client meeting

This article looks at the enhanced know-your-product (KYP) requirements of the client-focused reforms (CFRs). It’s the third in my series that explores aspects of the regulations that will have the greatest impact on advisors. The KYP changes will also have a significant impact on registered firms, so I’ll highlight key considerations for them as well.

With the new KYP standards, regulators have codified for the first time some of the best practices they’ve been recommending for years. They have also added a focus on initial and ongoing costs and the impact of those costs, and on a robust KYP process and documentation for both firms and advisors.

Let’s look at some of the specific requirements.

KYP obligations for registered firms

The KYP requirements under the CFRs clarify the onus on firms to assess, approve and monitor the securities they make available on their product shelf. Firms must:

  • Assess relevant aspects of the securities. This includes the securities’ structure, features, risks, initial and ongoing costs and the impact of those costs.
  • Approve securities made available on their product shelf.
  • Monitor those securities on an ongoing basis for significant changes. When there are significant changes to a security on a firm’s shelf, the firm and the affected advisors must also consider whether or not the change would require new suitability determinations for clients holding that security.
  • Provide “compliance training,” including around KYP requirements. In light of the new obligations, firms should consider what additional KYP training is required for advisors.

The rules indicate that firms may tailor their processes to the types of securities being considered and the complexity and risks of those securities. However, it’s clear that in all cases, firms should have clear and documented policies, procedures and controls. In addition, the regulators expect that firms will provide their advisors with the tools necessary to meet their obligations.

Next steps for registered firms

  • Review your product shelf: Regulators expect that firms will maintain a product shelf that meets the needs and objectives of their clients. Consider whether your firm should re-evaluate the securities it approves and makes available to clients.
  • Explore tools or technology: If you have a broad and open product shelf, determine whether you will need tools or technology to support your processes or help advisors meet their obligations. In particular, many firms are exploring tools to support the requirement that an advisor considers a “reasonable range of alternative actions” before making a recommendation to a client.
  • Prepare and provide advisor training: The KYP requirements under the CFRs are sufficiently different from today’s requirements that most firms will have to provide enhanced KYP training to advisors.
  • Significant change monitoring and notification: Consider whether the size of your product shelf and your advisor base requires technology support to monitor for changes in securities and to notify affected advisors.

KYP obligations for advisors

Making investment recommendations

Before making a recommendation to a client, you are required to:

  • Know relevant details about the security. This includes knowing its structure, features, risk, the initial and ongoing costs of acquiring, owning and disposing of the security and the impact of those costs on performance or client returns. Costs include fees such as commissions, sales charges, trailer fees, management fees, incentive fees, referral fees and redemption fees, and embedded costs such as expenses or bid-ask spreads. The more complex or risky an investment is, the more detailed consideration you’re expected to give it.
  • Compare the security to a reasonable range of alternatives available through your firm. The regulators don’t expect you to understand all the intricacies of hundreds of securities. They do expect you to have a general understanding of the types of securities that are available through your firm, to have compared the security you recommend to a “reasonable range of alternatives,” and to thoroughly understand the security you recommend.
  • Only recommend a security if it has been approved by your firm. Your firm’s approval is not, however, enough to enable you to meet your obligation to know your product. The KYP obligations on advisors are separate from the firm’s KYP obligations.

“Significant changes” to securities

Firms are required to monitor approved securities for significant changes. What constitutes a significant change is not defined and will vary by type of security.

Once a significant change has been identified, you will need to consider whether or not the change will require a new suitability assessment for clients who hold that security.

In some cases, firms are considering tools or other automated processes to support these requirements and help you identify impacted client portfolios. Ask your firm whether they will provide any specific support in this area.

Reviewing transfers of securities

Whenever a new or existing client transfers in a security, you must take reasonable steps to:

  • Understand the transferred securities and compare them to other reasonable alternatives
  • Determine whether it’s appropriate to recommend that the client hold or reduce their holding of those securities
  • Keep a detailed record of your process and determination

The regulators acknowledge that the depth of understanding required will vary depending on the type of security and the client’s circumstances and investment objectives. However, it’s clear that your KYP obligations apply to all securities in a client’s account, including those that were transferred in. In addition, firms are not required to approve all securities that are transferred in, so you may not have the benefit of your firm’s support or information around that security.

Next steps for advisors

Right-size your personal product shelf: Start thinking about how you will meet your KYP obligations, especially if your client portfolios include a significant number of different securities. Ask your firm whether or not your firm’s product shelf is changing in response to the CFRs.

Ask your firm how it will support advisors to meet the CFR obligations: Find out if your firm plans to provide any tools or technology for you.

Document, document, document: Ask your firm for clarity around how they expect you to meet the increased documentation requirements and whether they will provide any support.

Attend training: Be prepared to attend training provided by your firm. It will likely be mandatory (because the CFRs require it) and will help clarify how you need to meet the heightened expectations around KYP.