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  • Laura Bewick Howitt, CFA, CIPM, MBA

BCSC 2022 Compliance Report Card Highlights Emphasis on Conflicts of Interest

The BSCS currently regulates 159 B.C.- based portfolio managers (Advisers), investment fund managers (IFMs), and exempt market dealers (EMDs). According to its 2022 Compliance Report Card issued in May 2023, the BCSC conducted 27 compliance reviews and found 126 compliance deficiencies in 2022. Deficiencies identified primarily related to conflicts of interest. Top deficiencies identified in 2022 were:

· Policies and procedures 24 (19%)

· Conflicts of interest (COI) 23 (18%)

· Advertising, marketing and holding out 14 (11%)

· Client statements and reporting 13 (10%)

· Know your Client (KYC) and suitability 9 (7%) and records 9 (7%)


FOCUS ON CONFLICTS OF INTEREST

A majority of reviews in 2022 (17 of 27) were part of the Canadian Securities Administrators (CSA) Client Focused Reforms – Conflicts of Interest sweep. Approximately 50% of the COI deficiencies found in adviser/IFM firms relate to the firms’ process in dealing with COIs, which include mechanisms to adequately identify, assess, address, and/or disclose material COIs.


MAIN CONFLICTS OF INTEREST DEFICIENCIES


Failure to identify COI - The first step in the COI process is to identify what conflicts exist at a firm. Some firms indicated they had no material COIs, but failed to recognize common material COIs such as personal trading, outside business activities and fair allocation of investment opportunities. The BCSC expects firms “to consider all circumstances where the interests of the firm and/or its registered individuals do not align with the interests of clients and…may be reasonably expected to affect either or both of the decisions of the client and the registrant.”


Failure to adequately assess and address COIs – While some firms identified COIs, they did not take adequate steps to assess, mitigate or resolve the conflicts. Some firms incorrectly identified the COIs as immaterial and therefore failed to put controls in place to address the conflicts. The report card reminds firms “to consider whether the conflict may be reasonably expected to affect either, or both of the following: the decisions of the client in the circumstances, and the recommendations or decisions of the registrant in the circumstances.”


Failure to adequately disclose COIs – Some firms failed to provide updated COI disclosures to clients immediately after the COI requirements came into effect on June 30, 2021. Other firms provided updated disclosures that did not meet the requirements of section 13.4(5) of NI 31-103. For example, firms did not meet the disclosure requirements in NI 31-103 because their disclosure did not clearly describe:

  • the nature and extent of the conflict of interest,

  • the potential impact on and risk that the conflict of interest could pose to the client, and

  • how the conflict of interest had been, or would be, addressed.

There were firms that did not disclose material conflicts identified in internal firm COI documents. Some provided a boiler plate COI disclosure, which either included conflicts that did not exist at the firm or were not meaningful to clients.


Inadequate policies and procedures and COI records – About half of the COI deficiencies at adviser/IFM firms related to the lack of policies and procedures for specific conflicts, such as gifting and referral arrangements. Some firms had no written policies and procedures to identify, assess, and respond to COIs, while others identified material COIs when responding to the sweep questions, but these were not listed in their policies and procedures.


Referral arrangements - Material COIs almost always exist in paid referral arrangements. A referral includes any benefit provided for the referral of a client to or from a registrant. Some adviser/IFM firms have set up service fee collection arrangements with unregistered financial planners whereby the financial planner refers a client to a registered firm for portfolio management services and it collects financial planning fees to pay to the financial planner. The BCSC found firms that failed to recognize this scenario as a referral arrangement or recognize that these arrangements may not always be in the best interest of the client. When disclosure was provided, the written disclosures regarding referral arrangements failed to describe:

  • the nature and extent of the COIs,

  • the potential impact on and the risk that the COIs could pose to the client, and

  • how the COI has been, or will be, addressed

Compensation practices – The BCSC reminds registrants that “compensation arrangements that are entirely or partially variable based on sales and revenue targets almost always create material COIs between registered individuals and their clients.” The BCSC found that some adviser/IFM firms failed to identify material COIs relating to compensation arrangements including:

  • Providing compensation incentives that are based on revenue generation, sales and revenue targets, annual awards, promotions, and opportunities to become a partner of the firm.

  • Having negative consequences in compensation for failing to meet sales or revenue targets.

  • Paying different commission rates for certain products and/or certain clients, for example, depending on the source of the clients (such as referred clients).

  • Providing commission advances to registered employees, but requiring repayment of part of the commission advance as a consequence of not meeting a quarterly sales target.

Firms also failed to disclose the material COIs in their compensation practices to clients. Some firms provided disclosure but lacked details as to how exactly the conflicts relating to commissions, sales and revenue targets etc., would impact clients’ interests.


Gifts - Gifts to and from clients can result in a material COI. It can cause favouritism by a registered employee to certain clients or even suppress client complaints creating situations in which a registered individual may put their interests ahead of their clients’. The BCSC found that policies and procedures on gifts to clients were either missing or insufficient, and some firms “failed to address material COIs from gifting because they did not monitor and track the gifts and entertainment that registered employees receive from or provide to their clients.”


OTHER COI DEFICIENCIES

Proprietary and related party products – The BCSC points out that “it is almost always a material COI for a registrant to trade in, or recommend, proprietary and related party products.” most adviser/IFM firms identified the material COI, but did not implement policies and procedures to evaluate and address it. Section 13.4.1 of NI 31-103CP describes some controls that may be used to address the COI. Fundamentally, disclosure alone is not sufficient to address proprietary or related-party product conflict, nor is it sufficient to simply disclose that the firm recommends proprietary and related party products. Disclosure must include a description of the controls the firm uses to manage the material COI.


Negotiable management fees – Some firms allow clients to negotiate management fees that differ from the standard fee schedule. However, firms did not provide written disclosure to all clients about the ability to negotiate fees creating unfair dealing between the firm and clients who were unaware that some clients could negotiate their fees.


Registered individuals outside activities – The BCSC found that some firms “failed to disclose how they control material COIs arising from registered employees’ outside activities such as being the shared CCO of another firm or having roles at issuers, such as directorships.”


Other deficiencies


While the 2022 sweep focused on COIs, the BCSC also identified deficiencies in the following areas:


Misleading titles – Some firms appointed all of the client-facing registered employees as corporate officers in order for them to use corporate officer titles, but these employees did not have any substantive corporate responsibilities or authority.


Insufficient KYC information – The CFRs expanded the KYC obligations to specify the information required for a registrant to meet its suitability obligations. The BCSC found that some firms:

  • did not revise their KYC questionnaires and discussion points with clients to include details of personal circumstances, investment knowledge, and risk profile and/or,

  • did not ask the client to identify a trusted contact person or mistakenly believed it only applied to certain clients.

KYC and suitability continued to be the #1 area of compliance weakness for EMDs including:

  • inadequate ID verification for Corporations,

  • information collected not always used appropriately in suitability assessment, specifically regarding investment concentration,

  • over-concentration,

  • PPM deficiencies with no guidance for concentration thresholds for different client profiles, and,

  • inadequate note keeping regarding the suitability assessment process.


COMPLIANCE ACTION

The BSCS has taken a number of steps to address non-compliance by registrants including:


Imposing conditions on continued operation – The BCSC may impose conditions on continued operation such as: requiring firms to hire a compliance monitor; preventing firms from accepting new clients until they have rectified compliance failures, preventing firms from conducting trades for clients until they update KYC information and reassess suitability, preventing firms from registering new representatives until they have demonstrated appropriate compliance and supervisory systems, preventing firms from creating new proprietary funds, and requiring firms to hire a new CEO.


Charging costs - The BCSC will charge costs for compliance reviews when there are significant compliance failures, repeat deficiencies, or conduct that indicates the firm is not adequately managing its compliance program or business risks.


Enforcement action - The BCSC has referred a number of adviser and dealer firms to its Enforcement Division for systemic or significant failures that pose risks to clients, repeat significant deficiencies that firms fail to resolve or for significant further investigation.


Complaints investigations - The BCSC is required to review every complaint and assess its merits. The BCSC staff’s complaint review is separate and independent of the Ombudsman for Banking Services and Investments’ (OBSI) complaint process, which may occur before, after or concurrently with the BCSC review.


Administrative Penalty – Following recent amendments to the Securities Act, under section 162.01, the Executive Director now has the power to impose monetary penalties for contraventions of the regulations (which include national and multilateral instruments) or prior decisions. The maximum penalty for each contravention is $100,000 for individuals, and $500,000 for non-individuals.


THE COI COMPLIANCE CHALLENGE

In 2023 the BCSC plans to continue its sweep on the COI requirements, which may result in additional firms being selected for review. It will also expand on the CFR review with a second sweep focusing on the remainder of the CFRs that came into effect on December 31, 2021.


The CFR and COI regulations represent a fundamental shift in how firms and advisors do business. To comply with COI regulations and avoid compliance action, firms must continue to update policies and procedure manuals and implement changes to address the regulatory requirements. SGD Compliance Consulting has been working with clients to implement the appropriate compliance changes and we are available to provide our expertise in various areas of CFR and COI compliance.


© 2023 SGD Compliance Consulting Inc.


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