A perfect storm lies ahead for advisors and dealers

This article explains the basis for my concerns, the risks to advisors and dealers, and what I suggest advisors and dealers do to mitigate their risks for what may lie ahead.

My concerns are based on the potential for enforcement delays and the regulatory warnings about compliance with the client-focused reforms (CFRs).

CIRO enforcement delays. Given the above stats, there could be a surge of investigations in 2024 or later. Also, fewer investigations completed (on the fund dealer side) and fewer proceedings commenced come as the two self-regulatory organizations merge and a new rulebook is drafted. The potential for delayed investigations and enforcement proceedings while CIRO drafts a new rulebook, rather than proceeding with matters on a timely basis using the “old” pre-merger rules, is a serious concern for the Street and the investing public.

These challenges give rise to several questions:

• What will happen with this backlog of complaints waiting to be investigated?
• Will there be an onslaught of investigations and matters referred to enforcement with shorter timelines, rushing the matters through to hearings?
• Or will significant time pass, leaving advisors and dealers with insufficient memory to fill in blanks when interviewed by regulators?
• Will advisors and dealers be faulted for not repairing their systems and processes from the time of infraction, and expose themselves to higher penalties as a result?
• Will advisors and dealers gain a sense of false confidence that a matter will disappear due to the passage of time? The regulators have six years to pursue matters, and this law will be tested if CIRO misses this deadline (see 8107 in the consolidated rules). Will that be good for the advisor or dealer who committed the infraction and bad for the confidence investors have in the capital markets?

Warnings. While CIRO drafts its new rulebook, its audit results identify a serious failure to comply with the conflict of interest rules in the CFRs. Specifically, 78% of 172 firms audited (which includes those registered with CIRO and those registered with the provincial securities commissions) were not in compliance with the conflicts of interest provisions.

Staff Notice 31-363 from August outlines these results and states that those firms failing to comply must take corrective action “within a reasonable time frame” to resolve the deficiencies, and that the regulators (CIRO and the provincial securities commissions) reserve their right to take “appropriate regulatory action as necessary.”

While the report is specific and helpful, as it includes what firms should do to correct their non-compliance, all advisors and firms should interpret this as a warning that when CIRO/securities commissions conduct audits, the likelihood of regulatory action is increased in cases of non-compliance. By then the CIRO rulebook might be completed, so that the backlog in investigations are pursued by the enforcement department. At that time, the quiet before the storm will become the perfect storm for advisors and dealers, with a “we warned you” attitude from CIRO’s enforcement lawyers.

So, here is what a firm and its registrants (advisors, supervisors, compliance officers, ultimate designated persons, etc.) can focus on to prepare for this perfect storm.

Conflicts of interest. All registrants should take the time to critically read Staff Notice 31-363 to consider what conflicts of interest exist in their businesses. As an individual registrant, you should speak to your compliance department to ensure you are following the CFR requirements and that your firm’s policies and procedures address them.

As registrants, you should satisfy yourselves that you comply with both the CFRs and your firms’ internal policies. Use notice 31-363 to implement the necessary corrective action into your practice. Individual registrants should not passively rely on their compliance departments to identify every potential conflict. No one knows your business better than you do, and bringing any concerns to compliance would be in both of your interests, to ensure the policy manual addresses the potential conflict and that you comply.

Just because your firm might overlook a conflict doesn’t mean individual registrants will get a pass from the regulators — quite the contrary.  The regulators usually penalize both the dealer and the individual registrants for compliance breaches.

While you might be concerned that over two years have passed since the conflict of interest rules took effect, the enforcement folk may be more lenient if they see that you and your dealer have taken corrective action, particularly if it was done immediately after the publication of the staff notice in August 2023. So do it now!

Know your client (KYC) and know your product (KYP). I understand that the regulators are presently conducting KYC and KYP audit sweeps, so we should expect to receive another notice describing the results of the audit and more expected corrective action. While I believe (and hope) there will be better results (with much more than 22% adhering to the balance of the CFR rules), some firms are already taking corrective action to ensure compliance. For example, some have introduced software to make CFR adherence more workable, so registrants need to understand the usefulness and any limitations associated with the software, and use it to limit exposure to regulatory enforcement matters. For those firms not employing necessary software, advisors will not be off the hook, so make sure you comply using acquired tools pre-approved by your dealer.

Note taking. Note taking continues to be a problem — in terms of both quantity and quality. There is no one right way to keep a paper trail, so use a system that works best for you. I suggest all client communication include the following in your notes:

• who attended each call or meeting;
• what each person said;
• what was explained to the client(s);
• the location (virtual) of the meeting;
• what time the meeting started and ended; and
• proof that the client(s) understood your explanations.

When I speak specifically on this topic, I continue to explain the 5Cs of documentation: correct, complete, current, consistent and contemporaneous (at the same time as the call or meeting).

Note taking is an ongoing problem especially when the client’s evidence is different than the advisor’s recollection. Educate yourself on the risks of failure to have evidence, and how best to generate and keep the evidence, in the event of an audit or client complaint.

All this to say, just because the regulators might be quiet, fix your issues now. Don’t wait to change your habits until regulator readiness aligns with CIRO rulebook completion. Change your habits now, so you avoid the risks of the inevitable perfect storm.