Summary Report for Dealers, Advisers and Investment Fund Managers (Staff Notice 33-755)
The OSC’s annual Compliance and Registrant Regulation (CRR) branch Summary Report for Dealers, Advisers and Investment Fund Managers (the Report) was published on July 27, 2023.
This PMAC overview focuses on certain of the OSC’s regulatory oversight activities and guidance that pertain to portfolio managers and/or investment fund managers. Registrants are highly encouraged to read the Report, especially Section 2, in its entirety for a full picture of the OSC’s views on matters such as crypto-trading platforms, and mortgage investment entities. The Report also covers the CRR’s education and outreach programs, the impact of upcoming initiatives and a summary of registrant conduct activities.
SWEEPS
Conflicts of Interest
Registrants will be waiting a while longer to see the results of the reviews focused on the implementation of the Client Focused Reforms conflicts of interest requirements (the Conflicts of Interest Sweep). The CSA and the Canadian Investment Regulatory Organization (CIRO) will jointly publish a staff notice setting out the Conflicts of Interest Sweep findings “shortly”. PMAC will issue a special eBulletin to members when that staff notice is published.
In the meantime, members are encouraged to review the recently issued British Columbia Securities Commission Report Card (PMAC summary here) as well as the PMAC Conflicts of Interest Assessment Resources.
How to prepare for the year ahead: KYP, KYC and Suitability
For 2023-2024, firms should be prepared for sweeps of their know-your-product, know-your-client and suitability policies, as enhanced by the Client Focused Reforms. A reminder for private client firms: Trusted Contact Person policies and information, as well as senior and vulnerable investor policies, are likely to be a critical component of this review.
High-impact firms
During 2023, the OSC reviewed 4 firms with a combined AUM of approximately $530 billion that can be considered to have a high impact on the capital markets in the event of an operational or compliance incident. While there were no detailed findings of this high-impact firm sweep, the OSC’s review focused on the firms’ governance structures, risk framework (including risk identification and management processes) and any compliance issues (including how these firms remedy any non-compliance).
Firms with limited compliance staff
Firms with 1 or less full-time employees working in compliance and with an AUM of over $25 million were part of a limited compliance sweep to ascertain whether such firms have sufficient resources and an effective compliance system. Such firms may pose a higher risk of non-compliance with securities laws. The OSC reported that most of the firms that were part of the sweep did have adequate resources and effective compliance programs; however, at least 40% of the firms reviewed had similar deficiencies, which fall under the following broad categories:
1) compliance systems: inadequate written policies and procedures regarding cyber security, key person risk, portfolio management and the collection of trusted contact person information
2) Client reporting deficiencies:
-lack of relationship disclosure
-trade confirmations missing required information
– investment performance reports missing required information
– statements to clients missing the required firm letterhead and legal name
3) KYC: Inadequate KYC collection and documentation
4) Portfolio Management:
– Investment Management Agreements (IMAs) not being in place for all clients
– IMAs that are in place but missing information, such as who is responsible for insider reporting and proxy voting
5) Books and Records: missing adequate documentation to support a firm’s client asset reconciliation against that of the custodian
6) Use of service providers: Absent or inadequate oversight procedures to ensure that service providers are adequately performing the functions that have been outsourced. Specifically, the OSC noted the need for oversight procedures regarding NAV calculations, income and expense accruals, securities valuation, performance fee calculations, etc.
7) Client assets: client assets must be held in trust
8) Accredited investor exemption: missing adequate documentation to support reliance on the accredited investor prospectus exemption. There is no further information as to whether this means that self-certifications without additional evidence are considered to be deficient.
Online advisers
The Report focuses on online advisers more than in past years, including a detailed discussion about referral arrangements with online advisers who offer only third-party products to their clients. The OSC noted that these arrangements can create conflicts and suitability concerns. The OSC views the practice of limiting the products that an adviser offers to a client, depending on how that client is referred to the adviser, as failing to meet the suitability assessment and not managing conflicts of interest in the best interests of the client.
The OSC also noted inadequacies in the KYC questionnaires that some online advisers use when operating under the “call as needed” model. Such KYC collection mechanisms must be able to flag any disparities in KYC responses, as well as any other triggers that would require an AR to contact the client directly. The OSC also reminds online advisers that clients must always have a way to directly communicate with the AR. The OSC stresses that some investments are not appropriate for clients under a “call as needed “model and that advisers must offer only those securities set out in their terms and conditions (these tend to be unleveraged EFTs and straight forward mutual funds). Regular sample testing and exception reports should be conducted by online advisers to ensure sufficient KYC collection and suitability determinations are being made.
Widely disseminated hypothetical performance data
The OSC reminds registrants that, as set out in CSA Staff Notice 31-325, regulators have concerns with the presentation of hypothetical performance data on a widely disseminated basis to clients that lack the sophisticated investment knowledge to fully understand the risks and limitations of this type of information. The OSC notes that where this data is on public websites designed to attract new clients, this could be inappropriate because a firm will not know their clients’ investment knowledge or sophistication. As such, the Report states that PMs should present their actual client performance returns on public websites. The presentation of hypothetical data, in the limited cases this is appropriate, must be fair and not misleading and given to sophisticated clients with investment knowledge during one-on-one presentations. This data must be calculated on a reasonable basis and accompanied by disclaimers about past performance returns and meaningful disclosure about the calculation methodology and whether it is gross or net of fees.
Marketing Partnerships with third parties
With the increased adoption of digital marketing, firms are reminded to perform their diligence to verify that they are working with a reputable third-party firm that will competently disseminate information about registered products and services. As with other third-party provider agreements, marketing partnership agreements must be in writing and clearly delineate responsibilities, including written policies and procedures regarding the maintenance of adequate books and records and allowing for audits of the third party. Clients must also receive sufficient disclosure to understand any such marketing partnerships, including any conflicts of interest and compensation paid to the marketing firm.
Registration / Onboarding PMs from other firms
Concerns about registration – regarding timing, content and qualifications – have been top of mind for our members as well as the regulators. PMAC has been discussing ways to address and alleviate registration issues with each CSA member we meet with, and will continue to do so.
Noting the increase of formerly IIROC/MFDA/CIRO-registered individuals joining PM firms, the OSC has listed a number of concerns around their onboarding.
The OSC notes some cases where the former-CIRO advising representative did not have the proficiency to become registered as an AAR or AR, stressing that in such cases, these individuals must not undertake registrable activities. This includes a prohibition on such persons servicing any clients they brought over from their previous firm, while their registration application is being reviewed by the regulator. It is the responsibility of the PM firm to assess the RIME and qualification of prospective registrants to determine whether sponsoring their application for registration to service managed accounts is appropriate.
Client Relationship Manager / wealth adviser
The OSC found certain former CIRO-registered individuals working with PM firms doing registrable activity, despite not being registered. Some firms were calling these individuals client relationship managers or wealth advisers. The OSC noted the following common client-facing duties were taking place in contravention of the registration requirement: having meaningful discussions about clients’ financial circumstances, collecting and updating KYC, explaining securities and investment models to clients and conducting portfolio reviews and discussing investment performance. A reminder that the CSA has published guidance on the appropriate use of the “client relationship manager” title – it is only to be used where an individual is registered as a Client Relationship Manager AR under the CSA’s standardized terms and conditions for that role.
The OSC also notes that some individuals that joined a PM/EMD firm were inappropriately registered as dealing representatives under the EMD category when they were in fact engaged in registrable activity that would have triggered a need for registration as an AAR or AR.
The OSC continues to find that some firms have an insufficient number of registrants compared to their number of clients. They attribute this to inadequate planning and risk management, noting that the OSC will question how a small number of AARs/ARs can service unreasonably large numbers of clients. Maintaining correct levels of registrants is part of meeting a firm’s regulatory obligations.
Custody – reconciliation of assets between the PM’s internal system and the custodian’s
PMs must adequately perform a reconciliation of client cash and securities positions as compared with the custodian’s records. While some PMs believe that doing so is unnecessary given their trade reconciliation process, the OSC finds this to be an insufficient process and states that PMs must perform additional reconciliations to regulatory monitor the safe custody of client assets and reporting of positions on client accounts.
The Report notes that PMs must maintain their own records of clients’ cash and security positions and cannot rely entirely on the custodian’s records as a substitute. PMs must have an independent book of records in order to be able to verify the accuracy and completeness of cash and security positions as well as the accuracy of management fees charged to clients.
Outbound advice
The Report reminds firms that there is an obligation to register as an adviser if you are located in Ontario and advise or hold yourself out as advising in securities, whether or not the firm has clients in Ontario. The Report details the available US exemption as well as the exemptive relief the OSC may grant to advisers for clients that are outside of Canada and the USA.
Recordkeeping obligations of firms registered outside Canada
Due to the potential difficulties in accessing firm books and records located outside of Canada and the potential for conflicts of laws, it is each registered firm’s own responsibility to comply with local laws and to assess their impact on compliance with Ontario’s securities laws. Firms must be able to provide reasonable assurances that they can respond promptly to information requests, as the OSC requires unrestricted access to books and records and may impose terms and conditions, if needed, to ensure access to books and records located outside of Canada.
Registration Filings
Firms are encouraged to approach the OSC with any novel applications and where exemptive relief may be required. This is particularly the case if a firm is proposing a new business model or one with unique risks, as well as with respect to applications for individual registration where the applicant may not meet either the relevant investment management experience or proficiency requirements.
IFM Considerations
The Report also contains a section on the triggers to register as an investment fund manager (IFM) when a firm directs or manages the business or affairs of an investment fund. Drawing from the Companion Policy to MI 32-102, the Report highlights guidance on the types of functions and activities that IFMs typically perform.
The Report also highlights that the OSC will not consider any agreements or arrangements that would restrict an IFM from exercising its statutory standard of care to be in compliance with securities laws. These include the following types of arrangements: those that limit or restrict the IFM’s ability to change the funds service providers (such as portfolio managers and sub-advisers); those that limit or restrict the IFM’s ability to make operational decisions for a fund; and those that require the IFM to have permission from another firm in order to manage or direct the fund.
The Report reiterates that a person or company may not act as an IFM unless registered as such or exempt from the registration requirement. Any non-registered firm that acts as an IFM or any IFM that has entered into agreements restricting the IFM’s exercise of powers in the ways outlined above will be considered to be violating securities laws.