Product Due Diligence (Company/Issuer)
Dealing Representatives are only allowed to sell products that have been approved by the Chief Compliance Officer (CCO) — and only after they’ve been trained on a product features, risks and costs. Depending on your firm’s size, product due diligence may be performed by the CCO herself, or by a dedicated corporate finance team.
Here’s how you can supplement your firm’s process.
- STICK TO WHAT YOU KNOW
It makes sense to only look at opportunities that fit in with your expertise. If you are expert in mining, it is unlikely that you would be in a position to effectively evaluate the future prospects of a technology firm. If the investor in interested in a product that you don’t understand, you have a responsibility to turn them away or refer them to a qualified colleague.
- ASK WHO’S BEHIND THE PRODUCT
A product is only as good as the guiding minds behind it. Research who they are, where they’ve worked and how their experience applies to this venture. You want to do business with a management team that has the necessary expertise and a proven track record.
Also, look for potential conflicts of interest. For instance, if you’re vetting an exempt product, you may want to avoid a car part manufacturer that receives services from a related company (i.e., both companies are owned by the same people). That manufacturer may not look for the best deal on services if management receives compensation on both sides of the deal.
- SCRUTINIZE THE PRODUCT ITSELF
Examine the investment’s features to determine whether the product’s structure is overly complex and whether there is sufficient transparency in the product’s disclosures. What are the expected returns and do they make sense given the risks?
You’ll also need to determine the risks to a profitable outcome. This is particularly important when examining an illiquid product, which will offer few opportunities for selling if the investment does not perform as expected.
To do so, look at internal and external factors: if the CEO dies, are their qualified people to take over? If the first product prototype fails, does the company have enough cash to try again? If the Canadian dollar goes up, how would that impact the firm’s operating costs? If you recommend this product to a client, could they lose the full investment?
You also have to look at where the product is situated within its industry. Does the firm have something to offer that no one else does? Why would you choose this investment and not another one? You also have to ensure that the product issuers are abiding by their regulatory obligations regarding appropriate disclosure in their offering documents. Depending on the nature of the product, they may need to produce audited financial statements, file exempt distribution reports on a timely basis and have their marketing material conform to securities legislation. The type of product and how it is distributed will determine what sort of filings have to be done and whether or not they’re public. However, as part of the due diligence process, the issuer must be willing to share whatever information is necessary for you to make an informed opinion on the suitability of the investment.
- PUSH FOR BETTER ADVISOR TRAINING
Your firm should be able to provide detailed information to prospective clients about the product and teach you to do a suitability analysis. The training should include specific information about the features, risks, and costs associated with the investment. It should also explain what differentiates this product from others available. The compliance department must document who has attended the training and when, and include copies of the presentations in those people’s training files.
Having a compliance platform in place to manage both KYP and KYC, as offered by KoreConX, will help you to manage your due diligence process. All firms inherently do due diligence as part of their business activities, but one must be able to document each step in the process to show why one particular investment was favoured over another.
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.