KYC, Suitability, Accredited Investors, Permitted Client:
What is an exempt market dealer required to do?
implementation of National Instrument 31-103 - Registration Requirements and Exemptions (NI 31-103) introduced the
exempt market dealer registration category. Although there are new standards to
be met, the requirement to be registered is not a new concept for limited
market dealers in the provinces Ontario and Newfoundland and Labrador. The
biggest change for former limited market dealers and exempt market participants
is in the compliance area and in particular, the treatment of investors as
clients. Exempt market dealers (EMDs)
should not expect the light-touch regulatory approach previously taken by the
securities commissions with respect to limited market dealers and exempt market
participants. The fact that the Ontario Securities Commission has created an
Exempt Market Dealers division in the Compliance Branch is indicative of a
higher-touch regulatory approach.
1. Know-Your-Client Information
One of the
most important requirements is collecting know-your-client (KYC) information. The KYC obligation is
an exercise in due diligence that protects the client, the EMD and the
integrity of the capital markets.
registrants act as gatekeepers of the integrity of the capital markets. They
should not, by act or omission, facilitate conduct that brings the market into
disrepute. As part of their gatekeeper role, EMDs are required to establish the
identity of, and conduct due diligence on, their clients This includes the
requirement to make inquiries if a EMD has a cause for concern about a client's
reputation. The EMD must make all reasonable inquiries necessary to resolve the
concern, for example, determining the nature of the client's business.
KYC information forms the basis for determining whether trades in
securities are suitable for investors. The client's investment objectives, and
risk tolerance must be assessed based on the client's financial and personal
circumstances including time horizon. The stated investment objectives and risk
tolerance must be reasonable in light of those circumstances.
EMDs must take
reasonable steps to establish whether the client is an insider of a publicly
traded company or other entity. This includes domestic, foreign, exchange
listed and over-the-counter markets. It does not include issuers whose
securities have been distributed through a private placement and are not freely
KYC is also
collected for detection of money-laundering or terrorist financing and verification
of a client's identity is important in this respect[i].
There are also special requirements
regarding politically exposed foreign persons to prevent corruptly derived
funds from entering the Canadian market. EMDs are required to implement a risk assessment
program to identify businesses or clients that present a high risk of money
laundering, a training program for employees and a biennial audit of anti-money
laundering policies and procedures.
The regulations regarding identity verification are complex,
particularly for non face-to-face clients. Guidance from the Financial
Transactions and Reports Analysis Centre of Canada, the Federal agency charged
with ensuring compliance with the requirements, can be found at http://www.fintrac-canafe.gc.ca/re-ed/sec-eng.asp.
maintain written records of this information, usually in a new client account
the size of the firm, it is not appropriate to keep mental records or say "I
know Pat" and not have a written record the KYC information.
required to make reasonable efforts to keep their clients' KYC information
current. Since many EMDs only occasionally recommend trades to clients, they
should ensure that the client's KYC information is up-to-date when a trade is
made. FINTRAC has the authority to conduct audits of dealers and assess
penalties for non-compliance as high as $500,000 for a very serious violation.
EMDs must take
reasonable steps to ensure that a
proposed trade is suitable for a client before making a recommendation or
accepting instructions from the client. A client's investment objectives, risk
tolerance, investment knowledge and financial situation must be considered when
assessing suitability of trades and recommendations. Even in the institutional
setting, a Representative must make an assessment that products falls within
the client's expertise.
The suitability assessment obligations include a requirement to know and
understand the risks, key features, and initial and ongoing fees associated
with any product recommended to clients. To meet this
suitability obligation, EMDs should have in-depth knowledge of all products
that they buy and sell to their clients. This is often referred to as the "know
your product" or KYP obligation. EMDs have
the responsibility to assess the risks associated with the products that they
addition, EMDs must have reasonable grounds to believe that all material facts
of the investment are adequately disclosed in the offering documents. The EMD must conduct the necessary due
diligence to reasonably satisfy themselves that the disclosure is appropriate.
Individual representatives should understand, and be able to clearly
explain to clients, the reasons that a specific security is appropriate and
suitable for the client. Suitability obligations cannot be delegated.
There is no requirement to make a suitability
determination for a client that is a registered dealer, portfolio manager or
investment fund manager, a Canadian financial institution or a Schedule III
There will be occasion when an EMD determines a
trade is unsuitable for a client. In those cases the EMD must inform the client
that the trade is not suitable in the opinion of the EMD and must not make the
trade. However, the client can still instruct the EMD to make the trade after
receiving the warning that the trade may not be suitable.