Suitability obligations of registrants has been a top of mind concern of the Ontario Securities Commission (OSC) over the past few years. This is largely due to Compliance staff’s repeated findings of significant deficiencies in this area.
The OSC’s Statement of Priorities for 2013-2014 reported that staff of the OSC’s Compliance and Registrant Regulation branch (Staff) would complete the next steps in its suitability compliance review of registered firms undertaken in June 2012, and publish the results following completion of its largest ever targeted review (Sweep) of portfolio managers (PMs) and exempt market dealers (EMDs), and after OSC has published its findings in OSC Staff Notice 33-740.
The Sweep of 87 registrants was conducted to assess whether firms were in compliance with their know-your-client (KYC), know-your-product (KYP) and suitability obligations. The requirements for know your client and suitability are set out in section 13.2 and 13.3 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103). Staff made good use of their new procedure of contacting clients directly to ask about their experience with the firm and their representative, and to confirm the accuracy of the KYC information on file. This information may be viewed at http://www.osc.gov.on.ca/en/Investors_calling-clients_index.htm and http://www.osc.gov.on.ca/documents/en/Dealers/eb_20120604_new-review.pdf (PDF).
Firms are chosen for review on a risk based approach, which allows for the Compliance and Registrant Regulation branch to focus its energies on the more problematic firms. Selection for this review was based on:
- The results of the risk assessment questionnaire (RAQ) that firms are required to complete;
- Complaints received by the OSC;
- Non-compliance identified by Staff; and
- A random selection in order to have a balance of small, medium and large firms with varying types of businesses.
The most significant and prevalent problems were found among the 45 EMDs reviewed, including:
Selling to non-accredited investors
- Dealing representatives were encouraging clients to purchase $150,000 of a single exempt market investment in order to meet the definition of an accredited investor (AI). The AI definition is set out in NI 45-106 Prospectus and Registration Exemptions.
- Incorrectly determining a client’s status as an AI, e.g. KYC forms collected information on a client’s net worth rather than net financial assets
- Investments were inconsistent with KYC information on file
- Overconcentration of one security in clients’ portfolios
- Resulting from having no KYC information
Poor processes for collecting, documenting and maintaining KYC information, thereby being unable to demonstrate that investment recommendations made to their clients were suitable
- KYC forms were missing material information, such as level of risk tolerance, net worth, and investment objectives
Inadequately assessing suitability
- KYC forms collecting information on a client’s net worth rather than net financial asset
- No or inadequate policies and procedures for KYC, KYP and assessing suitability of investments
For the 42 PMs reviewed, the significant and most prevalent deficiencies Staff found were as follows:
- Over 70% of PMs did not have sufficient processes for collection, documenting and maintenance of KYC and 50% did not update KYC on an annual basis.
- NI 31-103 sets out the requirement for firms to provide each client with relationship disclosure information, setting out the firm’s obligation to assess the suitability of a purchase or sale of a security before executing a trade. Almost half of the PMs reviewed did not comply with this requirement.
- 35% of PMs were found to have inadequate policies and procedures of KYC, KYP and assessing suitability of investments.
Inevitably, these Sweeps allow Staff to identify those registrants that do not have an adequate compliance structure. In some cases, it may result in a registrant being fully audited in the near future or Staff recommending that regulatory action be taken.
The targeted review of PMs and EMDs that started last year resulted in Staff taking regulatory action against two firms and three firms closing their doors.
Staff are expected to provide guidance to firms based on their findings and we should expect to see that guidance published over the next few months.