Since the introduction of the new conflict of interest (COI) requirements in June 2021, the Canadian Securities Administrators (CSA) and New Self-Regulatory Organization of Canada (New SRO) have been actively testing how well the industry has adapted to the requirements, and in particular, their COI obligations. All aspects relating to COI are considered important by the regulators because conflicts, and how they are managed, are a key component of the client-registrant relationship.
In October 2022, the Ontario Securities Commission (OSC) released OSC Staff Notice 33-754, and in the same month the British Columbia Securities Commission (BCSC) held their Compliance Registrant Outreach Workshop-October 2022. Staff from both regulators shared their findings from their individual COI sweeps. There were similar findings and deficiencies noted by each regulator, including that firms had not taken the appropriate steps to:
- identify and address COIs, especially material COIs;
- address material COIs in the best interest of the clients;
- disclose all material COIs;
- ensure updates to policies and procedures were adequate; or
- train staff on their obligations and the firms’ expectations.
The CSA has stated that throughout 2023, they will continue to examine the effectiveness of the industry’s implementation of the COI requirements and the other Client Focused Reforms. They plan to provide further guidance to help the industry moving forward, but in the meantime, if a firm is found to have deficiencies, the first will be expected to rectify their processes and internal controls, within the CSA’s typically tight timelines.
What Does the CSA Expect Firms to Have in Place When It Comes to Dealing With COIs?
Firms are expected to take reasonable efforts to be aware of the COIs that they and their individual registrants face. Firms are expected to be able to evidence the actions taken to handle conflicts in the best interest of their clients, and for conflicts deemed to be material, that all mandated disclosures have been provided. The CSA has made it clear that when it comes to material conflicts, disclosure alone will not be sufficient to satisfy the firm’s obligations. Firms must, in addition, have controls in place to mitigate and manage conflict risk exposures that may arise from a material conflict or avoid the conflict all together.
As noted above, the regulators have found that some firms made no or insufficient updates to their policies and procedures. The BCSC noted that in the deficient policies and procedures they reviewed, firms failed to outline how the firm would comply with the requirements and why the firm believed that their procedures were adequate to meet these requirements.
In relation to COI, updated policies and procedures should include specific information, including how the firm will undertake the following items.
- Identify: Firms are expected to take reasonable steps to identify COIs at their firm, especially material conflicts of interest that are reasonably foreseeable. Firms are encouraged to have a consistent and ongoing method of identifying conflicts so that they can be dealt with effectively. Conflicts are based on circumstances and as those change so would the impact identified conflicts would have on clients. To support this ongoing process, the CSA expects firms to have an internal reporting framework (in the event one does not already exist) to allow for the timely capture of information relating to conflicts and outside activities.
- Assess: Firms should proactively assess the impact of a conflict and address accordingly. The assessment should be documented, and the analysis should include the nature of the “materiality” of the conflict, and the reasonability that once known the nature of the conflict could affect the client’s decision or recommendations made to the client. Professional judgement should also play a role in the analysis as to whether suggested controls are sufficient to mitigate the impact to a client.
- Address: Once the assessment has been done, the firm should retain supporting documentation on the firm’s decision on whether to avoid or manage/control the conflict. For certain material conflicts the CSA has stated that firms are required to avoid the conflict if they do not have adequate controls in place to address the matter in the best interest of the client.
- Disclose: For all material conflicts, disclosure to impacted clients is mandatory, even if the conflict has been resolved or avoided. The timeliness of the disclosure is a key requirement, and the CSA has mandated that disclosure provided to a client must be prominent and clear.
- Outside Activities: Conflicts may arise due to an outside activity of a representative, particularly if the activity involves a position of influence.
- Manage/Control: Conflicts are based on circumstances, and as circumstances change a firm’s records should reflect the changes and how the firm addressed them. The person or team responsible for oversight of the conflicts should also be documented.
- Report: Outside activities must be disclosed via the NRD within prescribed timelines.
- Train: Firms are required to train staff on identifying and reporting conflicts internally. Staff must be made aware of their obligations in relation to conflicts, the best interest standard, what constitutes a material conflict, and the firm’s expectations. Firms should maintain records of training sessions, attendance and the training material used.
If It’s Not Documented…
It is important to maintain a COI record of all the identified, assessed and addressed conflicts. A COI record should contain a conflict related analysis and actions taken by the firm to address and manage conflicts. The level of detail in a firm’s COI record is something that the CSA has left up to professional judgement. That said, the CSA has suggested the following as material conflicts of interest that require extensive detailed documentation to be maintained:
- Recommendation of use of proprietary products and services in fulfilling investment objectives or meeting client financial needs;
- sales practices;
- compensation arrangements;
- incentive practices;
- referral arrangements (and fees); and
- product-shelf development conflicts.
The companion policy of NI31-103 outlines the expectations of what the detailed documentation should contain.
Establishing a new internal reporting framework or enhancing what exists to capture in a timely manner information relating to COIs (even the non-reportable ones), is another tool firms will find helpful to have in place. A COI record will help demonstrate to regulatory staff that the firm is aware of its’ obligations and is being proactive in meeting them. If a regulator, a client, or a third party disputes the firm’s actions on a COI related matter in the future, having an analysis captured in a COI record may help the firm remediate the matter more efficiently.
February 28, 2023