CASES HIGHLIGHTED: LACK OF SUFFICIENT KYC INFORMATION / UNSUITABLE RECOMMENDATIONS / FAILURE TO SUPERVISE
This bulletin presents a comprehensive update on recent enforcement actions undertaken by Canadian regulatory authorities, shedding light on cases related to the collection and adequacy of KYC information, conflicts of interest, unsuitable recommendations, and failure to maintain an adequate compliance system.
CASE 1: LACK OF KYC / UNSUITABLE RECOMMENDATIONS
On July 4, 2023, the BC Securities Commission (BCSC) reached a Settlement Agreement with T.D.S for failing to maintain current and accurate KYC information for his clients and failing to ensure that the investments he recommended were suitable for them.
In the course of a limited-scope compliance examination of T.D.S.’s firm, examiners reviewed 16 of T.D.S.’s clients who had invested about $4.3 million in his company’s GMC Fund, an alternative strategies fund that he managed. The BCSC found that T.D.S.:
Breached sections 13.2(2)(c) and 13.2(4) of National Instrument 31-103) because he “did not maintain sufficient information regarding the Clients’ investment needs and objectives, financial circumstances, and risk tolerance (collectively, the KYC Information) to ensure that investments were suitable for them”, and,
breached section 13.3 of NI 31-103 because the investments the GMC Fund were too risky for each of the Clients, and unsuitable for their needs, objectives and personal and financial circumstances.
T.D.S. made an early admission regarding the misconduct prior to the BCSC issuing a notice of hearing, expressed genuine remorse, was cooperative with BCSC staff and worked proactively with the clients to address and mitigate harm. Nevertheless, T.D.S was prohibited from acting as a registrant or promoter or engaging in promotional activities for an issuer or related party for eight years, and agreed to pay a $60,000 fine.
Examiners will often review KYC information, particularly for clients with higher-risk investments. - The Settlement Agreement does not provide details of the KYC deficiency. However, a registrant must take steps to “ensure it has sufficient information regarding [the key information that is required as part of the KYC process]” and “take reasonable steps to keep the information current” as per NI 31-103 section 13.2(2)(c) and NI 31-103 section 13.2(4).
It is important to note that the regulations do not refer to specific KYC documentation, but to the KYC process. As per the Companion Policy: “The process of collecting and updating a client’s KYC information must amount to a meaningful interaction between the client and the registrant. Although standardized questionnaires or other tools may be used to facilitate the collection of KYC information and to document that information, the registrant remains responsible for the KYC process.”
Conflict of Interest (COI) obligations must be considered carefully when recommending proprietary products – Part 13,.2 of NI 31-103 outlines the firm and registrant’s obligations in identifying, addressing and disclosing material conflicts of interest. The Companion Policy stipulates: “It is an inherent conflict of interest for a registered firm to trade in, or recommend, proprietary products and this conflict is, in our experience, almost always a material conflict of interest. Firms that do so must be able to demonstrate that they are addressing this conflict in the best interest of their clients.”
The Companion Policy section 13.4.1 provides further guidance under the Conflicts arising from proprietary products section. For further information on what regulators are reporting regarding firm COI obligations see our articles: BCSC 2022 Compliance Report Card Highlights Emphasis on Conflicts of Interest and CSA and CRO Release Summary Findings of Conflicts of Interest (COI) Review.
CASE 2: LACK of KYC / FAILURE TO MAINTAIN AN ADEQUATE COMPLIANCE SYSTEM / FAILURE TO SUPERVISE
On May 26, 2023, the BC Securities Commission (BCSC) reached a Settlement Agreement with Registered firm LTA for numerous know your client (KYC) deficiencies, inadequate client statements and reporting, failure to update its policies and procedures manual, failure to establish a proper trade matching and monitoring process, having an inadequate cross trade and trade execution process and failing to complete an auditor’s report on audited financial statements. As a result, the BCSC also found that LTA’s Chief Compliance Officer and Ultimate Designated Person failed to adequately perform his functions.
In the course of an examination in 2020, the BCSC found that LTA:
failed to establish an adequate and effective compliance system that meets the requirements of subsection 11.1 of National Instrument 31 103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103), and,
failed to maintain current and accurate KYC information for its clients that would enable it to meet its suitability obligations, contrary to subsections 13.2(2)(c), 13.2(4) and 13.3 of NI 31-103.
As a result of the serious supervisory deficiencies LTA was subject to nine imposed registration terms and conditions by the BCSC including retaining an independent compliance monitor for one year, at its own cost. In November 2022, the registration terms and conditions were removed after the compliance monitor confirmed that LTA had corrected each deficiency. However, LTA chose to engage a compliance consultant for an additional two years to ensure continued compliance and support compliance updates.
LTA entered into a Settlement Agreement and agreed to comply with NI 31-103 and all applicable securities legislation and to provide the BCSC with reports of biannual reviews by the external consultant. It further agreed to pay $30,000 to the BCSC.
Firms should be proactive in fulfilling their compliance obligations – Regulators will conduct periodic examinations of firms to determine whether they are meeting their regulatory obligations. In this case, the BCSC identified numerous compliance failures at LTA across a broad spectrum of compliance obligations. Specifically, Commission staff found that LTA:
(a) failed to maintain current know your client (KYC) information;
(b) did not have evidence to demonstrate that it has taken reasonable steps to assess suitability because it failed to:
(i) have current client KYC to support suitability assessments;
(ii) have implemented or followed suitability policies and procedures;
(iii) have evidence of portfolio monitoring and rebalancing;
(c) produced inadequate client statements and reporting;
(d) failed to have an updated and current policies and procedures manual;
(e) failed to establish a proper trade matching monitoring process;
(f) had an inadequate cross trade and execution process;
(g) failed to obtain a complete auditor’s report on audited financial statements.
Firms have significant regulatory obligations and the rules are constantly changing. Some smaller firms may not have adequate resources to effectively fulfill their compliance function. Even larger firms may need support with specific elements of their regulatory obligations or during very busy periods.
External consultants can enhance a firm’s ability to meet its regulatory obligations by: fulfilling certain elements of the compliance function like regulatory updating policies and procedures or by conducting an impartial review of firm compliance to identify gaps. A proactive approach will help to reduce regulatory risk and costs.
Prepared by SGD Compliance Consulting in conjunction with David Borenstein, President, Borenstein Consulting Inc. Expert in Securities Industry and Regulatory Investigations, Policy Development and Training.
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