Staff of the Compliance and Registrant Regulation Branch (Staff) of the Ontario Securities Commission (OSC) recently released the findings of its largest-ever targeted review of portfolio managers (PMs) and exempt market dealers (EMDs).The compliance sweep, which began in June 2012, focused on assessing PM and EMD compliance with know-your-client (KYC), know-your-product (KYP) and suitability obligations under National Instrument 31-103 - Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103).
Staff determined that approximately 62% of the registrants reviewed had deficiencies with more than 30% of them characterized as significant, requiring remediation reports detailing how the registrants planned to rectify such deficiencies. Regulatory action has been taken in two cases, and in three cases registrants discontinued operations subsequent to Staff’s review.
Staff found that the sweep revealed substantive compliance breaches by PMs and EMDs and noted that certain registrants’ practices were unacceptable in Staff’s opinion. Staff’s major findings regarding compliance issues included:
- EMDs selling securities to non-accredited investors (without another exemption being available);
- inadequate suitability assessments;
- inadequate processes for the collection, documentation and maintenance of KYC information;
- inadequate relationship disclosure information;
- inadequate policies and procedures;
- improper delegation of KYC and suitability obligations to third parties by EMDs;
- inappropriate disclaimer language in client documentation by EMDs; and
- misuse of client-directed trade instructions by EMDs.
Tips resulting from the sweep
The following are among the points registrants should make note of as a result of the sweep:
- Staff will raise comments with EMDs where an investment representing more than 10% of a client’s net financial assets was sold under the $150,000 minimum amount prospectus exemption;
- registrants must update KYC information at least annually, and more often if the client has a significant life event (e.g., a marriage, divorce, birth of a child, or loss of or change of employment);
- KYC forms should be signed and dated by clients and by the registrant who reviewed the information with the client;
- relationship disclosure information provided to clients must disclose that the registrant has a suitability obligation;
- policies and procedures should address KYC, KYP and suitability practices;
- registrants should deal with their clients directly and should not delegate KYC and suitability obligations to third parties;
- registrants should not attempt to limit their liability for breach of suitability or other obligations by including limited liability language in the KYC form or other documentation signed by clients; and
- where an EMD relies on a client-directed trade instruction (i.e., the client instructs the registrant to buy, sell or hold a security that, in the registrant’s opinion, is not suitable for the client), the registrant should document his or her suitability review of the investment for the client, that the client has been fully informed of the registrant’s view, and that the client’s written instructions are to nonetheless proceed (and this should not be “buried” in boilerplate language).
Registrants should also note that as part of the sweep Staff phoned selected clients to confirm that the KYC information taken by registrants was accurate (e.g., to verify accredited investor status).