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
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
On September 17, the Canadian Securities Administrators (CSA) published final rule amendments (Amendments) to National Instrument 81-105 Mutual Fund Sales Practices (NI 81-105) and certain other instruments to prohibit:
- The payment of trailing commissions by members of the organization of any publicly offered mutual fund (Fund Organizations) to participating dealers who do not make a suitability determination in connection with the client’s purchase and ownership of prospectus-qualified mutual fund securities (Payment Ban); and
- The solicitation or acceptance of trailing commissions by participating dealers from Fund Organizations in connection with the securities of a mutual fund held in the account of a client of a participating dealer if that dealer wasn’t required to make a suitability determination in respect of that client for those securities (Dealer Ban and, collectively with the Payment Ban, the Trailing Commission Bans).
The Trailing Commission Bans are expected to take effect on June 1, 2022 (Effective Date), which is also when the ban on deferred sales charges (DSCs) for investment funds (DSC Ban) is expected to take effect in all Canadian jurisdictions except Ontario (Participating Jurisdictions). Unlike the DSC Ban, which will apply only in the Participating Jurisdictions, the Trailing Commission Ban will take effect across Canada.
Changes to the Final Rules: In response to comments received on its September 2018 proposals (2018 Proposals), the CSA made a number of changes that it considers “non-material” to the final rule amendments, including the following:
- What’s a Suitability Determination? A definition of “suitability determination” has been added to NI 81-105 to specify where a suitability determination is required under securities legislation and/or the rules and policies of self-regulatory organizations (SROs).
- Ban on Dealers Clarified: In the 2018 Proposals, the prohibition on participating dealers accepting or soliciting certain types of trailing commissions came about indirectly through existing subsection 2.2(2) of NI 81-105, which permits a participating dealer to solicit and accept certain payments, benefits and reimbursements from a mutual fund organization if that organization is permitted to provide the payments or benefits. The Amendments make this prohibition explicit in new subsection 2.2(3).
- Knowledge Qualifier Added to Payment Ban: In response to the 2018 Proposals, some Fund Organizations stated that they sometimes do not know whether a suitability determination is required to be made in connection with a mutual fund purchase, for example because they use the same dealer code for multiple affiliated dealers, including full-service and order execution only (OEO) dealers. To address this situation, the Payment Ban in subsection 3.2(4) of NI 81-105 has been amended to clarify that it applies only if the Fund Organization knows or ought reasonably to know that the participating dealer is not required to make a suitability determination.
- Exemptions from Fund Facts and ETF Facts Delivery Requirements Added: National Instrument 41-101 Prospectus Requirements has been amended to exempt switches from a trailing commission-paying series or class of a mutual fund to a no-trailing commission series or class of the same fund in client accounts administered by dealers who are not required to make a suitability determination (Switch Exemptions).
Transitional Impacts: The notice accompanying the Amendments summarizes the potential impacts of the Trailing Commission Bans and outlines options for Fund Organizations and affected dealers to consider.
- DSC Holdings: As of the Effective Date, dealers who are not required to make a suitability determination may not accept trailing commissions for mutual fund securities purchased under the DSC option (DSC Holdings).
- As of the Effective Date, mutual fund securities subject to trailing commissions and not purchased under the DSC option must be switched to a no-trailing commission series or class of the same mutual fund, if the dealer who administers the client account was not required to make a suitability determination. If, however, the mutual fund does not have a no-trailing commission series or class, then other alternatives should be considered, such as transferring the holdings to a dealer required to make a suitability determination.
- Pre-authorized purchase plans that provide for the purchase of mutual fund securities subject to trailing commissions payable to dealers not required to make a suitability determination will have to be amended to switch over to the purchase of no-trailing commission mutual funds.
- Transfers from full-service to OEO accounts: The CSA expects OEO dealers to inform investors at or before the time of a proposed transfer of accounts that they cannot accept transfers of trailing commission-paying mutual fund securities, including DSC Holdings, into OEO accounts. The CSA also noted that DSC Holdings, which pay trailing fees and are subject to early redemption fees, should not be transferred to OEO dealers after the Effective Date.
Deadlines: The CSA expects the definition of “suitability determination” and the Switch Exemptions to take effect on December 31, 2020. The Trailing Commission Bans and other amendments are expected to take effect on June 1, 2022.
September 30, 2020
On September 18, the Canadian Securities Administrators (CSA) published Staff Notice 81-333 Guidance on Effective Liquidity Risk Management for Investment Funds (Guidance) to help funds develop and maintain an effective liquidity risk management (LRM) framework. The Guidance is intended primarily for investment funds subject to National Instrument 81-102 Investment Funds (NI 81-102), but the CSA believes the practices and examples discussed in the Guidance may be relevant to other funds as well.
The Guidance summarizes key international regulatory developments in this area and the applicable Canadian securities framework. Under Canadian securities legislation, IFMs must establish and maintain an effective LRM framework and exercise due care, skill and diligence in managing the liquidity of their funds.
The Guidance discusses five key elements of an effective LRM framework:
- Strong and effective governance;
- Creation and ongoing maintenance of effective LRM processes;
- Stress testing (which is not specifically required under Canadian securities regulation but is encouraged);
- Disclosure of liquidity risks; and
- Use of LRM tools to manage potential and actual liquidity issues.
The Guidance also sets out six principles (LRM Principles) and related implementation strategies for investment funds to consider in connection with their creation and maintenance of effective LRM processes:
- At the design stage and on an ongoing basis, align the fund’s investment objectives, strategy, and redemption policy with the liquidity profile of the fund’s underlying portfolio assets and the redemption demands of the investor base.
- Create and adhere to robust policies and procedures that integrate LRM considerations.
- Perform active, ongoing portfolio monitoring using qualitative and quantitative metrics to ensure adequate levels of liquidity exist to meet redemption needs and other obligations. All relevant data should be used to actively manage liquidity risks.
- Set internal liquidity thresholds and targets that management of the fund can use to assess the liquidity profile of a fund and make any necessary adjustments.
- Report material liquidity events in a timely manner for consideration by relevant personnel of the IFM.
- Where possible, identify emerging liquidity concerns and potential liquidity shortages.
The Guidance also emphasizes that effective LRM approaches will vary, depending on the fund’s characteristics, and that the Guidance is not intended to suggest or endorse a “one size fits all” approach. If you would like to discuss the application of the Guidance to your business, please do not hesitate to contact us.
September 30, 2020
On September 24, the Financial Services Regulatory Authority of Ontario (FSRA) published for comment 22 proposed service standards (Standards) for its operations. They include, among other things, performance targets for handling individual applications for mortgage broker licenses. For example, FSRA aims to issue individual licenses within 10 days of receipt of a complete application, where payment has been made and there are no suitability issues, at least 80% of the time.
The proposed Standards also outline timelines for handling complaints. Among other things, FSRA aims to assess and “action” at least 80% of complaints within 120 days and at least 95% of complaints within 270 days of receiving a complain containing all relevant information. In this context, “action” means a range of possible outcomes including escalation to other areas of FSRA, transfer of the complaint to a third-party dispute organization, the issuance of a warning or caution letter, or closure of the complaint with no action.
The deadline for comments on the proposed Standards is October 23, 2020.
September 30, 2020
On August 6, the Canadian Securities Administrators (CSA) published final amendments to national rules affecting the prospectus and registration exemptions for distributions of securities involving syndicated mortgages (National Amendments). In addition, some provinces including Ontario have proposed additional changes to their local prospectus and registration exemptions, and the Financial Services Regulatory Authority of Ontario (FSRA) is consulting on draft guidance (FSRA Guidance) for its supervision of mortgage brokers and administrators dealing in certain syndicated mortgages. The National Amendments, proposed FSRA Guidance, and proposed Ontario-specific amendments prospectus and registration exemptions (Ontario Rules) are expected to come into effect on March 1, 2021. Below, we highlight key features of the reforms.
The National Amendments will amend National Instrument 45-106 Prospectus Exemptions (NI 45-106), National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103), and the related companion policies. Among other things:
- The existing prospectus and registration exemptions in Ontario, Newfoundland and Labrador, the Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island and the Yukon for securities that are syndicated mortgages (Mortgage Exemptions) will be removed. This will align the regulatory frameworks in these jurisdictions with the rest of Canada.
- The private issuer prospectus exemption (Private Issuer Exemption) will be removed for distributions of syndicated mortgages.
- Because of these changes, exempt distributions of syndicated mortgages in Canada will have to be effected under another prospectus exemption, such as the accredited investor exemption (AI Exemption), offering memorandum exemption (OM Exemption), or family, friends and business associates exemption (FFBA Exemption).
- Consistent with the current approach in British Columbia for syndicated mortgages distributed under the OM Exemption, the National Amendments will require supplemental disclosure tailored to syndicated mortgages.
- In Ontario and other jurisdictions where the Mortgage Exemptions currently apply to syndicated mortgages, market participants that are in the business of trading syndicated mortgages will need to determine whether the registration requirement applies to them.
Changes since 2019: The National Amendments are substantially similar to the proposed amendments published by the CSA for comment in March 2019 (2019 Proposal). But there have been a few changes. For example, Form 45-106F18 Supplemental Disclosure for Syndicated Mortgages will require disclosure of the potential subordination of the syndicated mortgage, clarify the calculation of the loan-to-value ratio, and include additional examples of risk factors.
Some jurisdictions have proposed further changes to their exemptions:
- Qualified syndicated mortgages: Ontario and New Brunswick have published for comment prospectus and registration exemptions for “qualified syndicated mortgages” (QSMs), and we expect Nova Scotia to introduce a similar pair of exemptions. Alberta and Québec have proposed a prospectus-only exemption for trades in QSMs.
- Distributions of non-qualified syndicated mortgage investments (NQSMIs) to permitted investors: Ontario and New Brunswick also have proposed prospectus and registration exemptions for distributions of NQSMIs to permitted clients (i.e. institutional and high net worth investors). Alberta has proposed a prospectus-only exemption for trades in NQSMIs to permitted clients, while Québec is asking for feedback on whether such an exemption should be introduced.
- Reports of exempt distribution: Ontario and New Brunswick will not require a Form 45-106F1 Report of Exemption Distribution to be filed for distributions of QSMs under their new prospectus exemptions or for distributions of NQSMIs sold to permitted clients.
Who will regulate what in Ontario beginning in March 2021? FSRA currently regulates all syndicated mortgage investments in Ontario. When the new regime comes into effect, FSRA will continue to supervise transactions involving qualified, syndicated mortgage investments and the mortgage brokers and administrators involved in such transactions. Oversight of NQSMIs will be split between FSRA and the OSC, depending on the status of the investor/lender and the type of transaction. In particular, FSRA will supervise:
- NQSMI transactions with permitted clients;
- NQSMI transactions with permitted and non-permitted clients before March 1, 2021 (Legacy NQSMIs); and
- Administrators of NQSMIs.
Mortgage brokerages that deal in mortgages and syndicated mortgages only with permitted clients will not have to register with the OSC and the distributions of these products to permitted clients will be exempt from the prospectus requirement. There will be dual oversight however, in some circumstances. For example, FSRA will have oversight over mortgage brokers dealing in NQSMIs when they act on behalf of the borrower who is not a permitted client, with the OSC having oversight over the trades with respect to that investor/lender.
The proposed FSRA Guidance describes FSRA’s forward-looking, risk-based approach to supervision of the firms and transactions over which it will have authority and outlines the data it plans to collect from firms to inform its risk assessments.
Comment Deadline: Comments on the proposed Ontario Rules and FSRA’s Proposed Guidance are due on September 21, 2020. If you are interested in submitting comments or have questions about how these changes to the syndicated mortgages regime could affect your business, please contact us.
August 31, 2020
On August 13, the Financial Services Regulatory Authority of Ontario (FSRA) published for comment Proposed Rule [2020-001] Financial Professional Title Protection (Rule), which will require individuals who use either the financial advisor (FA) or financial planner (FP) titles to have the appropriate credential from a FSRA-approved, credentialing body. FSRA’s authority to regulate the use of the FA and FP titles comes from the Ontario Financial Professionals Title Protection Act (FPTPA), which was passed in May 2019 but hasn’t come into force yet.
Instead of introducing a brand-new licensing regime for individuals, FSRA has proposed a framework that leverages existing credentials. The proposed Rule provides for the approval and oversight of bodies that offer credentials that meet FSRA’s minimum standards for FA and FP title users. Under the new regime, holding a designation (such as the CFA Charter) or a license from a regulatory agency will not automatically qualify an individual to use either the FA or FP titles. The body that issues the credential or license, and the specific license or credential, will have to be approved under the Rule first.
FSRA is seeking comments on, among other things:
- Its criteria for approval of credentialing bodies and specific credentials;
- Whether the baseline competency profiles outlined in the proposed Rule reflect the knowledge, skills and competencies that should be included in a credentialing body’s education program to establish the minimum standard for FP and FA title users; and
- Whether title holders should have to disclose to their clients the credential they hold that entitles them to use the FA or FP title (and what this disclosure should look like).
FSRA has also published draft guidance (Guidance) on the application process for approval of credentialing bodies and specific credentials.
Financial planning and advising activities that are subject to regulation will, in addition to oversight by the credentialing body with respect to the appropriate use of title, continue to be overseen and regulated by the relevant regulatory bodies.
Transition Period: Individuals who used either the FA or FP title immediately before January 1, 2020 and continue using it until the proposed Rule comes into force may continue using that title for another three years (in the case of FA title users) or five years (in the case of FP title users). This will give credentialing bodies time to become approved at the entity and credential level and give title holders time to obtain an approved credential, if required.
The comment period closes on November 12, 2020. If you have any questions about how the Proposed Rule could affect your business, please do not hesitate to contact us.
August 31, 2020
On August 13, the Ontario Ministry of Government and Consumer Services (Ministry) launched a consultation (Consultation) regarding potential reforms to Ontario’s privacy laws. Currently, the principal legislation governing privacy matters in Ontario’s asset management sector is the federal Personal Information Protection and Electronic Documents Act (PIPEDA). The Ontario government is considering whether there is a need for Ontario legislation or other measures to address potential legislative gaps or provide enhanced protections for individuals in Ontario.
This initiative is at an early stage of development, with the Ministry is seeking feedback on general concepts, including the following:
- Increase transparency: Provide individuals with more detail about how their information is being used by businesses and organizations;
- Enhance consent provisions allowing individuals to revoke consent at any time and establishing an opt-in model for secondary uses of their information;
- Introduce a right to be forgotten so that individuals can request that information relating to them be deleted;
- Introduce standards for de-identified data (i.e. anonymized data derived from personal information) to clarify how privacy protections apply;
- Introduce data portability standards, giving individuals greater freedom to change service providers without losing their data;
- Create a legislative framework for data trusts so that, for example, an organization’s data could be governed by a third party to ensure the data is used in a transparent and accountable way; and
- Increase the Information and Privacy Commissioner’s enforcement powers including the introduction of penalty powers.
Many of these themes overlap with issues being considered by the Government of Canada as part of its initiative to modernize PIPEDA, which we discussed in our May 2019 bulletin.
In Ontario, the Ministry has launched a survey to collect individuals’ views on privacy issues. Organizations are invited to make written submissions on the Consultation by October 1, 2020. If you want to make a submission or learn more about how existing privacy legislation and potential reforms may affect your business, please do not hesitate to contact us.
August 31, 2020
On August 27, the Canadian Securities Administrators (CSA) published a report on their four-year study of what individual investors think about fees and the performance of their investments and how they interact with their advisors (Report). The study was conducted to measure the impact of Phase 2 of the Client Relationship Model (CRM2) and the mutual fund “point of sale” (POS) rules on investor knowledge, attitudes and behaviour, although the CSA acknowledges that other developments such as news coverage and growing interest in low-cost funds may have contributed to the changes identified in the Report. Key findings include the following:
Fees: Readership of account statements hasn’t changed much since 2016, but more investors reported having a better understanding of how fees affect investment returns and considered it important to monitor the fees they were charged. However, there was no improvement between 2016 and 2019 in the number of investors indicating that their advisors discussed the impact of fees on returns with them.
Clients (Dis)Satisfaction: There was a statistically significant decline between 2016 and 2019 in how satisfied investors were with their advisors. More investors reported that they had changed, or were likely to change, their advisor in 2019 as compared with 2016.
Fund Facts Are Just Fine: Very few investors reported that they want more information to be included in the Fund Facts document.
Let’s (Not) Talk about Investment Plans: Investors reported little change in representatives’ practices of discussing investment planning with them, comparing 2019 to 2016 levels.
Firms with a significant number of individual clients might find it worthwhile to skim the Tracking Study as well as the Report. The Tracking Study includes demographic data and more detailed breakdowns of the findings (e.g. by province and account type). For example, the Tracking Study shows that a statistically significant increase in the percentage of investors advised under the discretionary authority (PM model) recently changed, or were likely to change, their investment firm (13% in 2016, versus 24% in 2019).
The CSA said that it expects the study results to inform its policymaking, although it did not provide any specifics. If you want to discuss the Report’s relevance for your business operations, please do not hesitate to contact us.
August 31, 2020
On August 19, the North American Securities Administrators Association (NASAA) reported on the activities of its COVID-19 Enforcement Task Force (Task Force), which has initiated actions to disrupt 200 schemes intended to profit fraudulently from the pandemic. Modelled on NASAA’s 2018 Operation Cryptosweep, the Task Force includes investigators from 44 jurisdictions in Canada, Mexico and the United States. Canadian Task Force members accounted for more than one quarter of the actions taken to date.
According to the Task Force, many of the fraudulent offerings share characteristics, such as preying on fear while promoting safety amid uncertainty, promising monthly payments to appeal to cash-strapped investors, and/or involving cryptocurrency-related investment products, foreign exchange, and/or other products unfamiliar to inexperienced investors. We think the Task Force’s work may of interest to participants in Canadian capital markets, since it shows how North American securities regulators can act swiftly, in a coordinated way, to address emerging risks.
August 31, 2020