compliance puzzle
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Regulatory action against industry misconduct is on the rise, according to the Ontario Security Commission’s (OSC) Annual Summary Report for Dealers, Advisors and Investment Fund Managers published Thursday.

The report highlights common compliance deficiencies, current issues and trends in registration, and key policy initiatives impacting registrants during the OSC’s most recent fiscal year ending March 31. It also provides guidance for firms to help ensure their future compliance in areas where the regulators continue to uncover deficiencies.

The report reveals that regulatory action is on the rise in recent years. The OSC’s Compliance and Registrant Regulation (CRR) branch undertook 136 actions in fiscal 2018 — up from 126 actions in the previous year — such as denying registration, imposing terms and conditions on registration, and referring cases to enforcement.

According to the report, the OSC is more frequently denying registration outright, with the number of these actions rising to 63 in fiscal 2018 from 47 in fiscal 2017. Referrals to enforcement declined to just four in fiscal 2018 from 12 in fiscal 2017.

“CRR is continually improving our information tools, which is having the intended effect of identifying high risk registrants and applicants for registration. This has resulted in an increase in regulatory actions over the past four years,” the report states.

A key change to this year’s report is the grouping of deficiencies by topic instead of registration category. Among the seven topic areas used by the OSC during its reviews during fiscal 2018, compliance systems accounted for 38% of overall deficiencies.

“We continue to have concerns that some registered firms are not establishing an adequate compliance system, based on the types of significant deficiencies we identify,” the report states.

Client disclosure and reporting — including firms not delivering the required reports on compensation and performance under the CRM2 regime, or providing inadequate versions of these reports — accounted for 18% of overall deficiencies, while KYC, KYP and suitability deficiencies totalled 14%.

Specifically, a compliance sweep focused on senior investors found widespread KYC and suitability failings. Most registrants (90%) haven’t adopted written policies specifically for dealing with seniors and other vulnerable investors, the report states. Firms are generally aware of the challenges that can accompany serving these clients, but most haven’t established specific practices for handling these challenges.

“While we do not expect firms and their staff to become experts in identifying clients with suspected financial abuse of cognitive impairment issues, they should have adequate procedures and oversight controls to address these issues as they arise,” the report states.

Conflicts of interest and referral arrangements accounted for 8% of overall deficiencies.

Regarding investment fund managers (IFMs), the OSC’s reviews uncovered instances of IFMs improperly outsourcing essential work to dealers, such as preparing offering memorandums, exercising signing authority over fund accounts, and indirectly making investment decisions, among other things. Indeed, the OSC found at least one instance where the dealer was effectively the “mind and management” of the investment funds, the report states.

These reviews also uncovered IFMs improperly charging certain expenses to their funds, which should have been covered in their management fees, such as research expenses, due diligence fees and portfolio management software.

A review of industry employment agreements found a “significant portion” that contained “inappropriate language,” and internal policies and procedures that could discourage whistleblowers from reporting concerns to the regulator or law enforcement.

According to the report, the OSC’s future compliance activities will focus on: industry compliance with the mutual fund sales practices rules, particularly the provisions involving promotional spending; compensation-driven conflicts of interest; testing the accuracy of responses to its risk-assessment questionnaire’ and examining high-risk firms; among other things.

“We continue to focus our reviews on evaluating the effectiveness of firms’ compliance systems, and will take further regulatory action when we see significant deficiencies,” says Debra Foubert, director of the OSC’s CRR branch, in a release.

The report also details the outreach work of the OSC’s fintech unit, OSC LaunchPad. In fiscal 2018, the unit: reviewed 25 applications from novel businesses seeking to participate in the Canadian Securities Administrators’ regulatory sandbox; dealt with 156 support requests from fintech businesses; and met with almost 250 fintech businesses and other stakeholders.

OSC LaunchPad has seen a shift in the sorts of businesses that it’s seeing, from an initial focus on robo-advisors and crowdfunding platforms towards more cryptoasset-based businesses, including initial coin offerings, cryptoinvestment funds, and algorithmic trading, the report states.