On February 11, 2008, OSFI released the final version of Guideline E-17 "Background Checks on Directors and Senior Managers of Federally Regulated Entities" (the "Guideline"). The Guideline, which will become effective on January 31, 2009, imposes new operational requirements related to mandatory background checks on directors and senior management.
For companies whose background checking processes have not been particularly rigourous or formalized, the Guideline will impose significant new burdens. Companies which already have in place diligent, formalized processes will likely feel little new burden, and companies already operating internationally, or considering expanding internationally, may benefit from heightened international regulatory acceptance of the calibre of OSFI's "home regulator" regime evidenced in part by OSFI's promulgation of the Guideline in conformity with international standards.
OSFI had historically specifically assessed directors and senior officers only at the time of an initial licensing application, and not thereafter. However, in recent years, the Basel Committee on Bank Supervision, the International Association of Insurance Supervisors and the international Financial Action Task Force have all issued recommendations/principles that applicable local regulators/members should, as part of their prudential function, evaluate directors and senior managers of financial institutions for appropriate expertise and integrity. The Guideline represents OSFI's response to that guidance and is the mechanism by which OSFI seeks to reduce regulated entities' exposure to reputational and other prudential risks by identifying minimum expectations for assessing the suitability and integrity of directors and senior management. The promulgation of the Guideline aligns OSFI's practices with other comparable international supervisory regimes and ensures that OSFI meets the minimum standards enunciated by those international groups. This should assist companies seeking foreign approvals for licensing or acquisitions in jurisdictions in which the local regulator, as part of its decision-making process, gives weight to the calibre of OSFI's regime as the "home regulator" (as, reciprocally, does OSFI when considering applications involving a foreign applicant).
The Guideline evolved markedly through a number of drafts, reflecting input received from a number of industry associations including the Insurance Bureau of Canada and the Canadian Life and Health Insurance Association.
Nature of the Guideline
The Guideline is reliance-based, and specifically acknowledges the primary responsibility of each institution's board and senior management. The Guideline is focused primarily on suitability (experience/expertise) and integrity (behaviour), and in keeping with the movement toward principles-based regulation, is also principles-based, in that it is a compendium of principles to assist regulated entities in establishing policies and procedures. The Guideline clarifies expectations regarding fundamental aspects of the required background checking policy, rather than stipulating specific compulsory procedures. Throughout the Guideline, the emphasis is on flexibility for regulated entities to develop their own policies and procedures suiting their own circumstances (based on the nature of their business, size, complexity, geography, risk profile, structure and ownership). Significantly, the Guideline does not apply to an insurance company or branch in run-off, as its scope only includes a company or branch whose Order is not restricted to serving existing policies.
Each entity must develop a written policy (the "Policy") for assessing the suitability and integrity of its Responsible Persons (as defined in the Guideline). The Policy itself must be approved by the board or, in case of a branch, the chief agent.
Which people are subject?
Under the Guideline, each regulated entity must identify its own Responsible Persons and the board or chief agent must approve the list. Responsible Persons, as a class, include directors, chief agents and the senior management of the organization (any person which the entity determines plays a significant role in the management of the entity, which may specifically include the chief executive officer, the chief financial officer and any other officer who has a functional reporting line directly to the board or the chief executive officer).
Certain transitional provisions in the Guideline exempt current employment contract holders from being required to be assessed immediately if their employment contract would preclude the regulated entity from conducting the required assessment. In such cases, transitional provisions apply until a change of contract, contract renewal or change of responsibilities of the applicable Responsible Person.
Only one assessment for a Responsible Person is required where the individual serves in more than one regulated entity of the same group. In addition, Responsible Persons of a subsidiary of a regulated entity are exempt from the assessment requirements where management of the subsidiary is directed by the Responsible Persons of the parent regulated entity.
When must assessments be conducted?
Under the Guideline, initial assessments for current Responsible Persons are required once the Policy is implemented (which must be not later January 31, 2009). In informal guidance, OSFI is encouraging entities to complete the initial checks by January 31, 2009. However, in informal guidance, OSFI has advised that, for example, where a company, for its own purposes, completed, in say, 2007, a background check, which would meet the Guideline requirements for an initial assessment, and the Company's Policy, adopted in 2008, requires updated assessments only every 5 years, the updated assessment of the relevant person will not be required until 2012 rather than by January 31, 2009.
The checks must be completed before a person is appointed to the Responsible Person position, unless it would be imprudent to delay the appointment, in which case the assessment must be conducted as soon as possible and in any event within the number of days specified in the Policy.
The assessments must be updated in accordance with the Policy but not longer than once every 5 years. Updates are required to focus only on elements of the assessment that change over time, and importantly, regulated entities can rely on attestations from a Responsible Person to update assessments. However, regulated entities are expected to independently verify criminal records at least every 7 years. Further assessments are required between the specified intervals if the regulated entity learns of material adverse information about a Responsible Person.
What's required in the policy?
Pursuant to the Guideline, the Policy is to include the key practices to be followed in conducting assessments, including when and how the Policy will be disclosed to Responsible Persons and candidates for Responsible Person positions as well as the practice to be followed if the regulated entity determines that a proposed Responsible Person is not suitable for the position or does not possess the required integrity, including procedures for escalating decision making, and for notification to the affected proposed Responsible Person. The Guideline notes that, in formulating and implementing the Policy, regulated entities will need to be vigilant of applicable privacy and employment law considerations.
The Policy is also required to establish internal procedures detailing how the Policy will be implemented (the "Procedures"). Again, for flexibility, the Procedures can be tailored to each regulated entity's circumstances.
Responsibility for conducting assessments can be assigned to any person or group within the regulated entity as long as the person or group is appropriately qualified and the Procedures allow individuals to escalate concerns about findings or the conduct of assessments. The Guideline acknowledges that, for branches, arrangements with the home office may be required. Branches are only required to check individuals resident in Canada; otherwise they must ensure that appropriate procedures are in place within the parent organization in respect of Responsible Persons resident outside Canada. Regulated entities are permitted to outsource some, but not all of the assessment functions, with the expectation that the appropriate person within the regulated entity will in each case make the ultimate determination. The Procedures themselves are to indicate the information to be obtained.
Regulated entities having procedures in place to meet certain Canadian public company requirements will be considered under the Guideline as already complying with the Guideline.
The Guideline indicates that the information to be gathered might include:
- criminal records, records of securities-related sanctions
or disciplinary actions;
- evidence that the proposed Responsible Person possesses
the required education, skills, qualifications and experience
(which would presumably be evident in any event in the hiring
- an attestation that the Responsible Person has not been
held civilly liable in connection with business or financial
misconduct, fraud or mismanagement; and
- attestations that the Responsible Person has no conflicts
that could create a material risk that the Responsible Person
would be unable to discharge their duties.
At the time of the initial appointment of a Responsible Person, the regulated entity is expected to verify information through third party sources, where available. Each entity is to determine which jurisdictions to search, and far back historically to verify, based on the Responsible Person's history and circumstances. In the case where a Responsible Person is permanently resident outside Canada, the regulated entity will need to determine the extent to which it will cause assessments to be conducted in the jurisdiction of residence, assuming such assessments can readily be conducted in that jurisdiction. An issue can arise in the case of a Responsible Person who has previously been employed outside Canada within the corporate group and is posted or seconded to Canada into a Responsible Person by the group/parent. Practically, even if the Canadian entity could effectively conduct an assessment in respect of a jurisdiction outside of Canada, if the assessment raised issues as to experience or suitability, practically how much recourse would the Canadian entity have to its parent or affiliate to object the posting of the individual by the parent or affiliate?
Regulated entities are also encouraged to conduct independent verifications if they suspect an attestation is insufficient or inaccurate, and verifications are to be updated periodically based on each regulated entity's circumstances and focused on particulars that can change over time. The regulated entity can rely on attestations for all aspects of an updated assessment, but is expected to independently verify criminal records. Entities are required to document their decision-making processes when an adverse finding is made; again, the response can be tailored a particular circumstance, and again, OSFI's focus is risk-based and principles-based, centred on OSFI's enunciated "expectations".
Role of directors
As noted above, the board is required to approve the Policy and any significant amendments to the Policy. In addition, it is to make necessary determinations where it would be inappropriate for any other person in the regulated entity to make the determination, and if applicable, ensure individuals found not suitable for Responsible Person positions do not hold such positions. Further, the Board is to receive concerns elevated by senior management regarding a particular Responsible Person or the manner in which the Policy is implemented. One board in a regulated entity group can discharge the board obligations of all boards of all regulated entities in the group.
It is OSFI's hope that the Guideline's principles and processes will be embraced and actively monitored by boards (as part of the setting of the right "Tone from the Top"), rather than being perceived and treated as merely another lower level compliance function.
Provision of information to OSFI
The Policy, Procedures and information about assessments conducted are to be retained for a reasonable length of time as specified in the Policy and be made available for examination by OSFI. However, they are not required to be proactively provided to OSFI, which was an evolution from the original draft, which required the provision of certain information to OSFI.
As noted above, compliance with the Guideline is required by January 31, 2009. OSFI has indicated that it will be undertaking a targeted one-time post-implementation review of entities' Policies and Procedures.
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.