Canada: Now The Work Begins — "Client Focused" Registrant Reform Rules Published By Canadian Securities Regulators

On October 3, 2019, the Canadian Securities Administrators (CSA) released final rule amendments intended to better align the interests of registrants, including individual registrants, with the interests of their clients. The CSA emphasize that their aim is to create a "new, higher standard of conduct" across all categories of registrants, which will result in registrants putting the interests of their clients first, particularly (but not solely) when managing conflicts of interest and making suitability determinations. Thus, the CSA describe the rule amendments as "client focused reforms" (CFRs).

The amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations and the associated Companion Policy will come into force on December 31, 2019 (subject to government approvals), but will become effective over phased-in transition periods of two years ending December 31, 2021. The CSA also expect that the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) will amend their rules within that time-frame, so that members of those self-regulatory organizations (SROs) — investment dealers and mutual fund dealers, respectively, and their representatives — will be subject to the same rules as other registrants.

It is clear that the CSA intend for the rule amendments to be transformational and give rise to real change in how registrants approach their interactions with clients, as well as compliance with existing principles of registrant regulation. While certain of the proposals published for comment in April 2016 and in June 2018 have been dropped pending further consideration by the CSA, much of the June 2018 proposals were adopted in final form. Consistent with the CSA's recent approach to registrant regulation, the CSA provide extensive and detailed guidance in the Companion Policy to NI 31-103, on the regulatory principles behind the rule amendments, as well as the regulatory expectations for compliance with the rules. It is vital that registrants work to implement the rule changes with a clear understanding and consideration of the CSA's regulatory expectations.

Although some firms will have less to do to implement the changes (depending on such factors as the size of their operation and business model), we believe that all registrants will need to proceed promptly to develop a project plan to identify and implement changes to client documentation, internal controls, training programs, compliance policies and procedures, compensation models and client services and product line-up, among other things. Significant work is required within the applicable transition periods and we anticipate that there will be much to discuss, both internally and with external advisers, including BLG. The CSA are organizing an implementation committee to provide guidance and answer questions on the client focused reforms; we have asked to be represented on this committee.

The CSA are also continuing to work on the next stages of reforms. Each of the following topics is described as a separate and longer-term project:

  • Considering proficiency requirements for registrants and their representatives;
  • Reviewing titles and designations, in addition to what is provided for in the rule amendments;
  • Imposing a "statutory" fiduciary duty for discretionary asset/portfolio managers in those provinces where one does not already exist;
  • Reviewing referral arrangements, given that the restrictive June 2018 proposals were dropped, pending this further study. With the rule amendments, referral arrangements must be considered in the context of considering material conflicts of interest;
  • Clarifying the role of Ultimate Designated Persons and Chief Compliance Officers;
  • Revisiting the June 2018 proposals regarding publicly available information, which have been dropped pending this further study.

NI 31-103 Amendments: Supersizing Existing Regulation and Regulatory Guidance

The NI 31-103 rule and policy amendments generally incorporate and expand upon SRO regulation and regulatory concepts and apply them to all registrants, as well as articulate CSA policy in relation to them. The CSA emphasize that a registrant may implement the new rules and guidance in ways that make sense for the particular firm — that is, the rules and guidance are not intended to be "one-size-fits-all", but rather are "scalable" in light of different business models. This concept is not specifically provided for in the rule amendments nor as a general overall statement in the Companion Policy. Rather, at various points in the Companion Policy, the CSA address this concept in general terms stating that firms may tailor their processes for compliance with the new requirements to the firm's "business model". Firms are expected to use their "professional judgement" in determining how best to implement the specific rule amendments and stated regulatory expectations. This should give some comfort to registrants in deciding to what extent they are obliged to implement the full panoply of rules and guidance, although the CSA staff will be the ultimate arbiters of whether firms have done enough.

The most significant NI 31-103 amendments are summarized below, along with some of our broader thoughts on their implications. As noted previously, in most cases, the new rules are concise; it is the guidance forming the CSA policy provided in the Companion Policy that is often lengthy and detailed and can be expected to give rise to the most significant implementation and compliance issues.

Our summary below highlights the rule amendments in the order that they appear in NI 31-103. Together with our clients, we will continue to consider the reforms over the coming weeks. We plan to host a focused seminar on the implementation issues associated with the rule amendments at our Toronto office on January 16, 2020, where we will address questions from our clients and other industry participants.

The new rules and guidance relating to conflicts of interest and the mandated changes to "relationship disclosure information" will come into effect on December 31, 2020, with the balance of the rule changes and guidance becoming effective on December 31, 2021.

New Training Obligation for Registrant Firms: Firms must provide training to representatives (which can be provided by external providers) on the firm's compliance with securities regulation, with particular focus on the new "know your client" obligations, suitability assessments, "know your product" obligations and conflicts of interest. Training of representatives is described as a fundamental obligation of firms. Specific training is expected on how to identify conflicts of interest and how to put clients' interests first when making suitability determinations. Training is an example of an area where the CSA acknowledge that "formal" training programs may not be "necessary or practical" for "small" firms, and that the scope of a firm's compliance training will depend on the "nature, size and complexity" of its business. Registered representatives are expected to "update their knowledge and training" to keep pace with new developments in their industry relevant to their business.

New and Supersized Books and Records, Policies and Procedures and Internal Controls Requirements and Expectations: Among other matters, firms must document how they provide training to their representatives, how they address various identified conflicts of interest in the "best interests of clients", their sales practices, compensation arrangements and incentive practices, their internal compensation and incentive practices and how they comply with the new "misleading communications" prohibitions. All of the new enhanced requirements must be reflected in revised and updated policies and procedures. Internal controls must be specifically designed to assist firms in monitoring compliance with the KYC, KYP and suitability determination obligations. Internal controls must also be in place to manage the risks associated with "referral arrangements" and "the use of titles and designations" by representatives of the firm. Specific attention must be provided to documenting and supervising how representatives and firms "address conflicts of interest in the best interest of their clients" and "put the client's interest first when making suitability determinations".

Supersized Know Your Client Requirements: In addition to taking reasonable steps to establish the identity of clients and ensuring that it has sufficient information about a client's investment needs and objectives, a registrant will be required to ensure it has sufficient information about a client's personal circumstances, financial circumstances, investment knowledge, risk profile and investment time horizon. The accuracy of all KYC information must be "confirmed" by a client within a reasonable period of time and must be kept current, particularly when the firm becomes aware of a significant change in the client's KYC information. KYC information must be reviewed (i) for managed accounts, every 12 months, (ii) by EMDs, within the previous 12 months before making a trade or recommendation to the client, and (iii) for all other accounts, by the registrant no less than once every 36 months.

There is significant guidance provided on the various elements of KYC in the Companion Policy, including discussions of the importance of obtaining and using this information to support the requirement to make suitability determinations in ways that "put the client's interest first". In particular, the CSA explain that they will expect firms to develop a process for collecting and updating KYC in ways that result in a "meaningful interaction" between the firm and the client. Although standardized questionnaires and other "tools" may be used to facilitate the collection of KYC information, firms will be expected to provide assistance to clients in understanding the various questions asked and concepts used, and to follow up with the client if there are inconsistent answers. The CSA provide specific guidance around the need for processes to assess the client's risk profile (risk tolerance and risk capacity), as well as how firms should resolve "conflicts" between the client's expectations and their risk profile. The CSA acknowledge that the nature of the KYC information requested for any client will depend on the nature of the services provided by the registrant, with the most extensive requirements being suggested for discretionary managed accounts. Registrants should not simply rely on the client's word for certain of the information – there are expectations that registrants will ask probing questions and request further information as follow-up. Client confirmations of the KYC information provided must be documented – either by way of client signature (including a digital signature) or as notes to the client file.

Supersized Know Your Product Requirements: The components of new KYP obligations include a requirement that a firm only make a security available to its clients once it has taken reasonable steps to assess the security — including its "initial and ongoing costs and the impact of those costs", to approve the security and to monitor and assess the security on an ongoing basis for significant changes. Representatives have their own KYP obligations, so that they can be certain they have met the requirements for a suitability assessment. Representatives must not buy, sell or recommend a security unless they take "reasonable steps" to understand "at a general level" the securities that are available at the firm and may only recommend a security that has been approved by the firm. The firm must ensure that representatives have the necessary information about each security approved by the firm to meet their obligations. Firms must develop an approval process for securities recommended by the firm – and here the CSA note that the process may vary based on the "complexity and risks" of the securities. The CSA provide guidance on what matters a firm must consider when developing an approval process, which must include a process to monitor significant changes in each approved security. KYP requirements will apply to securities transferred in to the firm by the client from another firm or that are acquired for the client in response to a client directed trade. KYP expectations regarding proprietary products ("related and connected issuers") offered by the firm are the same for any other type of security – although the CSA tie together the KYP requirements with the conflicts of interest discussion about proprietary products. Training programs and recordkeeping requirements are also closely tied to the KYP expectations.

Supersized Expectations for Carrying Out Suitability Determinations: The expanded rules around suitability require a registrant to determine, on a reasonable basis, that a specified investment action taken or recommended on behalf of a client, including the opening of an account or a recommendation to continue to hold a security, is suitable for the client. Suitability must take into account the client's KYC information, the registrant's KYP assessment, the impact of the action on the client's account (including concentration and liquidity considerations), potential and actual impact of costs on the client's return on investment and a consideration of a reasonable range of alternatives. In addition to the above noted points, any specific action must also "put the client's interest first". In this way, "suitability" (as we have always interpreted this word) is not enough — the registrant must be able to demonstrate how the action puts the client's interest first. There are new rules as to when suitability assessments must be carried out on an ongoing basis, including when the registrant becomes aware that a security or the account may no longer be suitable for the client.

There is much guidance provided in the Companion Policy on CSA expectations for registrants meeting the expanded suitability expectations. The bottom line is that the CSA will expect registrants to be able to demonstrate that a particular action for a client was made in a way that put the client's interest first. The CSA explain, however, that registrants must make these assessments "based on the information reasonably available to them at the time" of the assessment. The CSA will monitor how registrants carry out suitability by looking at what a "reasonable registrant" with a similar business model would have done under the same circumstances. This is intended as comfort to registrants that the CSA staff will not necessarily "second guess" registrants on suitability assessments.

A welcome change is that institutional permitted clients may now waive the suitability assessments even when they have established a managed account with the registrant, although it is not clear if this permission can be adopted prior to December 31, 2021, when the new suitability rules become effective. Permitted clients who are individuals can still only waive the suitability assessments if they do not have a managed account with the registrant, as NI 31-103 currently permits.

Supersized Expectations for Identifying and Managing Conflicts of Interest: The new supersized rules will continue to require firms to take reasonable steps to identify existing material conflicts of interest, and also those material conflicts of interest that are "reasonably foreseeable", between the firm and the client and each of its representatives and its clients. The CSA have reverted back to a "materiality" threshold for conflicts of interest, but have retained the fundamental concept that all material conflicts must be addressed in "the best interest of the client". If the conflict cannot be managed in the best interest of the client, it must be "avoided" (prohibited). Conflicts must be disclosed to clients, but registrants may not rely solely on disclosure to address conflicts in the best interests of the client. Representatives have specific responsibilities regarding conflicts, including identifying and reporting conflicts to their firm, addressing conflicts in the best interest of the client and waiting until the firm "approves" the representative's proposed actions in connection with a material conflict of interest. The guidance provided on identifying and addressing conflicts of interest is very detailed and extensive, but generally will require firms to establish well-defined processes for identifying and managing material conflicts of interest, and understand for each material conflict, how it can be managed "in the best interest of the client". Documentation and analysis will be critical.

The CSA provide specific guidance about the "inherent" material conflicts of interest which they consider are raised in the following circumstances:

  • a firm and its representatives trade or recommend "proprietary products" (a newly defined term);
  • a firm and its representatives receive "third-party" compensation;
  • a firm creates internal incentives to sell or recommend certain products over others or for representatives to receive compensation from their firm which varies according to specific products or securities recommended/traded for a client;
  • a firm manages a client's assets in a "fee-based account" where that account holds securities with embedded compensation or where the firm does not provide services to the client consistent with the terms of the account or agreement with their client;
  • a firm is involved in paid referral arrangements – we note that the existing referral arrangement provisions have been modified in ways that will require attention from firms that engage in these practices;
  • a firm acquires assets from a client "outside the normal course of a registrant's business";
  • a registrant has full control or authority over the financial affairs of an individual client;
  • a registrant acts as a director, officer, shareholder, owner or partner of an issuer whose securities the registrant also recommends to clients.

Disclosure as a way to mitigate conflicts of interest receives extensive attention in the Companion Policy — and while disclosure is required, it is also stated to be insufficient on its own to illustrate that the conflict was addressed "in the best interest of the client".

Note that investment fund managers are exempt from these requirements in connection with their management of public investment funds, given the conflicts regime inherent in National Instrument 81-107 Independent Review Committee for Investment Funds.

As noted above, these rule and policy amendments come into force on December 31, 2020 and therefore must be addressed first; in our view, the work to do what is expected by the CSA in the area of conflicts of interest should not be underestimated.

New Rules and Supersized Expectations for Disclosure and Holding Out: Notwithstanding that the CSA indicate that they will continue to work on a project around "titles and designations", new anti-"misleading communication" rules will serve to moderate titles of individual representatives. All titles must be approved by the firm, and "titles, designations, awards or recognitions" that are based partly or entirely on a registered individual's sales activity or revenue generation are prohibited. Registrants must not hold their services out in any manner that could reasonably be misleading in respect of qualifications and products and services provided. Any title that is a "corporate officer" title, such as President or Vice-President, cannot be used unless the individual has been appointed as a corporate officer under applicable corporate law. Other guidance on misleading communication is given, including when a firm exaggerates the products or services made available to clients.

Expansions to the requirements to provide clients with relationship disclosure information (RDI) are also mandated. These changes will be effective on December 31, 2020. We expect further clarity will be required on the CSA's expectations about immediately revising RDI documents and making the updated information available to clients.

BLG Analysis and Focused Seminar on Implementation: The NI 31-103 rule and policy changes are the outcomes of among the most time-consuming and detailed review of existing regulation and industry practices we have ever seen (dating back to pre-2012). In addition to understanding the impact of the amendments on your business, including your representatives, it will be important to consider how you may need to change your business models and practices in order to comply with the new requirements.

We have closely followed the path of the various reforms of registrant regulation for many years, as well as being in the heart of the discussions about conflicts of interest, sales practices and incentives, investment fund fees and disclosure. We would be pleased to discuss with you how you can learn about the rule amendments and analyze them to determine the impact on your business.

We intend to speak with our clients to seek to help ease the burdens associated with the impact of the amendments and discuss what will need to change with business models and operations, compliance systems, internal controls, compensation practices, disclosure, training programs, client documentation and the like. We will collect questions asked of us, along with our suggested answers, and will seek feedback from the regulators as necessary. Please watch for your invitation to our focused seminar on the NI 31-103 amendments and their implementation, scheduled for Thursday, January 16, 2020 at our Toronto office (we will offer Webex participation) where we will provide more in-depth analysis.

About BLG

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
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please 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