Richard Roskies, Senior Counsel at AUM Law, recently sat down with Parham Nasseri from InvestorCOM to discuss the Client Focused Reforms and practical approaches for investment dealers and advisors to meet their KYP obligations.
Parham: What are your thoughts on how investment dealers have generally responded to the CFR requirements and their state of readiness?
Richard: By now, the CFRs should be on every dealer and advisors’ radar. I’d say about 60% of the clients I work with are at least knee deep into the conflict-of-interest requirements that are due in June. When it comes to the KYP, KYC and Enhanced suitability segments, I believe most people have started to think about it, but they haven’t yet weighed in with full focus. For example, these topics have not been a huge topic on the implementation committees I sit on.
That being said, depending on the size of the dealer’s product shelf, the KYP piece requires a fair amount of work and now is the time to start thinking about implementation strategy.
In terms of materials coming out of the final SRO rules-based comments, there wasn’t much to be concerned about. While the rules are close to baked, the interpretation will be ongoing through implementation guidance and FAQs. In short, this will be an ongoing iterative process for our industry.
Parham: At a high level, are there any outstanding areas for clarification or is the implementation goal quite clear?
Richard: I believe we are going to get ongoing implementation guidance and FAQs throughout this year.
The Canadian Securities Administrators (CSA) has done a lot of work in setting out what the goals, principals and expectations of the CFRs are. When it comes to KYP, it is clear that the regulators now expect documented KYP evidence for all traded products. However, when you drill down to the details of what is a reasonable way for firms to achieve these goals, I believe CSA guidance defers to industry by using the term use your “professional judgement” about ten times.
The regulators have definitely given us enough guardrails about what reasonable KYP should look like, but the last details will be determined by the ongoing interaction between regulatory Staff and industry. In short, you should absolutely start working on the CFRs, including KYP, but it will be important to follow the clarifications that come out over the course of at least this coming year.
Parham: Given the Dealer’s new KYP obligations, can you comment on what it means to monitor for significant changes and what needs to happen when a significant change is detected?
Richard: First it is important that the CSA guidance explicitly narrowed the requirement here from general monitoring to monitoring for significant changes. We don’t get an explicit definition of “significant change”, as the guidance indicates that it will vary depending on your firm’s operations and the type of security. However, I think a generally safe litmus test is that you are looking for any event that may significantly affect market price.
To that end, for most securities, I would be thinking about creating proactive alerts for any news stories related to the issuer (including earnings calls). Where we are talking about private funds, there will still usually be certain disclosure events that you can use as triggers for reviews. These are the kinds of triggers that you would want to consider. You also would want to have policies on reviewing your shelf if a sector or broad market downturn arises as companies are likely change in those times of stress. I read into the guidance that the higher the risk profile of the security, the more often you should be “checking in”.
Parham: Can you discuss the requirement to assess products on your shelf, how frequently, is this the regulator’s way of reducing shelf sizes, how does this requirement differ for dealers that have a proprietary shelf or have proprietary products on their shelves?
Richard: I think industry’s major comment to regulators over the course of the discussion about KYP is that some of these changes may have the unintended consequence of reducing shelf size. Whether that occurs in actuality will have to be determined over the course of the next few years.
In terms of different KYP approaches, that term “professional judgement” comes back into play. The guidance is clear that you are indeed allowed to simplify the due diligence required as the product trends towards the lower risk/well understood end of the scale. In fact, we are talking to our clients and regulators have confirmed that for certain lower risk/public securities, you could even do KYP by sector (e.g. draft a KYP document for the “public banking sector in Canada”). As you trend towards higher risk, private and more complex securities, the diligence will need to become more detailed. Private proprietary products are likely much closer to the highly detailed side of the scale.
Parham: Clearly, the new KYP requirements are raising some questions in the industry. What are some practical approaches in your view for tackling this new requirement?
Richard: When it comes to what is practical and reasonable, I always come back to two rules:
- Effort counts. When it comes to compliance, the goal cannot be absolute perfection. The goal has to be creating a strong and demonstrable “culture of compliance”. This is a key term regulatory auditors look for. Basically, as long as you are adequately protecting clients, effort counts. Where compliance departments can show that they have taken the CFRs seriously and have built up processes that reasonably resemble those of their competitor firms, then in an audit, regulators may dispute interpretation or approach but you are not going to fall below that dangerous red line. Where thoughtful effort is not shown, that is where you start to get into trouble.
- “If it is not documented, it does not exist.” If you boil down the CFRs into one concept, it is that most of what they mandate are things that dealers and advisers have generally been doing in their heads. The CFRs ask that you better evidence your existing process. To that end, their needs to be a good paper trail for each of the tasks the CFRs are asking you to do. I get that creating a paper trail for each KYP review is onerous, and there are tech solutions that can help with that. However, the papering aspect of these CFRs cannot be understated.
Finally, tackling the CFRs from scratch are going to be hard. You need tools.
Parham: Did the comment letters (and any of the responses you’ve seen – introduce or raise any substantive items, or do you feel like what Advisor KYP is and what is required is fairly clear here?
Richard: The current round of comments for the IIROC/MFDA rules that ended January 18 was relatively sparse. I believe there were about a handful of letters and while they were thoughtful they were relatively short. As mentioned earlier, the implementation guidance/FAQs will be more informative over the coming year.
Parham: In your respective view, do the requirements raise the bar for advisors when it comes to meeting their KYP requirements?
Richard: I think that the requirements codify a lot of the best practices that Commission Staff have been recommending for a number of years. In short, most of what is in the CFRs are not “net new” from a substantive standpoint. What is new and onerous is that dealer/adviser activity will now need to be evidenced in a written and formal manner.
Parham: What are the challenges a dealer and advisors needs to consider with respect to their KYP obligation and considering a reasonable range of alternatives when making recommendations?
Richard: The first and main challenge is trying to determine what this phrase means for different firm models. While this specific phrase is drawn from the suitability requirement, there are a number of instances within the KYP requirement where you may have to look at comparator products as part of your due diligence requirements.
Understanding the “why” of this requirement will help inform when and how you should be including comparator product analysis in your KYP diligence.
The first “why” is conflicts of interest – If you are a dealer or adviser that is recommending a product (both proprietary and third party) where you are getting direct or indirect compensation for that recommendation, there is a (reasonable or otherwise) perception that you are only recommending this product because you are getting paid for it. Regulators have struggled with this issue for years. Where this conflict is identified for your firm, it is helpful to do a comparator product review so that you can show that the product you are recommending is being recommended because it is a good product, not because you are getting paid to sell it. This will give your firm additional protection as this area evolves.
The second “why” is based around some recent OSC decisions. Regulators have found that there is a client expectation that when they go to a firm, they are getting access to all the products the firm sells not just the products that an individual dealer sells. To the extent that you can show that a dealer considered all of the firm’s shelf when recommending a product to a client, you are avoiding a client expectation issue that has come up in the past.
Notwithstanding the above, I think this area will be an ongoing topic of discussion throughout the year through implementation guidance and FAQs.
February 26, 2021
On February 4, the Portfolio Management Association of Canada (PMAC) will be hosting a virtual webcast. AUM Law’s Kevin Cohen will participate as a panellist to discuss the importance of succession planning from a client, regulatory and business continuity perspective.
January 29, 2021
On January 28, the Canadian Securities Administrators (CSA) issued temporary blanket relief, which is expected to be codified at a later date. This relief expands the list of courses that allow mutual fund dealing reps to sell liquid alt funds thereby increasing investor access to these products. Dealing representatives (and supervisors) in the Mutual Fund Dealers Association (MFDA) channel (and outside the MFDA channel in Québec) now have four additional courses that they can pass in order to distribute these products – the courses are offered by the Canadian Securities Institute and the IFSE Institute.
January 29, 2021
On January 27, 2021, the International Organization of Securities Commissions (IOSCO) published a report titled “Complaint Handling and Redress System for Retail Investors” that sets forth practices aimed at assisting its members in developing and improving their complaint handling procedures and mechanisms for retail investors. The report notes that access to independent, affordable, fair, accountable, timely and efficient redress mechanisms is critical for investor protection. Effective mechanisms for addressing financial misconduct that harm financial consumers can also promote investor confidence in financial markets.
January 29, 2021
Answer: The FATCA and CRS provisions of the Income Tax Act (Canada) (the “ITA”) and the guidance issued by the Canada Revenue Agency (CRA) in connection with those provisions addresses the application of the FATCA and CRS due diligence and reporting requirements in circumstances where there are multiple financial institutions involved in a particular financial account. Generally, where an account is maintained by two financial institutions, each of which would have FATCA and CRS due diligence and reporting requirements, the parties can enter into arrangements to allocate the FATCA and CRS obligations applicable to the account amongst them in order to alleviate duplicate reporting. So, the answer is … yes!
If units of a fund are held in client name, both the fund and the dealer involved in the distribution have FATCA and CRS obligations with respect to the account. In general, the CRA expects dealers to perform the due diligence and account classification and funds to report on the accounts, unless a fund has been advised by a dealer that the dealer will take responsibility for its own reporting. While the ITA and CRA guidance sets out some default arrangements, financial institutions can enter into written agreements to allocate the responsibilities based on their circumstances. It is advisable to retain records of such arrangements in order to demonstrate compliance with FATCA and CRS obligations.
With respect to custodians, the CRA generally expects the financial institution with the most immediate relationship with the client to be best positioned to understand the client’s tax status (i.e. conduct the due diligence), however it is appreciated that custodians may be in a better position to provide reporting. The CRA expects a suitable arrangement to include one where the investment manager performs the due diligence and communicates the account classification to the custodial institution for reporting by the custodian to the CRA.
January 29, 2021
One of the five core requirements of a registered firm’s anti-money laundering and anti-terrorist financing (AMLTF) compliance program is to conduct a risk assessment of its business activities and relationships. The business-based risk assessment must assess the risks linked to a registered firm’s business activities and the relationship-based risk assessment must assess the risks linked to the nature and type of business of a registered firm’s clients. During an audit, FINTRAC may review these risk assessments, in part to verify if they consider certain risk factors. The risk assessments are not to be confused with the requirement to complete an independent two-year effectiveness review, which is a separate obligation that must be completed by registered firms every two years.
In January of 2021, FINTRAC published updated risk assessment guidance to include legislative amendments from June 2017 and legislative amendments that will come into force on June 1, 2021.
The key take away for registered firms is that you should review your risk assessments to ensure that the following are included among the risk factors that are considered: new developments, technologies and the activities of any affiliates. Registered firms should review the updated risk assessment guidance and reach out to their usual lawyer for assistance, as applicable. The updated risk assessment guidance can be found here. For any questions, please contact Chris Tooley or a member of our team.
January 29, 2021
On September 28, the Canadian Securities Administrators (CSA) published guidance in the form of responses to frequently asked questions (FAQs) about how to interpret and implement the client-focused reforms (CFRs) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103). As our readers already know, the conflicts-related CFRs must be implemented by June 30, 2021 and the remaining CFRs must be implemented by December 31, 2021. If you need a refresher on the CFRs, you can download our recently updated publication In a Nutshell: Implementing the Client-Focused Reforms.
The CSA recently released additional FAQs on December 18, 2020. We have noted with interest the following topics:
- KYC 2.0 Timing: In what can only help alleviate registrant stress, CSA Staff have made it explicitly clear that registrants do not need to both: (i) update their KYC and suitability process; and (ii) re-paper all their client accounts by December 2021. Registrants must only update their KYC and suitability process based on the CFR requirements by December 2021. Re-papering client accounts can occur after that date based on when a specific registrant is obligated to conduct a KYC update.
- Conflicts of Interest and Disclosure: The CFRs require registrant firms to compile an inventory of all their material conflicts and how they will mitigate those conflicts. Subsequently, the registrant firm must then disclose those conflicts in their relationship disclosure. CSA Staff have now clarified that where a registrant firm addresses a conflict by avoiding the conflict altogether, they do not need to include this conflict in their relationship disclosure. This clarification gives registrant firms some control over their required disclosure to clients and makes their choice of approach to conflict mitigation all that more important.
- Registrant Employee Oversight: For registrant firms that seek to provide a multi-discipline offering to their clients (e.g. a family office that provides services such as financial planning, securities advisory and insurance), CSA Staff have clarified that registrants have a broader due diligence obligation that just securities law oversight. CSA Staff have indicated that if a registrant employee holds themselves out as appropriately registered with another regulator, registrant firms have an ongoing obligation to ensure that this license is appropriate and that the registrant employee is in good standing with that regulator. This expectation may broaden existing due diligence procedures for registrant firms.
Implementing the CFRs will require changes to your policies, procedures, internal controls, record-keeping protocols, client-facing documentation and compliance training. Giving our clients practical advice on compliance with NI 31-103 is one of our core services. We can help you develop a project plan, work with you to systematically review and make any needed changes, and train your employees so that you are ready as the CFRs are phased in. In fact, our very own Richard Roskies is part of the Portfolio Management Association of Canada (PMAC) CFRs implementation committee. If you have any questions about the Guidance, please do not hesitate to contact us.
January 29, 2021
In our July 2020 Bulletin we reported on the Consultation Report of Ontario’s Capital Markets Modernization Taskforce. On January 22, the Taskforce released its Final Report after engaging with over 110 stakeholders and receiving over 130 stakeholder comment letters in response to the Consultation Report.
Background: The Taskforce was appointed by Ontario’s former Finance Minister to review the capital markets regulatory framework and make recommendations to modernize Ontario’s capital markets regulation. One of the Taskforce’s main objectives was to amplify growth and competitiveness in Ontario’s capital markets.
As we did in our July 2020 Bulletin when we last reported on the Consultation Report, in this month’s bulletin we have highlighted the proposals that we think will be of particular interest to readers who are following this initiative.
Improving Regulatory Structure: The Final Report sets out a number of recommendations which the Taskforce believes will lead to a more modern and efficient securities regulator including:
- Replacing the Securities Act (Ontario) and Commodity Futures Act (Ontario) with the Capital Markets Act (CMA). The recommendation is to see the implementation of the CMA by the end of 2021. As for this timing … we’re betting on the Over.
- Expanding the mandate of the OSC to include fostering capital formation and competition in the markets in order to encourage economic growth and help facilitate capital raising.
- Enhancing collaboration between the Ontario Securities Commission (OSC) and Financial Services Regulatory Authority of Ontario (FSRA) to achieve efficiencies including examining the potential of back-office efficiency opportunities.
- Introducing a single self-regulating organization (SRO) that covers all advisory firms, including investment dealers, mutual fund dealers, portfolio managers, exempt market dealers (EMDs) and scholarship plan dealers. In the short term the new SRO would regulate both investment and mutual fund dealers. In the long term this SRO would replace IIROC and MFDA and would also regulate exempt market dealers, portfolio managers and scholarship plan dealers and ultimately the OSC would delegate more registration responsibilities to the new SRO.
- Speed up the SEDAR+ project to create a more modern, centralized and user-friendly electronic filing/document retrieval system with the first phase to be complete in 2021. We’d love to see this happen in 2021 but again, don’t see this as being likely considering the heavy regulatory agenda this year.
Improving Regulations and Enhancing Investors Protection: Based on the Taskforce’s findings, capital markets participants are in favour of reducing regulatory burden and streamlining regulatory requirements. The Final Report recommends streamlining regulatory requirements and enhancing investor protection including:
- Lowering to 30 days the current four-month hold period for securities issued by a qualified reporting issuer using the accredited investor exemption and eliminating the hold requirement altogether after two years.
- Providing the Director of Corporate Finance at the OSC with power to impose terms and conditions on issuers similar to the power the Director of Compliance and Registrant Regulation has regarding registrants.
- Expanding civil liability for offering memorandum misrepresentation to extend to parties other than the issuer such as its board of directors, promoters, influential persons and experts.
- Allowing the OSC to adapt prospectus liability to address regulatory gaps resulting from new and evolving financing structures.
- For consistency with other jurisdictions, decreasing the ownership threshold for early-warning reporting disclosure from 10 to 5 per cent for non-passive investors.
- Designating a dispute resolution services organization that would have the power to issue binding decisions.
The Rise of Private Markets, Exempt Market Activities and Ensuring a Level Playing Field: The Taskforce included recommendations that aim to increase capital raising opportunities for small intermediaries and increase the variety and quality of independent products available to retail investors, such as:
- A dealer registration safe harbour for issuers that wish to distribute their own securities without an intermediary. We agree that this would be incredibly helpful to market participants.
- A finder category of registration which would impose fewer obligations compared to those imposed on EMDs or investment dealers (such as lower capital requirements) and eliminate the need for a finder to have an ultimate designated person or chief compliance office in certain instances. We also think this is a good idea, provided there’s clarity regarding when one crosses into being a registrable finder.
- The OSC and TMX to re-allow EMDs to act as “selling group members” in the distribution of securities made under a prospectus offering. This door was closed to EMDs a few years ago due to various policy concerns, so will be interesting to monitor this proposal.
- Additional accredited investor categories to include individuals that have passed relevant proficiency requirements.
- Improving access to the shelf system for independent product through guidance to address product shelf issues and the makeup of New Product Committees, title clarification for proprietary product to ensure a level playing field for all products gaining action to a distribution channel and that conflicts are addressed in the best interest of clients.
Fostering Innovation: The Taskforce made recommendations to help support stakeholders request for a more nimble and flexible regulator in order to foster innovation in the Ontario capital markets including:
- Foster an Ontario Regulatory Sandbox to benefit entrepreneurs and in the longer-term, consider developing a Canadian Super Sandbox where the OSC and FSRA should design an approach that would offer rapid exemptive relief or use other available regulatory tools to permit companies with innovative business models operating across the financial services sector in Ontario to test new financial services and products.
- Encourage access to retail investors in less liquid private equity and debt markets by introducing an appropriate retail investment fund structure (e.g. Interval Funds in the U.S.)
Other Recommendations: The summary above highlights only a handful of the Taskforce’s 70 plus recommendations. The Final Report also included other proposals such as:
- A fully electronic or digital delivery in relation to documents mandated under securities law requirements within six months.
- Name change of the Ontario Securities Commission to the Ontario Capital Markets Authority.
- Reducing the minimum consultation period for rule-making from 90 days to 60 days.
- Providing the OSC with additional tools for continuous disclosure and exemption compliance.
- Modernizing Ontario’s short selling regulatory regime to include protections allowed for in other jurisdictions (e.g., U.S. and U.K.)
- Introducing an exemption from the disclosure of conflicts of interest in connection with private
placements to institutional investors. An issue that’s been kicking around for years.
What’s Next? The next steps for the Final Report are now up to recently appointed Minister of Finance. The Minister may choose to act on some, none or all of the recommendations. As we have previously mentioned, we think that initiatives that can be implemented by Ontario authorities on their own could start moving forward if no legislative or rule changes are required. Other proposals (such as SRO reform) will require coordinated, cooperative and determined actions by multiple parties across the country and therefore likely to take much more time to achieve, if they are achievable at all.
AUM Law will continue to monitor the status of the recommendations and update you on significant developments. If you are interested in discussing any of the recommendations, please do not hesitate to contact Sandy Psarras, Chris von Boetticher or another member of our team.
January 29, 2021
As a proud member of the Canadian Association of Alternative Strategies and Assets (CAASA), AUM Law is pleased to contribute to CAASA’s ongoing educational programming. On November 23, our very own Jason Streicher contributed his expertise to CAASA’s webinar Client Focused Reform – A Closer look at KYP. The webinar shared discussions of changes to KYP coming from the Canadian regulators, with new rules taking effect in 2021.
December 11, 2020
On December 10, the Canadian Securities Administrators published guidance (including “recommended best practices”) for issuers and insiders on the establishment, use and disclosure of automatic securities disposition plans. These plans enable insiders to make preplanned sales of securities of an issuer through a dealer or an arms-length administrator, according to a predetermined schedule and set of instructions.
CSA Staff Notice 55-317 Automatic Securities Disposition Plans, can be found on CSA members’ websites.
December 11, 2020
On December 10, the OSC published a report on recent capital raising activity in the exempt market by corporate (i.e., non investment-fund issuers). As noted in CSA press release, the report revealed that while there has been notable year-over-year growth in the number of individual investors with capital invested in Ontario’s exempt market, the number of issuers raising capital has remained relatively stable. The report can be found on the OSC website here.
December 11, 2020
The Mutual Fund Dealers Association of Canada (MFDA) and the Investment Industry Regulatory Organization of Canada (IIROC) have both published a set of proposed changes to self-regulatory rules designed to conform to the provisions of the Canadian Securities Administrators’ (CSA) effort to enhance investor protection.
As we have reported previously, on October 3, 2019, the CSA published, in final form, the client-focused reforms (CFRs) which require the industry to put their clients’ interests before their own. The CFRs include a number of changes to investor protection rules, including conflicts of interest, suitability, KYC/KYP and disclosure obligations. IIROC has now published its own proposed rule amendments for public comment intended to make its requirements uniform in all material respects with the CFRs. In a notice published on November 19, IIROC stated that the objectives of the rule changes is to better align the interests of industry firms and reps with their clients, to improve client outcomes and to enhance clients’ understanding of the terms of their relationship with the industry. IIROC has published two sets of proposals: measures that are out for public comment until January 18, 2021, as well as a set of so-called housekeeping amendments which are required to conform with the CSA’s amendments but don’t add further material requirements on industry participants. The more substantive amendments subject to public comments include enhancements to IIROC’s suitability rules and changes to its account appropriateness requirement to ensure that client’s interests come first, along with measures setting out CFR exemptions from the core regulatory obligations of account appropriateness, KYC, suitability determination, product due diligence and KYP for certain account types, client types or service arrangements, as well as other changes of a consequential nature.
Similar to the approach taken by IIROC, on November 19, the MFDA published two sets of amendments. One set addresses housekeeping changes that are relatively minor and the other is a more significant set of proposals that must go out for public comment before they can be approved. The public comment proposals include changes to the MFDA’s rules on suitability, KYC/KYP and account supervision, as well as covering the guidance set out in various MFDA staff notices. The MFDA proposals are out for comment until January 18, 2021. The MFDA has indicated that it is seeking comments on the drafting of its own amendments to ensure that they are clear and properly applied to the business model of fund dealers. As with the CSA’s reforms, the proposed changes will, among other things, require that fund dealers resolve all conflicts of interest in the best interests of clients and provide conflicts disclosure to clients.
The CFRs are to be fully implemented by the end of 2021, with the conflicts of interest provisions taking effect as of June 30, 2021. It is expected that IIROC and MFDA rule changes will be implemented along the same timeline.
December 11, 2020
On December 7, the Ontario Securities Commission (OSC) released the final amendments to OSC Rule 45-501 Ontario Prospectus and Registration Exemptions (Amendments). The Amendments are a part of the proposed changes across Canada which, in Ontario, will have as one of their effects the transfer from the Financial Services Regulatory Authority of Ontario (FSRA) to the OSC of regulatory oversight over the distribution of non-qualified syndicated mortgages (NQSMIs) to persons that are not permitted clients. The final version of the Amendments contain no substantive changes from the earlier version released on August 6 other than coming into effect on July 1, 2021, a few months later than the originally scheduled effective date of March 1, 2021. A firm that intends to engage in trades of NQSMIs to persons other than permitted clients on or after July 1, 2021 will be required to 1) either meet the prospectus requirements (or rely on an available exemption) and 2) either be registered as an exempt market dealer (EMD) or engage the services of a third-party EMD (or rely on an available exemption).
December 11, 2020