On August 3, 2023, the Canadian Securities Administrators ("CSA") and the Canadian Investment Regulatory Organization ("CIRO," and together with the CSA, the "Regulators") published Joint CSA and CIRO Staff Notice 31-363 Client Focused Reforms: Review of Registrants' Conflicts of Interest Practices and Additional Guidance (the "Notice"). The Notice summarizes the Regulators' findings and guidance, following their review of registered firms' conflicts of interest practices. It also includes suggestions that the Regulators will consider when assessing registrants' compliance in future reviews.

Background

As we discussed in a previous post, amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations ("NI 31-103") came into force in 2021 (the "Client Focused Reforms" or "CFRs"). The CFRs in part require that registrants take reasonable steps to identify existing and reasonably foreseeable material conflicts of interest and address those conflicts in the best interest of clients. If such conflicts cannot be addressed, they must be avoided. The conflicts of interest requirements are fundamental registrant obligations, and the CFRs outline how conflicts are expected to be identified, documented, addressed and disclosed.

Compliance Review

The Regulators reviewed 172 registered firms to: (i) assess compliance with the conflicts of interest requirements; (ii) broaden the Regulators' understanding of and assess controls used to address conflicts; and (iii) develop a consistent compliance approach to reviewing conflicts of interest practices. In so doing, they identified the following common deficiencies:

  • inadequate policies and procedures related to conflicts (66% of firms reviewed);
  • missing or incomplete disclosure related to material conflicts (53% of firms reviewed);
  • failure by registrants to identify one or more material conflicts (34% of firms reviewed);
  • inadequate controls to address certain material conflicts in the best interest of clients (28% of firms reviewed);
  • lack of or inadequate training on conflicts (17% of firms reviewed); and
  • inadequate conflicts of interest recordkeeping (less than 10% of firms reviewed).

The Regulators also observed that some firms were not familiar with the guidance in the Companion Policy to NI 31-103 and did not consider the examples of conflicts or controls provided therein. These firms in turn failed to identify certain conflicts, assess them as material and/or implement sufficient controls.

While the Notice should be reviewed for more information, we summarize certain aspects of the Regulators' findings and guidance below.

Inadequate policies and procedures

Most of the firms reviewed had inadequate written policies and procedures on conflicts of interest. Of these firms, some had policies and procedures but had not updated them sufficiently to comply with the requirements introduced by the CFRs.

The Regulators note that a firm's policies and procedures on conflicts of interest should include:

  • a definition of "conflicts of interest" that enables the firm and individuals acting on its behalf to understand and identify conflicts that may arise;
  • a clear delineation of the firm's and registered individuals' responsibilities with respect to identifying and addressing material conflicts;
  • the process for registered individuals to report or escalate conflicts;
  • the process and criteria used by the firm to determine the materiality of conflicts;
  • guidance on how material conflicts will be addressed;
  • the controls the firm has in place to address material conflicts and how those controls will be tested;
  • the process for training employees with respect to conflicts;
  • the process for regular reporting on conflicts by the chief compliance officer to the firm's management and others;
  • the content of and process and timing for preparing and delivering conflicts of interest disclosure to clients;
  • the process for periodic review of the firm's inventory of conflicts and conflicts of interest disclosure for clients; and
  • the content and process for recordkeeping related to conflicts.

Missing or incomplete disclosure

Approximately 10% of the firms reviewed did not provide any disclosure to clients regarding material conflicts of interest identified, and in the case of approximately 43% of firms, incomplete disclosure was provided. Inadequate disclosure was identified in respect of: (i) internal compensation and incentives; (ii) compensation from clients; (iii) third-party compensation; (iv) outside activities; (v) distribution of proprietary products; (vi) referral arrangements; (vii) related or connected issuers; and (viii) leverage recommendations.

In the Notice, the Regulators emphasize the disclosure requirements introduced by the CFRs and the need for registrants to address all of the required elements. They also provide specific guidance regarding the format and timing of disclosure as well as disclosure prepared by another entity.

Failure to identify and inadequate controls to address material conflicts

Some of the firms reviewed did not identify certain conflicts of interest, assess them as material and/or implement controls sufficient to address them in the best interest of clients.

In addition to general guidance, the Regulators provide specific examples of and suggested controls for conflicts that were either not identified as material or adequately addressed. These include conflicts arising from: (i) internal compensation arrangements and incentive practices; (ii) third-party compensation; (iii) proprietary products; (iv) fees charged to clients; (v) supervisory compensation; (vi) director positions with issuers; (vii) referral arrangements; (viii) trades alongside clients (i.e., exempt market dealer relationships); (ix) gifts or entertainment; and (x) managing and distributing prospectus-exempt proprietary issuers.

Lack of or inadequate training

While most of the firms reviewed provided adequate training on conflicts of interest, the Regulators determined that training was inadequate when: (i) it was too generic and not specific to the firm's business operations or size; (ii) it did not provide descriptions or examples of the firm's existing material conflicts; (iii) all individuals who should have been included in the training were not included; and (iv) it did not mention or provide details of the firm's reporting or escalation process for when a material conflict is identified.

Some firms provided training but did not maintain adequate records to evidence that such training was provided. The Regulators encourage firms to demonstrate compliance by maintaining documentation such as copies of training modules or content, attendance logs and details of how employees who missed scheduled training were trained thereafter.

Inadequate recordkeeping

While most of the firms reviewed were compliant insofar as recordkeeping is concerned, the Regulators note that the CFRs introduced additional recordkeeping requirements specific to conflicts of interest. With sufficient detail, firms must document their identification, review and analysis of conflicts, determinations in respect of materiality and controls used to address material conflicts.

Apart from offering general guidance, the Regulators suggest that firms create a conflicts inventory and maintain evidence of periodic reviews of such inventory and the controls associated with each material conflict.

What's Next?

The Regulators continue to review and evaluate registrants' compliance with securities legislation, including the other requirements introduced by the CFRs. Over the course of this year, in particular, they will assess compliance with the know-your-client, know-your-product and suitability determination requirements. The Regulators caution that additional rules will be considered if they do not observe the results they expected from the CFRs, including the conflicts of interest provisions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.