Compliance reviews carried out in the past year by the Ontario Securities Commission’s (OSC) compliance and registrant regulation (CRR) branch resulted in more significant interventions, according to a new report published Thursday.
OSC Staff Notice 33-745 – 2014 OSC Annual Summary Report for Dealers, Advisers and Investment Fund Managers indicates that 10% of reviews resulted in the imposition of terms and conditions on registration, up from 3% last year; 9% led to suspensions, compared with 4% in 2013; 5% went to enforcement, up from 2%; and, 3% ended in the surrender of registration, versus 1% the previous year. At the same time, the use of “significantly enhanced compliance” measures dropped from 52% of reviews to just 28%; conversely, the use of enhanced compliance rose from 38% in 2013 to 53%.
Many of the more serious compliance concerns involve exempt market dealers (EMDs), particularly those that sell products from related issuers, the report indicates. It notes that the regulator continues to “have significant concerns with EMDs that trade in, or recommend,” related-party products; and, it is particularly concerned about firms that only deal in these kinds of products.
Among EMDs that only deal in related-party products, it says, “Significant deficiencies that we have continued to identify include misappropriation of investor funds; concealment of poor financial condition of related and/or connected issuer; sale of unsuitable, high-risk investments to investors; and high investment concentration in related party products.”
“Material conflicts of interest arise with these relationships, in large part due to the lack of separation between the mind and management of the EMD and the issuer,” it says. And, the notice warns that simply disclosing conflicts of interest to investors is not acceptable. The conflict may need to be avoided because the risk of harming a client, or the integrity of the markets, is too high, it warns; or, that the conflict should be controlled through the use of an independent review committee (IRC), and the provision of the issuer’s audited financial statements.
Another common deficiency, the report says, is that it continues to find firms that “do not maintain an adequate compliance system” and firms where top supervisors are not meeting their responsibilities. “This is most evident amongst EMDs that distribute related party products, where the same individuals form the management of both the EMD and the issuer,” it says; adding, “We found significant compliance issues across many areas,” including failures to address material conflicts of interests; trading without registration; suitability shortcomings; and insufficient product review processes.
“There were serious consequences to firms who had deficiencies of this nature and we took appropriate regulatory action including recommendations for suspension of the firm’s registration or referrals to enforcement,” it says.
“We continue to take corrective action, including suspension or sanctions or referrals to the enforcement branch, against EMDs that do not comply with applicable securities law requirements,” it says. “We continue to work toward our policy objective of increasing investor protection and deterring the misuse of investor funds by registrants and their related and/or connected issuers.”
The report also spells out many of the common deficiencies uncovered in the past year’s reviews of EMDs, fund managers and portfolio managers. Among those issues, the commission says that it continues to have concerns about dealers and advisers “not adequately meeting their KYC, KYP and suitability obligations.” And, it stresses that dealers must “take extra care in complying with their KYC, KYP and suitability obligations when dealing with clients who are seniors or those who may be in a position of vulnerability.” It also says that some EMDs are selling securities to investors that do not qualify under a prospectus exemption.
Among other common issues, the report says that firms are failing to notify the regulators about changes in ownership or asset acquisitions. The OSC says that it has “significant concerns” about firms not properly alerting them to these sorts of changes. In some cases, it says, firms mistakenly believe that notifying their self-regulatory organization is sufficient.
Reviews of newly registered fund managers found instances where firms “did not have a written policies and procedures manual that was tailored to their operations and did not adequately cover the processes and procedures that a firm should have in place to establish an adequate compliance system.” Others were not maintaining adequate insurance coverage.
In the report, the OSC also reminds EMDs that they are prohibited from using direct electronic access (DEA). “The CSA continue to be of the view that only dealers that are members of IIROC and subject to the [trading rules] are permitted to use DEA,” it says; adding that one caveat to this is that a firm registered as both an EMD and a PM can use DEA in its capacity as a PM for its managed account clients.