Notices / News Releases

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1 Chapter 1 Ntices / News Releases CSA Staff Ntice Guidance fr Prtfli Managers, Exempt Market Dealers and Other Registrants n the Knw-Yur-Client, Knw-Yur-Prduct and Suitablility Obligatins CSA Staff Ntice Guidance fr Prtfli Managers, Exempt Market Dealers and Other Registrants n the Knw-Yur-Client, Knw-Yur-Prduct and Suitability Obligatins January 9, 2014 Purpse f this Ntice The knw-yur-client (KYC), knw-yur-prduct (KYP) and suitability bligatins are amng the mst fundamental bligatins wed by registrants t their clients and are crnerstnes f ur investr prtectin regime. Staff frm the Canadian Securities Administratrs (CSA staff r we) assess registrants cmpliance with these imprtant regulatry requirements as part f ur cmpliance versight reviews. Fr example, in 2012, staff f the Ontari Securities Cmmissin cnducted a targeted review (Sweep) f 87 prtfli managers (PMs) and exempt market dealers (EMDs) t assess their cmpliance with the KYC, KYP and suitability bligatins. The findings f the Sweep are summarized in OSC Staff Ntice Reprt n the results f the 2012 targeted review f prtfli managers and exempt market dealers t assess cmpliance with the knw-yur-client, knw-yurprduct and suitability bligatins. As a result f ur cmpliance versight reviews, CSA staff have cncluded that additinal guidance (including CSA staff s views as t practices that may be cnsidered t be best practices and practices that we cnsider t be unacceptable practices ) in the areas f KYC, KYP, and suitability bligatins is required t assist registrants, such as PMs, EMDs, and ther registrants wh are nt members f a self-regulatry rganizatin (SRO) in meeting their regulatry bligatins. We strngly encurage registrants t use this Ntice t imprve their understanding f, and cmpliance with, the very imprtant KYC, KYP, and suitability bligatins. We als suggest that registrants use this reprt as a self-assessment tl t strengthen their cmpliance with securities laws. Ging frward, CSA staff will cntinue t clsely mnitr registrants cmpliance in these areas and will take apprpriate regulatry actin t ensure cmpliance with securities laws. Tp line highlights f the Ntice KYC, KYP and suitability bligatins are amng the mst fundamental bligatins wed by registrants t their clients, and are crnerstnes f ur investr prtectin regime. The CSA has repeatedly recgnised that these requirements are basic bligatins f a registrant, and a curse f cnduct by a registrant invlving a failure t cmply with them is an extremely serius matter. We expect registrants t cmply nt nly with the letter f the securities law requirements themselves, but als with the spirit f the requirements. We expect market participants t cnduct themselves in a manner that is cnsistent with the principles f securities regulatin. This requires market participants t respect nt just the letter f the law, but als the spirit f the law. KYC, KYP and suitability bligatins are extensins f each registrant s general duty t deal fairly, hnestly and in gd faith with its clients. In Quebec, this duty is framed as the registrant s duty t deal fairly, hnestly, lyally and in gd faith with its clients. January 9, 2014 (2014), 37 OSCB 401

2 A meaningful suitability assessment is required. Assessing suitability is mre than a mechanical fact-finding r tick the bx exercise. It requires meaningful dialgue with the client t btain a slid understanding f the client s investment needs and bjectives, and t explain hw a prpsed investment strategy is suitable fr the client in light f the client s investment needs and bjectives. Failure t adequately knw yur client may lead t a distributin f securities by an issuer r dealer in breach f a prspectus exemptin which is a serius breach f securities law. An illegal distributin may als prvide an investr with a cntinuing right f actin fr rescissin r damages against the issuer r dealer fr nn-delivery f a prspectus. Adequate dcumentatin f the suitability prcess (including KYC) is critical t ensuring that a registrant is meeting its securities law bligatins. What s in the Ntice? In additin t prviding guidance, this Ntice briefly summarises the applicable securities law requirements relating t KYC, KYP, and suitability fr registrants. It als sets ut selected requirements and guidance fr KYC, KYP, and suitability requirements fr dealer members f the Investment Industry Regulatry Organizatin f Canada (IIROC) and the Mutual Fund Dealers Assciatin f Canada (MFDA). Althugh these requirements are nt applicable t registrants wh are nt members f an SRO, they may prvide helpful guidance t registrants in their determinatin f hw t meet their KYC, KYP, and suitability bligatins under securities law. In this Ntice, we will generally refer t registrants wh are under the direct versight f the CSA as registrants. Unless the cntext therwise requires, a reference t registrants includes bth registered firms and their registered individuals. The guidance prvided represents ur expectatins f registrants. While the best practices set ut in this reprt are intended t present acceptable methds registrants can use t meet their KYC, KYP, and suitability bligatins, they are nt the nly acceptable methds. Registrants may use alternative methds, prvided thse methds adequately demnstrate that registrants have met their KYC, KYP and suitability bligatins. Outline f this Ntice The fllwing is an utline f this Ntice: Purpse f this Ntice Imprtance f the KYC, KYP, and suitability bligatins The KYC bligatin What is the basic KYC bligatin? What KYC infrmatin is required? When des the KYC bligatin apply? KYC guidance Hw ften shuld registrants update KYC infrmatin? Signing and dating f KYC infrmatin by clients and registrants What prcesses shuld registrants use t determine whether investrs are Accredited Investrs (AIs)? Hw shuld registrants cllect and dcument KYC infrmatin? What is the basic KYP bligatin? January 9, 2014 (2014), 37 OSCB 402

3 KYP guidance What are the key areas t cnsider in assessing KYP? Additinal areas t cnsider when dealing with prspectus-exempt securities Reliance n third-party analysis and reprts CSA Staff Ntice Suitability Obligatins and Knw-Yur-Prduct What is the basic suitability bligatin? Suitability guidance Why is the suitability analysis s imprtant? Hw shuld a registrant demnstrate cmpliance with the suitability assessment? Hw is the client-directed trade instructin apprpriately used? Imprtance f the KYC, KYP, and suitability bligatins Securities laws impse a general duty n registrants t deal fairly, hnestly and in gd faith with clients. Part 13 f Natinal Instrument Registratin Requirements, Exemptins and Onging Registrant Obligatins (NI ) sets ut the principal KYC, KYP, and suitability bligatins fr registrants. These bligatins wrk tgether. The KYC, KYP and suitability bligatins are an extensin f the duty t deal fairly. In turn, the suitability bligatin requires a registrant t knw the client, knw the prduct that is the subject f the prpsed recmmendatin r client rder, and t frm an pinin as t whether the prduct is suitable in light f the client s investment needs and bjectives. Certain KYC and suitability bligatins in NI d nt apply t firms that are members f a SRO and their representatives if they cmply with crrespnding SRO requirements. Hwever, a failure t cmply with SRO requirements by SRO dealer members may als be a breach f securities law. CSA staff is cmmitted t taking apprpriate regulatry actin where we identify significant cmpliance issues in these areas and the fllwing are examples f sme recent decisins which highlight the imprtance f a registrant s KYC, KYP and suitability bligatins: Recent Curt decisins (including Sawh v. Ontari Securities Cmmissin, 2013 ONSC 4018 and Ridel v. Cassin, 2013 ONSC 2279), Recent decisins f the Ontari Securities Cmmissin (including Re Trapeze Asset Management Inc. (2012) 35 O.S.C.B. 4322, and Re Sawh and Trkulja 34 O.S.C.B (Directr), 35 O.S.C.B at 164 (Cmmissin)), Recent decisin f the Bureau de décisin et de révisin (Autrité des marchés financiers c. Slutins mnétaires Mnarc inc. et Karina Stevens et Paul Hauck, ), and the withdrawal f their rights (news release f l Autrité des marchés financiers n Octber 17, 2013), Recent decisins f, and reviews by, IIROC and the MFDA fcusing n their members cmpliance with KYC, KYP, and suitability bligatins, As a result f the imprtance f these bligatins, we will cntinue t fcus cmpliance reviews n issues relating t KYC, KYP, and suitability. The KYC bligatin What is the basic KYC bligatin? NI Sectin 13.2 f NI , amng ther things, requires registrants (including dealer members f IIROC and the MFDA) t take reasnable steps t establish the identity f a client, and t ensure that they have sufficient infrmatin t meet their suitability bligatin. January 9, 2014 (2014), 37 OSCB 403

4 Sectin 13.2 f the Cmpanin Plicy t NI (CP ) explains why securities law impses a KYC bligatin n registrants: Registrants act as gatekeepers f the integrity f the capital markets. They shuld nt, by act r missin, facilitate cnduct that brings the market int disrepute. As part f their gatekeeper rle, registrants are required t establish the identity f, and cnduct due diligence n, their clients under the [KYC] bligatin KYC infrmatin frms the basis fr determining whether trades in securities are suitable fr investrs. This helps prtect the client, the registrant and the integrity f the capital markets. The KYC bligatin requires registrants t take reasnable steps t btain and peridically update infrmatin abut their clients. SRO rules The KYC requirements in NI als apply t SRO dealer members. Supplemental KYC requirements fr SRO dealer members are set ut in: IIROC Rule 1300 Supervisin f Accunts (IIROC Rule 1300), IIROC Rules Ntice Guidance Nte Knw yur client and suitability Guidance dated March 26, 2012 (IIROC Ntice ), Sectin f MFDA Rules, MFDA Plicy N. 2 Minimum Standards fr Accunt Supervisin (MFDA Plicy N. 2), and MFDA Staff Ntice 0069 Suitability (MFDA Ntice 0069). IIROC Ntice says the fllwing abut the suitability requirements: Dealer Members and Registered Representatives are reminded that cmpliance with the suitability requirements is fundamental t cmpliance with general business cnduct standards and is essential t gd business practice. The suitability requirement is als cmplementary t the fundamental bligatin under securities legislatin fr all Dealer Members and their representatives t deal fairly, hnestly and in gd faith with clients. What KYC infrmatin is required? NI T meet their suitability bligatin, registrants (including dealer members f IIROC and the MFDA) must take reasnable steps t ensure that they have sufficient infrmatin abut their client s: investment needs and bjectives (including the client s time hrizn fr their investments), financial circumstances (including net wrth, incme, current investment hldings, and emplyment status), and risk tlerance fr varius types f securities and investment prtflis (taking int accunt the client s investment knwledge) (cllectively, investment needs and bjectives). The extent f KYC infrmatin a registrant needs t determine suitability f a trade will depend n the: client s circumstances, type f security, client s relatinship t the registrant, and registrant s business mdel. Accredited Investrs and Permitted Clients If a registrant prpses t make a trade in reliance n the prspectus exemptin fr AIs in Natinal Instrument Prspectus and Registratin Requirements (NI ), the registrant must determine whether the client is an AI. Fr additinal guidance in this area, see the Cmpanin Plicy t NI January 9, 2014 (2014), 37 OSCB 404

5 A persn distributing r trading securities in reliance n a prspectus exemptin is respnsible fr determining whether the exemptin is available. A persn may rely n factual representatins by a purchaser, prvided that the persn has n reasnable grunds t believe the representatins are false. A registrant s bligatin t determine that a prspectus exemptin is available is supplemented and infrmed by the registrant s bligatin t knw the client. Accrdingly, the bligatin t determine whether (and hw) a client satisfies the AI definitin will generally be higher n registrants than an issuer r ther sellers that are nt in the business f trading securities. Factual representatins, such as a representatin in a subscriptin agreement that the client is an AI, will generally nt, by themselves, in CSA staff s view, be sufficient fr a registrant t satisfy its KYC bligatin. Similarly, if a registrant is relying n subsectins 13.2(6) and 13.3(4) f NI which allw a permitted client t waive certain KYC and suitability requirements, the registrant must cllect adequate infrmatin t determine that the client is a permitted client. It is nt sufficient t simply rely n the client's initialling r checking ff the bx in the permitted client certificate/attestatin frm. SRO rules IIROC recently amended its suitability requirements t require each Dealer Member, when making a recmmendatin t a client r accepting an rder frm a client (and als where certain ther triggering events ccur) t use due diligence t ensure that the suitability assessment is made cnsidering the verall accunt prtfli. See IIROC Rule 1300 and MFDA Plicy N. 2 (which is similar). Althugh the SRO rules in sme cases use additinal terms, such as time hrizn r prtfli cmpsitin that are nt explicitly used in NI , we take the view that these factrs are subsumed within the brader terms used in subsectin 13.2 f NI Fr example, a registrant cannt meaningfully determine a client s investment needs and bjectives, financial circumstances, r risk tlerance withut understanding the client s time hrizn r current investment prtfli cmpsitin. IIROC Ntice set ut a useful discussin n a registrant s assessment f a client s investment bjectives versus a client s risk tlerance. The ntice states: the client s investment bjectives and risk tlerance are tw separate but related factrs; each factr must be assessed based n the clients financial and persnal circumstances and must be reasnable in light f thse circumstances Fr example, designating an 80% high risk tlerance fr an elderly client may be unreasnable if the client has a mdest net wrth and has pened the accunt t invest a substantial prtin f her net wrth. On the ther hand, the 80% high risk tlerance may nt be unreasnable if the elderly client has a substantial net wrth and pens an accunt t invest a small fractin f her net wrth. MFDA Ntice 0069 prvides guidance t its dealer members n hw t establish a suitability framewrk t ensure cmpliance with their bligatins. The ntice als prvides guidance n KYC infrmatin and hw t maintain accurate and cmplete KYC infrmatin. When des the KYC bligatin apply? NI A registrant must have current KYC infrmatin whenever a suitability determinatin is required. A registrant (ther than a dealer member f IIROC r the MFDA, which is subject t the requirements set ut in the next sectin) is required in sectin 13.3 f NI t make a suitability determinatin befre a registrant makes a recmmendatin t r accepts an instructin frm a client t buy r sell a security, r purchases r sells a security fr a client s managed accunt. In additin, registrants are required in subsectin 13.2(4) t make reasnable effrts t keep their clients KYC infrmatin current. We cnsider infrmatin t be current if it is sufficiently up-t-date t supprt a suitability determinatin. SRO rules Under SRO rules, a suitability determinatin is generally required when: accepting an rder frm a client, recmmending t the client the purchase, sale, exchange, r hlding f a security, securities are received int the client s accunt by way f depsit r transfer, January 9, 2014 (2014), 37 OSCB 405

6 KYC guidance there is a change in the registered representative r prtfli manager respnsible fr the accunt, r there is a material change in the client s life circumstances r bjectives that has resulted in revisins t the client s KYC infrmatin as maintained by the dealer member. 1. Hw ften shuld registrants update KYC infrmatin? A registrant is required t btain current KYC infrmatin abut a client s investment needs and bjectives whenever a suitability determinatin is required. Sme registrants ask their clients t advise them when their KYC infrmatin changes. Hwever, we expect registrants t be practive in ensuring that KYC infrmatin is kept up-t-date. We expect PMs (and EMDs that have an nging relatinship with their clients see belw fr further infrmatin) t update KYC infrmatin at least annually and mre ften if there is a material change in a client s circumstances (fr example, marriage, divrce, birth f a child, lss r change in emplyment), r investment needs r bjectives. Withut adequate and timely KYC infrmatin, registrants cannt meet their suitability bligatin t clients. EMDs An EMD may have a transactinal relatinship r an nging relatinship with a client depending n the particular facts and circumstances. An example f a transactinal relatinship is a situatin where the EMD s relatinship with the client is limited t a specific private placement transactin, neither the EMD nr a related issuer f the EMD hlds (directly r indirectly) client assets r securities, the EMD is nt paid a trailer fee r similar nging cmpensatin in relatin t the client s wnership f a security, and there is n expectatin n the part f the client that the EMD will cntinue t prvide services t the client after the cmpletin f the transactin. In cntrast, if any f these factrs are present, r if the EMD is als registered in anther categry f registratin such as PM, the EMD may be viewed as having an nging relatinship with the client. Similarly, if an EMD acts fr a client in a series f transactins, we wuld cnsider that the EMD has an nging relatinship with the client. In the case f an EMD r ther registrant that is nt an SRO member with an nging relatinship with a client, we recmmend that they implement plicies and prcedures that reflect the SRO cncept f trigger events as a best practice. PMs We think that a PM s suitability bligatin in the cntext f a managed accunt is a cntinuing bligatin t ensure that the investment strategy determined by the PM remains suitable fr the client. Accrdingly, we think that it wuld be prudent business practice fr a PM with discretinary trading authrity ver a client s accunt t fllw the SRO criteria relating t KYC trigger events (set ut briefly belw) in rder t ensure that the investment strategy determined by the PM remains suitable fr the client. SRO rules Bth IIROC Rule 2500 Minimum Standards fr Retail Custmer Accunt Supervisin and MFDA Rule Updating Client Infrmatin have similar requirements that their dealer members must update KYC infrmatin when there is a material change in client infrmatin, such as a change in investment bjectives, financial situatin r risk tlerance. In additin, MFDA Rule requires dealer members t (a) send a written request at least annually t each client asking the client t ntify the dealer member if there are any material changes t the client s circumstances, and (b) update the client infrmatin accrdingly. As well, IIROC Ntice prvides that accunt infrmatin must be updated any time there is a material change in a client s circumstances such as marriage, divrce, birth f a child, lss f r change in emplyment, etc. The ntice states that this requirement can be met by peridically asking each client abut material changes in their circumstances, asking abut material changes when meeting with the client t review his/her prtfli, therwise crrespnding with the client t discuss accunt related matters, r by annually cntacting the client t verify the accuracy f accunt infrmatin. 2. Signing and dating f KYC infrmatin by clients and registrants Althugh NI des nt expressly require the signing and dating f KYC infrmatin by clients and registrants, we recmmend that registrants implement plicies and prcedures t ensure that bth the client and the registrant that reviewed the KYC infrmatin with the client sign and date the infrmatin. Bth the client and registrant shuld als sign and date amendments t KYC infrmatin, whether dne as addendums t the riginal infrmatin, r as fresh KYC infrmatin. Signing and dating KYC infrmatin: January 9, 2014 (2014), 37 OSCB 406

7 assists with demnstrating cmpliance with securities law requirements, assists with prviding evidence that the client cnfirmed that the infrmatin prvided was accurate and that the infrmatin was discussed with the registrant, and may prtect the registrant in the event a client later claims that an investment was unsuitable. 3. What prcesses shuld registrants use t determine whether investrs are AIs? NI requires all registrants selling securities under an exemptin t ensure that adequate prcesses are in place t determine whether the exemptin is available. If a registrant is relying n the AI exemptin, the registrant must ensure that the client meets the criteria in the AI definitin. In ur cmpliance reviews, we identified sme EMDs that had sld exempt securities t nn-ais withut adequate prcesses in place t assess whether the investrs were AIs, r whether ther prspectus exemptins were available. In Sawh and Trkulja (Re Sawh and Trkulja (2012), 35 O.S.C.B. 7431, at 7454, para. 183, affirmed 2013 ONSC 4018 (Div. Ct.)), the Ontari Securities Cmmissin said: The fact that an investr declared himself t be an accredited investr des nt abslve a registrant f the respnsibility t take adequate steps in the circumstances t ascertain that the investr meets the criteria t be accredited based n his r her financial circumstances. As well, sme KYC frms used by these EMDs were nt designed t allw the EMD t determine whether the client met the AI definitin. In additin, sme f the infrmatin cntained in the s-called AI certificate was incnsistent with the client s KYC frm. If a client des nt satisfy the definitin f AI r fall within anther exemptin, the distributin is a serius breach f securities law. It is als imprtant t nte that EMDs are limited t dealing with clients wh are eligible t purchase securities under a prspectus exemptin. Accrdingly, if the client des nt meet the requirements f the prspectus exemptins, then the EMD is acting utside f its registratin categry cntrary t securities law. Suggested practices fr registrants that distribute securities in reliance n a prspectus exemptin Registrants shuld ensure that they have adequate plicies and prcedures in place t ensure cmpliance with the cnditins f the exemptin. Registrants shuld: Develp a KYC frm that has sufficient infrmatin abut the client t allw the registrant t determine if the client meets the requirement f the prspectus exemptins. Threshlds used in the KYC frm shuld be cnsistent with the minimum incme and asset threshlds in the AI r eligible investr definitin cntained in NI Tailr r develp a separate KYC frm fr clients that are crpratins, partnerships, trusts r ther entities, and nt individuals, t supprt reliance n the exemptin. Fr example, if the registrant is relying n paragraph (t) f the AI definitin in NI [an entity that is wned by persns wh are AIs], the registrant must cllect and dcument adequate infrmatin abut the wners f the entity t supprt reliance n the exemptin. Understand the different categries f investr that make up the definitin f AI r eligible investr and the cnditins cntained in these categries. Registrants shuld pay specific attentin t the differences between the definitins f assets and financial assets (which exclude an investr s persnal residence r ther real estate) and the requirement that financial assets be net f any related liabilities. Obtain a breakdwn f financial assets and net assets f the client t ensure that the infrmatin cllected accurately reflects the client s financial circumstances and t assist the registrant in assessing the availability f the prspectus exemptins and the suitability f any investment made. Make further inquiries abut the client s financial circumstances in situatins where there is a reasnable dubt abut the accuracy f infrmatin given by the client r the validity f the client s claim t be an AI r eligible investr. Dcument the inquiries in the client s file. Establish plicies and prcedures and prvide training t dealing and advising representatives t ensure they fully understand the prspectus exemptins and that exempt securities may nly be distributed t investrs wh meet the requirement f the prspectus exemptins. January 9, 2014 (2014), 37 OSCB 407

8 Unacceptable practices Registrants shuld nt: Rely slely n the investr s representatin in an AI certificate, Resident Exemptin Frm r Eligible Investr Questinnaire withut btaining KYC infrmatin frm clients t independently assess reliance n the exemptin. Als, it is nt apprpriate t rely n inferences based n the registrant s knwledge f a client (example, jb title, type f car, r lcatin f residence) t assess whether a client is able t rely n an exemptin. Assume that anther persn (whether anther registrant that has previusly dealt with a client r anther individual within a registrant firm that is dealing with a client) has cmplied with the KYC bligatin r the bligatin t determine that the client is eligible t purchase securities n a prspectus-exempt basis. Each registrant dealing with a client has an bligatin t cmply with these bligatins r t cnfirm that the registrant firm has prperly cnducted and dcumented this determinatin. Prcess prspectus-exempt trades withut cmplete and adequate KYC infrmatin t supprt reliance n the exemptin. 4. Hw shuld registrants cllect and dcument KYC infrmatin? In ur cmpliance reviews, we cntinue t identify issues related t inadequate cllectin and dcumentatin f KYC infrmatin. Registrants did nt ensure that KYC frms were fully cmpleted fr all clients. As well, many registrants did nt have a prcess in place t update KYC frms. In rder t meet the KYC and suitability bligatins, registrants must take reasnable steps t ensure they have sufficient current infrmatin regarding a client s investment needs and bjectives. Cllecting and dcumenting KYC infrmatin is mre than just a fact-finding r tick the bx exercise. Registrants shuld make all necessary enquiries t btain a slid understanding f a client s investment needs and bjectives. They shuld engage in a meaningful dialgue with their clients and explain t them why the KYC infrmatin is required. The MFDA and IIROC have issued similar KYC guidance t their member firms. Fr mre details please refer t: IIROC Ntice , IIROC Ntice Client Relatinship Mdel Guidance, and MFDA Staff Ntice Suggested practices fr cllecting and dcumenting KYC infrmatin Registrants shuld: Engage in meaningful KYC discussins with clients and cnsider the use f a questinnaire t facilitate the cllectin and dcumentatin f KYC infrmatin. If pssible, meet with clients face t face and ask detailed questins t assist in their understanding f the clients investment needs and bjectives. If it is nt pssible t meet with a client face t face, a registrant shuld carefully dcument the additinal steps taken t demnstrate cmpliance with KYC and suitability bligatins. Cllect and dcument sufficient minimum KYC infrmatin including name, age, investment bjectives, annual incme, net financial assets, net assets, liquidity needs, time hrizn, risk tlerance, and prtfli cmpsitin. This shuld include registrant representatives ntes f discussins with clients. Registrants shuld als btain a breakdwn f financial assets (depsits and type f securities such as mutual funds, listed stcks, exempt securities etc.) and net wrth (types f assets and liabilities). Cllect relevant infrmatin frm each client s as t establish their identity. Maintain a recrd f the identificatin dcument (fr example, passprt r driver's licence number and place f issue). Develp an investr-friendly KYC frm by ensuring all terms used in the KYC frm such as investment bjectives, investment knwledge, and risk are clearly explained in plain language. January 9, 2014 (2014), 37 OSCB 408

9 Cnsider a client s willingness t accept risk and ability t accept risk when assessing a client s risk tlerance. A client may be willing t accept risk; hwever, this des nt necessarily mean that a client has the ability t financially withstand a dwnturn in the market r ther partial r ttal lss f their investment. Alternatively, a client may have the financial means t absrb lsses, but may nt be willing t d s. Review the cmpleted KYC frm with the client fr accuracy t ensure that the infrmatin cllected reflects the client s investment needs and bjectives. The KYC frm shuld als be signed, dated and reviewed by the registrant and the client shuld receive a signed cpy f the KYC frm fr their recrds. Update KYC infrmatin at least annually (fr PMs, and fr EMDs that have an nging relatinship with their clients), if there is a significant change in a client s life circumstances, r a significant change in market cnditins. Any changes in KYC infrmatin (r a cnfirmatin that there are n changes) shuld be signed, dated and reviewed by the registrant and the client shuld receive a signed cpy f the revised KYC frm fr their recrds. PMs shuld develp a tailred investment plicy statement (IPS) fr each managed accunt. The IPS shuld dcument the client s investment needs and bjectives and set ut a planned asset allcatin. PMs shuld prvide a signed (and dated) cpy f the IPS t each client at the time the IPS is first signed and when it is updated. Establish plicies and prcedures fr cllecting, dcumenting and reviewing sufficient KYC infrmatin fr each client. Prvide adequate training t their staff t ensure they fully understand the imprtance f cllecting, reviewing and maintaining adequate and up-t-date KYC infrmatin. Unacceptable practices Registrants shuld nt: Cllect KYC infrmatin slely by asking clients t tick a bx that best describes their investment bjectives r risk tlerance. This mechanical tick bx apprach is nt sufficient t fulfill a registrant s suitability bligatin. Rely nly n a KYC frm r ther dcument t knw the client. This frm based apprach is nt sufficient t fulfill a registrant s suitability bligatin. Prcess a trade (ther than a liquidating transactin upn a client s request) if there is any missing r cnflicting KYC infrmatin that may affect their ability t assess the availability f the prspectus exemptin r the suitability f the investment. Delegate the KYC r suitability bligatin t an unregistered individual (fr example, an administrative assistant r a referrer) t cllect KYC infrmatin, cmplete the KYC frm fr the client, r explain prducts t a client. Althugh a registrant may rely n an unregistered individual t assist in incidental administrative tasks related t the cllectin f KYC infrmatin, the registrant has the bligatin t knw the client and the client s investment needs and bjectives. If an unregistered individual r firm purprts t cllect KYC infrmatin r explain prducts t clients, these activities may be cnsidered t be registerable dealing r advising activities (since these activities may themselves cnstitute acts in furtherance f a trade). Use utdated KYC infrmatin r an utdated KYC frm t assess the suitability f a client s investment. Use a KYC frm r ther dcument that cntains disclaimer language which purprts t limit liability fr all lsses, including lsses resulting frm a breach f the registrant s bligatins under securities law. What is the basic KYP bligatin? NI As explained in sectin 3.4 f CP [Prficiency initial and nging], registered individuals must understand the structure, features, and risks f each prduct they recmmend as part f their initial and nging prficiency bligatins. Sectin 3.4 f NI sets ut that an individual must nt perfrm an activity that requires registratin unless the individual has the educatin, training and experience including understanding the structure, features and risks f each security the individual recmmends. January 9, 2014 (2014), 37 OSCB 409

10 These requirements are applicable t all registrants, including SRO members. This prficiency requirement (als referred t as knw-yur-prduct r KYP) is in additin t the suitability bligatin in sectin 13.3 and applies even when there is an exemptin frm the suitability bligatin (such as, fr example, the exemptin fr permitted clients). The KYP bligatin is als a necessary element f the KYC and suitability determinatin. Sectin 13.3 f NI requires registrants t take reasnable steps t ensure that a prpsed trade is suitable fr a client befre making a recmmendatin r accepting instructins frm a client. T meet this bligatin, registrants shuld have an in-depth knwledge f all securities that they buy and sell fr, r recmmend t, their clients. Althugh the KYP bligatin is triggered when a registrant recmmends a prduct t a client, a registrant may expressly r implicitly recmmend a prduct thrugh cnduct such as placing a prduct n the registrant s shelf and making it available t a client, by advertising r prmting the prduct, r by distributing marketing material abut the prduct t a client. SRO rules IIROC Ntice sets ut similar requirements fr their dealer members. In additin, IIROC Guidance Nte Best practices fr prduct due diligence revised n March 25, 2009 sets ut IIROC s expectatins regarding prcedures and criteria that dealer members shuld cnsider when assessing and intrducing prducts that they apprve r recmmend fr sale. Lastly, IIROC recently published Guidance Nte Recmmendatins and best practices fr distributin f nn-arm s length investment prducts which prvides guidance n distributins f nn-arm s length investment prducts. MFDA Staff Ntice MSN-0048 Knw Yur Prduct dated Octber 31, 2005 (MSN-0048) clarifies the bligatins f MFDA dealer members and apprved persns with respect t the apprval and sale f investment prducts by dealer members. The ntice requires dealer members t perfrm a reasnable level f due diligence n prducts prir t their apprval fr sale by Apprved Persns. In additin, as part f the KYP bligatin, CSA staff expects a registrant t assess the suitability f leveraged trades r leveraging strategies fr thse clients that brrw funds t trade in securities. The MFDA recently amended their KYC rule and Plicy N. 2 (see MFDA Rule and Plicy N. 2) t clarify the bligatin f their dealer members t assess the suitability f rders invlving the use f brrwed funds. The rule clarifies that dealer members must assess suitability f leveraging strategies in light f the client's investment knwledge, risk tlerance, and investment bjectives. The MFDA als published a leveraging supervisin guide which prvides further guidance t its dealer members n hw t maintain apprpriate dcumentatin f leverage recmmendatins and supervisin, and addressing unsuitable leveraging. KYP guidance 1. What are the key areas t cnsider in assessing KYP? Registrants must cnduct their wn prduct due diligence and be able t explain t their clients the security s risks, key features, and initial and nging csts and fees. As part f their prduct due diligence, registrants shuld review and assess the infrmatin cntained within the ffering memrandum (OM) r ther dcumentatin prvided by the issuer. If the infrmatin is nt sufficient t allw the registrant t cnduct a meaningful KYP assessment f the issuer and the prduct, the registrant will need t cnduct further due diligence n the issuer and the prduct r refrain frm dealing with that prduct. Registrants must be able t evidence their wn prduct due diligence. A registrant shuld nly place a prduct n its apprved prduct list after they have cncluded that the prduct has a reasnable prspect f meeting its investment bjectives and that the prduct has a reasnable prspect f being a suitable investment fr sme clients. The prduct assessment requires a critical analysis f the features inherent in the prduct, and hw thse features affect the investment s ptential risk and reward. Registrants shuld assess what factrs may affect the success f the prduct, and shuld prceed nly n the basis f sme reasned assessment f the prduct s actual ptential. Having the registered firm s apprval fr representatives t sell a prduct des nt mean that the prduct will be suitable fr all clients. Individual registrants shuld understand the structure, features, risks, fees and csts f each prduct they recmmend t their clients t determine the suitability f each transactin. CSA staff take the view that the KYP bligatin is triggered nt nly by the particular attributes f a security, viewed in islatin, but als by the prpsed quantum f the investment amunt r the prpsed trading strategy invlving the security. Fr example, an investment in a high-risk security may be suitable fr a client where the prpsed investment wuld represent a small prtin f the client s investment prtfli. Hwever, an investment in the same security may nt be suitable fr the client where the prpsed investment wuld represent a substantial prtin f the client s prtfli r where the prpsed investment strategy invlves leverage. If registrants chse t categrize prducts using brad categries such as lw risk, medium risk and high risk, registrants shuld ensure that the categrizatins are reasnable, and cnsistent with industry standards and January 9, 2014 (2014), 37 OSCB 410

11 client expectatins. Registrants shuld carefully explain the meaning f these terms t the client in plain language terms and shuld dcument this prcess. As well, registrants that chse t categrize investment bjectives r trading strategies using terms such as balanced shuld ensure that these categrizatins are reasnable, and cnsistent with industry standards and client expectatins. Registrants shuld als carefully explain the meaning f these terms t the client in plain language terms and dcument this prcess. 2. Additinal areas t cnsider when dealing with prspectus-exempt securities The sale f prspectus-exempt securities pses a special KYP challenge fr registrants. In Sawh and Trkulja, the Ontari Securities Cmmissin reviewed the KYP bligatin described in MSN-0048 and NI , and fund that the registrants had failed t prperly discharge their KYP bligatin in the cntext f the sale f securities sld pursuant t prspectus exemptins. The Ontari Securities Cmmissin was critical f the registrants simple reliance n representatins made in the ffering memrandum and ther dcuments prvided t them by the issuer. The Ontari Securities Cmmissin went n t add: In ur view, the Applicants due diligence prcess was particularly inadequate in light f the fact that [the securities in questin] were sld pursuant t exemptins under applicable securities legislatin. Limited partnership units sld under an exemptin frm securities law d nt benefit frm the same transparency and liquidity characteristics r regulatry versight as ther prducts. Fr example, securities sld under an exemptin will nt be liquid investments. Offering memranda are nt prspectuses and are nt subject t regulatry review. Given the absence f such safeguards, we find that the Applicants failed t cnduct an adequate review f the Exempt Prducts. In assessing prducts sld n a prspectus-exempt basis, registrants shuld als cnsider additinal risks assciated with: Liquidity risk, reflecting the fact that any resale f such securities may be subject t resale restrictins r indefinite hld perids and the fact that there will generally be n market fr such resale, Valuatin risk, reflecting the fact that the securities may be mre difficult t value due t the lack f prspectus and cntinuus disclsure abut the issuer, and Cnflict f interest risk, reflecting the fact that the securities may be issued by a related party. A failure t prperly categrize a prduct may result in significant legal and regulatry risk t a registrant. See Re Trapeze Asset Management Inc. (2012) 35 O.S.C.B Reliance n third-party analysis and reprts We have recently identified a number f situatins where issuers and registrants have distributed securities n the basis f marketing materials that include s-called independent analyses r reprts prepared by unregistered third parties. We have als seen cases where a registrant may chse t rely n a reprt prepared by a third-party as part f its wn due diligence prcess; hwever, this des nt relieve the registrant f its bligatin t "knw-the-prduct" and t cnduct its wn KYP and suitability analysis. Registrants shuld be particularly careful when relying n disclsure prepared by an issuer r a scalled independent reprt prepared by a third-party and cmmissined by the issuer. Where a registrant distributes a security n the basis f a third-party reprt that purprts t rate a security, cmpare a security with ther securities f ther issuers, r describes an exempt market security as investment grade, the registrant shuld perfrm its wn prduct assessment t ensure that the reprt is fair, balanced and nt misleading. 4. CSA Staff Ntice Suitability Obligatin and Knw-Yur-Prduct CSA Staff Ntice Suitability Obligatins and Knw-Yur-Prduct dated September 2, 2009 reminds registrants f their duty under securities law t satisfy their suitability bligatins, including the requirement t fully understand the prducts recmmended t clients. In particular, the ntice cntains guidance n a firm s prduct review prcess, including prcedures fr identifying, reviewing and apprving (r rejecting) new prducts, and fr mnitring existing prducts fr significant changes t thse prducts. January 9, 2014 (2014), 37 OSCB 411

12 Suggested practices t satisfy the KYP bligatin Registrants shuld: Have an in-depth understanding f each f the items listed belw befre recmmending a prduct t clients: - general features and structure including return, use f leverage, cnflicts f interest, time hrizn, verall cmplexity f the prduct. - risks including the pssibility that clients may lse sme r all f the principal invested, liquidity risk, redemptin risk, risks frm underlying derivatives r structured prduct, cnflicts f interest risk. - csts including fees paid t registrants r ther parties (cmmissins, sales charges, trailer fees, management fees, incentive fees, referral fees, embedded fees, executive cmpensatin) - parties invlved including issuer s financial psitin and histry, qualificatins, reputatin and track recrd f the parties invlved in key aspects f the prduct, and - legal and regulatry framewrk including frequency, cmpleteness and accuracy f the issuer s disclsure. Establish plicies and prcedures fr reviewing and apprving new prducts and existing prducts whse structure r features have significantly changed. The extent f the prduct review prcess will vary depending n the structure and features f the prduct. Fr example, cmplex investment prducts (including thse that are nvel, nt transparent in structure, invlve leverage, ptins, ther derivatives, r have limited disclsure) may require a mre extensive review than mre straightfrward prducts. Carefully review ffering dcuments r ther dcumentatin prepared by the issuer r ther third parties and ask questins where apprpriate. Prducts that are sld under a prspectus exemptin may require a mre extensive review because f the limited disclsure available abut them. As part f their prduct due diligence, registrants shuld review and assess the infrmatin cntained within the ffering dcuments r ther dcumentatin prepared by the issuer r ther third parties. If the infrmatin cntained within des nt cntain sufficient infrmatin t allw the registrant t cnduct a meaningful KYP assessment f the issuer and the prduct, the registrant will need t cnduct further due diligence n the issuer and the prduct r refrain frm dealing with that prduct. Cnsider cmpetitive prducts that may be less risky r less cstly t clients. If cmpetitive prducts are less risky r less cstly, registrants shuld maintain adequate dcumentatin t demnstrate the suitability f the prduct recmmended. Perfrm a cnflict f interest assessment, particularly if a registrant is planning t distribute a prduct f a related issuer r cnnected issuer, where ften the same individuals frm the management f bth the registrant and the issuer. Assess and determine whether the cnflicts f interest can be adequately managed thrugh disclsure r cntrl. If nt, a registrant shuld nt distribute the prduct. Assess suitability f leveraging strategies in light f the client s investment knwledge, risk tlerance, and investment bjectives. Prvide training sessins t ensure that dealing representatives and advising representatives fully understand and are able t explain clearly the prduct features and risks t clients. Unacceptable practices Registrants shuld nt: Fail t fully understand the structure and features f the prducts and recmmend a prduct slely based n: infrmatin frm issuers r ther third parties, including related parties, abut the prduct s suitability, risk prfile r expected return, similarities with ther prducts, r recmmendatins made by ther market participants t their clients r by unregistered persns prviding general advice. Rely slely n a prduct being n the firm s apprved prduct list rather than cnducting a prduct analysis r understanding a prduct themselves. January 9, 2014 (2014), 37 OSCB 412

13 What is the basic suitability bligatin? NI Sectin 13.3 f NI requires a registrant t take reasnable steps t ensure that, befre it makes a recmmendatin t, r accepts an instructin frm, a client t buy r sell a security, r makes a purchase r sale f a security fr a client s managed accunt, the purchase r sale is suitable fr the client. As explained in CP , suitability bligatins cannt be: delegated t a third party, satisfied simply by disclsing the risks f the trade, r waived (except by investrs that are permitted clients as defined in NI ). Sme EMDs may have a relatinship with the issuer (r ther sellers f the securities). In sme cases, these EMDs failed t recgnize that the persns purchasing securities frm these issuers r sellers were the EMD s clients and that the EMDs have bligatins, including suitability bligatins, t these purchasers. CSA staff reminds EMDs that it is a breach f their bligatins, including their fair dealing bligatins t prefer an issuer, seller r their wn interests ver an investr s interests. Similarly, even if a registrant has determined that a prspectus exemptin is available t the client this des nt necessarily mean that the investment will be suitable fr the client. The bligatin t determine that a prspectus exemptin is available is entirely separate and distinct frm the bligatin t determine that a prpsed recmmendatin r client rder is suitable fr the client. A prpsed trade r recmmendatin may be whlly unsuitable fr a client in light f the client s time hrizn, risk tlerance, existing prtfli cmpsitin, r ther factrs within the client s investment needs and bjectives, ntwithstanding the fact that the client is eligible t make the investment n a prspectus-exempt basis. SRO rules IIROC s suitability requirement is set ut in IIROC Rule , which requires dealer members t use due diligence t ensure that recmmendatins t clients regarding the purchase, sale, exchange, r hlding r any security is suitable fr the client based n factrs including investment bjectives, time hrizn, risk tlerance and the accunt s current investment prtfli cmpsitin and risk level. IIROC Ntice expands the suitability bligatin and requires dealer members t ensure that the rder type, trading strategy and methd f financing the trade recmmended are als suitable fr the client. Suitability guidance 1. Why is the suitability analysis s imprtant? As set ut in this Ntice, KYC, KYP, and suitability bligatins are amng the mst fundamental bligatins wed by registrants t their clients. These bligatins are als crnerstnes f ur investr prtectin regime. Thus it is critical fr registrants t fully cmply with these bligatins nt nly the securities law requirements themselves, but als with the spirit f the requirements. CSA staff will take apprpriate regulatry actin t ensure cmpliance. We expect registrants t perfrm a meaningful suitability assessment and t apprpriately dcument that assessment. The suitability assessment shuld be mre than a mechanical fact-finding r tick the bx exercise. It requires a meaningful dialgue with the client t btain a slid understanding f the client s investment needs and bjectives, and t explain hw a prpsed investment is suitable fr the client in light f the clients investment needs and bjectives. Suggested practices t satisfy the suitability bligatin Registrants shuld: Cnsider all relevant KYC infrmatin (including, investment bjectives, time hrizn and risk tlerance) when assessing the suitability f an investment. Fr example, a client may have a high risk tlerance but als have a shrt term time hrizn and therefre a high risk investment with redemptin restrictins may nt be suitable fr that client. Review each trade independently t ensure it is suitable. A registrant shuld nt prcess a trade unless it is reviewed and apprved. In additin, PMs shuld have an adequate prcess in place t mnitr clients prtfli hldings in accrdance with their investment mandate. January 9, 2014 (2014), 37 OSCB 413

14 Develp a system r prcess t identify and reject trades that are incnsistent with a client s investment needs and bjectives. The firm shuld als mnitr trends r patterns (fr example, number f rejected trades by the Chief Cmpliance Officer fr a particular dealing representative) that may indicate ptential areas fr training r revisins t prcesses t ensure cmpliance. Prvide adequate training t registered individuals t ensure they fully understand the suitability bligatin and the firm s prcess fr assessing suitability f investments. Unacceptable practices Registrants shuld nt: Assume that all prducts that are set ut n the firm s apprved prduct list are suitable fr every client. Rely n ut-f-date KYC r KYP infrmatin. 2. Hw shuld a registrant demnstrate cmpliance with the suitability assessment? In ur cmpliance reviews, we fund a number f instances where it was nt clear that the registrant had cnducted an apprpriate KYC, KYP, r suitability determinatin due t inadequate, incmplete, r (in sme cases) cmpletely missing dcumentatin. These instances cnstitute a breach f securities law requirements as sectins 11.1 and 11.5 f NI require registrants t establish, maintain and apply plicies and prcedures that establish a system f internal cntrls and supervisin, and t maintain bks and recrds that demnstrate the extent f the registrant s cmpliance with applicable securities law requirements. As well, a failure t dcument the KYC, KYP, and suitability prcess als significantly raises the risk f adverse legal and regulatry cnsequences t the registrant in the event a client s investment ultimately prves t be unsuitable. Therefre, it is critical that registrants establish plicies and prcedures and maintain adequate dcumentatin t supprt their suitability analysis. EMDs and PMs are specifically reminded t take extra care in cmplying with their KYC, KYP, and suitability bligatins when dealing with clients wh are senirs, n a fixed incme, r wh therwise may be in a psitin f vulnerability. A lss frm a registrant s failure t cmply with these bligatins may have particularly devastating cnsequences fr these clients. CSA staff will take regulatry actin, including enfrcement actin, in circumstances where registrants d nt apprpriately address the special needs f these clients. SROs Bth IIROC and the MFDA have prvided suitability guidance t their member firms n hw t cmply with their suitability assessment requirements including when t perfrm a suitability assessment and hw t deal with unsuitable investments. Fr details, please refer t IIROC Ntice , IIROC Ntice Client Relatinship Mdel Guidance and MFDA Ntice 69. Suggested practices t demnstrate cmpliance with the suitability bligatin Registrants shuld: Establish plicies and prcedures fr assessing suitability f an investment (including the criteria used t assess suitability and when t perfrm a suitability assessment) and ensure that it is cnsistently applied acrss the firm. Sme examples f criteria include risk tlerance, investment bjectives, time hrizn, cncentratin risk, and cnflicts f interest. There shuld als be adequate cntrls and versight in place t identify and respnd t any cnflicts f interest with any investment recmmendatin. Maintain adequate dcumentatin f the suitability analysis fr each trade. A registrant shuld be able t demnstrate hw each prpsed trade was assessed fr suitability. Establish a prcess t peridically review a sample f client files t ensure that the suitability prcess is cnsistently applied thrughut the firm. Results f the suitability review shuld be dcumented and independently reviewed by smene senir in the firm (like the CCO). Areas f nn-cmpliance shuld be discussed with staff in a timely manner and highlighted in training sessins. If the review identifies significant cmpliance issues, they shuld be escalated t the UDP t ensure that crrective actin is taken in a timely manner t reslve the issues. January 9, 2014 (2014), 37 OSCB 414