Canadian securities regulators publish results of review of conflicts of interest practices

The identification and management of conflicts of interest, whether actual, potential or perceived, is one of the great challenges facing investment professionals and firms. Registrants are subject to strict, specifically mandated requirements as well as the overarching principles articulated by the Canadian Securities Administrators (CSA) across the country.

On August 3, 2023, the CSA and the Canadian Investment Regulatory Organization (CIRO) released joint Staff Notice 31-363 (the Notice), which sets out the findings of their review of conflicts of interest practices at 172 firms across various registration categories. The Notice provides guidance to securities advisers, dealers and representatives (Registrants) on identifying and remedying non-compliance.

Brief history of Client Focused Reforms

In October 2019, the CSA and the Investment Industry Regulatory Organization of Canada (IIROC) (one of the predecessors to CIRO) published the Reforms to Enhance the Client-Registrant Relationship (Client Focused Reforms), which were implemented through amendments to National Instrument 31-103 and its companion policy. These reforms established heightened standards of conduct for Registrants and were set to be phased in over a two-year transition period (which was extended because of the COVID-19 pandemic).

The Client Focused Reforms included conflicts of interest requirements, which came into force on June 30, 2021. These requirements create an ongoing obligation for Registrants to take steps to identify existing and reasonably foreseeable material conflicts of interest and either address conflicts in the best interest of clients or avoid conflicts that cannot be addressed.

Key findings of the review

The Notice documents the results of a review conducted by the CSA and CIRO on Registrant compliance with the conflicts of interest requirements.

The review found that 135 of 172 firms reviewed had some deficiencies and required each firm to take corrective actions. The following deficiencies were identified:

• Failure to identify material conflicts of interest: The review found that 34% of Registrants failed to identify various conflicts, including in relation to internal and third-party compensation arrangements, referral arrangements and proprietary products. The Notice recommends that firms maintain compensation arrangements that do not differ by product or service, provide detailed disclosures on proprietary products and prohibit monetary or non-monetary benefits that could bias recommendations towards proprietary products.
• Missing or incomplete disclosure related to material conflicts of interest: Approximately 10% of firms reviewed did not provide any disclosure to clients about material conflicts of interest and approximately 43% of firms provided incomplete disclosures. The Notice recommends that disclosures expressly and concisely address (a) the nature and extent of the conflict of interest, (b) the potential impact/risk of the conflict and (c) how the conflict has been or will be addressed.
• Inadequate policies and procedures: Approximately 66% of firms had inadequate written policies and procedures. The Notice sets out specific requirements for compliance, including defining conflicts of interest, delineating individual responsibilities and setting processes for training employees and conducting periodic reviews.
• Lack of or inadequate training: The review determined that training was inadequate where it was too generic, did not give examples, did not include all relevant individuals or did not provide details of a reporting or escalation process for when a material conflict of interest was identified. 83% of firms failed to meet this standard. The Notice also cautioned that firms should maintain adequate documentation that training has occurred to demonstrate compliance.
• Inadequate record keeping: Firms generally complied with record keeping obligations, with less than 10% having deficient practices. To ensure continued compliance, the Notice advises that records should be increasingly detailed in proportion to the materiality of the conflict and that firms should conduct periodic reviews of all records.

Key takeaways

The publication of the Notice highlights the importance of advisors and firms ensuring they have robust compliance systems in place to meet the requirements of the Client Focused Reforms specifically, and the general, overarching obligation to identify and manage actual, potential or perceived conflicts. It is particularly striking that two-thirds of firms were found to have inadequate policies and procedures, and five out of six firms provided inadequate training. It is arguably understandable that there might be a failure to identify a conflict in a particular situation from time to time.

Training and policy-setting, on the other hand, are entirely within the control of member firms. While there is no one-size-fits-all approach to ensure compliance, the Notice demonstrates that there is a significant gap between what member firms are doing and what CIRO and the CSA expect. It is crucial for advisors and firms to familiarize themselves with the Client Focused Reforms, implement necessary changes and ensure ongoing compliance to meet the evolving regulatory landscape.

The CSA and CIRO’s review process is ongoing. They have indicated that their next review will target other Client Focused Reforms, including the know your client, know your products and suitability determination requirements, which came into force on December 31, 2021.