Audit Findings and Compliance Issues

Transcription

1 Audit Findings and Compliance Issues Jason A. Chertin, McMillan LLP (Toronto) PMAC Compliance Officers Network Meeting Offices of McMillan LLP April 24, 2018 McMillan LLP Vancouver Calgary Toronto Ottawa Montréal Hong Kong mcmillan.ca

2 Audit Findings and Compliance Issues 1. Equitable Distribution of Investment Opportunities 2. Best Execution of Transactions 3. Use of Client Brokerage Commissions mcmillan.ca l 2

3 Equitable Distribution of Investment Opportunities Equitable Distribution of Investment Opportunities (NI ) 14.3 Disclosure to clients about the fair allocation of investment opportunities deliver to client a summary of the policies that complies with section (allocating investment opportunities fairly) deliver update of summary when there has been a significant change Allocating investment opportunities fairly Registered advisers must ensure fairness in allocating investment opportunities among their clients. mcmillan.ca l 3

4 Equitable Distribution of Investment Opportunities Fairness Policy NI CP s If the adviser allocates investment opportunities among its clients, the firm s fairness policy should, at a minimum, indicate the method used to allocate the following: price and commission among client orders when trades are bunched or blocked (average price and average commission) block trades and initial public offerings among client accounts block trades and initial public offerings among client orders that are partially filled, such as on a pro-rata basis The fairness policy should also address any other situation where investment opportunities must be allocated. mcmillan.ca l 4

5 Equitable Distribution of Investment Opportunities Where adviser acts for investment funds and managed client accounts on a discretionary basis Positions on securities are established in the funds before they are replicated in the managed accounts of the clients. Testing transactions in the funds and later replicated in the accounts of the clients. Principles all clients for which a transaction meets its investment policy should benefit from the same investment opportunities client or fund accounts should never be used to test positions mcmillan.ca l 5

6 Equitable Distribution of Investment Opportunities Principles conflict of interest related to remuneration received by advisor fund provides performance bonuses, managed accounts generally do not provide such benefits difference between the two models of remuneration opens the door to a potential conflict of interest, the company promotes the funds to the detriment of the managed accounts in order to maximize its remuneration mcmillan.ca l 6

7 Equitable Distribution of Investment Opportunities Never use any client account (fund or managed account) to test positions. No client should be a guinea pig for another client. Saying things like the best picks from the names in our fund are given to our managed account clients is not acceptable. If managed accounts are going to have only a subset of the names in the fund, it should be explained by the differing investment objectives of the fund and the managed account the managed account doesn t hold short positions, so we also don t buy the longs which are tied to those shorts e.g. long US lumber and short Canadian lumber might be a strategy, but because you can t short Canadian lumber in the managed account, you don t buy the US lumber either mcmillan.ca l 7

8 Equitable Distribution of Investment Opportunities Equitable and Fair in practice means identical unless there is a reason it shouldn t be. There needs to be documentation around why investment opportunities are not allocated identically. With funds, you clearly will have articulated investment objectives, strategies and restrictions for those funds and that will explain the variance in portfolios. Advisors are much less likely to have similar documentation for managed accounts. mcmillan.ca l 8

9 Equitable Distribution of Investment Opportunities There also needs to be documentation about non-identical allocation of investment opportunities at the time such allocation was made. A short note saying these four portfolios get this stock, but these two don t and here s why. Shouldn t be difficult because the advisor already has made the decision, it s just recording the process. mcmillan.ca l 9

10 Equitable Distribution of Investment Opportunities The fee structure of various investment vehicles will also be a source of potential conflicts of interest. Regulators will look at fee structure when considering why portfolios differ (so a fund with a performance fee might get all the high volatility stocks while the managed accounts with a fixed fee might get low volatility stocks). Adopt policies that mention these potential conflicts of interest explicitly and how they will be overcome. General market consensus is that portfolios should be identical unless the difference is driven by differences in investment policies. Policy should be adopted, followed and documented. mcmillan.ca l 10

11 Trading and Best Execution Obligation Trading and Best Execution Obligation Trades on behalf of managed accounts and investments funds require reasonable efforts to obtain best execution Obligation to deal, fairly, honestly and in good faith with clients (OSC Rule Conditions of Registration ) Reasonable efforts to obtain best execution (s. 4.2 NI Trading Rules) Prohibition on directing brokerage transactions involving clients (s. 3.1 NI Use of Client Brokerage Commission) mcmillan.ca l 11

12 Trading and Best Execution Obligation Reasonable efforts to obtain best execution (s. 4.2 NI Trading Rules) most advantageous execution terms reasonably available under the circumstances reasonable efforts test that does not require achieving best execution for each and every order demonstrate that advisor has, and has abided by, policies and procedures that: outline a process designed to achieve best execution describe how the advisor evaluates whether best execution was obtained should be regularly and rigorously reviewed mcmillan.ca l 12

13 Trading and Best Execution Obligation Reasonable efforts to obtain best execution (s. 4.2 NI Trading Rules) adviser should consider a client s requirements or portfolio objectives, selecting appropriate dealers and marketplaces and monitoring the results for inter-listed either within Canada or a foreign exchange assess whether it is appropriate to consider all marketplaces documented best execution policies and procedures would include the rationale for accessing or not accessing particular marketplaces, and that the rationale reviewed annually factors including the frequency at which a better price is available, size and depth of quotes, traded volumes, potential market impact, and market share mcmillan.ca l 13

14 Trading and Best Execution Obligation Compliance issue typically arises when transactions are tested and there are costs that stand out as being unusually high the issue is not always that execution costs are not necessarily the best, but there needs to be a process in place to ensure that the best execution is being achieved There are two elements to best execution First pick the right person to do the job. That happens both when a specific broker is chosen for an on-going relationship and when a broker is chosen for each individual transaction. If volume transactions or stronger relationships will lead to better execution, this needs to be documented and it needs to be an explicit goal when choosing a broker mcmillan.ca l 14

15 Trading and Best Execution Obligation Second is to structure trading so as to get the best prices and lowest transaction costs. Trading illiquid stocks at periods of low volume or in difficult market conditions is not usually a good idea. If it is being driven by a client request (usually redemptions) or because of portfolio reasons (for instance, you are convinced the price is only going to get worse). This needs to be documented both as a policy (trading driven by clients may result in higher transaction costs), made clear to clients and documented at the time of the transaction itself. If a client pushes for a redemption, it may be worth reminding the client that the transaction costs may be high and to confirm they still want to liquidate. mcmillan.ca l 15

16 Use of Client Brokerage Commissions Prohibition on directing brokerage transactions involving clients (s. 3.1 NI Use of Client Brokerage Commission) Adviser must not direct any brokerage transactions involving client commissions to a dealer in return for goods or services, other than: order execution goods and services research goods and services must used to assist with investment or trading decisions, or with effecting securities transactions, on behalf of the adviser s client or clients good faith determination is made that the client or clients receive reasonable benefit adequate policies and procedures in place so that all clients whose brokerage commissions may have been involved receive fair and reasonable benefit mcmillan.ca l 16

17 Use of Client Brokerage Commissions order execution goods and services includes the actual execution of the order, as well as goods or services to the extent that they are directly related to order execution should generally be integral to the arranging and conclusion of the transactions that generated the commissions used between the point at which an adviser makes an investment or trading decision and the point at which the resulting securities transaction is settled order management systems, algorithmic trading software and market data, and custody, clearing and settlement services mcmillan.ca l 17

18 Use of Client Brokerage Commissions research goods and services include advice, analyses or reports, as well as databases and software relating to investments in order to link these to order execution, they should be provided or used before an adviser makes an investment or trading decision research reports, publications, seminars and conferences (i.e. fees but not incidental expenses), trading advice, quantitative analytical software, market data and order management systems For mixed-use items adviser should make a reasonable allocation of those commissions paid according to the use of the goods or services mcmillan.ca l 18

19 Use of Client Brokerage Commissions non-permitted goods and services: business office overhead, furniture, equipment, trading surveillance or compliance systems, costs for correcting error trades, portfolio valuation and performance measurement services, administrative computer software, legal and accounting services, memberships, marketing services, payment of salaries, including those of research staff mcmillan.ca l 19

20 Contacts Jason A. Chertin Co-Chair, Investment Funds and Asset Management T: Questions? mcmillan.ca l 20

21 McMillan offices Vancouver Royal Centre, 1055 West Georgia Street Suite 1500, PO Box Vancouver, British Columbia Canada V6E 4N7 t: Ottawa World Exchange Plaza 45 O'Connor Street, Suite 2000 Ottawa, Ontario Canada K1P 1A4 t: Calgary TD Canada Trust Tower, Suite th Avenue S.W. Calgary, Alberta Canada T2P 4K9 t: Montréal 1000 Sherbrooke Street West Suite 2700 Montréal, QC Canada H3A 3G4 t: Toronto Brookfield Place, Suite Bay Street Toronto, Ontario Canada M5J 2T3 t: Hong Kong 3502 Tower 2 Lippo Centre 89 Queensway Hong Kong, China t: McMillan LLP Vancouver Calgary Toronto Ottawa Montréal Hong Kong mcmillan.ca