Compliance roundup – February 2014

By Staff | February 14, 2014 | Last updated on February 14, 2014
7 min read

01 CSA floats standardized risk-classification methodology

The risk-rating section of the Fund Facts may get a make-over, and it could have a major impact on the way you do suitability assessments.

CSA has proposed to standardize the methodology fund managers use to assess risk. Currently, managers have discretion, notes Anick Morin, a partner at Borden Ladner Gervais (BLG) in Montreal.

Once they do the assessment, they plot it on Fund Facts’ familiar five-band scale: Low, Low to Medium, Medium, Medium to High, and High.

The regulator suggests standard deviation be used as the uniform risk indicator, based on the following:

  • The risk scale in the Fund Facts is intended to measure volatility risk, and standard deviation is the most widely accepted measure of volatility;
  • Its calculation methodology is well-known and established;
  • The calculation is simple and does not require sophisticated skills or software;
  • It provides a consistent risk evaluation for a broad range of investment funds;
  • It provides a relatively stable but still meaningful evaluation of risk when coupled with an appropriate historical period;
  • It is already broadly used in the industry, and serves as the basis for the IFIC and Committee of European Securities Regulators methodologies;
  • It is available from third-party data providers, thereby providing a simple and effective source of data for oversight purposes both by regulators and by market participants (including investors); and
  • The implementation costs are expected to be minimal.

So far, so good. But the proposal also calls for replacing the five-band scale with a six-band alternative (see, “Proposed changes,” this page). Morin says the new scale, if adopted, could mean some mutual funds will migrate into different risk categories—not because of any actual change in volatility risk, but simply because of the new yardstick. “Advisors will have to understand those changes in risk classification,” she says, and this means “adjusting the suitability assessment process to reflect the changes in the risk scale.”

This may be less of a burden with new clients, but what about existing accounts? Say you have a client suited to funds that rise no higher than the Medium risk rating. The new scale is released and all of a sudden some of his holdings are now in the Medium-to-High category. What now? “This is something the CSA has acknowledged as being an issue that will need to be dealt with, [both] with registrants and the SROs.

Proposed changes

Risk Rating Standard Deviation (IFIC’s system) Standard Deviation (CSA proposal)
Low 0%–6% 0%–2%
Low to Medium 6%–11% 2%–6%
Medium 11%–16% 6%–12%
Medium to High 16%–20% 12%–18%
High 20% and above 18%–28%
Very High N/A ≥ 28%

“We’re going to need to flush out how this transition…will impact suitability assessments.” You would think that if there’s no actual change in an investment’s risk, there would be no need to make changes to the portfolio. At the same time, says Morin, “there can’t be a disconnect between what the client reads in the Fund Facts and his investment profile.”

02 Outside business activities and other NI 31-103 changes

CSA has proposed a fresh round of changes to NI 31-103. The main theme for advisors is conflicts arising from outside business activities.

“It’s been an area of focus for CSA behind the scenes for a couple years,” says Susan Silma, a Toronto-based industry consultant and former OSC director, who launched the CRM II and Fund Facts initiatives.

She notes that, initially, regulators were focused on disclosure of potential conflicts during the registration process. The emphasis has shifted towards ongoing disclosure and monitoring. “This is the first time I’ve seen such a detailed list of the things they’re interested in,” Silma says. The list appears on pages 164-165. Key items include:

  • whether the advisor will have sufficient time to properly carry out registerable activities;
  • whether the advisor will be able to properly serve clients;
  • the risk of client confusion and whether there are effective controls and supervision in place to manage the risk;
  • whether the outside business activity presents a conflict of interest for the advisor, and whether that conflict of interest should be avoided or can be appropriately managed;
  • whether the outside activity places the advisor in a position of power or influence over clients; and
  • whether the outside business activity provides the advisor with access to privileged, confidential or insider information relevant to their registerable activities.

If you sit on the board of your local church, for instance, “[CSA] considers that a position of influence and they want to know about it,” says Rebecca Cowdery, a partner at BLG in Toronto. The regulator’s worried you might use that influence to entice clients into your book, so the activity “has to be added to the national registration database, and [your] firm has to monitor it.”

Proficiency requirements

The proposed amendments also include changes to proficiency requirements for chief compliance officers and portfolio managers. And while there’s nothing specific for advisors, it’s likely in the pipeline, Silma suggests.

“CSA indicates proficiency in general remains ‘an area of active interest’; that they’ll ‘continue to monitor and assess the adequacy of current requirements’; and that they may identify the need for improvements or enhancements.” She says these statements are “generically positioned” in the proposal document, suggesting they apply across all registrant categories. Silma adds, “Between the fact that the CSA has signalled that it’s not moving forward as quickly as they anticipated with the fiduciary duty mandate, and the fact that…proficiency is an active area internationally, I expect we should watch for upgrades to the proficiency regime, including for retail advisors, to be floated in the future.”

Another reason for an upgrade is product complexity. “There’s been a concern for a few years,” she says, “that it might be difficult for advisors to keep abreast of all of the changes.”


If adopted, the proposed amendments will have a major impact on exempt market dealers. The document says EMDs can’t:

  • participate in a distribution of securities offered under a prospectus; or
  • directly or indirectly, participate in a resale of securities traded on a domestic or foreign marketplace, whether the transaction is on-exchange or off-exchange.

EMDs also cannot establish an omnibus account with an investment dealer and trading securities for clients through that account. Instead, these activities should be conducted by investment dealers.

Additionally, EMDs “may only underwrite securities in limited circumstances,” such as a private placement of securities of a reporting or nonreporting issuer, but participate in an underwriting of a prospectus-offered security.

“It’s an over-response to a legitimate concern,” says Brian Koscak, chair of the board at the Exempt Market Dealers Association of Canada and a partner at Cassels Brock & Blackwell LLP in Toronto.

The impetus for the proposals dates back to 2011, when CSA issued Staff Notice 31-327 detailing concerns about American broker-dealers setting up shop as EMDs and directing brokerage activities to their U.S. firms. “They were using the EMD [designation] to circumvent becoming an IIROC member. There are policy concerns with that,” Koscak says.

IIROC put out a request for comment to consider whether it should establish a separate registration category to accommodate the Americans. “It would be an ‘enhanced EMD’ but ‘IIROC lite’ registrant,” he notes.

But the idea was nixed on concerns it would tip the playing field. “There was also a lack of reciprocity in the U.S.,” Koscak explains.

The U.S. wouldn’t accommodate IIROC dealers who wanted the same deal south of the border, so why should we carve out a separate category for them, especially since it would negatively impact IIROC dealers?

So IIROC passed the hot potato over to CSA.

“There has been a practice,” says Koscak, “where certain EMDs are not underwriters in a prospectus offering, but have been participating as selling group members in connection with a prospectus offering in accordance with their registration category.”

Prohibiting these selling groups is one of the more significant changes the proposals would usher in.

In Koscak’s view, “EMDs should be able to sell any security, whether it’s prospectus-qualified or not, provided it’s made in accordance with all available prospectus exemptions.”

03 OBSI for everyone

In late December, CSA amended NI 31-103 to require all registered dealers and advisors to use OBSI as the common dispute resolution service, except in Quebec. That means it’s no longer just IIROC and MFDA members who fall under the ombudsman’s purview. EMDs, portfolio managers and others must now join the club, unless they deal exclusively with institutional or permitted clients. The amendments will likely be finalized on May 1, 2014.

You’ll have until August 1, 2014 to comply.

CSA says the move “is an important component of [its] investor protection framework.” And it’s a boon for OBSI, which boasts its “membership will more than double to almost 1,600 firms.” This expansion comes despite a 2011 independent review that states OBSI cannot meaningfully punish misconduct.

“Consistent with its Terms of Reference, OBSI’s final recourse for non-compliance is to make public any refusal by a firm to accept OBSI’s recommendation. […] The effectiveness of this weapon is only of utility where there is widespread goodwill and co-operation and being named has a significant reputational cost,” says the review. “[A] concern arising from the significant deterioration of goodwill and co-operation from member firms between 2007 and 2011 is the significant number of case files that have stalled at the end of the resolution process because some member firms are simply refusing to accept the Ombudsman’s decision. [OBSI] does not ultimately have binding power over its participating firms.” And worse: “The current impasse with a number of firms that are refusing to comply with OBSI decisions clearly illustrates the limitations of naming and shaming as a deterrent.”

The report goes on to suggest that unless OBSI’s given “substantive” authority, it’s questionable whether the body can fulfil its public interest role. staff


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