Canada: ASC Exempt Market Dealer Sweep Prompts Best Practice Guidance

The Alberta Securities Commission (ASC) recently completed a compliance "sweep" of 66 Alberta-based exempt market dealers (EMDs). The results of the sweep, which involved EMDs of many stripes, were released on May 10, 2017 as ASC Notice 33-705 - Exempt Market Dealer Sweep (Report). Overall, the ASC found a spectrum of compliance levels. Some firms achieved a high level of compliance or were found to be "at least generally compliant". At the opposite end of the spectrum, compliance levels of certain firms necessitated regulatory action on the part of ASC staff.

The sweep focused on compliance systems, sales practices and marketing (including KYC, KYP and suitability) as well as conflicts, relationship disclosure and client reporting issues. The EMDs reviewed included some that offer third-party exempt market products, others that are primarily involved with oil and gas-related venture capital and private equity (or with hedge funds and other pooled investment funds investing in publicly traded securities) and a third group that focus on mortgage-based investments.

The purpose of the Report is to summarize the results of the sweep and provide guidance to assist firms in complying with their regulatory obligations. Some of the highlights are summarized below.

Know Your Client

Many of the EMDs were deficient in the collection and documentation of Know Your Client (KYC) information, with required information often missing from forms. Under CSA Staff Notice 31-336 - Guidance for Portfolio Managers, Exempt Market Dealers and Other Registrants, KYC information is to be updated annually where the EMD is in regular contact with the client and at the time of each new trade where the EMD acts for the client only on occasion. Other issues included the misuse of the prospectus exemption qualification (a serious breach of securities law, as the Report pointed out) and "investment cap circumvention" (where the $10,000 cap for non-eligible investors was finessed through multiple transactions in that amount on the same day).

Know Your Product

Many firms failed to meet Know Your Product (KYP) requirements. For example, the Report notes a lack of attention to risks related to the exempt market. Moreover, reliance was placed on third-party reports and reports prepared by the issuer, with little or no independent review. The Report states that KYP due diligence should include (among others) background checks, an assessment of the issuer's track record, verification of claims in offering documents and marketing materials, stress testing of the product with respect to economic and financial variables, an analysis of pricing and an independent consideration of the risk factors disclosed in the offering documents.

Suitability

Section 13.3 of NI 31-103 - Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) requires registrants to take reasonable steps to ensure that a proposed purchase or sale is suitable for the client. The ASC's expectation that firms will be able to demonstrate suitability on a trade-by-trade basis was not met in a number of cases. The ASC noted a mismatch between the assessed risk tolerance of investors and their investments and concluded that investors were often invested too heavily in exempt market securities as a class. Moreover, KYC forms used by many firms did not collect information about the use of leverage, which can create serious liquidity problems, particularly when combined with an over-concentration in exempt securities.

The ASC identifies a number of practices to address over-concentration in exempt market securities. It also expects EMDs to have specific policies and procedures to address suitability for clients over 60, investors with limited knowledge and other vulnerable investors. These policies and procedures include:

  • Enhanced due diligence (focusing on holdings outside the firm and other illiquid assets, such as real estate-backed exempt market securities);
  • "Red flag" second-level review by the CCO of transactions:

    • with concentration near or over 10 per cent of net financial assets;
    • for clients over 60 years of age or with limited investment knowledge;
    • that are leveraged; or
    • in which the client barely qualifies for the prospectus exemption; and
  • Discussing and documenting concentration issues and establishing stricter/lower concentration thresholds for clients requiring liquidity.

These requirements are consistent with the themes of CSA Consultation Paper 33-404 - Proposals to Enhance the Obligations of Advisers, Dealers, and Representatives toward their Clients.

Sales and Marketing Practices

The ASC reminds EMDs to establish marketing policies and procedures consistent with the guidance in CSA Staff Notice 31-325 - Marketing Practices of Portfolio Managers. Other ASC guidance focuses on review, approval and centralization of marketing materials as well as procedures for storage and retrieval. EMDs are encouraged to engage independent third party service providers to verify performance calculations.

Conflicts of Interest

Under section 13.4 of NI 31-103, firms are required to avoid conflicts of interest that pose a serious threat to client interests or market integrity, while mitigating and disclosing less serious conflicts. Here again, compliance was less than ideal; while most firms did have some internal controls, policies and procedures were often insufficient to identify conflicts. The ASC recommends a product-specific disclosure form that discusses conflicts of interest that apply to a particular product. The ASC wants the CCO or other compliance personnel involved in addressing conflicts to

  • Record and track all existing and potential material conflicts of interest along with the firm's response to these conflicts; and
  • Discuss directly with each client, in person or over the phone, all material conflicts of interest to ensure the client understands the firm's conflicts prior to commencing trading activities.

Relationship Disclosure Information

The failure to disclose conflict information forms part of the ASC's broader concern about Relationship Disclosure Information (RDI). Section 14.2(1) of NI 31-103 requires that registrants provide clients with all of the information that a reasonable investor would consider important.

Consistent with CSA Consultation Paper 33-404, the ASC seeks to raise the bar on relationship disclosure by ensuring that clients have read and understood RDI. The Report accordingly suggests including fields in the KYC form for the client to acknowledge that each section has been discussed with the dealing representative and is understood. This would significantly increase the number of fields in a KYC form that need to be specifically acknowledged by the client, adding further time and compliance cost to the process. It also adds uncertainty with respect to how and when such RDI acknowledgments must be updated.

RDI should be provided in a single document that discloses all fees payable by the client, including those relating to custody for RRSP and TFSA accounts. RDI must be kept up to date and should be delivered in a timely manner. The ASC also emphasizes the importance of drafting RDI in plain language.

Reporting to Clients

The ASC seeks to impose an onerous a requirement for EMD clients to acknowledge receipt of trade confirmations and client statements (e.g., by obtaining an electronic notice of delivery). The ASC also puts its gloss on certain market practices:

  • Subscription agreement as trade confirmations – A subscription agreement should not be delivered in lieu of a trade confirmation unless it includes information that meets the trade confirmation requirements and delivery meets the timing requirement; and
  • Third-party trade confirmations and client statements – EMDs should not rely on trade confirmations and client statements provided by an issuer or custodian unless oversight procedures are in place.

Other Compliance Issues

Additional issues that were identified included (among others) inadequate supervision and disclosure of outside business activities, use of non-compliant trade names, failures to inform the ASC about significant changes to a firm's business model, failures to update information on the National Registration Database, allowing registerable activities to be performed by non-registered individuals, and an absence of policies regarding the allocation of investment opportunities among clients.

Conclusion

The above is only a selection of highlights from the Report, which is worth reading in its entirety. The ASC recommends that firms use this Notice to strengthen their compliance with Alberta securities laws. Although the Report is focused on Alberta-based EMDs, much of the guidance draws on previous CSA guidance and is consistent with the themes set out in CSA Consultation Paper 33-404. The best practice guidance seeks to raise the bar in several areas and may over time be taken into consideration by other CSA jurisdictions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions