On October 14, 2022, the Compliance and Registrant Regulation (CRR) Branch of the Ontario Securities Commission (OSC) published its annual summary report in OSC Staff Notice 33-754 Summary Report for Dealers, Advisers and Investment Fund Managers (the Report). The report is akin to an industry report card on how registered firms have been handling recent regulatory changes and enhancements. Many firms appear to be in the same boat when it comes to the positive progress made in implementing the required changes. However, the deficiencies observed by staff means that industry still has work to do to meet staff’s expectations.
The CSA, IIROC and the MFDA have all been conducting targeted sweeps. The findings and remedial efforts that result from these sweeps will be used by the CSA and self-regulatory organizations (SROs) to improve the guidance provided to industry to accommodate their expectations and shape the focus of compliance sweeps going forward. This article will focus on the types of firms targeted, main deficiencies found, and recent industry initiatives.
In terms of firms chosen for a review over the period covered by the Report, a profile of high risk and high impact type firms was developed from the results of previous annual compliance reviews. These firms, believed to pose a greater risk for non-compliance due to their size and/or business activity, were targeted throughout 2021 and 2022.
The high risk firms that were targeted included smaller firms, registered as either a singular registrant or a combination of an investment fund manager (IFM), portfolio manager (PM), or exempt market dealer (EMD), with at least $25 million of assets under management. These firms tended to have limited staff and resources in relation to their assets, reducing the likelihood that they would have an effective compliance program in place that would allow them to meet their regulatory requirements.
The other high risk firms targeted were PMs that offered discretionary investment management services online, typically through an interactive portal where investor profiles are derived, and model portfolios offered to clients. The concerns with this business activity related to how these firms market their business to clients as well as the firms’ ability to meet the know-your–client (KYC), know-your-product (KYP), and suitability obligations for each investor.
The high impact firms chosen for review were those that had large amounts of client assets under management, on average $900 billion, and a large client base which would have adverse effects on the capital markets in the event the firm failed to carry out its obligations.
The deficiency trends observed relating to high risk and high impact firms to date included:
- inadequate policies and procedures;
- trade confirmations and investment performance reports missing required information;
- insufficient cyber security controls;
- incorrect working capital calculations;
- client statement deficiencies (i.e.: missing firm name); and
- the use of data and information (e.g., hypotheticals) that were not representative of products in the client’s actual portfolio.
Sweeps of these types of firms are still ongoing, and the OSC plans to publish its findings and observations of these targeted sweeps in next year’s summary report.
CFR and NI 33-109 amendments: The CSA and the SROs are committed to the Client Focused Reforms (CFRs) changes that came in force in two phases in 2021. To this end, the Report provided highlights of the progress firms have made in the implementation of all aspects of the CFRs, and the gaps that were commonly observed. A key CFR enhancement relates to the handling of material conflicts of interest. Firms are expected to have in place internal processes that identify material conflicts of interest, both between a client and the firm and a client and individual registrants. Notably, material conflicts that result from compensation arrangements or incentive practices are expected to be addressed in the client’s best interest.
From all the compliance sweeps conducted, the Report cites areas for improvement relating to addressing material conflicts of interest requirements. Notably, firms have not:
- developed a process whereby existing material conflicts of interest, or those that are reasonably foreseeable, can be identified between the firm and the client and those acting on behalf of the client;
- avoided material conflicts or used internal controls to mitigate conflicts in the best interest of the client;
- provided clients with required disclosure that is “prominent and specific” regarding material conflicts in a timely manner;
- kept adequate records of identified conflicts and the controls in place to address these conflicts in the best interest of the client; and
- updated or provided conflicts related training to their staff.
NI 33-109 Registration Information (NI 33-109) amendments: The CSA’s goal with the NI 33-109 amendments was to create an efficient registration and oversight process for firms. The Report outlined some of the key components of the amendments, one of which extends the deadlines to report changes in registration information via the NRD. The other key component of the amendments is to establish an internal reporting framework that allows for the capture and reporting of outside activities and business titles and professional designations to regulators within the prescribed timelines.
The Report notes that instances of non-disclosure of material information relating to insolvency events (i.e., bankruptcies (Form 33-109F4- Item 16)), are not being disclosed. Instances of non-disclosure of information relating to dismissals for cause or other identified misconduct by individuals while registered (Form 33-109F4 – Item 12 and Schedule I) with former sponsoring firms were not disclosed and were causing delays in registration approvals. The amendments to NI 33-109 encourage full disclosure to be able to determine suitability of each registrant. Staff expect registered firms to make reasonable efforts to ensure that the information included in Notices of Termination (Form 33-109F1 Notice of End of Individual Registration or Permitted Individual Status (Notice of Cessation)) filed through NRD are truthful and complete.
As a result of recent industry trends, the need for virtual business locations has given rise to more registered individuals working from their homes. In an email blast sent September 7, 2022, the CSA indicated it was providing firms with the flexibility to create virtual business locations (Form 33-109F4- Item 9) on the NRD for registered persons working from home.
Looking ahead: Finally, the Report noted that staff’s compliance review activity for 2022-2023 would prioritize the following:
- The next phase of the CFR requirements – i.e. assessing the effectiveness of the implementation of the CFRs. This is a multi-year priority, and will start with a review of conflicts of interest requirements (already well underway) and later transition to a review of KYC, KYP and suitability requirements;
- Continued compliance reviews of high-risk firms, following the analysis of the data collected in response to the 2022 Risk Assessment Questionnaire; and
- Compliance reviews of crypto asset trading platforms.
Please don’t hesitate to reach out to our team if you require any assistance with the matters covered by the Report, and we encourage all registrants to review the Report carefully.
October 31, 2022