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"Now and the Years Ahead: Ongoing Priorities and Projects Being Developed by the Compliance and Registrant Regulation Branch"

Debra Foubert, Director, Compliance and Registrant Regulation Branch,
Ontario Securities Commission
Strategy Institute: Annual Registrant Regulation, Conduct & Compliance Summit

April 9, 2013

I would like to thank the Strategy Institute for allowing me to kick off the conference. As a regulator now, I will start with the standard disclaimer: the views expressed today are my own and may not represent those of the Commission.

My primary objective this morning is to highlight a few of the 2013-2014 priorities of the Compliance and Registrant Regulation (CRR) Branch. I will also take the opportunity to highlight information for you that can be used as self-assessment and benchmarking tools, or point you in the direction of where additional information regarding regulatory expectations can be found. Finally, I will discuss a few other initiatives of the Branch and then that should leave plenty of time for questions at the end.

Before getting to the specific Branch priorities, it is worth mentioning that the OSC’s draft Statement of Priorities (SOP) was just published for comment on April 4th. The SOP drives the priorities for each of the Branches through the development of key themes and areas of focus for the coming year. The SOP is open for comment until June 3rd so if you want to provide comments there is still plenty of time.

The CRR priorities that I will focus on link specifically to two of the organizational priorities listed in the SOP: To deliver strong investor protection and deliver effective enforcement and compliance.

The investor protection initiatives that I will discuss are:

1. The Client Relationship Model (CRM2); and

2. Fiduciary Duty/Best Interest Standard Consultation.

And the Enforcement and compliance initiatives are:

3. Suitability review; and the

4. Compliance review program for registrants.

The OSC has a responsibility to deliver strong investor protection: it’s at the core of everything we do. Therefore, it should be no surprise that investor protection remains a high priority for the OSC in the next fiscal year. With the creation of the Office of the Investor last year, the OSC is focusing on deepening its understanding of investor concerns and considering investor issues in our policy and operational activities.

One such policy initiative is CRM2.

The final amendments to National Instrument 31-103, incorporating the requirements for cost disclosure, performance reporting and enhanced client statements, were published on March 28th.

The amendments require that clients of all registrants receive clear and complete disclosure information relating to all charges and registrant compensation associated with the investment products and services they receive as well as receiving meaningful reporting on how their investments perform.

The rationale for CRM2 is that a large portion of retail investors are not getting the right information about the ongoing costs and performance of their investments. Research conducted for our Investor Advisory Panel suggests that many investors want to see more use of plain language in product information as well as improved content and presentation of information on the investment statements.

These amendments create a common baseline of requirements that will provide all retail investors in Canada with key information about the costs and performance of their investments. And, the same reporting requirements will apply to all types of registered dealers and portfolio managers.

The next steps for CRM2:

  • Subject to obtaining all necessary approvals by various jurisdictions, the amendments will come into force on July 15, 2013.
  • There will be a phased-in approach with transition times of one, two or three years for various aspects of the amendments.
  • The transition period will take into account the time registrants will need to build or adapt their systems to implement the new requirements.

All of this information is listed in the CSA media release of March 28, 2013. The release is available on the OSC website in the “News & Events section” under “CSA News Releases”. I encourage all of you to review the release and start the planning process to meet the implementation deadlines.  

As well, Chris Jepson from the OSC and others will be presenting more detailed information on CRM2 later this morning, so you can save all of your hard questions for him.  

The second investor protection initiative currently underway is our re-evaluation of the advisor-client relationship. We are considering whether an explicit statutory fiduciary duty or best-interest standard should apply to dealers and advisers in Canada.  

We know that many investors value the work of their advisers and consider it to be an important relationship. 

For example, on March 18th, our Investor Advisory Panel released a study on the views of more than 2,000 Ontario investors regarding their relationships with financial advisers and how they perceive and use investment product information and advice. The survey found that 56% of investors see value in having financial advisers, and believe their returns are higher because of their adviser. The study also found strong support for a statutory best interest duty: 93% of respondents agreed that it is needed (with 59% strongly agreeing that it is needed). 

If you would like to review the study, it can be located on the OSC website. Go to the Investor tab and then select Investor Advisory Panel.  

The OSC has made fiduciary duty an area of focus because of the importance of delivering strong investor protection. I believe this also demonstrates the CSA’s commitment in examining opportunities to improve the relationship between clients and their advisers and dealers. But this is a complex area that requires careful consideration to determine the right approach for Canada. We want to ensure our standards are appropriate for Canadian investors and Canadian capital markets. 

As I’m sure you are aware, the CSA Consultation Paper 33-403 was published on October 25 last year. In my opinion, the paper provides a balanced and broad review of the key issues and questions in the fiduciary duty debate. Even though the paper articulates one possible version of a statutory best-interest standard for advisers and dealers, the paper does not presume that a best interest rule is a foregone conclusion.  

The very first paragraph states that the purpose of the paper is to provide a forum for stakeholder consultation regarding the desirability and feasibility of introducing a statutory best interest standard. The CSA was clear that the paper was the initial step in soliciting comments from all interested stakeholders on this important issue. 

The comment period ended on February 22, 2013, and we received over 80 comment letters, most of them devoted significant time and attention to the issues and questions raised in the paper. If you are looking for some light reading, all of the comment letters are posted on the OSC website under the Securities Law & Instruments section.  

So, I know many of you are wondering where the CSA is going from here. What are our next steps for this project? 

As I mentioned earlier, the CSA sees the paper as an important but initial step in the broad public consultation process. We need your input to make sure that we land on a path that is appropriate for Canadian investors and Canadian capital markets. To this end, we are in the process of organizing roundtables that will allow more of a dialogue among the CSA and its stakeholders.  

In Ontario, CRR is organizing three roundtables: one for investors, one for industry and then a combined (investor and industry) roundtable. The sessions should be held in late spring or early summer so watch for an announcement and I encourage you or representatives from your firms to participate in the roundtables.  

Once we’ve had an opportunity to absorb and analyze the feedback and data generated from the comment letters and the roundtables, we will be in a better position to determine if we have sufficient information to proceed with a policy recommendation or whether further consultation and/or data collection is required.  

Ultimately, any direction we take on a best-interest standard will have, at its core, the interests of investors in mind. However, all of us share a common interest in sustaining robust, fair and efficient capital markets in Canada so to work properly, in our opinion, the advisor-client relationship has to ensure that the interests of investors and advisors are aligned.  

The question is what is the best way to ensure this alignment happens? 

Since there is a natural linkage between fiduciary duty/best interest standard and suitability, this is a good segue to discuss CRR’s priorities that align with the OSC’s goal to Deliver Effective Enforcement and Compliance.  

The CRR Branch undertook its largest targeted sweep last year. The suitability sweep focused on testing compliance with know-your-client (KYC), know-your-product (KYP), and suitability obligations of almost 90 portfolio managers (PMs) and exempt market dealers (EMDs). 

The KYC, KYP, and suitability obligations are among the most fundamental obligations owed by registrants to their clients, and are cornerstones of our investor protection regime. As stated by Vice-Chair Mary Condon at a Strategy Institute seminar last year:  

“Participation as a registrant in Ontario’s capital markets is a privilege that comes with significant responsibilities to investor and the public at large. Registrants are obligated to understand the general investment needs and objectives of their clients and to fully understand the products recommended to them. From our perspective, the suitability obligations of registrants are key protections for investors.” 

Some of the drivers that led to the review were the following.  

In 2011/2012, 35% of our deficiency reports for portfolio manager and EMDs contained significant deficiencies in one or more of the areas of KYC, KYP or suitability. 

We were seeing these issues come up in more registrant misconduct cases – such as the Sawh and Trkulja matter. If you are interested in more information on the Commission’s perspective on KYC, KYP and suitability obligations of registrants, you may be interested in reading the Commission Decision issued on August 1, 2012 for this matter.

Also, the Commission had issued its first suitability-focussed decision in the Trapeze matter. Trapeze is an example of a registered portfolio manager firm failing to ensure that certain investments were suitable for all of its clients. Under terms of a settlement agreement, the OSC ordered the respondents to pay an administrative penalty of $1,000,000, and $250,000 towards the costs of Staff’s investigation, and Trapeze agreed to submit to a review of its practices and to conduct account reviews.

Another matter was in Re Morgan Dragon Development Corporation where the Director found that the EMD did not verify any of the information contained in subscription agreements relating to accredited investor status and KYC forms were not collected until after trades were made. The registrants in Morgan Dragon were also referred to the Enforcement Branch, and a Statement of Allegations was issued on March 22, 2012. This matter is still outstanding.

CRR staff has worked diligently to complete the reviews in a reasonable period of time and I’m happy to report that the review is now complete and our findings will be presented to the Commission shortly. After the Commission presentation, we will publish key findings and “best practice” guidance to address the deficiencies identified. You can expect a report in the fall.

But, I can preview some of the issues identified. For Exempt Market Dealers:

  • Substantive and procedural issues were found. For example: selling securities to non-accredited investors without another prospectus exemption being available was found during the review.
    • For further guidance on this type of issue, OSC Staff Notice 33-735 published in May 2011, sets out our expectations of issuers and dealers who sell exempt securities to accredited investors. If you have not done so already, I would recommend reviewing this notice.
  • Also, improperly delegating KYC and suitability obligations to a third party and no or inadequate policies and procedures relating to KYC, KYP or suitability processes were some other substantive issues that were found. Procedural issues consisted of inadequate processes for the collection; documentation and maintenance of KYC info were also found.

For portfolio managers, there were fewer substantive issues found in the review of portfolio managers but practically the same amounts of procedural issues were found. More information will be available once the report is published.

A new procedure that CRR implemented during the suitability sweep was the practice of contacting clients to confirm information contained on the KYC forms and confirm the client’s understanding of information about their investments. This practice is a tangible way for the OSC to fulfill our investor protection mandate and we have incorporated this into our compliance review “toolkit.”

During the sweeps, CRR staff contacted approximately 200 clients with positive results. The vast majority of the clients spoke to us freely and in most cases confirmed what was on the KYC form and what their dealer or advisor told us as part of the oversight review. In some cases though, we received conflicting information from the client, which required follow-up with the firm.

Now, I want to address some of the concerns previously raised by industry about this process:

First, CRR staff are well trained to make these calls. They used a script when calling clients and clients are advised up front that the call is a “routine part of a review process and should not be interpreted as a sign of any misconduct of the firm.”

Clients are further informed that they do not have to talk to Staff.

Or, if the client wants to confirm the identity of the Staff person, they are directed to the OSC website for further information including FAQs or the OSC Contact Center.

Clients are never asked about certain information such as birth date, social insurance number, address, or other type of information that can be used for identity theft. Staff already has this information from the KYC forms received from the firms so there is no need to ask for this information.

Second, we will be actively pursuing opportunities to get the word out directly to clients that the OSC may contact them as part of a normal course review of their dealer or portfolio manager.

Our first step has been in collaboration with the OSC’s Office of the Investor. CRR has added explanatory information about the purpose of the call, the procedure used for the call, and FAQs about the process to the Investor Section and the FAQ sections of OSC website. These sections can be accessed directly from the home page of the OSC website.

The last point I would like to make about the suitability sweep is that we sent a survey to the firms that participated in the sweep to obtain feedback on the overall process. Over 50% of the sweep participants responded to the survey and the results of the survey were positive:

  • Over 75% of the registrants who responded thought that our Sweep was helpful in improving their firms’ compliance with securities legislation;
  • Over 80% thought that our report was clear, concise and issued in a timely manner;
  • Over 95% thought that our staff was professional when conducting the review; and
  • About 55% of the registrants received feedback from their clients regarding our new process of call investors and approximately 50% of the responses were positive.

Overall, our sweep was successful in highlighting the importance of KYC, KYP and suitability obligations to the industry and it was effective in enhancing compliance at the firms we visited. Once the guidance is published, I encourage all of you to use the report as a self-assessment tool to review your firm’s KYC, KYP and suitability practices.  

The second Branch priority that aligns with delivering effective enforcement and compliance is CRR’s compliance review program. We have just completed our business planning process and yes, you guessed it, CRR will continue to conduct targeted sweeps for hot topics and focused reviews of firms that are considered high to medium risk.  

CRR’s risk-based compliance review program is an effective means of focusing our finite resources on higher-risk and problematic issues and/or firms. Also, by being risk-based we are nimble enough to marshal our resources to review emerging risks.  

One of the topics that we will be focusing on this year is custody of client assets. This aligns with the investor protection priority of the OSC. Another focus will be on reviewing supervision and oversight practices at “systemically important” larger firms. We will also participate in joint reviews with other regulators, both domestic and international.  

But that’s not all that we do. Other initiatives within CRR include, publishing guidance like the Annual Summary Report for Dealers, Advisers and Investment Fund Managers (OSC Staff Notice 33-728, last published in November 2012). 

I’m sure many of you use this report as a self-assessment/benchmarking tool. I know I did when I was in industry. I would also recommend that you read the entire report. Even though the deficiency findings in the report are presented by registrant category, you should review all sections of the report because issues identified in one category can apply to another registrant category.  

Another source of guidance that can be used as a benchmarking tool, are the “Opportunity to be Heard” decisions that are published on the OSC website under the Information for Dealers, Advisers and Investment Fund Managers section.  

As part of the “compliance and enforcement continuum”, the Ontario Securities Act provides the Director with certain powers that can be used to take actions against registrants for misconduct. We have a separate team within CRR that manages this OTBH process. Kelly Everest and Michael Denyszyn will be speaking more about this process in the Registrant Misconduct panel tomorrow. 

We have also established a Registrant Advisory Committee. The mandate of the committee is to provide a forum where Staff and industry representatives are able to discuss policy matters and issues faced by registrants in complying with Ontario securities law, including registration and compliance-related matters.  

We received an overwhelming response from industry for the limited number of positions on the committee. We selected representatives from each registrant category that we oversee and we struck a balance between large and small firms. Also included are representatives from law firms and SROs. We held our first meeting in February and based upon the discussion at the first meeting, I have high expectations for the committee going forward.  

Finally, we are also working on new outreach programs to help registrants understand their regulatory obligations. We want to provide registrants with tools to build proactive compliance systems. Some of the suggested topics include a tutorial on how to correctly calculate working capital and another is how to prepare for a CRR compliance review. The method of delivery for these types of tutorials has yet to be determined, but stay tuned, once we figured it out we will let you know.  

With that, I will conclude by stating that the OSC regulates in the context of rapidly changing capital markets and global regulatory reforms. We face a growing number of challenges and so our draft Statement of Priorities identifies the five most important areas where the OSC intends to focus its resources in the 2013-2014 fiscal year. I’ve provided you with information on a few of the CRR Branch priorities that align with the SOP. As well, I’ve discussed other initiatives that we are working on in the area of compliance oversight. Our desire is to use outreach to registrants to foster proactive compliance programs that cover regulatory requirements. 

I hope this was informative and I’m happy to take questions.