From the Regulators

Regulator spells out expectations on product due diligence, conflict assessment and suitability

By James Langton |

The Investment Industry Regulatory Organization of Canada (IIROC) has issued new guidance for dealers on the distribution of proprietary products to ensure that they are aware of, and prepared to deal with, the added regulatory risks these sorts of products pose.

In the guidance note issued Wednesday, IIROC indicates that the distribution of products that are not at arm's length "raises potential regulatory and investor protection concerns." It points out four recent cases where clients have lost money as a result of investing in non-arm's length investment products — Essex Capital Management Limited, iForum Securities Inc., Graydon Elliott Capital Corp. and First Leaside Securities Inc.

"Where conflicts of interest exist, potentially exist, or are perceived to exist, it becomes more difficult for the dealer to meet its legal and regulatory obligations to its clients," it says.

The new guidance aims to alert dealers to the sorts of regulatory concerns that are inherent in the distribution of non-arm's length products, and to spell out the regulator's expectations in these sorts of cases. At this point, IIROC is not proposing any new rules, indicating that the current rules are adequate in this area; but it says that it does intend to increase its monitoring for compliance.

Indeed, an earlier draft of the note proposed requiring dealers to inform IIROC in advance of distributions of these sorts of products, but that provision has been removed, and IIROC indicates that it would impose that requirement through a new rule, if it deems it necessary.

Among the concerns IIROC cites in its note, it worries that dealers may fail to understand the added conduct issues these sorts of distributions raise; that product due diligence is particularly important in such situations; added conflicts may arise, and must be disclosed; objective suitability assessments are harder to make; the incentive to provide full disclosure may be impaired; and, clients may be confused about the limitations of contingency fund coverage involving proprietary products.

The guidance sets out IIROC's expectations in three key areas: product due diligence, conflict assessment and suitability. It also notes that in its compliance reviews, it will focus on the written policies and procedures, and underlying controls relating to the identification and review of non-arm's length investment products distributed by a dealer to its clients, and the management of conflicts of interest.