Compliance roundup: November 2014

The OSC’s Annual Summary Report for Dealers, Advisers and Investment Fund Managers is a mix of new initiatives, friendly reminders and pointed warnings. Here are the highlights.

New pre-registration rules

Firms trying to register for the first time will be asked for more information than previously. They may also be required to undergo in-person meetings.

“[Meetings] as part of the registration process is a European-type concept,” says Rebecca Cowdery, a partner at Borden Ladner Gervais in Toronto. “It all goes to the concern about registrant misconduct: [OSC] wants to see if they can catch it early enough.”

The report says firms must:

establish an effective compliance system prior to starting registerable activities;
ensure that written policies and procedures adequately address all aspects of business operations;
be prepared to answer detailed questions regarding the firm’s business plan and compliance systems, including:
products and services that will be offered,
business growth plans,
details about referral arrangements,
supervisory structure within the context of the firm’s growth objectives,
marketing plans,
material business contracts, and
oversight for outsourced business arrangements; and
be prepared to provide:
the firm’s application or membership in OBSI, if applicable;
custodial arrangement details;
copies of business plans and policies and procedures manual; and
copies of other information, such as offering documents, referral agreements, KYC documents, and disclosure documents.

“You have to be completely ready to go at the beginning,” notes Cowdery, adding that “was always required, but [OSC] didn’t ask to see it. Now they’re going the extra step of not assuming.”

Simon Romano, partner in the Toronto office of Stikeman Elliott, says this development may slow registration for some, but it’s logical. “Years ago, you could get registration without them looking at a business plan. Now they want to see policies and procedures, and the other things you should have. It’s reasonable.”

CCO proficiency problems

Some chief compliance officers aren’t doing their jobs well enough. “This deficiency,” says OSC, “is often [because] the CCO does not have relevant experience.”

In response, the regulator has proposed changes that would require CCOs of mutual fund dealers, scholarship plan dealers and EMDs to have logged a year of relevant experience in the 36-month period prior to applying for registration. The new rules would only apply to new firm applications.

Romano says it’s likely OSC’s seeing problems mainly with smaller dealers. “They’re not all hugely profitable and may be using part-time CCOs. They can’t afford to pay $300,000 a year for a top-notch compliance guy.”

M&A reporting failures

Some firms are failing to give OSC notice of ownership changes and asset acquisitions. For instance, the regulator’s seen multiple cases where “registered firms have not provided […] the required notice as soon as [they] knew, or had reason to believe, that 10% or more of […] voting securities were going to be acquired by a non-registrant.”

Some IIROC firms have also failed to report to OSC, wrongly assuming that fulfilling the requirements of their SRO is enough. “They understand what the [SRO] rules are,” says Cowdery, “but sometimes they forget they’re not exempted from [NI] 31-103 in this case.”

Romano says this wouldn’t happen if firms had in-house or outside counsel. “It’s been a rough few years and [firms] are folding all the time, particularly in IIROC-land. When you’re buying a block of business and doing it yourself to keep costs down,” he says, an oversight becomes more likely.

Shortcomings with KYC & KYP

The regulator says some firms and advisors are falling short when it comes to KYC and KYP. And, if you look at the history of compliance reports and enforcement actions, this is a common problem, says Romano.

So, OSC says to:

make sure you fully understand a client’s personal and financial circumstances;
update KYC information at least annually, and more often if there is a significant change to the client’s life circumstances or a significant change in market conditions;
conduct product due diligence and be able to explain a security’s risks, key features, any conflicts of interest and initial and ongoing costs and fees;
maintain adequate documentation to support the suitability analysis of each trade; and
be able to explain to clients how a proposed investment strategy is suitable and how it aligns with investment needs and objectives.

And don’t:

delegate KYC and the suitability obligation to an unregistered person;
only ask clients to tick a box that best describes their investment objectives or risk tolerance without talking with them about their personal and financial circumstances; and
fail to fully understand the structure and features of products before recommending them to clients.

Romano adds that advisors can still look bad, even if they do everything necessary to meet KYC and KYP obligations.

“What if you were a well-meaning broker who put someone in non-bank asset-backed commercial paper a few years ago? They exploded and lost a lot of value. You could say, ‘I checked out what it was; it was fixed income, it was [getting] a good yield and was rated AAA. What more do you want from me?’ ”