IIROC New Product Due Diligence Regulatory Review – Common Deficiencies and Requirements for Written Policies, Procedures and Controls

Winter 2011 | Dwight D. Dee

In our Fall 2009 issue, we discussed the Canadian Securities Administrators’ (“CSA”) Staff Notice 33-315 entitled Suitability Obligation and Know Your Product (the “Staff Notice”) in which the CSA gave guidance to registrants with respect to the “know your product” and “suitability” requirements.  The Staff Notice was similar to the guidance given by the Industry Investment Regulatory Organization of Canada (“IIROC”) to its members entitled Best Practices for Product Due Diligence (IIROC Notice 09-0087) (the “Guidance Note”). In the Guidance Note, IIROC indicated that it would be performing compliance reviews based on the Guidance Note.

Recently, IIROC published a summary of the findings of their compliance reviews of IIROC members between March and May of 2010.  The goal of the review was to assess the extent to which Dealer Members incorporated the recommendations outlined in the Guidance Note and, in particular, assess whether the Dealer Members had adequate written policies, procedures, and underlying operational controls with respect to new products. The notice, entitled “New Product Due Diligence Regulatory Review – Common Deficiencies and Requirements for Written Policies, Procedures and Controls” (the “Review”), was published on August 31, 2010.

IIROC’s review found that a number of Dealer Members either did not have written policies or had deficient policies. These deficiencies include the following:

  1. Policies did not have a clear definition of a “new product”. Determining whether something is a “new product” is what triggers whether a specific product must undergo due diligence review.  IIROC has indicated that the definition adopted by Dealer Members should adhere to the guidance given in the Guidance Note in order that complex and non-transparent products having features such as embedded derivatives, variable maturities, complex fee structures or opaque assets should be captured in the definition and be subject to review.    The definition should also include details of when an existing product is modified in such a way that it should be subject to the due diligence review process.
  2. Policies did not have an appropriate level of internal review.   IIROC has indicated that policies should require, as a minimum, a written proposal and internal review by the firm’s Chief Compliance Officer.
  3. Policies did not have an adequate analytical framework for the assessment of whether a new product should be offered.  The Guidance Note provides specific examples of questions and considerations for this analytical framework.
  4. Policies did not provide for scenarios of conflict of interest and how the Dealer Member should address such conflicts.  For example, policies should outline specific steps as to what types of disclosure must be given if a new product is from a non-arm’s length issuer or if there are additional incentives for sales staff.
  5. Policies did not provide for a consideration of proficiency, training and marketing issues in the due diligence process.   For example, documentation of the features and risks of a “new product” should be properly tied into training.  Advisors and supervisors must fully understand the product in order to support the suitability of any recommendations made to clients.  Policies should address the need to continually review and revamp training and marketing materials.
  6. Policies did not include a process to monitor and review customer complaints with respect to “new products”.  In addition, policies did not have a proper process for monitoring compliance with any sale restrictions of “new products”.

Furthermore, IIROC’s review found deficiencies in operational controls of the Dealer Member’s policies and procedures.  These include (i) the absence of adequate controls underlying written policies; (ii) the absence of control methods to capture all sources of “new products”, whether through advisors or client deposits, (iii) absence of a standardized process necessitating a “new product” written proposal for internal review; and (iv) an absence of “new product” due diligence committee.

As part of IIROC’s review, IIROC sent participating Dealer Members suggested corrective action and will be ensuring that those Dealer Members make necessary improvements. Furthermore, IIROC’s Business Conduct Compliance Department has started referring any significant deficiencies in the “new product” due diligence process to IIROC’s Enforcement Department. Dealer Members should carefully review the Guidance and ensure that their policies and practice adhere to IIROC’s recommended best practices.

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