requests comments on draft guidelines on KYC and suitability
On October 2 IIROC published a draft guidance note on KYC and
suitability obligations, seeking comments by December 16, 2009. Comments can be sent in writing or by
Sherry Tabesh-Ndreka, Policy Counsel
Investment Industry Regulatory Organization of Canada
121 King Street West, Suite 1600
Toronto ON M5H 3T9
The following items in the proposed guidelines warrant careful
consideration and possibly comment by retail advisory dealers.
1. The proposed guidelines would drastically restrict the use of a
portfolio approach to KYC and suitability.
The proposed guideline
includes an IIROC "position" which is couched as an interpretation rather than
a guideline. It would permit the
use of a single new account application form only when:
The client's investment objectives and risk tolerance are identical for
all of the accounts covered by the application;
In the case of
individuals, the beneficial owner is identical for all of the accounts or in
the case of non-individual accounts, the entity is identical for all of the
The client understands that the accounts on the
same account application will be assessed for suitability on a multiple account
or portfolio basis; and
The Dealer Member has the ability to conduct
supervision, including reviewing orders for suitability and updating KYC
information, on a multiple account or client basis.
The first point contradicts the third and
fourth. There is little point in
having multiple new account forms when taking a portfolio approach to
suitability across multiple accounts.
This is a more restrictive approach than was
taken in the proposed new account application requirements and guidelines developed
in consultation with the IDA Compliance and Legal Section. Those requirements were passed by the
IDA Board in April, 2006 to replace Form 2, but have been withdrawn from the
CSA approval processFF. In brief, that
proposal required clarity on which clients and/or accounts were covered by the
application details and whose investment knowledge was being assessed. It also
required that the relevant information be usable in the dealer's supervision
The proposed guidelines are also inconsistent
with the following guidance in section 13.1 of the Companion Policy to National
Instrument 31-103: Registration Requirements: "If a client is opening more than
one account, the registrant should indicate whether the client's investment
objectives and risk tolerance apply to a particular account or to the client's
whole portfolio of accounts."
This aspect of the notice is also a departure
from the principles-based approach, which would permit a dealer to take a portfolio
approach across an individual's or household's accounts provided that the objective
- suitability of the portfolio - was attained.
proposed guidelines state that a client's investment objectives and risk
tolerance must be reasonable.
requirement for multiple forms when accounts have different investment
objectives and risk tolerance will limit flexibility on which accounts to use
for particular types of investments within a portfolio, for example changing the
asset mix in Canadian and US funds accounts while maintaining suitability
across the portfolio. One or both
of the accounts could falsely appear to be unsuitable judged against the
separate account applications, even though the portfolio is not.
proposed guideline also prohibits the use of a household portfolio approach
because each member of the household and any accounts in which they have
differential interests have to be considered separately rather than as an
legitimate reasons such as tax considerations for concentrating one type of
investment in the account of one member of a household and another type in
another member's. When that
approach has to be reflected in separate forms, it could result in a false
appearance that the objectives for the account of one household member are inappropriate.
appears on Page 3 of the guidelines:
Know your client
Registered Representatives are reminded that the
client's investment objectives, and risk tolerance must be assessed based on
the client's financial and personal circumstances. The stated investment objectives
and risk tolerance must be reasonable in light of those circumstances.
It has been recognized in previous
disciplinary decisions that appropriateness and consistency with investment
objectives are different standards.
A client is entitled to have investment objectives and risk tolerance
that someone else would consider inappropriate to their financial and personal
circumstances, but that is the client's privilege.
This approach is
reiterated in the discussion of suitability analysis on Page 4 of the proposed
guideline, where the draft guidance suggests that the suitability of certain
types of accounts "(margin, trust, options accounts, etc.)" should be
assessed. This again suggests a
standard that may not be reasonable in all circumstances. As examples:
dealers have all clients open margin accounts as a matter of convenience should
the client ever want to use margin, while recognizing that its use is not
appropriate to all and should be considered in assessing the suitability of
specific recommendations, trades or accounts.
An RR commenting on the suitability of a
trust account risks overstepping the bounds of his or her expertise.
The proposed guidelines will in effect
prevent the dealer or RR from accepting an account if the dealer or RR concludes
that the client's investment objectives and risk tolerance are inconsistent
with his or her financial position, even after advising the client
appropriately and then only accepting unsolicited orders.
This result is also unfair to the
client. While such a client can,
of course, use a discount broker, the guideline would prevent him or her from
opening an account with an advisory dealer who would give much needed warnings
about the risk of particular investments or strategies.
While a dealer or RR may have to consider
extra self-protection where the client's self-generated objectives and risk
tolerance are inappropriate, and should refrain from making specific recommendations
in pursuit of a course of investment that the dealer or RR considers.
imprudent, the guideline suggests that it would be improper to open the account
proposed guidelines include as "best practices" recommendations that go beyond
the proposed Client Relationship Model rules.
that the suitability obligation in Regulation 1300 relates to recommendations
to a client, the proposed guidelines suggested as a "best practice" a periodic
enquiry about changes in the client's circumstances and a periodic review of client
accounts, both to be done at least annually.
There are certainly many clients whose
circumstances can be expected to change little from year to year and whose
portfolios may also change little.
A perfectly reasonable practice might take account of different classes
of clients or objectives while deviating from the proposed "best practice"
Similarly, the draft guideline notes that the
proposed Client Relationship Model (CRM)FF rules are pending. Under those rules suitability has to be
reviewed after certain triggering events, but there is no requirement for a
Section XX05(2)(c)(III) of the proposed CRM rule
requires a disclosure of whether or not the dealer will reassess suitability "in
the case of other triggering events not described in Rule 1300.1(r) and, in
particular, in the event of significant market fluctuations," but does not
require disclosure as to whether the dealer will conduct a periodic review.So
"Best practices" are guidelines, but can be
perceived to be more like hard standards and therefore have to be crafted
carefully. They can be raised in
civil actions or arbitrations where the adjudicator may not be attuned to how
far a reasonable practice may deviate from a "best" practice.
The guidance might benefit, therefore, from a
broader discussion including not just "best practice" but also acceptable
alternatives and factors to be considered in deciding what approach to take.
these issues are of concern to you, Sutton Boyce Gilkes Regulatory Consulting
Group can help you draft a comment letter.
staff would not recommend approval because the proposed rule did not require
that the client sign the form, only acknowledge in some form the accuracy of
See HUIIROC Rules Notice 09-0120UH, April 24, 2009