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.

Disclaimer

This publication is provided as an information service and may include items reported from other sources. We do not warrant its accuracy. This information is not meant as legal opinion or advice.

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