Securities Regulators Look to Improve Client-Registrant Relationship with Client Focused Reforms
October 23, 2019
The Canadian Securities Administrators (CSA) recently published reforms to enhance the client-registrant relationship (Client Focused Reforms). The Client Focused Reforms amend National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) and its companion policy (Companion Policy) by, among other things:
- Expanding the list of enumerated “know-your-client” (KYC) information required to be gathered at inception of, and updated over the course of, the client-registrant relationship, and prescribing time periods for updates of KYC information
- Implementing new “know-your-product” (KYP) requirements
- Adding to registered firms’ existing obligations to assess the suitability of client trades and investment recommendations, including that the registered firm must reasonably determine that any requested or recommended investment action “puts the client’s interest first”
- Amending the suitability waiver provisions, including to permit non-individual permitted clients to waive suitability determinations for managed accounts
- Expanding requirements relating to client-registrant conflicts of interest
- Prohibiting misleading or deceptive communications by registrants aimed at clients or potential clients
- Requiring registered firms to provide training to registered individuals on compliance with securities legislation
- Clarifying the scope of the general requirement that a registered firm maintain records to accurately record its business activities and compliance with securities legislation.
The Client Focused Reforms are expected to come into force on December 31, 2019 and will be phased in over a two-year transition period.
As implemented, the Client Focused Reforms codify industry best practices and existing regulatory guidance. Certain controversial aspects of earlier rule proposals, most notably new restrictions on referral arrangements and additional, detailed KYP requirements, have not been carried forward in these amendments. For details on earlier proposals on the Client Focused Reforms, see our July 2018 Blakes Bulletin:CSA Publishes Reforms to Enhance Client-Registrant Relationship and Policy on Embedded Commissions.
The Client Focused Reforms clarify registrants’ KYC obligations by prescribing additional categories of required KYC information. The stated purpose of the new KYC requirements is to “support the enhanced suitability determination requirement by clarifying the content and scope of the KYC process.” The enumerated categories of KYC information that registrants are required to gather have been expanded to include information regarding each client’s (a) personal circumstances, (b) investment knowledge, (c) risk profile and (d) investment time horizon. Registrants are also required to take reasonable steps, within a reasonable time after receiving the information, to have clients confirm the accuracy of collected information.
Registrants are required to update and review KYC information in certain circumstances and at regular intervals. For example, the Client Focused Reforms require registrants update a client’s information after becoming aware of a significant change in the client’s information. The final version of the NI 31-103 amendments removes an earlier proposal requiring updated KYC information where a registrant “reasonably ought to know” about a significant change. Managed accounts must be reviewed at intervals no less than every 12 months, and a registrant that is an exempt market dealer must review KYC information within 12 months before making a trade for, or recommending a trade to, a client. In other cases, registrants are required to review KYC information no less frequently than every 36 months.
NEW KYP REQUIREMENTS
The Client Focused Reforms introduce express KYP requirements. These requirements, along with the revisions to NI 31-103’s KYC provisions, are intended to support the enhanced suitability determination. The Client Focused Reforms have not implemented an earlier proposal that would have required a comparison between the securities a registered firm makes available to its clients and similar securities in the market.
Both registered firms and registered individuals will have KYP obligations. Registered firms must take reasonable steps to assess, approve and monitor securities made available to clients. Assessments must consider relevant aspects of the securities (e.g., structural features, risks, initial and ongoing costs) and securities must be approved before being made available to clients, then monitored for significant changes.
Registered individuals have similar obligations. They must take reasonable steps to understand securities that they purchase or sell for, or recommend to, clients. The steps required to understand a security are those that are reasonable to enable the individual to make a suitability determination. Registered individuals may only purchase or recommend securities approved by their firms to be made available to clients.
The Companion Policy provides guidance on tailoring internal processes to meet KYP obligations. The CSA observe in this connection that “[f]irms may tailor their processes to the types of securities being considered and the complexity and risks of those securities, and their policies and procedures should set out the different levels of assessment, approval and monitoring for different types of securities” and that “security by security process will not be required in all circumstances”.
ENHANCED SUITABILITY DETERMINATION
The Client Focused Reforms enhance and clarify registrants’ obligations regarding client suitability determinations. A new core component of these obligations is that registrants must “put the client’s interests first” when determining if an investment action is suitable.
A suitability determination is required before opening an account for a client or taking any investment action for a client. Registrants must first determine, on a reasonable basis, that the action is suitable based on five factors. The first two factors integrate the KYC and KYP obligations into the determination. The last three factors require the registrant consider the impact of the action on the client’s account including: (i) the concentration of securities within the account and the liquidity of those securities, (ii) the potential and actual impact of costs on the client’s return on investment, and (iii) a reasonable range of alternative actions available to the registrant through the registered firm, at the time the determination is made. Finally, to take the investment action or open the account, such action must “put the client’s interest first.”
Three events also trigger a requirement for a registrant to conduct a suitability review of their client’s account and the securities in the account:
- If a registered individual is designated as responsible for the client’s account;
- If the registrant becomes aware of a change in a security in the client’s account that could result in the security or the account not satisfying the suitability requirement;
- If the registrant reviews the client’s information under its obligation to periodically update KYC information. Registrants have a reasonable amount of time to conduct any such suitability review and to take any required reasonable steps.
The new suitability provisions also include a new rule replacing the current provision for client directed trades. The rule provides an exemption, if certain steps are taken by the registrant, such as getting an informed affirmation from the client, after presenting the client with a suitable alternative action, where the registrant receives an instruction from a client to take an action that does not satisfy suitability requirements.
A new section of NI 31-103 consolidates existing exemptions from certain KYC requirements and the suitability requirement. The exemptions apply to clients who request in writing that the registrant not make suitability determinations for the client’s account. If a client is an individual, the client’s account must not be a managed account to fall within the relevant exemption. As noted above, this expands the existing exemption in section 13.3(4) of NI 31-103, which does not apply to managed accounts, including where the waiver is from a permitted client that is not an individual.
CONFLICTS OF INTEREST
The Client Focused Reforms’ amendments to the existing conflicts of interest rules introduce a requirement that conflicts must be addressed in the best interest of the client.
Registered firms are required to take reasonable steps to identify existing material conflicts of interest, and material conflicts of interest that are reasonably foreseeable, between the client and the firm or any individual acting on the firm’s behalf. Registered firms must disclose in writing material conflicts to a client whose interests are affected by the conflict if a reasonable client would expect to be informed of those conflicts. The disclosure must be prominent, specific and written in plain language, and include a description of: (a) the nature and extent of the conflict of interest, (b) the potential impact on, and risk that the conflict could pose to, the client, and (c) how the conflict has been, or will be, addressed. The amendments require disclosure before opening an account for the client if the conflict has been identified at that time, or in a timely manner upon identification of a conflict that had not been previously disclosed.
Registered individuals are similarly required to identify and address material conflicts of interest and promptly report conflicts to their sponsoring firm.
The Client Focused Reforms add a new section to NI 31-103 prohibiting misleading communications. A registrant must not hold themselves out in a manner that could reasonably be expected to deceive or mislead any person or company as to the (a) proficiency, experience, qualifications or category of registration of the registrant; (b) the nature of the person’s relationship, or potential relationship with the registrant; or (c) the products or services provided, or to be provided, by the registrant.
Furthermore, a registered individual who interacts with clients must not use (x) a title, designation, award or recognition based partly or entirely on the registrant’s sales activity or revenue generation, (y) a corporate officer title, unless their sponsoring firm has appointed that registered individual to that corporate office pursuant to corporate law or (z) any title or designation unless their sponsoring firm has approved the use.
RELATIONSHIP DISCLOSURE INFORMATION
The Client Focused Reforms revise NI 31-103’s relationship disclosure requirements. The purpose of the changes is to maintain consistency with other revisions to the rule, and to bolster the principle that “a registrant must deliver to a client all information that a reasonable investor would consider important about the client’s relationship with the registrant”.
Changes to relationship disclosure information requirements include:
- A general description of the products and services offered by registered firms (e.g., whether the firm will primarily or exclusively offer proprietary products to the client)
- A general description of the benefits received, or expected to be received, by the registrant, from a person other than the client in connection with the client’s purchase or ownership of a security through the registrant
- A general explanation of the potential impact of fees on a client’s investment returns
Registered firms must also disclose, before trading in any account that is not a managed account, if there are any investment fund management expense fees or other ongoing fees that the client may incur in connection with the relevant security.
PHASED TRANSITION PERIOD
Amendments to NI 31-103 relating to conflicts of interest and the associated relationship disclosure information requirements will take effect on December 31, 2020. The remaining amendments will take effect on December 31, 2021.
POTENTIAL FOR FURTHER CLIENT FOCUSED REFORMS
In the notice announcing the Client Focused Reforms, the CSA states that it intends to further develop certain proposals discussed in earlier consultations and that future reforms may include:
- Reviewing proficiency standards
- Imposing a statutory fiduciary duty when a client grants discretionary authority in those jurisdictions which do not currently have this provision
- Clarifying the role of ultimate designated persons and chief compliance officers
- Reviewing titles and designations
- Reviewing referral arrangements
- Revisiting the provision, originally included in earlier proposals, requiring the disclosure of publicly available information that a reasonable investor would consider important in deciding whether to become a client of the registered firm.
For further information, please contact:
or any other member of our Capital Markets group.
Blakes and Blakes Business Class communications are intended for informational purposes only and do not constitute legal advice or an opinion on any issue.
We would be pleased to provide additional details or advice about specific situations if desired.
For permission to reprint articles, please contact the Blakes Client Relations & Marketing Department at email@example.com. © 2019 Blake, Cassels & Graydon LLP