“Know your product” is not a phrase that advisors will find in any of the regulatory rules or “best practices” manuals. Instead, it is implied in the concept of suitability that governs matching clients with suitable investments.

But to what extent should, or can, advisors know their products? In a world of increasingly complex investments, shouldn’t advisors be able to rely on their dealers’ analysts to vet the products they sell?
And what about the product-makers that provide dealers and advisors with information? Should the regulators be watching them more closely?

Exempt products pose a real problem when it comes to scrutiny. The ongoing debacle enveloping Toronto-based Portus Alternative Asset Management Inc. shows how hard it is to apportion “know your product” responsibility. The Portus case involves advisors referring clients to a company selling a highly complex “alternative investment” via an offering memorandum,
which was therefore “exempt” from the regulatory scrutiny that prospectus products face.

Portus appears to have been offering a hedge-fund investment, in which a portion of the investment involved buying a bank note guaranteed over 10 years by a prominent French bank, Société Générale. The rest of the investment monies were apparently earmarked for investment in a complex web of hedge funds — some of them offshore — and, of course, for management fees.

There is a lot of finger-pointing going on within the industry about who should be held responsible for checking out Portus’s product. Regulators say the ultimate responsibility lies with advisors — even if their dealers vet and approve the products they sell. Meanwhile, advisor organizations are steamed that the regulators have been quick to blame advisors while hiding behind the exempt-product regime.

Karen McGuinness, director of compliance at the Mutual Fund Dealers Association, puts her position succinctly: “If you don’t
know your product, how can you sell it?”

Knowing the product is not the flip side of the know-your-client coin, she says: “It’s the first side of the coin. You have to know what you’re selling when clients come. You have that menu of options. How can you comply with your suitability obligations if you don’t?”

Suitability is also the key issue for the Investment Dealers Association of Canada.
There’s no bylaw that speaks specifically to knowing your product, says Paul Bourque, senior vice president of member regulation at the IDA. Instead, he says, KYP falls under “general suitability.”

He refers to IDA Regulation 1300.1. For example, Subsection (p) states that “each member shall use due diligence” to ensure that an order is suitable for a customer based on factors such as “the customer’s financial situation, investment knowledge, investment objectives and risk tolerance.”

Knowing your product is an essential part of suitability for advisors, says Randee Pavalow, director of capital markets at the Ontario Securities Commission.

Advisors have to use their professional judgment, says Bourque. “You’re getting paid for your advice,” he points out.

Ed Waitzer agrees. The Toronto-based chairman of national law firm Stikeman Elliott LLP and former OSC chairman says, “At the end of the day, the advisors are the ones giving advice to clients. If they’re giving it, they’d better be prepared to justify it.”

However, industry commentator Glorianne Stromberg questions whether all advisors have that commitment. “KYP and KYC are part and parcel of the same thing,” she says, but too many advisors see KYC as an act of form-checking. They file it away, and proceed to sell as much product as possible, she says.

“They adopted the term ‘advisor’ because they didn’t want to be called ‘salespersons’,” she adds.

But situations like that of Portus, Stromberg points out, beg the question of whether or not advisors appreciate their fiduciary responsibilities.

Reps don’t act alone

Bourque says many IDA firms have review committees that vet the products the firms will permit their reps to sell. The committee will review several factors, such as whether the product is backed by a guarantee that is legally enforceable. It will also check out the “custodian” of the assets. Is it a reputable trustee? Is the trustee at arm’s-length from the producer of the product?

This process results in what is commonly known as the “approved list.”

In the MFDA world, reps also wait for their dealers to approve securities products before they can sell them.