Three Compliance Commandments to Obey
Advisors have a duty to act fairly, honestly and in good faith with clients. To meet these obligations, they must know their clients, understand the products they sell them and ensure investments are suitable.
Having clients complete a basic KYC form isn’t enough. You also need to make detailed notes about client discussions. This will help protect you in the event of a dispute. CSA lets you accept client statements at face value unless you have good reason for doubt. According to Staff Notice 31-336, “A person may rely on factual representations by a purchaser, provided that the person has no reasonable grounds to believe the representations are false.” So, if a client has significantly more money than you’d expect given where he works, for instance, you need to discover and document where the money’s coming from before doing any trades.
Regulators don’t provide a list of documents you need to obtain from clients. Advisors have to have a sense of what’s needed to paint a complete picture of the client’s financial situation.
This is especially important if you have Accredited Investor (AI) clients. They must demonstrate they meet annual income and asset thresholds to be eligible for certain types of investments, including prospectus-exempt products. Having these clients sign subscription documents stating they’re AIs simply isn’t enough.
Consider formulating a supplemental, plain-language questionnaire with specific queries about the client’s financial picture. This will help ensure you aren’t missing any important details; it will also help compliance determine if a trade is suitable. Ask about clients’ ultimate financial goals (e.g., saving for retirement, paying off loans, buying a cottage).
Having an idea about how much money they need, and by when, will assist in choosing the right investments. Understanding risk tolerance by asking a client how concerned they would be if an investment dropped in value by 20% over a six-month period will give a better picture of how much risk they really could withstand. This is far more pointed than having a client say their risk tolerance is low, medium or high, which is how most KYC forms characterize risk. Regulators also expect you to ensure client information is up to date. Contact clients at least once a year to confirm or revise your files.
Advisors must understand the products they sell. The firm needs to review offering documents and marketing materials to ensure they meet regulatory requirements.
It’s also important to do a risk and cost assessment that includes a comparison with similar products. If other offerings are less costly and risky, it may be appropriate not to approve the product under review. To be approved, a product should have a reasonable prospect of meeting its objectives and be suitable for client portfolios.
Firms may use third-party analysis as part of their due diligence on a product, but this doesn’t replace an internal review. Advisors must be trained on a product’s specifics before they can recommend it. Advisors should ask questions covering the features, structure and risks of the products approved for sale. They should also know about competing products to be able to show why one is more suitable than another. As with KYC, each step of this process must be documented. Imagine the regulator auditing your firm in three years. Do your files justify all recommendations?
The products you recommend must be suitable for clients. This is particularly important for firms dealing in prospectus-exempt offerings, because these investments are typically more illiquid and may have to be held for longer.
Firms that have a related-party relationship with an issuer must ensure they’re putting client interests first. And just because a client is eligible for an investment doesn’t mean it’s suitable. A client may be an AI, but if she needs to access her money in the short term to buy a property, an illiquid product wouldn’t be suitable.
Since these investments are generally high-risk, avoid allocations of more than 10% of client assets. There are no specific regulations governing the concentration of assets in specific investments, but the Regulators will look long and hard at advisors who invest too much in too concentrated assets, particularly illiquid ones. Compliance should review all trades to ensure suitability.
Jonathan Heymann began his career in the financial services industry working at Spectrum United, a mutual fund company. In 1999, Jonathan joined the Ontario Securities Commission and within two years became a Supervisor in the OSC Contact Centre, where he developed a broad knowledge of the Capital Markets in Canada and particularly the role of compliance.