Accredited Investor Status in the Exempt Market Fund Context. Regulatory spotlight on the importance of verifying exempt purchaser status

Transcription

1 Accredited Investor Status in the Exempt Market Fund Context Recent Developments Presentation to the PMAC Compliance Officers Network September 16, 2015 Regulatory spotlight on the importance of verifying exempt purchaser status Recent IIROC settlement August 2015 Amendments to National Instrument Prospectus Exemptions ( NI ) May 2015 Continued regulatory focus on KYC records during compliance reviews 2

2 Recent IIROC settlement 1 Dealer self reported to IIROC that dozens of its advisors had sold exempt market funds to hundreds of clients that did not qualify for a prospectus exemption Dealer agreed to settlement terms with IIROC: $500,000 penalty Voluntary remediation plan to address supervisory deficiencies Reimbursement of client losses 1 This portion of the presentation is based on In the Matter of the Rules of the Investment Industry Regulatory Organization of Canada (IIROC) and Scotia Capital, IIROC settlement and James Langdon, Scotia Capital to pay $500,000 IIROC penalty, Investment Executive, August 11, Recent IIROC settlement Registered firm s compliance process identified and addressed the problem: Non compliant conduct occurred between September 2005 and December 2013, ending shortly after DundeeWealth amalgamated with Scotia Capital and was rebranded as HollisWealth In mid to late 2012, registered firm identified deficiencies in documentation to support whether clients qualified for an exemption Registered firm conducted an internal review of all exempt funds sold to clients between 2005 to

3 Recent IIROC settlement Internal review found the following results, which were reported to IIROC: Exempt funds, including proprietary and third party funds, were sold to almost 10,000 clients under the following exemptions Accredited investor, offering memorandum (except in Ontario), minimum amount, additional investment in investment fund and employee, executive officer, director and consultant Approximately 1,700 clients account information did not support their qualification for an exemption Of the unqualified clients, just under 600 experienced combined losses of about $4.5 million, rest had net gains of $16.7 million 84% of clients lost less than $25,000 and only one lost more than $100, advisors improperly sold funds to affected clients 5 Recent IIROC settlement Registered firm is adopting a voluntary remediation plan: Clients who have suffered a net realized loss will be reimbursed in full, plus interest Encouraging clients that still hold these funds to redeem and receive payment for realized losses Internally fining advisors a total of $440,000 which will be donated to charity, and advisors will also contribute to client restitution Introducing enhanced compliance procedures, policies and training modules relating to documentation and sale of exempt market products IIROC settlement credited Scotia for self reporting, internal review, proactive and exceptional cooperation 6

4 Recent IIROC settlement Details of enhanced compliance program: Prospectus Exemption Certificate ( PEC ) mandatory for all exempt market trades completed and signed by clients, advisors and branch managers and forwarded to head office Automatic compliance system flags all purchases of exempt funds which match PECs on file Automatic permitting of clients to qualify for prospectus exempt transactions based on account information in client files and produce exceptions for review Update account documentation of all affected clients, including new suitability assessment for any client that wants to keep an affected fund Current branch managers will be required to write or rewrite the Conduct and Practices Handbook Examination and an industry course on exempt market products and be trained on the new compliance procedures 7 NI Amendments verifying purchaser status Bulk of the changes in Section 1.9 of Companion Policy: responsibility for compliance and verifying purchaser status Requirement to verify that a prospectus exemption is available includes obligation to retain all documents necessary to demonstrate proper reliance on prospectus exemption For registered dealers and reps, verification of purchaser status is part of their KYC/KYP and suitability obligation PMs not directly mentioned, but get pulled in through exempt market dealer registration when selling proprietary funds or other securities directly to clients CSA Staff Notice Guidance for Portfolio Managers, Exempt Market Dealers and Other Registrants on the KYC, KYP and Suitability Obligations applies to PMs and includes a similar discussion to NI CP under Accredited Investors and Permitted Clients Even if accredited investor status has already been verified, suitability analysis must still be conducted for each trade 8

5 NI Amendments verifying purchaser status When distributing securities in reliance on an exemption based on purchaser characteristics, obtain information to determine whether purchaser meets exemption terms, including: Income or asset tests in accredited investor exemption Evidence of relationships in private issuer, friends family and business associates exemption Eligible investor test in OM exemption in some jurisdictions Focus for most PMs is on accredited investor exemption 9 NI Amendments verifying purchaser status Reasonable steps must be taken to verify purchaser status Not sufficient to rely on box checking or standard rep in subscription agreement What is reasonable depends on the facts and circumstances, including: How much and what type of background information is known about purchaser Whether person who meets with purchaser and conducts verification is registered PM must use judgment to determine whether backup documentation is required or oral discussions are sufficient 10

6 NI Amendments verifying purchaser status (continued) PMs can rely on existing relationships with clients, including ongoing KYC and suitability analyses, investment policy statements for managed accounts, etc. Be able to explain why this reliance was appropriate if certain steps were not taken Explain to purchasers the meanings of each exemption, including differences between categories of AI financial assets means cash, securities, insurance contracts and deposits related liabilities means liabilities incurred for the purpose of financing the acquisition or ownership of financial assets or secured by financial assets net financial assets in asset tests means financial assets less related liabilities 11 NI Amendments Risk Acknowledgement Form Completing the new Risk Acknowledgement Form Not enough to accept reps or initials next to category on Form F9 Form for Individual Accredited Investors ( RAF ) Additional steps to confirm purchaser understands meaning of RAF and was truthful in making rep Is a RAF required when the AI is relying on the managed account exemption? Technically, no, but PM is expected to have detailed information regarding client s risk tolerance in order to conduct suitability analysis for exempt trades Still useful to gather AI reps and address concepts contained in the RAF as part of KYC and IPS process to support this approach Might be useful to compare risk disclosures and information gathered in RAF to KYC form and risk factor disclosure in RDI to identify any relevant gaps 12

7 NI Amendments AI and RAF documentation and recordkeeping When is supporting documentation required? Ask questions about the purchasers net income, financial assets or net asset or otherwise elicit details regarding financial circumstances for PMs this is often done through ongoing KYC and not in connection with a specific investment Back up documentation likely not required for institutional investors whose AI status can be verified online Prudent to collect copies of government issued documents or financial statements during onboarding How often must AI certificates and RAFs be refreshed? Technically for each trade, but we recommend following timing of KYC updates, i.e. annually or more frequently if material change 13 NI Amendments AI and RAF documentation and recordkeeping RAF Recordkeeping requirements: RAFs must be kept for eight years after trade, longest limitation period under Canadian securities legislation Apply general recordkeeping approach Consider privacy law requirements for dealing with personal information 14

8 OSC focus on KYC during compliance reviews Detailed review of sample client files, including all KYC information Focused on completeness and currency of information Expectation to collect information regarding assets held outside of PM Maintain record of steps taken to update KYC annually, negative assurances from clients likely insufficient without proactive action For PMs that invest in exempt market products, verification of AI status should be included in client files Less relevant for private pooled funds in managed accounts, provided that PM can demonstrate that investments were made to achieve clients IPS/investment mandate 15