|
Amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”) and the new requirements under Client Focused Reforms (“CFRs”)
The Canadian Securities Administrators (“CSA”) have amended NI 31-103 to introduce new registrant conduct requirements, with the stated objective of better aligning the interests of registrants with the interests of their clients, improving outcomes for clients, and making clearer to clients the nature and terms of their relationship with registrants. The core elements of the amendments are enhanced know your product (“KYP”), know your client (“KYC”), suitability, conflict of interest and relationship disclosure information (“RDI”) requirements.
The CFRs relating to conflicts of interest come into effect on June 30, 2021 and all the other reforms come into effect on December 31, 2021. The CSA has provided for a phased transition period with no grandfathering provisions.
We anticipate that certain of the amendments will require revisions to registrants' policy and procedures manual (“PPM”) and RDI forms.
Of all of the CFRs, the new conflict of interest obligations, which come into force June 30, 2021, are likely to cause the most significant changes to a firm’s compliance practices, particularly for registrants that are captive dealers.
See “Additional Resources” at the end of this blog for links to documents referenced herein.
CONFLICTS OF INTEREST – CHANGES EFFECTIVE JUNE 30, 2021
The amendments to the conflicts of interest rules introduce a new obligation to address material conflicts in the client’s best interest. Determining what is in the best interest of the client must be addressed on a case-by-case basis and can change over time depending on the facts and circumstances of the individual relationships. This requires analyzing what the registrant has done to address the material conflict of interest in the best interest of their client and considering what a reasonable registrant would have done under the same circumstances.
When addressing material conflicts of interest in the best interest of clients, a registered firm and its registered individuals must put the interests of their clients first, ahead of their own interests and any other competing considerations. Importantly, the CSA has expressly stated that consent without other action on the part of the registrant will no longer be enough to address a material conflict in the best interest of a client. Rather, CSA Staff expect registrants to address material conflicts of interest by either avoiding those conflicts or by implementing controls to mitigate those conflicts sufficiently. A registrant’s conflict of interest analysis should include materiality, reasonability and professional judgment, taking into consideration the client-registrant relationship and the registrant’s business model. Captive dealers, whose business model includes structural conflicts of interest that are unavoidable, will be particularly impacted by these amendments and will be expected to introduce new and effective controls.
Registrants must implement these new protocols and communicate new mandated conflict of interest disclosure to existing clients by not later than June 30, 2021. Thereafter, all new clients must receive the mandated disclosure at the time of the new client account opening.
Implementing new controls
Registered firms, particularly captive dealers, will have already identified actual and potential conflicts of interest in their business model and adopted conflict of interest protocols and procedures. Until now, most firms have relied on disclosure of the conflicts to clients as the primary or exclusive method of meeting the regulatory requirements. As noted above, disclosure alone is no longer sufficient. Now, a registered firm must implement controls that reasonably mitigate the conflict.
According to the Companion Policy to NI 31-103, registered firms who trade in, or recommend, proprietary products in addition to non-proprietary products could consider the following examples of controls when determining how to address such conflicts in the best interest of their clients:
- prohibiting monetary or non-monetary benefits at the firm that could bias individual recommendations towards proprietary products over non-proprietary products;
- demonstrating that proprietary products are subject to the same know your product processes and selection criteria, as well as ongoing performance and other monitoring, as non-proprietary products;
- clearly documenting how proprietary products fit within the firm’s business model and strategy, and how they are aligned with client interests;
- monitoring the use and level of proprietary products in client portfolios to assist in evaluating whether the conflict is being addressed in the best interests of clients;
- making non-proprietary products offered by the firm as easy to access for its registered individuals and its clients as proprietary products offered by the firm;
- clearly disclosing to clients the nature of the firm’s product and service offerings and the extent to which proprietary products may be included in client portfolios; and
- obtaining independent advice on, or an independent evaluation of, the effectiveness of the firm’s policies, procedures, and controls to address this conflict.
The Companion Policy further provides that registered firms who only trade in, or recommend, proprietary products could consider the following examples of controls when determining how to address this conflict in the best interest of their clients:
- clearly documenting how the proprietary products fit within the firm’s business model and strategy, and how they are aligned with client’s interests;
- providing clear disclosure to clients about the nature of the firm’s product and service offerings and that only proprietary products will be included in client portfolios;
- developing client profiles setting out the types of investors for whom the proprietary products may be suitable, including concentration or other limits for such securities where appropriate, and turning away any potential clients who do not fit the profile for that product;
- establishing a robust oversight process for compliance with Part 13 Division 1 [know your client, know your product and suitability determination] in respect of proprietary products;
- establishing a robust know your product process for the proprietary products, including subsequent performance and other monitoring of the securities, and an ongoing evaluation of the suitability of the securities for client portfolios;
- conducting periodic due diligence on comparable non-proprietary products available in the market and evaluating whether the proprietary products are competitive with the alternatives available in the market (See the CSA discussion about this recommended practice in the CFR Frequently Asked Questions, a link to which is included at the end of this memorandum); and
- obtaining independent advice on, or an independent evaluation of, the effectiveness of the firm’s policies, procedures, and controls to address this conflict.
Registrants will need to consider which of the above (or other) controls are best for your firm’s business model, having regard to the best interests of your clients and the professional judgment of your firm’s registered individuals.
Communicating new conflict of interest disclosure
For existing clients, registered firms must deliver (in paper or electronic format) their new conflict of interest disclosures that will either comprehensively replace those that were delivered in the past or, supplement existing conflicts of interest disclosures with updates that include CFRs mandated conflicts of interest information.
Registered firms may provide the CFRs mandated conflicts of interest disclosure together with or separately from any other disclosures using integrated or stand-alone documents in any form.
The CSA have stated that a reasonable approach would be to:
- Step 1: on or before June 30, 2021, deliver a plain language notice that:
- Describes the upcoming CFRs mandated conflicts of interest disclosure, including: (i) an overview discussion of conflicts of interest (ii) what is changing in terms of how conflicts will be addressed, and (iii) explaining why the disclosure is important for the client to read;
- Describes where the client can find the CFRs enhanced conflict of interest disclosure on the registered firm’s website prior to, or on, June 30, 2021 and how and when it will be delivered to the client; and
- Explains how the client can contact their registered firm/registered representative and also how they can exercise the option to receive communications electronically (if this option is available at the registered firm).
- Step 2: the CFRs mandated conflicts of interest disclosure is posted to the registered firm’s website and each client that has opted for documents to be delivered electronically receives a digital notification granting the client with access to the disclosure through the registered firm’s secure client portal on or before June 30, 2021.
- Step 3: the CFRs mandated conflicts of interest disclosure is delivered in a timely manner with the delivery of the client account statements for the quarter ended June 30, 2021 by the registered firm to each client.
Registered firms may adopt other methods to ensure timely compliance with the conflict of interest disclosure requirement. Registrants are encouraged by the CSA to use plain language in order to mitigate the risk that clients may not fully understand the information provided by the firm and to spend sufficient time with clients to adequately explain the information that is delivered to them.
OTHER CFRS – EFFECTIVE DECEMBER 31, 2021
Know Your Product
The amendments prescribe the following obligations with respect to KYP:
- Registered firms should establish a KYP process that works for their business models while ensuring that all securities that they make available to clients are assessed, approved and monitored on an ongoing basis for significant changes.
- Registered individuals must not purchase, sell or recommend securities to clients unless reasonable steps have been taken to understand the securities and have obtained their firms’ approval before doing so.
Know Your Client
Amendments to the KYC requirements include:
- An expanded 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; and
- The specification of minimum periods of when a client’s KYC information must be reviewed
- for managed accounts, no less frequently than once every 12 months;
- if the registrant is an exempt market dealer, within 12 months before making a trade for, or recommending a trade to, the client; and
- in any other case, no less frequently than once every 36 months.
Suitability
The amendments establish that before a registrant takes any action on behalf of a client, the registrant must put their clients’ interests first (and before their own interests) when making a suitability determination.
The factors that must be assessed by a registrant in order to determine that an action (ie: a buy or sell order) is suitable for the client are:
- KYC information collected in accordance with KYC obligations;
- The registrant’s assessment or understanding of the security in accordance with KYP obligations;
- The impact of the action on the client’s account, including the concentration of securities within the account and the liquidity of them;
- The potential and actual impact of costs on the clients returns; and
- A reasonable range of alternative actions available at the time the determination is made.
Relationship Disclosure Information
The amendments to the RDI requirements provide that registrants will be required to disclose the following information to a client as part of their RDI:
- A general discussion of any restrictions, costs and limitations on any products or services offered to a client;
- A general discussion of any benefits received, or expected to be received, by the registrant from a person or company other than the registrant’s client, in connection with the client’s purchase of a security through the registrant;
- 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 returns.
As noted above, we expect that these amendments will result in changes to most registrants’ existing form of RDI.
Other CFRs
There are also new provisions concerning misleading communications. The amendments expressly 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.
Finally, the amendments include additions to internal controls and a requirement for firms to provide training on compliance with securities legislation, including without limitation the obligations under KYC, KYP, suitability and the conflicts of interest sections, to their registered individuals.
ADDITIONAL RESOURCES
We refer you to the following additional resources:
Please contact Angela Austman at [email protected] or Alaina Zecchini at [email protected] if you would like our assistance with the review and revision of these documents, and with updating your business materials to capture the amendments.
|