New year’s resolutions aren’t just for drunken revellers. The turn of the calendar is also a convenient time for securities regulators to set their own aspirations for the year ahead – an exercise that both reveals new tactics and alerts firms in the sector to the items that are likely to come up in compliance exams.
In recent weeks, various securities regulators have been detailing their compliance priorities for the coming year. For example, the Investment Industry Regulatory
Organization of Canada (IIROC) indicates that it’s going to be focusing on firms’ implementation of new requirements relating to the client relationship model, including rules regarding disclosure, suitability and managing conflicts of interest. IIROC also intends to look at reps’ personal financial dealings with their clients, outside business activities and use of social media, among other things.
But the regulators’ signals could also highlight the emergence of new regulatory methods as well. In Ontario, for example, securities regulators are embarking on a so-called “mystery shopping” exercise, which they hope will give them some real-world insight into the experience of a would-be investor seeking investment advice.
Rather than poring through a firm’s trade blotters and “know your client” (KYC) forms to get an idea of whether the rules are being followed, mystery shopping involves a researcher posing as a client and getting a front-line look at the experience.
The Ontario Securities Commission (OSC) signalled its intention to use a mystery shopper, a tactic that has been used by regulators in other countries around the world, in its latest statement of priorities. Since that statement was issued, the project has evolved into a joint initiative involving IIROC and the Mutual Fund Dealers Association of Canada (MFDA).
The regulators are remaining relatively tight-lipped about this exercise and are refusing to provide any details about when and where the mystery shopping is going to take place. That is not entirely surprising, given that the research has to remain secret if regulators are hoping to get an unvarnished picture of the investor experience.
What’s known from the public request for proposal (RFP) tendering process is that the OSC has hired an outside firm to help with this research. Public records indicate that the OSC contracted with Toronto-based Forum Research Inc. for the project this past autumn. The contract with that firm is slated to end on March 31, which indicates that the research is likely to take place in the first quarter of this year.
The RFP provides some insight into the probable focus of the research, and indicates that the mystery shopper will seek to assess the quality of advice currently being provided in compliance with KYC, “know your product” and suitability requirements – the process for establishing a client’s risk tolerance and the disclosure of fees and costs.
The RFP also reveals that the research will provide data for ongoing regulatory initiatives, such as the Canadian Securities Administrators‘ (CSA) projects to consider mutual fund fee reform and the possibility of adopting a statutory fiduciary duty for retail investment advice. In addition, the research will be used to help the OSC, the MFDA and IIROC develop common criteria for assessing the quality of financial advice.
The OSC says that the objective of the mystery shopping project “is to collect primary research into the quality of investment advice currently being provided to retail investors in Ontario. This will give us first-hand knowledge of an investor’s experience, inform future policy decisions and ultimately allow for better investor protection.” The OSC also indicates that it intends to issue a report on its findings sometime this year.
Although the mystery shopping exercise is a new way for regulators to collect compliance information, they’re also making other changes to their examination programs and establishing new areas of focus for that work.
For example, according to Mark Gordon, president and CEO of the MFDA, that regulator will be performing routine financial compliance examinations of its Level 4 dealers on either a one- or two-year cycle starting in January; the MFDA also will be reviewing its Level 2 and 3 dealers on either a two- or a four-year cycle, based on risk assessments of the individual firms.
This effort to bring a more risk-based methodology to financial compliance examinations is also reflected in changes the MFDA has made on the sales compliance side, for which firms now either face a two- or four-year examination cycle based on their perceived riskiness.
Further, the MFDA will begin carrying out integrated exams for Level 2 and 3 dealers whose financial and sales compliance examination cycles coincide.
IIROC, which has been using integrated examinations since 2011, expects to ramp up its use of that approach in the year ahead. Lucy Becker, vice president of public affairs with IIROC, reports that the regulator conducted 12 integrated examinations in 2012-13, and is expecting to double that number this year.
Becker notes that the integrated approach allows IIROC to examine a firm’s business model and activities on an enterprisewide basis in order to assess its risks better. The approach also streamlines the examination process, allowing firms to deal with one set of questions from the regulator and to receive one comprehensive report on the findings instead of having to make multiple requests.
As for the MFDA, along with its shift to more risk-sensitive examination cycles and integrated examinations, Gordon says, it soon will be issuing a bulletin outlining specific areas of focus for the regulator this year. In general, he says, the MFDA will be targeting key investor-protection issues, such as suitability, outside business activities and providing guidance and education to improve compliance, along with efforts to help firms implement the latest reforms concerning cost disclosure and performance reporting known as Phase 2 of the client relationship model reforms.
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