By Michael C. DeCosimo, David Coultice and Henry Machum

Overview

In 2019, the Canadian Securities Administrators (the CSA) published changes (the Amendments) to enhance the relationship between clients and securities advisers, dealers, and representatives (Registrants). Reflecting the central concept that client interests come first, the Amendments aim to strengthen the client-Registrant relationship by:

• Expanding conflicts of interest obligations;
• Enhancing the existing suitability, know your client (KYC), conflicts of interest, and relationship disclosure information (RDI) requirements;
• Introducing a new know your product (KYP) requirement;
• Imposing new prohibitions applicable to misleading or deceptive communications;
• Clarifying when clients can waive Registrant obligations; and
• Creating new requirements for internal controls and systems, including training.

The Amendments will significantly increase Registrants’ regulatory obligations, requiring a number of operational and procedural alterations. The key changes and effective dates are summarized below.

Key dates

• June 30, 2021: Conflict of interest Amendments take effect.
• December 31, 2021: All remaining Amendments take effect.

The conflicts and RDI amendments were scheduled to be effective December 31, 2020, and the remainder on December 31, 2021. Due to the impact of COVID-19, in April 2020 the CSA postponed the effective date of the conflicts changes to June 30, 2021 and the RDI requirements to December 31, 2021.

Key amendments

Conflicts of interest

The Amendments introduce a new requirement that firms must address material conflicts in the best interests of the client, and avoid material conflicts where such resolution is not possible.

Registered firms will be required to identify existing and reasonably foreseeable material conflicts, and to disclose any material conflicts to clients. However, Registrants’ conflict obligations will not be satisfied solely by providing disclosure to the client, or by obtaining client consent. Registered individuals will have to promptly report conflicts to their sponsoring firm.

Suitability determination

The Amendments introduce new obligations that apply before a Registrant opens an account for a client, takes investment action for a client, makes a recommendation, or exercises a discretion to take any such action. The core requirement is that Registrants put client interests first when making a suitability determination, based on the following factors:

• KYC information;
• The registrant’s assessment or understanding of the security;
• The impact of the action on the account, including its concentration and liquidity;
• The actual and potential impact of costs on the client’s returns; and
• A reasonable range of alternatives available through the firm at the time.

Additionally, registrants will be required to review clients’ accounts and the securities in the account and take appropriate action in the following circumstances:

• A registrant individual is designated as responsible for the client’s account;
• The registrant becomes aware of a change in a security in the account, or a change in the client’s KYC information, that could result in the security or account not satisfying the suitability determination criteria; or
• The registrant has undertaken a review of the client’s KYC information.

Regulatory authorities will review suitability determinations without hindsight, based on what a reasonable Registrant would have done in the circumstances.

Know your client

The Amendments concerning KYC requirements aim to clarify the content and scope of the KYC process and support the enhanced suitability determination requirements. The KYC information that Registrants must collect will be expanded to include the client’s:

• Personal circumstances;
• Investment knowledge;
• Risk profile (including both the client’s risk tolerance and their risk capacity); and
• Investment time horizon.

Registrants will be required to take reasonable steps to obtain client confirmation of the accuracy of their KYC information. There are also new requirements for when and how often a client’s KYC information must be reviewed and updated, such as when a Registrant becomes aware of a significant change.

Know your Product

The Amendments introduce an express KYP requirement, aiming to support the enhanced suitability determination obligation. Registered firms will be required to take reasonable steps to ensure the securities they make available to clients are:

• Assessed with regard to their relevant aspects, including for their structure, features, risks, initial and ongoing costs, and the impact of those costs;
• Approved to be made available to clients; and
• Monitored for significant changes.

Registered individuals will be required to take reasonable steps to understand the securities they purchase, sell, or recommend to a client, including the impact of the initial and ongoing costs associated with holding each security.

Firms will be able to tailor their processes for meeting the KYP obligation depending on:

• The firm’s business model;
• The type of security at issue;
• Whether other registrants are also involved in a security’s distribution to the client; and
• Whether a security is being transferred in.

Relationship Disclosure Information

The Amendments modify RDI requirements to better implement the principle that “[a] registrant must deliver to a client all information that a reasonable investor would consider important about the client’s relationship with the registrant”. Registrants will be required to disclose the following information to clients:

• Restrictions on the client’s ability to liquidate or resell a security;
• Investment fund management expense fees and other ongoing client fees or charges, and a general explanation of the potential impact of these fees;
• A general description of any limits on the selection of the products or services the Registrant will offer to the client; and
• Pre-trade disclosure of investment fund management expense fees and other ongoing fees the client may incur.

Misleading communications

New requirements in the Amendments will prohibit a registrant from holding themselves out in any manner that could reasonably be expected to deceive or mislead any person as to

• Their proficiency, experience, qualifications, or category of registration;
• The nature of the person’s actual or potential relationship with the registrant; and
• The products or services actually or to be provided by the registrant.

Additionally, the Amendments impose new restrictions on the use of titles, awards, and recognitions by Registrants where such labels are based on the Registrant’s sales activity or revenue generation. A Registrant’s sponsoring firm must approve the use of any title or designation. Additionally, Registrants may not use corporate officer titles unless they are appointed to a corporate office by the sponsoring firm.

Waivers

NI 31-103 expands on the existing exemptions from KYC and suitability determination requirements. This exemption applies where a client requests in writing that the Registrant not make a suitability determination for the client’s account. The client must be an individual, and the client’s account must not be a managed account.

Internal controls and systems

Registered firms will be required to provide training to their registered individuals on compliance with securities legislation, including training with respect to conflicts of interest requirements and the KYC, KYP, and suitability determination obligations.

Record-keeping requirements will be expanded to include requirements for demonstrating compliance with KYP and conflicts of interest requirements. Firms will be required to document sales practices, compensation arrangements, and incentive plans, along with any other compensation and incentive arrangements.

Implications

These amendments bring increased regulatory attention to the relationship between clients and Registrants. All Registrants will need to develop a comprehensive plan to implement the Amendments well in advance of the applicable deadlines to address any operational challenges related to implementation.

Registrants should immediately take steps to comply with the conflict of interest requirements if they have not already done so, including a review of actual and potential conflicts as well as developing new procedures for conflict identification, client disclosure, and training for individuals. New procedures for assessing suitability and KYC information collection and updating must be developed and implemented. Individual Registrants will require significant training to be able to satisfy the KYP and RDI requirements, and firms will have to modify their processes that monitor, assess, and approve securities made available to clients. New policies will have to be developed to ensure compliance with the misleading communications requirements.

Finally, it is important to note that certain exemptions will continue to be in effect or will be expanded. Some of the Amendments will not apply to certain clients. Additionally, some Amendments will not apply to investment fund managers, order-execution-only services, and trades directed by portfolio managers. A determination of which Amendments apply to an individual should be made on a case-by-case basis with the assistance of counsel.

If you have questions or concerns about how these new regulations might affect you or your firm or would like assistance with implementing required changes, please reach out to the authors or a member of Dentons’ securities and corporate finance in Canada.