The Ontario Securities Commission (OSC) continues to find significant compliance problems concerning suitability, improper reliance on exemptions, and conflicts of interest, among the exempt market dealers (EMDs), and other firms it reviews.
The OSC published its compliance department’s annual report Thursday, detailing many of the issues uncovered in its compliance exams of the firms directly regulated by the OSC, including EMDs, portfolio managers, and investment fund managers.
In addition to highlighting common compliance deficiencies, the report also reviews new and proposed rules; current trends in registration issues; and, recent cases of registrant misconduct. The commission says that the report is intended to help firms comply with the rules.
“This report is a key part of our ongoing outreach to Ontario registrants,” said Debra Foubert, director of the compliance and registrant regulation branch at the OSC. “We strongly encourage registrants to read and use this report in order to ensure they are fully compliant with our requirements.”
The report indicates that the compliance reviews carried out in the most recent year resulted in a higher proportion of follow-up compliance action, but less enforcement activity. It shows that, across all registration categories, 38% of reviews resulted in “enhanced compliance” action, up from 34% in the previous year; and, 52% involved “significantly enhanced compliance” action, up from 45% in fiscal 2012. However, only 2% of cases were referred to enforcement, down from 6% the previous year; and only 3% resulted in terms and conditions on registration, down from 8% previously.
The report goes on to detail some of the major issues that the regulator continues to uncover, highlighted by continuing non-compliance with due diligence (know-your-client (KYC), and know-your-product (KYP)) requirements; and, failures to meet suitability and accredited investor requirements.
“We continue to have concerns that some dealers and advisers are not adequately meeting their KYC, KYP and suitability obligations. We also remain concerned that some EMDs are selling securities to investors that do not qualify under a prospectus exemption (such as the accredited investor exemption),” it says.
It reports that its reviews of EMDs found instances of dealers selling exempt securities to non-accredited investors; inadequate suitability assessments, including investors with an over-concentration in a single investment, and inadequate documentation to satisfy how a suitability determination was made; and, inadequate processes for collecting, documenting and maintaining KYC information. It noted examples of inadequate relationship disclosure information, and inadequate KYC processes at portfolio managers too.
The report notes that the OSC is planning to issue guidance later this year regarding KYC, KYP and suitability processes, in an effort to help firms meet their obligations.
“We will continue to focus on assessing if EMDs and PMs are meeting their KYC, KYP and suitability obligations, and if EMDs are selling exempt securities to non-accredited investors,” it says, adding that it intends to pay particular attention to registrants relying on purported “client-directed trade instructions”, or selling investments using the $150,000 minimum amount exemption when the investment represents more than 10% of the client’s net financial assets.
Additionally, it notes that the OSC continues to have “significant concerns” with EMDs that distribute the securities of related issuers, particularly firms that only distribute these types of securities. It says that it found significant deficiencies in some of these cases, including misappropriation of investor funds, concealment of the poor financial condition of the issuer, selling unsuitable, high-risk investments to investors, and portfolio concentrations in the securities of these issuers.
“These deficiencies are in large part attributable to the lack of separation between the mind and management of the EMDs and their related or connected issuers, which gives rise to significant conflicts of interest,” it says. “Investor proceeds are not being used in accordance with what has been disclosed to investors and in some instances are used to pay for the personal expenses of officers or directors or to satisfy obligations to existing investors.”
The report also notes disclosure deficiencies among EMDs, including firms that aren’t delivering adequate risk disclosure information, and firms that aren’t properly disclosing conflicts of interest. And, it says that the OSC found a limited number of cases where firms had inadequate compliance systems, and supervisory personnel were not meeting their responsibilities.
“There are serious consequences when firms have deficiencies of this nature,” it says, noting that these sorts of issues may prompt further regulatory action including enforcement, replacing top compliance personnel, and requiring firms to hire external compliance consultants.
Looking ahead, the OSC indicates that it’s also planning a “mystery shop” research sweep of dealers and advisers to gauge the suitability of advice currently being provided. Once this research is completed, it expects to publish its findings.
For investment managers, the OSC says it found cases where expenses are being over-allocated to the funds themselves; inadequate disclosure in offering memorandums; and, insufficient oversight of outsourced functions and service providers; among other things.
At portfolio managers, some of the top issues include inadequate personal trading policies, deficient investment management agreements, and the improper delegation of KYC and suitability obligations to fund dealers reps and financial planners.