Since the implementation of the Client Focused Reforms (CFRs), the Canadian Securities Administrators (CSA) and staff of the Canadian Investment Regulatory Organization (CIRO) (together the Regulators), have been monitoring and assessing registrant conduct relating to conflicts of interest to gauge compliance with the enhanced CFR requirements.
On August 3, 2023, the Regulators published the Joint CSA and CIRO Staff Notice 31-363 (Notice), which outlined their review findings relating to the conflict practices of 172 registered firms. Of the 172 firms reviewed, only 37 firms were found to have no conflicts related deficiencies.
The objectives of the Regulators during their review included broadening their collective understanding of the controls used by registrants and developing a consistent approach when reviewing a registrant's conflict practices.
This article will highlight the top three deficiencies observed, being inadequate policies and procedures, missing or incomplete disclosure, and failures to identify material conflicts and address them in the client's best interest.
Inadequate P&Ps/ compliance manuals (66%)
The number one deficiency noted was inadequate policies and procedures relating to conflicts of interest. Most of the registrants reviewed had policies and procedures that were not updated to comply with the CFR requirements. The Regulators provide a listing of the controls and processes they expect to see in well-established policies and procedures, including:
- a process for registered individuals to promptly report or escalate existing or reasonably foreseeable conflicts of interest that have been identified to the firm;
- controls the firm has in place to address the material conflicts of interest identified and how those controls will be tested;
- regular reporting on conflicts of interest by the chief compliance officer to the firm's ultimate designated person, executive management, and board of directors (or equivalent), including how the firm has / is addressing material conflicts of interest;
- content of the required conflicts of interest disclosure for clients, and the process and timing for preparing and delivering the disclosure to clients, as well as any updates to that disclosure; and
- a process for training employees regarding conflicts of interest and their obligations.
At the end of the Notice it is reiterated that robust policies and procedures must align with a registrant's business model in order to mitigate the potential impact that the conflict of interest could pose to a client (and the registrant).
Missing or incomplete disclosure (53%)
Lacking or incomplete disclosure deficiencies were the second highest deficiency noted. The Regulators reiterate that firms are required to provide clients, impacted by a material conflict, with clear and meaningful disclosure that is presented in a manner that ensures clients understand the information presented to them.
Timing of disclosure: Conflicts must be disclosed if identified during the account opening process or prior to a client's subsequent transaction with the firm. Mandated disclosure requirements are meant to provide reasonable clients enough time to assess the conflict to make an informed decision about the firm or transaction they may be participating in. When it comes to material conflicts firms are reminded that disclosures must be fulsome in content, prominent, specific, and written in plain language.
Disclosure format: The disclosure should include the nature and extent of the conflict of interest, the potential impact to the client and the risk(s) that the conflict of interest could pose to them, and how the conflict of interest has been, or will be, addressed.
Disclosures prepared by another entity: It was observed that some firms referred clients to an issuer's documents (e.g., the issuer's offering memorandum) to satisfy their disclosure obligations. The Regulators advise that this could result in the registrant being off-side of their obligations as the issuer's perspective would be different than that of the registered firm.
Failure to identify material conflicts and addressing them in the client's best interest. 34%
The third highest noted deficiency relates to a repeated comment made throughout the Notice in that firms were not aware of, or they failed to identify, material conflicts of interest. Regulators consider identifying conflicts a fundamental registrant obligation. Identifying, assessing and addressing material conflicts of interest in the best interest of the client is a crucial part of this obligation.
While judging the materiality of a conflict, registrants may rely on their professional judgement, but the Regulators expect registrants to consider whether the conflict may be reasonably expected to affect either or both of the following: (i) the decisions of the client in the circumstances; and /or (ii) the recommendations or decisions of the registrant in the circumstances.
In addition, the Notice cited that too many firms only had generic conflicts training that in some cases was not even attended by the appropriate individuals. Regulators expect firms to train all staff on conflicts of interest generally, and to provide more tailored training for registered individuals, support staff and compliance staff specifically around how to recognize material conflicts and their obligations regarding conflicts and the firm's escalation and internal reporting process so that conflicts can be appropriately addressed.
Finally, the Regulators state that additional rules will be considered if they do not observe the results they expect relating to compliance with the CFRs, including the conflicts of interest provisions.
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.