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
 
In association with
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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.