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