Copyright 2009, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, March 2009
On March 23, 2009, the Investment Industry Regulatory Organization of Canada (IIROC) published a notice entitled Best Practices for Product Due Diligence (the Notice), which provides guidance for IIROC dealer members on the introduction and supervision of new financial products.
Process – IIROC had published the Notice for comment on October 16, 2008, indicating submission of comments due by December 15, 2008. Subsequently, IIROC received six comment letters. Concurrent with the Notice, IIROC has also published a notice that summarizes and responds to the comments received.
IIROC notes that the guidance provided in the Notice has benefited through insights from a similar notice issued by the Financial Industry Regulatory Authority in April 2005 and findings from a recent IIROC Compliance Sweep of all dealer members that acted in the manufacture or distribution of third-party asset-backed commercial paper.
Background – According to IIROC, the requirement for product due diligence arises from a dealer member's regulatory obligations. In that regard, dealer members must take a proactive approach to reviewing and improving their procedures for introducing new products and monitoring those that are not new but that have unique and complex features that may require monitoring.
IIROC notes that dealer members are responsible for meeting their regulatory obligations and cannot simply rely on the work of others. If assessment of new products that will be sold through a dealer member is done by a parent company or affiliate, the dealer member should be represented in the process and must ensure that it has sufficient documentation of the process and decision.
The Notice provides guidance under these broad categories:
(1) Establish written procedures for vetting new products – All dealer members that sell new products must have formal written policies and procedures appropriate to their business to ensure that no new product is introduced to the marketplace before it has been thoroughly vetted from regulatory, risk management and business perspectives.
(2) Identify new products – The Notice provides sample criteria for identifying products or transactions for institutional and retail clients that may require due diligence review.
(3) Ask the right questions – IIROC notes that the fundamental goal of every due diligence process should be to ensure that the right questions are asked and satisfactorily answered. The Notice sets out a list of questions that every dealer member should ask and answer before a new product is offered for sale.
(4) Establish best practices for a due diligence program – The Notice lists the following items as components of an effective product due diligence program and notes that these recommended practices facilitate compliance with suitability obligations, mitigation of conflicts of interest, and planning for appropriate training and supervision. However, IIROC acknowledges that, given the relative size of dealer members, it is difficult to have a universal industry standard on best practices.
- A standardized process that requires a written "new product" proposal;
- A preliminary assessment of a proposed product or concept by personnel or a department designated in the firm's policies and procedures to determine, among other things, whether it is a new product or a material modification of an existing product, and the appropriate level of internal review;
- For new products or material modifications to existing products, detailed review by a committee or working group made up of representatives from all relevant sectors of the firm, including compliance, legal, finance, marketing, sales and operations;
- A formal decision to approve, disapprove, or table the proposal by a new product committee or other decision-making group that includes members of the firm's senior management;
- An assessment of the extent of training in product features and risks necessary to ensure that registered representatives and supervisors can judge the suitability of recommendations and sales to clients as well as the development and implementation of the necessary training; and
- If the product is approved, a determination of the appropriate level of and process for post-approval follow-up, including consideration of:
- Monitoring of customer complaints and grievances related to the product;
- Reassessment of training needs on a continuing basis;
- Monitoring of compliance with restrictions placed on the sale of the product; and
- Periodic reassessment of the suitability of the product.
Next Steps – IIROC intends to undertake a "product due diligence sweep" later in 2009 "to ensure that dealer members develop and implement procedures for product due diligence and undertake adequate supervision of the due diligence process." The purpose of the sweep will be to not only test selected dealer member's product due diligence processes, but also to test whether new products have been subject to a review prior to offering such products to their clients.
- Investment Industry Regulatory Organization of Canada (IIROC) publishes notice which provides guidance on the introduction and supervision of new financial products
- Notice sets out components of an effective product due diligence program
- IIROC intends to undertake a "product due diligence sweep" later in 2009
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.