IIROC Publishes its Annual Compliance Priorities Report for 2018/2019

On January 15, 2019, the Investment Industry Regulatory Organization of Canada (“IIROC”) published its annual Compliance Priorities Report for 2018/2019. The Report is intended to help IIROC Dealers Members (“Dealers”) focus their supervision and risk-management efforts to comply with regulatory requirements in a way that is appropriate for their business model.

IIROC uses risk models to assess each Dealer’s risk and to drive the frequency and content of its compliance examinations.

The Report summarizes IIROC’s compliance findings from 2018 and priorities for 2019.

Financial and Operations Compliance

  1. Cybersecurity Findings

IIROC organized tabletop exercises in 2018 for small and mid-sized Dealers which highlighted the following:

  • An effective incident response plan must be detailed and specific and identify and define each team member’s role and responsibilities.
  • Employee training and awareness are identified by IIROC as high-impact ways to mitigate the risk of insider threats.
  • Cyber insurance is recommended for small and mid-sized Dealers.
  1. Documenting Portfolio Manager Service Arrangements

Dealers that provide recordkeeping and custody services on behalf of clients of registered PMs will be an examination priority for IIROC in 2019.[1]

Such Dealers are subject to the following minimum requirements:

  • Written Agreements: Dealers must execute agreements with each PM explaining the arrangement and clearly defining the roles and responsibilities of each party.
  • Account Opening and Operation: Each account must be opened in the client’s name and the PM must have trading authority over the account.
  • Disclosure: Dealers must provide clients with information as required under IIROC Dealer Member Rule 3500.
  • Client Confirmations and Statements: Dealers are responsible for the custody of client investments and must send a monthly or quarterly statement.

Trading Conduct Compliance

  1. Trading Supervision Obligations under UMIR 7.1

Dealers should assess and document the risks associated with their trading-related activities to determine where their compliance and supervisory efforts should be focused.

A written agreement must be in place for each risk-management or supervisory control before authorizing a third party to perform the control. The terms of this agreement must be confirmed at least annually.

  1. Best Execution Requirements

IIROC will focus its reviews on changes in the best execution requirements introduced on January 2, 2018. Areas of focus include:

  • policies and procedures that consider what factors and elements result in best execution
  • content and disclosure of best execution policies
  • governance around best execution decisions
  • training conducted by the Dealer, including that training is provided to all employees who are involved in the best execution process.

IIROC expects non-executing Dealers to have an informed understanding of how their executing Dealer achieves best execution and how the approach taken will reasonably achieve best execution for their clients.

  1. Electronic Trading

IIROC continues to identify the following issues with Dealers’ electronic trading controls:

  • credit/capital limits that do not consider the unique needs of their clients and traders
  • limits set well in excess of what would be appropriate or effective.

IIROC will continue to focus on Dealer risk controls and whether limits are set appropriately for their firm and clients.

  1. Wash Trading

IIROC considers any trade printed on a marketplace that does not result in a change in beneficial or economic ownership to be a “wash trade”

IIROC expects all Dealers to:

  • monitor both client and proprietary wash trading activity;
  • take reasonable steps to minimize this activity; and
  • use available tools that reduce or prevent the occurrence of wash trading where appropriate.

Each Dealer must report any trade not cancelled by the marketplace through a gatekeeper report. IIROC recommends filing a gatekeeper report on a monthly basis.

Business Conduct Compliance (“BCC”)

  1. Compensation-related Conflicts of Interest

BCC continues to focus on compensation-related conflicts of interest. Following a review in 2017,[2] and the implementation of a conflict-of-interest module in 2018, IIROC reiterates that many firms have not implemented an effective process for identifying and managing compensation-related conflicts.

In 2019, BCC will collect data related to conflict-of-interest findings and assess it for:

  • potential systemic issues
  • areas to increase focus
  • identification of best practices.

BCC examiners will also focus on more complex conflicts including:

  • non-monetary incentives
  • sales targets
  • mutual-fund sales incentives.
  1. Automated/Online Advice

BCC will continue to enhance its testing module for automated/online-advice services offered directly to clients by Dealers to address a growing number of business models involving strategic alliances, referral arrangements and automated advice tools used by advisors.

  1. Order-Execution-Only (“OEO”) Platforms

In April 2018, IIROC published guidance that sets out its expectations and the regulatory requirements applicable to all OEO firms.[3] IIROC has enhanced BCC test processes to consider the different factors outlined in the guidance.

Registration Deficiencies

IIROC continues to see filing deficiencies as highlighted in past Compliance Priorities Reports, including:

  • deficiencies with Notices of Terminations and filings relating to outside business activities
  • late and incomplete disclosures about regulatory, civil, criminal and financial disclosure items.

IIROC plans on delivering training in early 2019 to Dealers with repeat deficiencies. The Authorized Firm Representatives and Chief Compliance Officers of these Dealers will be required to attend a training session with IIROC’s Registration team to ensure they understand their obligations. Basic registration functions and Dealer-specific issues will be reviewed to ensure that IIROC’s expectations are clear.

Once IIROC has met with a Dealer, a strict approach to compliance will be taken and any of the following steps may be taken:

  • reject deficient filings in their entirety
  • impose terms and conditions on the Dealer
  • refer matters to Enforcement for potential disciplinary action.

IIROC will also provide training to other Dealers upon request and to new Dealers.

  1. Disclosure of Outside Business Activities

IIROC recommends that Dealers require their Approved Persons to provide periodic attestations regarding Outside Business Activities (“OBAs”) and to notify them of any material change to their OBAs. Dealers must provide sufficient detail when describing an OBA and address the potential for conflicts of interest or client confusion that may arise in the specific case. If there are no conflicts of interest or client confusion, the Dealer must outline their reasons for this conclusion.[4]

  1. False and Misleading Disclosure

IIROC views false or misleading applications as a serious regulatory issue[5] and emphasizes the need for Dealers to ensure their applicants and Approved Persons understand the questions in Form 4 IIROC when submitting filings. Individuals must also ensure they have an opportunity to discuss the questions in IIROC Form 4 with the Dealer to answer questions correctly.

  1. Discretionary Exemptions for Portfolio Management

IIROC continues to observe deficient exemption applications for Portfolio Management. Dealers are advised to review the email sent to all Chief Compliance Officers on December 4, 2017 before submitting an application. IIROC emphasizes that this approval category has the most onerous proficiency requirements because of the discretion the position affords. Applicants are expected to demonstrate a high level of experience that is clearly relevant to the discretionary portfolio management activities.

Applicants must either (a) meet IIROC’s current requirements under Dealer Member Rule 2900, Part I. A. 6, or (b) seek exemptive relief from Dealer Member Rule 2900, Part I. A. 6, on the basis that they have both:

  • a CIM (either the Canadian Investment Manager or Chartered Investment Manager) designation in good standing, and
  • 48 months of Relevant Investment Management Experience, with 12 months gained in the 36-month period before applying for registration.
  1. Post-licensing Requirements

IIROC believes that RRs and Supervisors have adequate time to complete their post-licensing requirements and that Dealers have ample time to ensure that they do so. Applications for extensions will not be granted unless there are “extreme extenuating circumstances”. IIROC will not grant extensions simply because a Dealer does not have a Supervisor to assume the functions. 

IIROC automatically suspends Approved Persons and Dealers who do not complete the applicable post-licensing requirements within the relevant time period. RRs must complete the Canadian Securities Course, Conduct and Practices Handbook Course and 90-Day Training Program to be eligible for approval. Once approved, RRs have 30 months to complete the Wealth Management Essentials course, or otherwise face automatic suspension. Similarly, Supervisors have 18 months to attend the Effective Management Seminar.

 

[1] See IIROC Notice 18-0242 – Service arrangements between Dealer Members and Portfolio Managers (December 20, 2018) and CSA Staff Notice 31-347 - Guidance for Portfolio Managers with Service Arrangements with Dealer Members.

[2] See IIROC Notice 17-0093 – Managing Conflicts in the Best Interest of the Client – Compensation-related Conflicts Review (April 27, 2017).

[3] See IIROC Notice 18-0076 – Guidance on Order Execution Only Services and Activities (April 9, 2018).

[4] See OSC Staff Notice 33-749 - Annual Summary Report for Dealers, Advisers and Investment Fund Managers. In addition, guidance about what is a reportable OBA is available in the Companion Policy to NI 31-103, in IIROC Notice 13-0163 – Disclosure and Approval of Outside Business Activities (June 13, 2013), and CSA Staff Notice 31-326 – Outside Business Activities.

[5] See CSA Staff Notice 33-320 – The Requirement for True and Complete Applications for Registration.

IIROC IIROC 2019 Compliance Priorities

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