Managing Conflicts of Interest: CSA and CIRO Offer Regulatory Guidance
On August 3, 2023, the Canadian Securities Administrators (the “CSA”) and the Canadian Investment Regulatory Organization (“CIRO”) jointly published Staff Notice 31-363 – Client Focused Reforms: Review of Registrants’ Conflicts of Interest Practices and Additional Guidance (the “Notice”). The Notice summarizes findings of various firms’ (“registrants”) conflict of interest practices following the 2021 amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”), and Companion Policy 31-103CP Registration Requirements, Exemptions and Ongoing Registrant Obligations (“31-103CP”). The stated aims for these Client Focused Reforms (“CFRs”) were to improve outcomes for clients, better align the interests of registrants with the interests of their clients and to improve investor protection.
Under the CFRs, registrants are required to take reasonable steps to identify and foresee material conflicts of interests (“COIs”), such as those related to the firm’s product offerings or compensation structure, and address them in the best interest of the client. In the event that the registrant identified a client that would be affected by a COI, registrants are expected to disclose the material COI prior to opening an account for the client, or in a timely manner if the conflict was not previously disclosed. In order to effectively address a COI, the Notice states that controls, such as policies, pre-/post-trade controls and reviews, must be used in conjunction with the disclosure to the client.
One hundred and seventy-two registered firms from a variety of registration categories, including portfolio managers, exempt market dealers, mutual fund dealers, investment dealers and investment fund managers, were reviewed for compliance with the CFRs, and compliance deficiencies were identified in over 78% of registrants (135 firms). Accordingly, the Notice sets out the CSA and CIRO’s guidance for registrants when complying with relevant securities regulations by identifying material COIs, disclosing COIs, implementing policies, training and properly documenting COIs.
CSA and CIRO Guidance
The CSA and CIRO identified five common deficiencies and provided guidance as follows:
- Identifying material COIs and addressing them in the best interest of the client. This includes identifying and addressing circumstances where (i) the interests of the client and the registrant are inconsistent or divergent; (ii)
the registrant may be influenced to place their interests ahead of the client; or (iii) there are benefits, monetary or non-monetary, or potential detriments to the registrant that may compromise the trust a reasonable client has in their registrant.
The specific response and appropriate controls to these COIs will depend on the specific scenario. For example, an internal compensation structure for registered individuals tied to sales targets or commissions generated from the sale of products has the potential to strongly influence the type of product that is recommended to the client. In order to avoid recommendations that would place the registered individual’s interests ahead of the client’s (i.e. recommending a riskier security), the registrant can implement controls such as an annual review of compensation of registered individuals, limiting the portion of compensation that is variable, or implement a compensation structure that does not differ by product or service sold.
- Ensuring adequate disclosure of material COIs to clients, including (i) the nature and extent of the COI; (ii) the potential impact and the risk the COI poses to the client, and; (iii) how the COI has been, or will be addressed. Specifically, the disclosure must be in plain and clear language that expressly lays out each of the three elements of the COI and made in a timely manner, either during the account opening process or upon identification of the COI, whichever is sooner. The Notice also notes that disclosures prepared by a third party, such as an issuer, may not be sufficient to satisfy the registrant’s disclosure obligation.
- Implementing robust policies and procedures relating to COIs. The Notice sets out a list of items that should be included in a firm’s written policies and procedures, including a definition of COI, a clear description of the responsibilities of registered individuals and the firm with respect to the COI, the process for addressing the COI including guidance and criteria, employee training, the content of the COI disclosure to clients, record keeping, the process for periodic review of the firm’s COIs and reporting to the firm’s ultimate designated person, executive management and board of directors.
- Implementing adequate employee training on COIs. Training should be tailored to the firm’s business operations and size, describe or provide examples of existing COIs at the firm and outline the process of reporting a COI. All appropriate staff (e.g. compliance staff, registered individuals and supervisory staff) should participate in training on COIs. Training should be documented in the form of attendance logs and copies of training modules to demonstrate compliance with the training requirement.
- COI record keeping obligations to demonstrate compliance and document the firm’s compensation arrangements and its registered individuals or affiliates or associates. These records must include the identification, review and analysis of the COIs, their assessment as to whether the COI is material or not, and the controls that the firm will use to address the material COIs. Documentation of periodic reviews of previous COIs and associated controls should be included in the record keeping as well.
Going forward, the CSA and CIRO will continue to conduct reviews in 2023 to assess compliance with other CFRs implemented in 2021, such as the know your client, know your product and suitability determination requirements.
The Capital Markets Group at Aird & Berlis will continue to monitor developments in the COI compliance requirements. Please contact a member of our group if you have any questions related to securities legislation, including the aforementioned Notice.