senior management to go over their preliminary findings. The OSC typically takes about three to five weeks to send their final written report. If they have identified significant deficiencies during their review, they will inform the firm immediately. There will usually be a deficiency report advising the firm of the deficiencies that have to be addressed, and the time within which the firm must either correct and/or correct and send proof of the required changes. If the deficiency is significant (i.e. a material breach of securities law) then OSC staff can take stricter action, such as impose terms and conditions on the firm’s registration or activities, refer the matter to the Enforcement Branch, or even suspend or revoke the registration of the firm or impacted individual.

Question: What Are the Top Deficiencies Identified by the OSC?

While each audit and audit results are unique, firms that require some remediation of their compliance activities could expect at least some of the following deficiencies to be noted on an audit report:

Compliance Systems and Supervision

  • Out of date, or inadequate compliance manuals/policies and procedures;
  • Inadequate disclosures, no or insufficient internal mechanisms to report and address conflicts of interest;
  • Misleading or inaccurate statements in marketing materials and inappropriate sales practices, or materials lacking appropriate approvals from management; and
  • Insufficient oversight over service providers.

Registration and Business Operations

  • Inadequate monitoring for insider trading and early warning reporting (e.g. with respect to personal trading monitoring); and
  • Client confusion regarding services provided by the firm and services provided by a referral agent.

 

Know Your Client (KYC), Know Your Product (KYP) & Suitability

  • Missing or inadequate collection and documentation of KYC information and financial circumstances resulting in the inability to truly assess suitability;
  • Missing proof that client is an accredited investor to qualify for the accredited investor prospectus exemption (if applicable);
  • Missing or incomplete Investment Policy Statement (IPS) or Investment Management Agreement (IMA) or an incomplete suitability assessment;
  • Missing or inadequate relationship disclosure information (RDI); and
  • Missing or inadequate disclosure to clients in respect of referral arrangements.

AUM Law has extensive experience helping firms prepare for and respond to regulatory audits. Please contact your usual lawyer at AUM Law for more information.

April 29, 2022

A Matter of Time: FSRA Consultation on Licensing Requirements for Mortgage Agents and Brokers

On February 11, 2022, the Financial Services Regulatory Authority of Ontario (FSRA) announced that it is consulting on guidance that outlines new educational requirements and new licence categories for mortgage agents and mortgage brokers transacting in private mortgages (the Guidance).

The Guidance sets out new proposed licence classes that would be effective April 1, 2023, being mortgage agent level 1, mortgage agent level 2, and mortgage broker. Mortgage agents with a level 1 licence would be permitted to deal and trade in mortgages provided by financial institutions (as defined by the Mortgage Brokerages, Lenders and Administrators Act, 2006 (MBLAA)) and lenders approved by the Canada Mortgage and Housing Corporation (CMHC). Mortgage agents with a level 2 licence would be permitted to deal and trade in mortgages provided by financial institutions (as defined in the MBLAA), lenders approved by the CMHC, and all other lenders, such as mortgage investment corporations, syndicates, private individuals, brokers, and brokerages. Mortgage brokers would be permitted to deal and trade in mortgages provided by financial institutions, lenders approved by the CMHC and all other lenders. Mortgage brokers would also be permitted to supervise mortgage agents and could be appointed as the principal broker for a brokerage.

While a mortgage agent level 1 would not need any particular outlined experience, an applicant would have to complete the Mortgage Agent Level 1 Course and apply for a mortgage agent level 1 licence within two years of successfully completing the course. A mortgage agent level 2 would need to have at least 12 months experience over the last 24 months as a mortgage agent level 1 and complete the Mortgage Agent Level 2 Course and the Private Mortgages Course. A mortgage broker would need to have at least 24 months experience over the last 36 months as a mortgage agent level 2 and complete the Mortgage Agent Level 1 Course, Private Mortgages Course and the Broker Course.

There are a number of proposed transition periods for persons licensed under the current requirements which start April 1, 2023, and end March 31, 2024. Certain existing licensees with more than 5 years experience who wish to obtain the mortgage agent level 2 or mortgage broker license may be permitted to take a challenge exam in lieu of the Private Mortgages Course.

The Guidance also includes details on licensing fees, new continuing education requirements that are effective April 1, 2023, labour mobility between provinces, applications for education and experience equivalency, supervision approach and principles, and compliance and enforcement provisions.

Along with the Guidance, draft proposed amendments to the MBLAA reflecting the changes proposed in the Guidance have also been published.

If you have any questions regarding these proposed changes, please contact a member of our team.

March 31, 2022

FSRA Releases New Approach Guidance for Principles – Based Regulation at All Times

The Financial Services Regulatory Authority of Ontario (FSRA) released a draft Approach Guidance (Guidance) which outlines its plans for principles-based regulation, including its “Framework Principles” and an explanation of how such regulation will be implemented and how it will impact FSRA regulated entities and individuals. In the Guidance introduction, FSRA notes that principles-based regulation is used by leading financial services regulators globally, and helps regulators respond quickly to consumer needs and technological changes, focus on desired regulatory outcomes and reduce regulatory burden through a flexible regulatory approach. This approach by nature allows regulated entities to determine how they can each best achieve the desired regulatory outcomes, based on size, complexity and risk profile.

The general statements included in the Framework Principles include the following:

  • FSRA will be outcome focused and spend its time on the outcomes it seeks to achieve for consumers and pension plan beneficiaries;
  • FSRA will facilitate innovation in the sectors it regulates;
  • The focus will be consumer-centric (i.e. the impact on consumers and pension plan beneficiaries);
  • FSRA will utilize a risk-based approach and focus on issues and entities that pose the highest risk;
  • FSRA will be transparent by communicating its expectations, requirements, activities and performance to stakeholders; and
  • Stakeholders will be engaged though public consultations as part of FSRA’s collaborative

The principles-based approach means that FSRA will refer to broadly stated principles in guidance or rules and explain desired outcomes. For credit unions, pension plans or insurers, the Guidance specifically notes that FSRA will place more reliance on an entity’s senior management (for a pension plan, the plan administrator) and board of directors to internalize the requirements needed to achieve the stated outcomes. While industry best practices may be used to help assess the regulated entity/individual’s approach, they are intended to provide insights into what is being done by industry peers and provide a baseline to help identify practices that work best for the individual organization. FSRA does note further on in the Guidance that in certain areas, it will need to continue to rely on detailed rules and requirements to ensure adequate consumer and pension plan beneficiary protection. Factors that will impact the approach to be adopted by FSRA include the complexity of the regulatory problem and the sophistication and resources of the entity to address the issue effectively. Finally, FSRA notes it will be releasing specific guidance on its approach to investigations and enforcement processes and practices.

Comments on the draft Guidance will be accepted until April 29, 2022.

March 31, 2022

Make Time for IIROC’s Compliance Priorities Report

Earlier in March, the Investment Industry Regulatory Organization of Canada (IIROC) released its 2021/2022 Compliance Priorities Report, outlining its past actions and current issues that are impacting IIROC-regulated firms that should be a compliance focus for those firms in 2022. The report notes that these initiatives, including those related to cybersecurity, client focused reform sweeps and proficiency requirement updates, are in the context of the ongoing SRO consolidation with the Mutual Fund Dealers Association of Canada (MFDA), which is currently scheduled to occur by year-end.

In connection with the work of the Financial and Operations Compliance group (FinOps), the report noted that cybersecurity remains a key risk for all dealer firms and thus FinOps looks at how such risks are managed during regularly scheduled reviews. The importance of self-assessments is mentioned, as is the fact that IIROC has engaged Deloitte to create a cybersecurity self-assessment checklist for firms to assess their own risk and identify potential improvements. The reliance on technology and associated risks has also been incorporated into the FinOps risk model. It is noted that FinOps intends to review supply chain risks, and systemically important vendors to the industry, with a view to identifying and managing these risks.

The report indicates that IIROC, together with the Canadian Securities Administrators (CSA) and the MFDA, is conducting reviews to look for compliance with the new conflict of interest requirements that were enacted in connection with the client focused reforms back in June 2021. The objective of the review is stated to be to determine if dealers have met the “spirit” of the new rules and implemented controls to address material conflicts in the best interest of clients (rather than disclosure alone, which is not sufficient). IIROC (and we suspect, the CSA), will focus next on KYC and suitability requirements. IIROC, along with the CSA, has a prohibition on using a corporate officer title unless a person has been appointed as an officer pursuant to corporate law. In its reviews, the Business Conduct Compliance (BCC) group of IIROC will also look at the substance and nature of the relationship between an Approved Person and the dealer where the person uses a corporate officer title in dealing with clients to ensure it is appropriate – such as whether the individual is really part of the mind and management of the dealer. In its exams, BCC staff will also assess compliance with the amended rules regarding older and vulnerable clients, which are intended to address issues of diminished mental capacity and/or financial exploitation of clients.

Dealers are required to have a supervisory framework to ensure management of all significant areas of risk within a firm. IIROC has existing guidance to help dealers with these policies and procedures, and it is expected to publish additional guidance regarding permitted delegation of the responsibilities of executives to manage these risks shortly. IIROC will also be focusing in on order-execution-only firms and any advertising done through social media platforms.

Finally, the report notes that IIROC is working on amendments to some of the registration and proficiency provisions within the IIROC rules, to clarify expectations. In addition, while draft competency profiles have been released for Directors, Executives, UDPs, CCOs and CFOs, IIROC is continuing to work on all other approved person categories (i.e. supervisors, associate PMs, PMs and traders). There is a lot for dealers to focus on in 2022, in addition to any forthcoming changes in advance of the SRO consolidation.

March 31, 2022

A Devil of a Time: When the Regulatory “Best Interest” Standard is Not a Fiduciary Standard

At a Glance: Earlier this month, the Ontario Divisional Court decision in Boal v. International Capital Management Inc. provided some clarity on the scope and nature of the duty owed by financial advisors to their clients, and their obligations under the client focused reforms (CFRs), introduced by the Canadian Securities Administrators (CSA) in 2019 (and subsequently integrated into the rules and policies of the Investment Industry Regulatory Organization of Canada and the Mutual Fund Dealers Association of Canada) (IIROC and MFDA, respectively). Specifically, the court re-affirmed that a fiduciary duty between financial advisors and their clients is ad hoc, established on an individual, case-by-case basis, and is dependent on a multi-factorial analysis as required by common law. As such, a fiduciary duty does not arise solely due to regulatory standards and professional rules which require advisors to act in the “best interest” of the client.

Background: The plaintiff, a former client of the defendant, a registered member of the MFDA, commenced a class action against the investment advisor claiming breach of fiduciary duty, knowing receipt and knowing assistance, stemming from losses sustained from an investment in promissory notes. The certification judge denied the motion, holding that the Statement of Claim did not establish the material facts necessary to support a finding of a fiduciary relationship between the class members and the financial advisor. Further, it would not be possible to establish an ad hoc fiduciary relationship with the class, unless it could be shown on an individual, case-by-case examination that each individual of the class evidenced the traditional common law hallmarks of a fiduciary relationship. The plaintiff then appealed the decision to the Divisional Court.

Issue: On appeal, the primary issue was whether an ad hoc fiduciary relationship could be established between the class members and the defendant based on the “best interest” regulatory standard enshrined in the rules, regulations and by-laws of the MFDA and the FP Canada Standards Council Code of Ethics (professional standards).

Decision: In a 2 to 1 decision, the majority of the Divisional Court held that because ad hoc fiduciary relationships arise based on the specific circumstances of a given relationship, a fiduciary duty between a financial advisor and a client will only be found where the multi-factor test stated in the Ontario Court of Appeal decision of Hunt v. TD Securities Inc. (taken from the Supreme Court of Canada test in Hodgkinson v. Simms) is satisfied, on an individual basis. The Hunt test considered five factors: a) the client’s degree of vulnerability; b) the degree of trust between the client and advisor; c) the history of reliance and any representations of special skills and knowledge by the advisor to the client; d) the extent of the advisor’s discretion over the client’s account; e) and any professional rules or codes of conduct which inform the duty owed by the advisor and the standard of care.[1] As such, the majority found that a fiduciary duty could not be established on a class wide basis as strictly the result of standards imposed by regulatory rules and regulations which require advisors to act in the “best interest” of the client.

The key distinction between the dissent and majority opinions centered around the weight afforded to the fifth factor (professional rules or codes of conduct). Sachs J. in dissent, placed a strong emphasis on a self-regulating body to set the standard for their profession, relying on the remark in Hodgkinson, that “It would be surprising indeed if the courts held the professional advisor to a lower standard of responsibility than that deemed necessary by the self-regulating body of the profession itself.”[2] While in the majority’s view, the dissent had reduced the five-factor analysis to a “’one-size-fits-all’ duty that would apply to every investor, regardless of discretionary authority over the account, or sophistication of the client.”[3] The majority also took the view that imposing a fiduciary duty in the absence of the other four indicia would negatively impact both investors and capital markets.

Additional points and takeaways: It is important to note that the dissent of Sachs J. opens the door for the plaintiff to appeal the Divisional Court’s decision to the Ontario Court of Appeal. Even so, parties should keep in mind, as the majority notes, that even if the “best interest” regulatory standard does not impart a fiduciary relationship between financial advisors and their clients, “duties of good faith, care, confidentiality and disclosure apply to a variety of non-fiduciaries as well.”[4]

Footnotes:

  1. [1] Hunt v. TD Securities Inc. (2003), 66 OR (3d) 481 (CA), at para 40.
  2. [2] Hodgkinson v. Simms, [1994] 3 SCR 377 at 425.
  3. [3] Boal v. International Capital Management Inc., 2022 ONSC 1280 at para 68.
  4. [4] Ibid at para 70.

March 31, 2022