The importance of a working understanding of compliance and supervisory obligations of IIROC-regulated entities or Dealer Members cannot be underestimated. In particular, the roles and responsibilities of the Ultimate Designated Person (the “UDP”) and the Chief Compliance Officer (“CCO”) have been scrutinized in recent decisions of the Investment Industry Regulatory Organization of Canada (“IIROC”). For example, IIROC released two decisions in 2012 in which the UDP and/or the CCO of IIROC-regulated entities faced disciplinary proceedings in relation to compliance and supervision. BLG was involved in both decisions including securing an acquittal on behalf of top officers of an investment firm. The first, Re Carbonelli & Conway, 2012 IIROC 56 (“Conway & Carbonelli”), was decided on October 5, 2012 and featured the BLG-represented UDP and the CCO of Evergreen Capital Partners Inc. (“Evergreen”). The Notice of Hearing alleged failures on the parts of the UDP and the CCO to establish and maintain adequate internal controls for the use and operation of Evergreen’s client accumulation accounts, contrary to IIROC’s Dealer Member Rule 17.2A.
Conway & Carbonelli involved a complex fact scenario. In brief, Evergreen, through its Carrying Broker, conducted a large volume of trades with relatively high purchasing costs, for institutional clients. The time to fill each trade order would customarily extend over a period of time, resulting in partially filled trade orders being recorded in an average price inventory account (an “API”). The ordinary process would be for the partial orders to stay in the API accounts until they were filled and booked out through the Carrying Broker. This became problematic when large sums began to remain in the API accounts and were not being booked out. The growing value of the un-booked amounts in the API accounts, combined with the significant economic downturn in 2008 proved disastrous when the securities were eventually marked to market and the clients rejected the trades as unauthorized. Ultimately, it was discovered that the head trader of Evergreen had perpetrated a fraud that, together with the un-booked trades accumulated in the API accounts and the market downturn, created the “perfect storm” for Evergreen’s collapse.
With respect to the responsibilities of the UDP and the CCO of Evergreen, the IIROC Hearing Panel concluded that “the standard to be applied to the Respondents is not one of perfection”. Specifically, the Panel stated that “[t]he standard to be applied is not whether or not the Respondents could have done something that might have provided a better result. Instead, the standard expected of the Respondents is that they act as reasonably proficient and diligent individuals…” The counts against the UDP and CCO in Conway & Carbonelli were ultimately dismissed.
A month later, on November 10, 2012, the disciplinary decision, Re Northern Securities, 2012 IIROC 63 (“Northern Securities”) was decided involving a UDP and CCO that had both failed in many respects in their supervisory and compliance obligations. BLG represented IIROC in this proceeding which saw sanctions levied on the UDP and CCO in question.
Conway & Carbonelli and Northern Securities were decided based on the Dealer Member Rules and in particular Dealer Member Rule 38 which provides the framework for Compliance and Supervision generally. Since these decisions, though, IIROC has made recent statements which elaborate on and clarify the responsibilities of specific individuals which it appears to view as manning the compliance and supervisory frontlines. On December 17, 2012, IIROC issued a Dealer Member Rule Rules Notice 12-0379 entitled “The Role of Compliance and Supervision” (the “Rules Notice”) which instructed that it was to be read in conjunction with Dealer Member Rule 38. The Rules Notice expressly maintains that the responsibility for compliance generally, extends to “each individual acting on behalf of a firm”. Notwithstanding this shared responsibility however, the Rules Notice makes it clear that titles such as UDP, CCO and CFO carry specific compliance obligations. In brief, these specific obligations include but are not limited to the following:
- Supervision of the compliance-related activities of the Dealer Member and individuals acting on its behalf;
- Promotion of compliance by the Dealer Member and individuals acting on its behalf;
- Establishment and maintenance of an effective compliance system and a compliance culture at the firm;
- Communication and reinforcement of the importance of compliance within the firm;
- Ensuring that all staff understand the importance of consulting with the Compliance Department;
- Ensuring that effective procedures for identifying and escalating all instances of non-compliance are in place; and
- Ensuring the timely resolution of all instances of non-compliance.
- Establishment and maintenance of policies and procedures for assessing compliance by the Dealer Member and individuals acting on its behalf;
- Monitoring and assessing the Dealer Member’s compliance with its requirements and applicable securities laws and reporting of the results of the assessment to the board of directors at least annually;
- Reporting of all material incidents of non-compliance to the UDP;
- Provision of the board of directors with reasonable assurance that all standards and requirements of applicable securities laws and regulations and the Dealer Member’s requirements are met; and
- Identification and discussion of material findings contained within IIROC compliance reports, early warning designations, gatekeeper reports, disciplinary actions, compliance risk trend report results and other relevant items in the CCO’s annual report.
- Establishment and maintenance of policies and procedures for the Dealer Member relating to financial requirements; and
- Monitoring adherence to the Dealer Member’s policies and procedures as necessary to provide reasonable assurance that it complies with all relevant requirements.
The Rules Notice ultimately serves as a concise culmination of statements made and themes captured in Conway & Carbonelli and Northern Securities. It, along with Conway & Carbonelli, Northern Securities and Dealer Member Rule 38 are surely required reading for IIROC-regulated UDPs and CCOs in terms of compliance and supervision.