CSA issues KYC guidance for EMDs and portfolio managers

The CSA says it is issuing Staff Notice 31-336 Guidance for Portfolio Managers, Exempt Market Dealers and Other Registrants on the Know-Your-Client, Know-Your-Product and Suitability Obligations “in response to a number of compliance oversight reviews where CSA staff concluded that additional guidance for [firms that don’t belong to a self-regulatory organization (SRO)] is required to enhance overall compliance with these important regulatory obligations.”

For example, it points to a compliance review carried out by the Ontario Securities Commission (OSC) in 2012 that examined the compliance of EMDs and PMs with their KYC, KYP and suitability obligations. That review found, among other things, that 75% of EMDs had inadequate KYC documentation procedures, 22% made inadequate suitability assessments due to lack of documentation, 18% sold exempt securities without a proper exemption, and 15% made inadequate suitability assessments because of portfolio over-concentration. Among PMs, the OSC found that 70% had inadequate KYC documentation processes, 45% had inadequate relationship disclosure information, 35% had inadequate policies and procedures, and 5% made inadequate suitability assessments.

In the wake of these sorts of results, the CSA notice indicates that its staff have concluded that additional guidance setting out their views on “best practices” and “unacceptable practices” is needed to help non-SRO firms meet their regulatory obligations. “We strongly encourage registrants to use this notice to improve their understanding of, and compliance with, the very important KYC, KYP, and suitability obligations,” it says, adding that firms should use the report as a self-assessment tool to strengthen their compliance with securities laws.

Next: KYC, KYP, and suitability obligations are fundamental
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KYC, KYP, and suitability obligations are fundamental

The notice indicates that 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.” And, it says that the regulators expect firms to comply with both the letter and the spirit of the requirements and securities laws generally.

“KYC, KYP and suitability obligations are extensions of each registrant’s general duty to deal fairly, honestly and in good faith with its clients,” it says, adding that, “A meaningful suitability assessment is required. Assessing suitability is more than a mechanical fact-finding or ‘tick the box’ exercise. It requires meaningful dialogue with the client to obtain a solid understanding of the client’s investment needs and objectives, and to explain how a proposed investment strategy is suitable for the client in light of the client’s investment needs and objectives.”

Failure to adequately “know your client” may lead to an illegal distribution of securities, it says, “which is a serious breach of securities law”, and may give an investor the right to sue an issuer for failing to deliver a prospectus. “Adequate documentation of the suitability process (including KYC) is critical to ensuring that a registrant is meeting its securities law obligations,” it says.

The notice also sets out the requirements for dealers that belong to the SROs — the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) — noting that, while these requirements don’t apply to non-SRO firms specifically, “they may provide helpful guidance to registrants in their determination of how to meet their KYC, KYP, and suitability obligations under securities law.”

“We strongly encourage registrants to conduct a thorough review of their current practices in the context of the guidance published today in order to ensure compliance with these obligations,” said Bill Rice, chair of the CSA and chair and CEO of the Alberta Securities Commission (ASC).