On July 11, 2017, the Ontario Securities Commission released Staff Notice 33-748 Annual Summary Report for Dealers, Advisers and Investment Fund Managers (the Report). Prepared by the Compliance and Registrant Regulation (CRR) Branch, the six-part Report addresses current trends in registration and deficiencies identified through compliance reviews of registrants, the CRR Registrant Outreach program and various policy initiatives – areas that the CRR Branch continues to focus on for the 2017-2018 fiscal year. Like previous reports, the Report summarizes regulatory actions taken, highlights cases of interest and provides additional resources for registrants.
Specific issues discussed in the Report include several that will be familiar from our earlier discussion of the Alberta Securities Commission’s (ASC) Exempt Market Dealer Sweep, including Know Your Client (KYC), Know Your Product (KYP) and suitability, as well as an emphasis on registrants’ obligations to seniors and trending issues such as fintech and cybersecurity (with respect to which a survey has been conducted, with results to follow).
While firms selected for review last year had fewer significant deficiencies than in the prior year, the OSC found that KYC, KYP and suitability continue to be the most problematic areas across all registrant categories. The Report underscores the importance, for all registrants, of reviewing and improving the process by which suitable investments are identified on the basis of the client’s current circumstances and risk tolerance profile and properly documenting KYC, KYP and suitability processes.
Ten topics of interest from the Report are highlighted below.
- Registration form deficiencies: The Report cautions firms that they are responsible for deficiencies in individual registration forms. Other issues include improper use of titles by individuals who are not registered and incomplete information with respect to surrender applications or category removals. The Report sets out best practices for such surrenders. The persistence of deficiencies in applications prompted the CSA to publish CSA Staff Notice 33-320 The Requirement for True and Complete Applications for Registration on July 13, 2017.
- Canadian CCO for international firms: The OSC has streamlined the process for non-resident firms to appoint a separate CCO for Canadian registration purposes who need not be the global head of compliance. The required relief to have more than one CCO can be obtained through the registration process; a formal application for an exemption order is not required. (We are experienced in assisting clients with respect to the appointment of a CCO for their Canadian operations under these procedures.)
- Review of “lending firms”: Post-global financial crisis, shadow-banking risks posed by non-bank financial entities remain on systemic risk watch lists. So it no surprise that the OSC conducted reviews of a sample of “lending firms” as part of a sweep, with a view to determining if the firms were registered in the appropriate registration categories.
- All firms great and small: As we previously reported, in 2016 the CSA reviewed “one person” firms for business continuity and succession planning issues. Large firms are not immune from regulatory scrutiny, however. Areas of the Report directed at large firms include best practice guidance on the use of automated compliance systems (desirable but not a substitute for qualified compliance staff) following a review of “impact firms”— firms that could have “significant impact to the capital markets if there are compliance breaches”. The Report touches on the “excessive fee issue” that has led to a series of high profile no-contest settlements (nine to date). Finally, the Report raises concerns about PM firms that are affiliated with an IIROC dealer and the inappropriate delegation of KYC and suitability obligations, best execution requirements and conflicts of interest.
- Bolstering whistleblower protections: Contractual provisions that seek to silence whistleblowers are void under Ontario securities law. The OSC will be working to identify any such restrictive provisions in firm contracts and encourages firms to be proactive in ensuring their contracts do not contain such provisions. Firms are also encouraged to consider facilitating the reporting of misconduct internally to allow the firm to investigate and remediate as appropriate.
- EMD Issues: Not unlike the ASC’s EMD sweep, the OSC’s review of EMDs revealed a number of non-compliant practices related to prospectus exemptions. In addition to the use of incorrect or modified risk acknowledgment forms, the sweep found cases in which EMDs processed investments in excess of investment limits under the Offering Memorandum prospectus exemption without properly addressing suitability requirements or taking into account other investments made by the client under the OM exemption in the applicable 12-month period. It also uncovered instances of misuse of the Family, Friends and Business Associates (FFBA) exemption, e.g. where a client was only a “Facebook friend” of a principal of the issuer. The Report contains a list of do’s and don’ts for EMDs, in light of the deficiencies found in the sweep.
- Seniors and vulnerable investors: The Report emphasized a growing concern about vulnerable investors (primarily seniors, but also including people with mental or physical impairments and those with limited fluency in the advisor’s language). After providing guidance on this issue in the 2016 Annual Summary Report (Staff Notice 33-747), the OSC is continuing to urge advisors to ensure that their policies and procedures deal adequately with issues like powers of attorney, diminishing mental capacity and even suspicions of elder abuse. The OSC is currently focusing its compliance resources on seniors’ issues and intends to review firms with a significant number of senior investors as clients.
- Online (robo) advisers: Providing greater transparency, the Report outlines the information that should be included in proposals to launch online advisory platforms submitted to the OSC for review. Deficiencies revealed in compliance reviews of online advisers that have been operating for more than one year include inadequate online KYC questionnaires (and KYC not being updated annually), over-reliance on computer-generated model portfolios and a failure to follow the guidance in CSA Staff Notice 31-342 that KYC in an online context requires a “meaningful discussion” with the client or prospective client. The Report notes that, in December 2016, IOSCO C3 (the Committee on Regulation of Market Intermediaries) published its final report, Update to the Report on the IOSCO Automated Advice Tools Survey, which identifies how automated advice tools have developed in IOSCO member jurisdictions. The OSC is a member of the IOSCO Board.
- Advisor discount fee arrangements: The CRR Branch has determined that fee rebates selectively provided to certain mutual fund security holders that are clients of representatives that distribute the funds is an inducement that is not compliant with NI 81-105. The OSC’s concern is that such non-monetary benefits may influence those representatives’ investment recommendations to clients.
- Outside business activities (OBAs): After many years, lots of late fees, an amnesty period to facilitate delinquent reporting and multiple review notices, the CRR Branch continues to observe a number of instances where registrants and applicants for registration have failed to disclose, or were late in disclosing, positions of influence with religious and community organizations. Citing the Director’s decision in Re: Ranisau, Staff reiterate the ability to impose “restricted client” terms and conditions on registrants conducting outside business activities that potentially pose a conflict of interest with their registerable activity. See OSC Staff Notice 33-738 and CSA Staff Notice 31-326. In the interest of red-tape reduction, query whether the external reporting of OBAs that do not raise conflict of interest concerns could be made on a less frequent, perhaps annual, basis (a position advocated by PMAC and others in the past).
Finally, the CRR Branch is also involved in a number of projects, discussed in Part 5 of the Report, that have impacted or will impact the regulatory landscape in Ontario. These include syndicated mortgages, the Targeted Reforms and Best Interest Standard projects, review of compensation practices and the publication of amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations pertaining to custody requirements, CRM 2 and exempt market dealer activities.