New CSA and CIRO Guidance for Registrants on Avoiding Conflicts of Interest
On August 3, 2023, the Canadian Securities Administrators (“CSA”) and the Canadian Investment Regulatory Organization (“CIRO”) published Staff Notice 31-363 (the “Notice”). The Notice provides a comprehensive review of securities advisers, dealers and representatives’ (“registrants”) conflicts of interest practices in response to the Client Focused Reforms (the “Reforms”) which amended National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”) and its Companion Policy (“31-103CP”). The Notice acts as a resource for registrants to navigate potential conflicts of interest within the context of the Reforms. The Reforms were introduced to enhance investor protections, align the interests of registrants with those of their clients, and address concerns regarding potential conflicts of interest.
The CSA and the CIRO conducted reviews of 172 registered firms to assess compliance with the Reforms. Of the 172 registered firms, compliance deficiencies regarding conflicts of interest were identified with 135 registered firms.
In response, the Notice aims to provide additional guidance to registrants on how to meet obligations concerning conflicts of interest in the Reforms. The CSA and CIRO reference the suggested controls outlined in the Notice when assessing a registrant’s compliance. This update highlights key suggested controls and takeaways found in the Notice.
The specific issues found in the CSA and CIRO’s review were:
- lack of identifying and addressing material conflicts of interest;
- missing or incomplete disclosure of conflicts of interest;
- inadequate policies and procedures concerning conflicts of interest;
- lack of or inadequate training on conflicts of interest; and
- lack of or inadequate record keeping.
Suggested Controls and Takeaways
Thorough Identification and Conflict Assessment
Registrants must address conflicts of interest by either avoiding them entirely or using controls to mitigate the conflict effectively such that the client’s best interests are preserved. If no controls are available, the registrant should avoid the conflict in its entirety even if they must sacrifice an otherwise attractive business opportunity. This is particularly relevant in internal compensation arrangements and other incentive practices, which can influence recommendations of the registrant to then achieve their desired compensation. As such, registrants must examine their own business models, especially compensation structures and any relationships with third parties. Suggested controls include limiting variable compensation and maintaining consistent internal compensation structures regardless of the client, service and/or product. Specifically, registrants that trade in proprietary products, which inherently creates a conflict of interest, should document how these products align with clients’ interests and provide clients with adequate disclosure that the portfolio will include proprietary products.
If a registered individual holds a director position of an issuer whose securities are being advertised, a conflict of interest arises. Accordingly, several controls can be developed to mitigate the conflict of interest. Some may include restricting compensation that the director can accept, recusal from discussions, resignation, supervision and disclosure to the client. Supervision by a registrant’s compliance staff can also serve as an effective control where a registrant addresses material conflicts with referrals, including referrals in and referrals out.
Proactive Conflict Mitigation
Registrants are encouraged to establish policies which prioritize clients’ interests and specifically outline the steps to be taken when conflicts arise. Adequate transparency with the clients is key and registrants must be forthcoming with any existing or possible conflicts of interest and management strategies with their clients.
Transparent Disclosure and Communication
During the review, some registrants did not sufficiently disclose material conflicts of interest, such as internal compensation, related issuers, third party compensation and referrals. Registrants are required to describe the overall nature of the conflict, its potential impact and risk on the client along with the plan to address the conflict. Effective disclosure is achieved when communication is clear and comprehensible, void of technical jargon and includes fulsome descriptions when appropriate and necessary.
Disclosure must include potential impacts and risks that the client can face and how the registrant is planning to address them. Registrants should not solely rely on an issuer’s disclosure documents to provide their clients with effective disclosure. The timing of disclosure can be paramount to compliant disclosure. Accordingly, a registrant must disclose any material conflicts of interest during the account opening process or upon identification of the conflict. Other requirements can be found in 31-103CP.
Policies and Procedures
Policies and procedures are required to be compliant with regulatory requirements. Registrants should ensure that their policies and procedures are robust, written down and updated to ensure compliance with the Reforms.
Registrants’ written policies should include, among other suggestions outlined in the Notice:
- the definition of a conflict of interest;
- training procedures;
- procedures used to identify and report conflicts of interest; and
- the process employed to identify material conflicts of interest and how to address them.
Continuous Monitoring and Record Keeping
The possibility of an emergence of a conflict must be reviewed periodically. The Reforms outlined further criteria regarding conflicts of interest records in addition to s. 11.5 of NI 31-103.
- demonstrating compliance with conflicts of interest obligations; and
- documenting the registrant’s compensation and incentive arrangement, and sales practices.
Registrants must keep records of any identification of conflicts of interest, their review and analysis assessment of their materiality, and any controls used to maintain clients’ best interests. The greater the materiality of a conflict, the more detail is required to ensure compliance. To do this, registrants may opt to maintain a conflicts inventory with evidence of any periodic reviews that have been undertaken.
The CSO and CIRO will continue to conduct reviews to assess regulatory compliance in 2023 and additional rules may be added if registrants remain non-compliant.
If you have any questions or would like further information with respect to the matters discussed above, please contact Geoffrey Cher at email@example.com or any other member of Wildeboer Dellelce LLP. The author gratefully acknowledges the assistance of articling student Maria Nikitouchkin in the preparation of this update.
This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.
If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.