Regulators’ review of industry compliance with critical elements of investor protection measures that took effect at the end of 2021 — the know your client (KYC), know your product (KYP) and suitability provisions of the Client-Focused Reforms (CFRs) — found a variety of failings by industry firms.
In a joint notice issued Wednesday, the Canadian Securities Administrators (CSA) and the Canadian Investment Regulatory Organization (CIRO) detailed the results of a sweep to examine the state of industry compliance with the tougher KYC, KYP and suitability requirements that were introduced as part of the CFRs.
The review — which covered 105 firms, including a range of investment dealers, fund dealers, exempt market dealers, fund managers and portfolio managers — found that while “many firms made efforts, and some invested significant resources” to adopt the CFR requirements, “some firms” were found to be falling short of full compliance with those requirements.
Among the issues flagged by the regulators, the review found that “many firms had not updated their suitability determination processes to ensure they are complying with their enhanced obligations under the CFRs.”
In particular, the review found that firms’ suitability processes failed to consider certain specific factors, their documentation of these assessments lacked detail and were ultimately inadequate — many of these same failings were also found when it came to periodic reassessments of suitability.
The regulators also found firms failing to consider the actual and potential impact of costs on clients’ returns — including failing to assess the impact of the costs for different fund series, failing to adopt policies requiring their reps to consider lower-cost options when considering various investment options, and firms not implementing processes to monitor when clients may qualify for cheaper versions of an investment when an asset threshold is reached.
“Given that costs can significantly affect client returns, registered individuals should consider the relative costs of investment options, including any compensation paid directly or indirectly to the firm or individual,” the report said.
“They must put the client’s interest first when choosing among suitable options and document the rationale if recommending higher-cost products.”
In terms of the new KYC requirements, the regulators found that while most firms had processes to collect and update clients’ information, “many firms lacked an adequate process to collect sufficient information from clients about their risk tolerance and risk capacity … some firms failed to collect adequate information about clients’ financial circumstances; and some firms had inadequate processes to keep KYC information current.”
When it came to the KYP requirements, the regulators found that many firms didn’t adequately document their KYP assessments, some firms failed to document their approval of securities and some firms had inadequate processes for reviewing securities that are transferred into the firm, and for monitoring securities for significant changes.
It also noted that some firms didn’t review securities from related issuers.
“In some cases, firms incorrectly assumed that their involvement at the issuer level was sufficient to demonstrate that they had met the KYP assessment requirement,” it said.
Additionally, certain firms improperly relied on KYP assessments that were carried out by an affiliate, and some failed to document their KYP assessments for model portfolios, the regulators noted.
Firms that were found to be deficient as part of the regulators’ sweep were required to resolve those failings, the report said.
“However, in some instances, the non-compliance issues were significant enough to warrant further regulatory action,” it noted.
More broadly, the regulators said the compliance review “[highlights] the fundamental importance of firms developing policies and procedures to ensure compliance with all aspects of the CFRs” — which are principles-based requirements that give firms latitude to adapt regulatory requirements their own businesses.
“Staff will continue to review and evaluate firms’ compliance with securities legislation, including all CFR requirements, during regular compliance examinations and will use all regulatory tools available to address any non-compliance or other issues identified,” the report said.
In addition to documenting the failings that regulators found, the report also provides guidance for complying with the CFR requirements and sets out examples of best practices.
“The CFRs are an integral part of the CSA’s effort to protect retail investors across Canada. These findings and additional guidance are intended to help registrants implement more efficient processes that are tailored to their business, further enabling them to be compliant with regulations,” said Stan Magidson, chair of the CSA and chair and CEO of the Alberta Securities Commission (ASC), in a release.