On October 3, 2019, the Canadian Securities Administrators (the CSA) published the Reforms to Enhance the Client-Registrant Relationship (Client Focused Reforms) (PDF), Notice of Amendments to National Instrument 31-103 and Companion Policy 31-103CP (collectively, the Amendments) (PDF). The Amendments provide the final text of the changes whose objective is to implement a series of measures by the CSA, in the framework of reforms designed to improve the client-registrant relationship (Client Focused Reforms).
The publication of the Amendments stems from the comments received from various industry participants during the comment period following publication of the draft amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) and to Companion Policy 31-103CP Registration Requirements, Exemptions and Ongoing Registrant Obligations (Companion Policy) issued on June 21, 2018 (the Proposals). The Proposals were featured in the bulletin, penned by our Investment Management team, entitled Client Focused Reforms - New Obligations for Registrants Arising Out of Proposals to NI 31-103.
The objective of the Client Focused Reforms is to better align the interests of securities advisers, dealers and representatives and, in certain cases investment fund managers (each a Registrant) with those of their clients, as well as to make the nature and the terms of their relationship with Registrants more transparent towards clients in order to improve outcomes.
This bulletin provides an overview of the Amendments, the changes made to the Proposals following the comment period, as well as the transition period for implementing the Amendments.
Summary of the Amendments to NI 31-103 and its Companion Policy
We remind you that the Amendments are relevant to all categories of registered dealers and advisers, and that certain provisions are also applicable to investment fund managers.
In addition, the Investment Industry Regulatory Organization of Canada and the Mutual Fund Dealers Association of Canada, which participated in the formulation of the Amendments, are expected to bring their own respective rules and policies into line with the Amendments in the near future.
The Amendments will institute or bolster the following obligations:
- Know Your Client (KYC)
- Know Your Product (KYP)
- Conflict of Interest
- Relationship Disclosure Information (RDI)
- Misleading Communications
- Internal Controls and Systems (including the training of registered individuals)
Moreover, after reviewing the 135 comment letters received during the comment period following publication of the Proposals, the CSA decided to make certain changes to the measures that they had initially submitted. Overall, the CSA took into consideration the industry's concerns and revised the Proposals in light of the comments received during the comment period. Among the more notable changes to the Proposals made by the CSA are:
- the decision not to adopt, for the moment, limitations on referral arrangements;
- the elimination of the proposed obligation to publish RDI on a Registrant's website;
- the deletion of the CSA's expectation that a Registrant recommend the least expensive security; and
- the addition of a materiality threshold with respect to conflicts of interest that should be identified, addressed or avoided.
The other most important changes that will be implemented as a result of the Amendments are described below:
Know Your Client (KYC)
The Amendments pertaining to KYC include:
- an expansion of the list of KYC information that must be collected by Registrants;
- the requirement that Registrants take reasonable steps to obtain a client's confirmation of the accuracy of their KYC information;
- an explicit requirement to update a client's information if a Registrant learns of a significant change;
- the specification of minimum intervals when a client's KYC information must be reviewed
- 12 months for managed accounts;
- 12 months before making a trade or a recommendation for exempt market dealers; or
- 36 months for other cases.
Most of the detailed instructions regarding the changes to how KYC is to be obtained and updated is contained in the amendments to the Companion Policy.
Know Your Product (KYP)
The Amendments introduce an express KYP obligation applicable to both registered firms and registered individuals.
Registered firms will have to take reasonable steps to ensure that the products they offer (which include promoting or advertising a security, and distributing marketing materials) to their clients:
- have been assessed with regard to their relevant aspects, including for their structure, features, risks, initial and ongoing costs and the impact of those costs;
- have been approved of to be made available to clients; and
- are monitored for significant changes.
As for registered individuals, they will have to:
- take reasonable steps to understand the securities that they purchase or sell for a client, or recommend to a client, including the costs associated with acquiring and holding each security, sufficient to enable them to make a suitability determination; and
- have obtained approval from their sponsoring firm with respect to any security they wish to offer to their clients.
The KYP obligation will also apply to securities of related and connected issuers. Registered firms offering securities of both related and connected issuers as well as other issuers, will have to apply the KYP process equally to all.
The principal changes between the Amendments and the Proposals include:
The Amendments establish a new core requirement that, before taking any steps as regards an investment action for a client account, Registrants must put their clients' interests first when making a suitability determination. When several options are suitable, Registrants must prioritize the client's interest over their own and any other conflicting interest (e.g., higher returns or other incentives). Several options may adequately meet this enhanced suitability obligation.
The Amendments also specifies the factors that must be assessed by a Registrant in order to make a suitability determination:
- KYC information (consistent with their KYC obligation);
- the Registrant's assessment or understanding of the security (consistent with their KYP obligation);
- the impact of the action on the account (including its concentration and liquidity);
- the actual and potential impact of costs on a client's returns; and
- a "reasonable range of alternatives" available at the time the determination is made.
The CSA acknowledge that these factors may not apply equally to each suitability determination. Rather, they expect Registrants to exercise their professional judgment to determine how much importance to assign to each factor when making a suitability determination.
Suitability should not be established for a client's single transaction, but on the client's overall situation, taking into account the relationship between the client and the registered individual as well as the securities and services the latter offers.
The Amendments also provide that the suitability of a client's account and the securities held in the client's account will need to be revisited within a reasonable period of time if:
- a registered individual is designated as responsible for the client's account;
- the Registrant becomes aware of a change in a security in the account or in the client's KYC information that could result in the security or account not satisfying the suitability determination criteria; and
- the Registrant reviews the client's KYC information.
Finally, the Amendments establish enhanced suitability obligations in situations where instructions from a client are determined by the Registrant to be unsuitable for the client.
Contrary to what was announced in the Proposals, the CSA withdrew from the amendments to the Companion Policy the requirement for a Registrant to recommend the lowest cost security to a client, unless the Registrant had a reasonable basis for determining that a higher cost security was better for the client.
Conflicts of Interest
The Amendments provide a new requirement that registered firms identify, address and disclose existing and reasonably foreseeable material conflicts of interest between a client and the registered firm or any individual acting on the registered firm's behalf. Registered firms must avoid any material conflict of interest that cannot be resolved in the best interest of the client.
Following the comment period, the CSA decided to add a "materiality threshold" to the assessment of whether or not a conflict of interest exists. Thus, conflicts of interest that are not material do not have to be identified and addressed by Registrants.
It is explicitly stated in the Amendments that simply providing disclosure about a conflict of interest to a client does not relieve a Registrant from their obligation to identify and address material conflicts of interest.
|The restriction as regards lending money to clients was revised and a new prohibition on borrowing money from clients was added.|
|The prohibition against acting as a power of attorney or trustee for clients was also removed.|
Relationship Disclosure Information (RDI)
As a result of the Amendments, the requirements of the Proposals were scaled back and Registrants will only be required to disclose to a client the following information as part of their RDI:
- a general discussion of any limitations on any products or services offered to a client, although any restrictions on the client's ability to liquidate or resell a security must be disclosed;
- a statement about the investment fund management expenses or other ongoing fees that a client may incur;
- the types of products offered, which may be both proprietary and non-proprietary; and
- a general explanation of the impact of fees and charges on a client's investment returns.
The CSA decided not to include in the Amendments the obligation of a Registrant to publish on its website all information that a reasonable investor would consider important about the client's relationship with the Registrant, which was part of the Proposals.
As announced upon publication of the Proposals, the Amendments prohibit Registrants from holding themselves out in such a way as to mislead a client about their proficiency, experience, qualifications or category of registration, the nature of their relationship, or the products and services provided.
The use of designations or titles by a registered individual based on sales activity or revenue generation, the use of a corporate title, unless the registered person has actually been appointed to that position by their sponsoring firm in accordance with applicable corporate law requirements, or the use of any title or designation by the registered individual that has not been approved of by their sponsoring firm, is prohibited when dealing with clients.
Internal Controls and Systems
In general, requirements to establish procedures and controls as well as recordkeeping processes and requirements will need to be revised to reflect the enhanced obligations that Registrants must comply with when the Amendments come into force.
Registered firms will also be required to offer ongoing training to their registered individuals regarding compliance with securities law and, more specifically, on KYC, KYP, suitability, and conflicts of interest obligations.
Restrictions on Referral Arrangements
The CSA decided not to proceed with the Proposals that would have imposed certain restrictions on referral arrangements. As a result, there have been no real changes to NI 31-103 as applies to referral arrangements.
However, the proposed Companion Policy has been revised to make it clear that referral arrangements in exchange for remuneration create material conflicts of interest and can only be entered into if they are in the best interest of the client. In addition, a Registrant referring a client to another person must ensure that the other person is appropriately qualified to provide the contemplated services and, if applicable, appropriately registered.
Future Reform Projects
Finally, the CSA announced that the following topics, while not part of the Amendments, may in the long term be the subject of future regulatory initiatives:
- reviewing proficiency standards;
- imposing a statutory fiduciary duty when a client grants discretionary authority in those jurisdictions which do not currently have this provision;
- clarifying the role of the ultimate designated person and chief compliance officer;
- reviewing titles and designations;
- reviewing referral arrangements; and
- reviewing the provision, originally included in the Proposals, relating to publicly available RDI.
Subject to the required ministerial approvals, the Amendments will come into force on December 31, 2019. Their implementation, however, will be subject to a transition period.
As such, the Amendments regarding conflicts of interests and the associated RDI provisions will come into force on December 31, 2020, and the other Amendments on December 31, 2021.
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.