In its 2014 report, IIROC identified many cases where firms and advisors hadn’t fulfilled their obligations as efficient market gatekeepers.
So, firms need to more closely monitor the trading activities of both advisors and their clients, especially if clients have been granted direct access to markets (see “Learn the lingo”).
Firms must have systems to detect and prevent violations of universal market integrity rules (UMIR) and dealer member rules, says IIROC.
If a firm grants direct electronic market access to clients, it should use automated software to keep tabs on those clients’ trades and identify red flags. The regulator is currently most concerned about:
- Securities Act violations, such as insider trading;
- instances of spoofing, where orders are entered during market pre-opening and subsequently amended to gain advantages ahead of other participants; and
- artificial pricing at or near market close.
How to monitor clients
Firms can be held liable for failing to notice that a client has violated the rules, even if the firm doesn’t know about or sanction the activity. Violations can include insider trading and money laundering (the latter offense is under FINTRAC’s jurisdiction).
Before taking on a client, ask for details on his investment background, including from whom he regularly seeks financial advice, says Jonathan Heymann, president of Wychcrest Compliance Services.
Also, be cautious if a prospect is evasive about his portfolios and assets. “Consider that, based on FINTRAC guidelines, one of the questions that often comes up in internal reviews is whether there are any alarm bells when you look at clients who have similar profiles,” he says. For example, if two people’s occupations and lifestyles are similar, their incomes and investment styles should also be roughly in line.
But, say a prospect is vague about his income sources. If he earns a modest wage but spends and invests like a wealthy client, you’ll need to ask more questions about his portfolio, additional assets and non-work activities (see “Key questions for prospects” on our tablet edition).
If you decide to take on that client, instruct him to always disclose his relationships to companies before investing, says Heymann. That includes whether he owns more than 10% of a company and whether he knows insiders—those insiders have reporting requirements. “They have to file their trades on SEDI, so an advisor could check that public database.”
Also, be wary of uncharacteristic trade requests. Before filling them, find out whether clients have been given stock tips by asking:
- What do you know about the company?
- What research have you done/did you do before investing?
- Have you ever received any information about this particular stock?
- Do you have access to any non-public information? This could include details of a merger before it happens, for instance, or information about a product before it’s released.
IIROC’s enforcement priorities
IIROC completed 174 cases in 2014 and, as a result, prosecuted 47 individuals and 10 firms. Forty percent of cases involved suitability of client portfolios. IIROC stated in its 2014 Enforcement Report that it “detected an increasing number of potential market-related violations by clients of IIROC dealers,” but that such matters are out of its jurisdiction and are referred to the relevant CSA jurisdiction.
When you report clients
If an advisor suspects a client has broken market rules, she must contact compliance. That may lead to follow-ups with the client, and the firm will assess the trading activities of all those involved. And, if the firm still suspects a client is guilty of breaking the rules, a gatekeeper report must be filed with IIROC. According to UMIR, there must be written records of investigations and findings, and these have to be delivered to regulators no later than the fifteenth day of the month following the month in which findings were made.
Smaller firms may perform manual retail supervisory review, but larger firms should perform automated, sample-based testing of trading activity in client accounts and by direct-access clients.
Client investigations are handled by the CSA, but an advisor may still be affected if IIROC finds she, or her firm, failed to meet supervisory requirements by identifying red flags. IIROC adds that when firms identify and self-report clients who are suspected of breaking market rules, it shows supervision systems are in place.
But the regulator may still halt activity in a client’s account, says Heymann. IIROC notes that firms and advisors who are involved will then be required to retain relevant records for seven years, and to allow regulators to request and make copies of the files. Even if you don’t manage a client’s whole portfolio, encourage him to be open about his financial history and investment intentions. Keeping a paper trail will show regulators you’re vigilant about getting to know your book.
Katie Keir is assistant editor of Advisor Group.
Originally published in Advisor's Edge
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