Many conflict-of-interest practices deficient, finds securities regulators' report

With regulators highlighting plenty of deficiencies in conflicts-of-interest practices in a recent staff notice, securities registrants will be busy comparing their procedures with the findings, says Nancy Mehrad, a securities lawyer and founder and CEO of Registrant Law.

Released in early August, the Canadian Securities Administrators (CSA) and the Canadian Investment Regulatory Organization (CIRO) published the joint staff notice to guide securities advisors, dealers, and representatives on practices related to conflicts of interest requirements. The review was intended to assess compliance, enhance understanding of controls used to address conflicts and develop a consistent compliance approach. The CSA and CIRO found compliance deficiencies with 135 of the 172 firms reviewed and said they required each to take corrective action and will work with the firms to resolve the issues.

“Essentially, it's saying that the Street still has a lot of work to do when it comes to conflicts of interest,” says Mehrad. The most important takeaway for lawyers and their registered clients, she says, is to examine the notice and conduct a “gap analysis” against their existing practices, policies, and disclosures.

The CSA’s client-focused reforms came into force in 2021 through amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. Under the reforms, registrants must take reasonable steps to identify “existing and reasonably foreseeable material conflicts of interest, and must address those material conflicts in the best interest of clients,” said the staff notice.

Following the introduction of the client-focused reforms, the regulators audited registrants to evaluate their level of compliance, and the staff notice is the result of their findings, says Mehrad. She says the findings show inadequate controls, lack of recognition of material conflicts of interest, insufficient or missing disclosures, and inadequate policies and procedures.

The CSA and CIRO found that 66 percent of the firms reviewed had inadequate conflict-of-interest policies and procedures, 53 percent had missing or incomplete disclosures, and 34 percent had failed to identify one or more material conflict(s) of interest.

The type of securities registrants the regulators assessed in the review included investment fund managers, exempt market dealers, investment dealers, mutual fund dealers, portfolio managers, and investment fund managers.

The CSA and CIRO found that conflicts tend to arise from internal compensation arrangements and incentive practices, including when compensation is tied to sales or revenue targets, client-account performance, client-generated fees and revenue, and bringing in new assets or clients. While the regulators understood that incentives allow firms to succeed, they said the internal compensation arrangements must be assessed through a conflict-of-interest lens.

The CSA and CIRO also found that conflicts arose from third-party compensation, proprietary products, fees charged to clients, supervisory compensation, director positions with issuers, referral arrangements, trading alongside clients, gifts and entertainment, and managing and distributing prospectus-exempt proprietary issuers.

While registrants should examine all practices giving rise to conflicts, the fees charged to clients are particularly important, says Mehrad. The CSA and CIRO had much to say about the controls, actions, or disclosures required where a registrant allows deviations from its standard fee schedule, changes the fee schedule, or charges new clients different fees than legacy clients. There is also detailed guidance on the level of oversight, controls, and monitoring required for referral agreements.

On January 1, 2023, the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) amalgamated and became CIRO.