Two compliance reviews of member firms by the Investment Industry Regulatory Organization of Canada have uncovered deficiencies in disclosure practices, training, client reporting, and due diligence practices concerning new products.

IIROC released the results of the two compliance reviews on Tuesday — one dealing with principal-protected notes, the other addressing due diligence concerning new products — both of which had their roots in the financial crisis. The review of new product due diligence practices came in the wake of deficiencies IIROC uncovered when examining the failure of the non-bank sponsored asset backed commercial paper market during the crisis, and subsequent regulatory guidance. The PPN review was launched after volatile markets triggered “protection events” in a number of those products, but before the new guidance on new product due diligence was issued.

PPN review

In the PPN review, IIROC found that the dissemination of the required disclosure to clients was inconsistent among dealers. Many dealers had no clear due diligence process in place to ensure that issuers delivered required disclosure to clients, and most could not establish that the information was delivered to clients. The review recommends that dealers review their contractual agreements with issuers to ensure they clearly set out which party is responsible for distributing protection event notification, and that they obtain confirmations from issuers.

It also found deficiencies in the disclosure that dealers produced, including: marketing material that did not contain adequate information about charges and fees, and reporting that made it tough for clients to monitor these investments due to a lack of clear information. “These inadequate descriptions made it likely that most clients would not be able to readily understand what they held or know when to redeem the PPN investment,” it says.

Additionally, the review found that some reps clearly did not understand all of the features of the PPNs they were recommending to their clients. Nevertheless, IIROC determined that the PPNs were suitable for the 128 accounts it reviewed.

Finally, it also found that there was no uniformity in the level of training offered to reps on PPNs and indicated that the training and education programs on structured products at many dealers could be improved.

IIROC reports that it has followed up with all firms involved in the review, and says all the deficiencies have been addressed.

New products due diligence review

In the wake of the PPN review, and the subsequent guidance concerning new product due diligence, IIROC also undertook a broader compliance review to determine whether dealers have properly incorporated the new guidance into their policies and procedures. That review tested for adequate written policies, procedures, and underlying operational controls on “new products”.

It found that two of the 14 dealers reviewed did not have written policies, and for those that did have them, “many of the policies were deficient in some material aspect. Some had no meaningful written procedures to accomplish the intent of their policies.”

The deficiencies included a lack of clear definitions; insufficient internal review; an inadequate analytical framework to consider whether a “new product” should be offered; a lack of consideration of possible conflict of interest scenarios; the absence of consideration of proficiency, training and marketing issues; no process to monitor and review customer complaints, or for monitoring compliance with any restrictions on the sale of new products.

The regulator’s review of the controls underlying the firms’ policies and procedures also found a variety of deficiencies, including: inadequate controls underlying written policies; a lack of controls to capture sources of new products; no standardized process requiring a written new product proposal for internal review; and the absence of Product Due Diligence Committees.

Each of the firms covered in this compliance review has received a letter reporting IIROC’s findings and proposed corrective action. IIROC says that it will ensure that each of those firms undertake the necessary improvements to their policies and procedures, and it warns that any material deficiencies in the “new product” due diligence process uncovered during examinations will be referred to enforcement.

IE