Over the course of the Client Focused Reforms (CFR) journey, InvestorCOM has hosted a series of virtual forums for wealth management leaders to better understand the nuances of the regulation, openly discuss compliance challenges, and consider viable strategies for meeting the regulations. Anchored by these discussions, on February 2 2021, InvestorCOM hosted leading industry experts, including Richard Roskies, Senior Legal Counsel from AUM Law, to discuss practical approaches for investment dealers and advisors to meet their KYP obligations.
The highlights of the dialogue between Parham Nasseri, VP Regulatory Strategy at InvestorCOM and Richard Roskies is shared in this article to help guide the investment dealer community stay on side of the regulatory expectations as it relates to the CFRs.
Parham Nasseri: What are your thoughts on how investment dealers have generally responded to the CFR requirements and their state of readiness?
Richard Roskies: By now, the CFRs should be on every dealer and advisors’ radar. I’d say about 60% of the clients I work with are at least knee deep into the conflict-of-interest requirements that are due in June. When it comes to the KYP, KYC and Enhanced suitability segments, I believe most people have started to think about it but they haven’t yet weighed in with full focus. For example, these topics have not been a huge topic on the implementation committees I sit on.
That being said, depending on the size of the dealer’s product shelf, the KYP piece requires a fair amount of work and now is the time to start thinking about implementation strategy.
In terms of materials coming out of the final SRO rules-based comments, there wasn’t much to be concerned about. While the rules are close to baked, the interpretation will be ongoing through implementation guidance and FAQs. In short, this will be an ongoing iterative process for our industry.
Parham: At a high level, are there any outstanding areas for clarification or is the implementation goal quite clear?
Richard: I believe we are going to get ongoing implementation guidance and FAQs throughout this year.
The Canadian Securities Administrators (CSA) has done a lot of work in setting out what the goals, principles and expectations of the CFRs are. When it comes to KYP, it is clear that the regulators now expect documented KYP evidence for all traded products. However, when you drill down to the details of what is a reasonable way for firms to achieve these goals, I believe CSA guidance defers to industry by using the term use your “professional judgement” about ten times.
The regulators have definitely given us enough guardrails about what reasonable KYP should look like but the last details will be determined by the ongoing interaction between regulatory staff and industry. In short, you should absolutely start working on the CFRs, including KYP, but it will be important to follow the clarifications that come out over the course of at least this coming year.
Parham: Given the dealer’s new KYP obligations, can you comment on what it means to monitor for significant changes and what needs to happen when a significant change is detected?
Richard: First, it is important that the CSA guidance explicitly narrowed the requirement here from general monitoring to monitoring for significant changes. We don’t get an explicit definition of what is “significant change”, as the guidance indicates that it will vary depending on your firm’s operations and the type of security. However, I think a generally safe litmus test is that you are looking for any event that may significantly affect market price.
To that end, for most securities, I would be thinking about creating proactive alerts for any news stories related to the issuer (including earnings calls). Where we are talking about private funds, there will still usually be certain disclosure events that you can use as triggers for reviews. These are the kinds of triggers that you would want to consider. You also would want to have policies on reviewing your shelf if a sector or broad market downturn arises as companies are likely change in those times of stress. I read into the guidance that the higher the risk profile of the security, the more often you should be “checking in”.
Parham: Can you discuss the requirement to assess products on your shelf, and how frequently? Is this the regulator’s way of reducing shelf sizes? How does this requirement differ for dealers that have a proprietary shelf or have proprietary products on their shelves?
Richard: I think industry’s major comment to regulators over the course of the discussion about KYP is that some of these changes may have the unintended consequence of reducing shelf size. Whether that occurs in actuality will have to be determined over the course of the next few years. In terms of different KYP approaches, that term “professional judgement” comes back into play. The guidance is clear that you are indeed allowed to simplify the due diligence required as the product trends towards the lower risk/well understood end of the scale. In fact, we are talking to our clients and regulators and have confirmed that for certain lower risk/public securities, you could even do KYP by sector (e.g., draft a KYP document for the “public banking sector in Canada”). As you trend towards higher risk, private and more complex securities, the diligence will need to become more detailed. Private proprietary products are likely much closer to the highly detailed side of the scale.
Parham: Clearly, the new KYP requirements are raising some questions in the industry. What are some practical approaches in your view for tackling this new requirement?
Richard: When it comes to what is practical and reasonable, I always come back to two rules:
- Effort counts. When it comes to compliance, the goal cannot be absolute perfection. The goal has to be creating a strong and demonstrable “culture of compliance”. This is a key term regulatory auditors look for. Basically, as long as you are adequately protecting clients, effort counts. Where compliance departments can show that they have taken the CFRs seriously and have built up processes that reasonably resemble those of their competitor firms, then in an audit, regulators may dispute interpretation or approach but you are not going to fall below that dangerous red line. Where thoughtful effort is not shown, that is where you start to get into trouble.
- “If it is not documented, it does not exist.” If you boil down the CFRs into one concept, it is that most of what they mandate are things that dealers and advisors have generally been doing in their heads. The CFRs ask that you better evidence your existing process. To that end, there needs to be a good paper trail for each of the tasks the CFRs are asking you to do. I get that creating a paper trail for each KYP review is onerous, and there are tech solutions that can help with that. However, the papering aspect of these CFRs cannot be understated.
Finally, tackling the CFRs from scratch is going to be hard. You need tools. There are a number of tools out there including those presented at this seminar.
Parham: Did the Comment Letters (and any of the responses you’ve seen – introduce or raise any substantive items, or do you feel like what advisor KYP is and what is required is fairly clear here?
Richard: The current round of comments for the IIROC/MFDA rules that ended January 18 was relatively sparse. I believe there were about a handful of letters and while they were thoughtful they were relatively short. As mentioned earlier, the implementation guidance/FAQs will be more informative over the coming year.
Parham: In your respective view, do the requirements raise the bar for advisors when it comes to meeting their KYP requirements?
Richard: I think that the requirements codify a lot of the best practices that Commission Staff have been recommending for a number of years. In short, most of what is in the CFRs are not “net new” from a substantive standpoint. What is new and onerous is that dealer/adviser activity will now need to be evidenced in a written and formal manner.
Parham: What are the challenges a dealer and advisors need to consider with respect to their KYP obligation and considering a reasonable range of alternatives when making recommendations?
Richard: The first and main challenge is trying to determine what this phrase means for different firm models. While this specific phrase is drawn from the suitability requirement, there are a number of instances within the KYP requirement where you may have to look at comparator products as part of your due diligence requirements.
Understanding the “why” of this requirement will help inform when and how you should be including comparator product analysis in your KYP diligence.
The first “why” is Conflicts of Interest – If you are a dealer or advisor that is recommending a product (both proprietary and third party) where you are getting direct or indirect compensation for that recommendation, there is a (reasonable or otherwise) perception that you are only recommending this product because you are getting paid for it. Regulators have struggled with this issue for years. Where this conflict is identified for your firm, it is helpful to do a comparative product review so that you can show that the product you are recommending is being recommended because it is a good product, not because you are getting paid to sell it. This will give your firm additional protection as this area evolves.
The second “why” is based around some recent OSC Commission decisions. Regulators have found that there is a client expectation that when they go to a firm, they are getting access to all the products the firm sells not just the products that an individual dealer sells. To the extent that you can show that a dealer considered all of the firm’s shelf when recommending a product to a client, you are avoiding a client expectation issue that has come up in the past.
Notwithstanding the above, I think this area will be an ongoing topic of discussion throughout the year through implementation guidance and FAQs.
About the Speakers
Richard Roskies, Senior Legal Counsel, AUM Law
Richard’s regulatory and compliance practice focuses on assisting portfolio managers, exempt market dealers and investment fund managers in complying with Canadian securities law and advising them on how to deal with securities regulators’ expectations. He also regularly engages with securities regulators on behalf of clients in connection with registration matters, compliance audits and regulatory proceedings. In addition, Richard has acted as primary counsel on files where AUM Law has been approved by the Ontario Securities Commission as compliance consultant in connection with a registrant’s remediation of compliance deficiencies.
Parham Nasseri, Vice President Regulatory Strategy, InvestorCOM
Parham Nasseri has over a decade of wealth management and regulatory experience. He is the Chair of the Canadian Advocacy Council of CFA Societies Canada and previously held roles at the Ombudsman for Banking Services & Investments and the Brattle Group. Mr. Nasseri holds a CFA Charter and an MBA from Schulich School of Business.