In the year ahead, compliance reviews undertaken by the Investment Industry Regulatory Organization of Canada (IIROC) will be focusing on dealers’ implementation of the client relationship model (CRM) reforms, their handling of conflicts of interest, and their use of social media, among other emerging issues.
IIROC published its latest Annual Consolidated Compliance Report, which spells out some of the common deficiencies uncovered in its latest round of compliance reviews, along with its priorities for the coming year. The regulator says that it views the report as a “significant tool” that it uses to “promote higher industry standards, improve investor protection and strengthen market integrity.”
The report notes that IIROC expects to continue conducting more integrated compliance reviews in the year ahead — when its business conduct, trading and financial compliance teams carry out simultaneous reviews — in the name of improving efficiency and effectiveness. And, it points out various areas where those reviews will focus in the current round of examinations.
In terms of business conduct, it’s going to be looking at the implementation of CRM 2 requirements, including rules regarding relationship disclosure, suitability, and managing conflicts of interest. It also intends to look at reps’ personal financial dealings with clients and outside business activities, and their use of social media.
The report notes that an ongoing review of firms’ compliance with relationship disclosure requirements has found that many firms are using the same disclosure document for different types of client accounts, including advisory accounts, order-execution service accounts and managed accounts. “The relationship disclosure should be meaningful and relevant to the client. At the very least, a dealer should tailor the relationship disclosure document to the client account type,” it says.
It also notes that its reviews have found widespread issues with firms’ handling of conflicts of interest. The report says that IIROC staff raised concerns with about one-third of firms reviewed regarding conflict of interest issues, including: inadequate evidence of reviews being conducted to identify and manage material conflicts of interest, inadequate disclosure of conflicts, and inadequate policies to identify and manage conflicts.
In the coming year, IIROC intends to conduct a review of how dealers identify and analyze the conflicts that they face, and how they implement a conflicts management framework appropriate to the size and scope of their business. “The results of the review will inform policy development in this area,” it notes.
It also says that its review of dealers’ social media policies and procedures will inform policy in that area too.
Additionally, IIROC says that it will be participating in the Ontario Securities Commission’s (OSC) mystery shop exercise that are designed to look at dealers from the client’s perspective. “As IIROC registrants will be involved, we have agreed that this will be a joint initiative that we can help shape, including the development of appropriate methodology, communication, analysis and reporting of results,” it says.
For the financial & operations compliance teams, priorities include dealers’ balance sheet leverage, liquidity, and outsourcing practices. On the trading side, it says it is focusing on clearly erroneous trades, compliance with new electronic trading rule requirements, and best execution.
The report also indicates that cyber-crime is a growing threat; and that, in particular, it has received “a significant number” of reports regarding intrusions into client accounts, many of which involved trading in multiple securities. It reminds dealers to take steps to prevent cyber crime in the first place, and to deal with it when it happens.
Another ongoing issue is dealers that manufacture and distribute non-arm’s length investment products. A recent targeted review in this area found that the majority of dealers had appropriate controls for meeting their suitability obligations and determining accredited investor status, and adequate policies for dealing with conflicts. But some dealers did not maintain sufficient written evidence of their due diligence process and analysis, and some used a bundled approach to product reviews.
“The distribution of non-arm’s length products will continue to be an area of focus during regular compliance examinations,” the report notes, adding that the issue of conflicts of interest will be further reviewed in 2014.
IIROC also says it has enhanced its modules to monitor firms’ use of titles and financial designations, and it expects to publish final guidance in this area in March 2014.
The report stresses that, while it recognizes that dealers’ resources and business activities are challenged in the current economic environment, “Dealers still have an obligation to have strong and effective compliance and risk control systems in place.” And, it calls on firms to “maintain a robust, effective compliance and risk management framework.”