MFDA report raises KYC, concentration concerns

April 10, 2019 | Last updated on April 10, 2019
3 min read
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Mutual fund dealers should be scrutinizing their sales forces for reps who have books with highly concentrated client portfolios or cookie-cutter know-your-client (KYC) information, suggests the Mutual Fund Dealers Association of Canada (MFDA) in a new report.

The industry self-regulatory organization issued a report on Wednesday analyzing data from its client research project, which collected detailed information on dealers’ client bases.

That analysis sought to identify patterns or trends that could reveal possible regulatory concerns, such as concentration risk and suitability concerns.

Overall, the review found that clients’ portfolios are broadly diversified, with approximately 55% of client assets in balanced funds, 14% in fixed income funds and 31% in equity funds.

“This translates approximately to an overall asset allocation of 60-65% in equities and 35-40% in fixed income,” the MFDA reported, noting that younger clients have the highest equity exposure, and clients over age 75 have the lowest.

Yet, within the population, the analysis also identified outliers. In particular, it sought reps with the bulk of their assets in high-risk funds, and reps with little diversification in client portfolios.

The report indicated that the MFDA didn’t uncover many reps with significant concentration issues, and that most of those it found were already under investigation.

Still, the MFDA said that, among the reps with concentration issues, it also found some who had KYC information that was uniform across virtually all of their clients — raising regulatory concerns.

“Such patterns raise questions as to whether the documented KYC information accurately reflects the individual client circumstances, particularly where the risk tolerance, objectives and time horizon for clients appear identical despite differences in age and financial situation,” the report noted.

The MFDA said the biggest concerns were reps with precise, identical KYC information throughout their book, and cases where reps said the KYC info was tailored to match the *rep’s investment philosophy, rather than the client’s actual risk tolerance, investment objectives and time horizon.

Given the findings of the review, the report makes a series of recommendations for dealers to address these issues within their own firms.

Among other things, it calls on firms to carry out periodic reviews of their reps to identify these sorts of patterns; it says they should have policies and procedures to assess concentration risk in exempt securities and higher-risk funds; that they need to demand sufficient documentation of client KYC information from reps; and that significant external client investments should be documented too.

Additionally, the report said that in cases where firms uncover significant issues with “the accuracy or adequacy” of KYC information, “steps need to be taken to reassess the information and re-perform the KYC collection process.”

“Allowing the [rep] who originally collected the KYC information to obtain new KYC forms for their clients without significant support and supervision is inadequate. Therefore, the KYC collection process may need to be re-performed using objective tools such as risk profile questionnaires and in some cases with the direct involvement of a supervisor,” it said.

*Correction: A previous version of this article stated there were cases where reps said the KYC info was tailored to match the client’s investment philosophy, rather than their actual risk tolerance, investment objectives and time horizon. In fact, the KYC info was tailored to match the rep’s investment philosophy. Return to the corrected sentence.