Investment Suitability and Strategies

Suitability of Investments and Investment Strategies

• Registered Representatives (RRs) must understand the products they recommend or sell to clients
• Product due diligence and suitability assessment are important concepts
• RRs must meet general and specific regulatory requirements when purchasing and selling securities
• Know Your Product (KYP) is a critical concept alongside Know Your Client (KYC)
• Key transaction related topics for RRs:
  • Issuance of securities via prospectus i.e., new issue
  • Prospectus exemptions available to certain investors
  • Rules and processes for issuers purchasing securities of another issuer, i.e., take-over bid, issuer bid
• The registered representative must match a client’s needs and risk-return attributes of potential investments
• Important client investment variables to consider:
  • New security (primary distribution), length of time in existence
  • Price fluctuations, research evaluations
  • Firm approval for purchase
  • Training requirements
  • track record, and availability/reliability of corporate or market information
  • If the potential product is structured or synthetic
  • If the purchase is speculative

Transaction Considerations

• Structured and synthetic products require greater understanding

• Speculative investments generally have little to no history of earnings, and depend on unpredictable future events

• Matching a security's attributes with a client's needs is a key suitability standard

• Canadian Investment Regulatory Organization (CIRO) rules apply to accounts and individual orders

• Important questions to determine suitability:

  • Type of transaction
  • Purchase or sale
  • Use of borrowed funds
  • Amount of risk
  • Order size
  • Short sale
  • Issue review
  • Hedge or speculation

• RRs must answer "yes" to the questions:

  • Have I analyzed each factor professionally and competently?
  • Will I be able to defend the analysis as meeting an acceptable professional standard?

• Dealer member suitability includes the risk profile of the client and the account portfolio diverging over time.

• To deal with an unsuitable unsolicited order, advisors must:

  • Advise against the order
  • Recommend suitable alternatives
  • Document actions

• Day trading accounts should be assessed for appropriateness as well as the client warned about inherent risks

• Strict leverage limits and margin requirements must be implemented for day trading accounts

Know Your Client (KYC) Key Information

• Provide a copy of KYC information at account opening
• Consider client's:
  • Time horizon
  • Current investment portfolio composition
  • Risk profile
• Reassess suitability at prescribed triggering events and update the KYC profile for significant changes

Case Study Example

• Ben, an RR, gets a call from Sam, a 72-year-old client whose application describes his investment objective as income
• Sam wants to invest in penny mining stock based on a tip from his son-in-law, by liquidating all his T-bills
• Ben accepts the order, rather than doing his due diligence
• Ben violated due care requirements, by not ensuring Sam knew the risks of speculative stocks
• If the customers account objectives are not up to date they must be changed
• If the objectives are the same other alternative options must be sort or the order is to be refused

Compliance for RRs

• RRs have a responsibility to be competent in their recommendations

• Recommendations must be based on substantiated, relevant information

• Give balanced presentation to the client

• Disclose all relevant information, both positive and negative

• Be aware of new developments affecting client investments

• Do your own research if your research department does not follow a security and the recommendation is from you alone

• There can be no guarantees regarding:

  • Future market price
  • Dividends or interest
  • Ability to sell security at stated price (unless retractable or callable)
  • Exchange listing at future date

• Whether a transaction is recommended depends on analysis of all facts, determining if a reasonable person would have made a recommendation

Examples of recommendations

• Individually tailored information
• Using client data to target investment-related information
• Promoting a specific security or trading strategy
• A dealer member taking into account client objectives/financial situation for a specific transaction
• A client entering an order with the same dealer member online after an RR's phone recommendation
• The following have no bearing in determining whether a recommendation has been made:
• Supplying a waiver or disclaimer
• Charging a lower commission
• Classifying a transaction as buy or sell
• No previous relationship existed
• Discount brokers or Order Execution Only firms are still considered to be recommendations sometimes

Suitability Considerations for Institutional Accounts

• CIRO has minimum standards for institutional accounts but the approach is flexible
• Business activities must be reviewed to determine appropriate standards

Institutional Clients

• An institutional client as defined in the IDPC rules are:
  • acceptable counterparties,
  • acceptable institutions,
  • regulated entities,
  • registrants,
  • non-individuals with total securities under administration or management exceeding $10 million
• CIRO considers anyone on their platform to be a retail client, regardless of sophistication/securities under management/net worth
• Establish an institutional client’s level of sophistication
• Determine the suitable assessment owed to an institutional client

Product Due Diligence

• Firms must have a process in place to evaluate products permitted for sale by the firm and its RRs
• Guaranteed Investment Certificates (GICs), individual securities, and mutual funds are relatively straightforward
• Complex products require evaluation for placement on the product shelf
• Impose obligations for product sales (training, documentation, supervision)
• Understand construction/performance of investment products
• RR must explain new/non-traditional/complex/structured products because clients have a right to know what they're purchasing
• If a customer cannot explain the features and risks involved, the client will not be able to properly instruct the execution of the product

New Product Due Diligence

• NI 31-103 states a firm must take reasonable steps to assess products and approve their use before they are available to clients
• Firms must monitor securities for material changes
• Registered firms must ensure all steps are in accordance with the firms business model
• Policies, procedures and controls should also include proper relationship processes with clients
• CIRO considers the following components of an effective Product Due Diligence Process:
• Documented & Standardized approval process
• Staff preliminary assessment to determine if a new changes has occurred
• A formal decision determined by a senior member of the new product committee
• Qualified expertize
• Post approval follow up, including:
  • monitoring complaints on the security,
    • reassessment of training needs,
    • monitoring restrictions around sales of security,
    • periodic reassessments of the appropriateness of the security
• Dealer member must ensure the committee has documentation of the process and its decisions
• Committee members must have skills/experience need to conduct product review and cannot simply rely on others work
• Dealer members and RRs must always be keenly aware and acknowledge what is in the new product

Role of Exchange-Traded Funds (ETFs)

• RRs and Dealer members must know about their new products
• RRs also need to know the risk of non GIC and money market instruments in order to keep clients who have limited or no experience with high-risk products safe

Leveraged and Inverse Exchange-Traded Funds

• Guidance Note 20-0086 reminds investment dealer members of responsibilities when selling leveraged or inverse ETFs
• Leveraged and inverse ETFs are complex financial instruments because their performance can differ significantly from daily objectives over time
• Leveraged and inverse ETFs are generally unsuitable for retail investors planning to hold them long term, particularly in volatile markets
• Policies and procedures should be in place for leveraged and inverse ETFs, and should include: suitability, communication, and supervision

Assessing Suitability when using leveraged and inverse ETFs

• Dealer members must determine suitability and registered representatives must review the clients accounts
• Registered Representatives must understand features, risks, and designed performance, along with market volatility combined with leverage

Communication with the public

• Sales materials and oral presentations must be fair and balanced, discussing the risks and benefits involved
• Communications must not omit any material facts or qualifications

Communication with Dealer Members

• They must have a supervisory system that is under compliance with:
• Product suitability analysis for both member and client
• Accurate sales materials and fair information Also must align with all CIROs rules and meet all securities laws

Role of Principal-Protected Notes (PPNs)

• Guidance Note provide CIRO’s expectations when selling PPN by registered investment dealers
• CIRO acknowledges regulators allow specific PPNs to be sold by bank/deposit-taking institutions with no KYC or suitability obligation.
• However, other PPNs must be sold by registered dealers including CIRO investment dealer members.

RR dual employment regarding PPN

• RRs might be dually employed and sell PPNs through distribution channels
• CIRO requires that all sales of PPNs by RRs be conducted as an employee or agent of the dealer member.
• Requires policies and procedures to ensure oversight over activities involving PPNs.

Non-Arm’s Length Investment Products

• Dealer members must be aware of regulatory distribution concerns
• Concerns include conduct, issuer scrutiny, product review, conflicts of interest, suitability, disclosure, and protection fund coverage
• CIRO's expectations of dealer members and their sales:
• Perform product diligence by learning every aspect of the non-arm's length products they intend to distribute.
• Identify any conflicts and assess whether they can be addressed.
• Assess the suitability of client orders and RR recommendations.
• A trade gets completed provided it complies with applicable laws and SRO rules, and the conflict is addressed

New product due diligence deficiencies-IIROC targeted examinations:

• Lacking a clear definition of "new product”
• Lack of subject matter experts involved from all relevant areas and chief compliance officer
• No consideration of proficiency, training, or marketing issues
• Lacking a formal process to monitor customer complaints

Stanley an RR at ABC Financial Case Study

• Stanley, an RR, discusses investing in a takeover of a company with Felicia
• Felicia instructs Stanley to invest remaining margin in the companies shares.
• Stanley does not review the the details of the proposed take-over.
• Stanley's negligence makes him liable for her lost as he did not provide duty of care.
• Stanley must enlist the help of the firm's research department, and read up on financial industry news and seek help from supervisor to ensure compliance

New Issues and Prospectus Exemptions

• RRs must know the clients situation, explain products on sale including risks, and perform transactions in various conditions
• New Issues:
• Company raises equity capital by selling original security and gaining proceeds
• An initial public offering (IPO) occurs when a new company is raising equity for the first time.
• Filing a formal contract outlining the facts of the company for potential purchasers is required

Reporting issuers

• When a company is issuing additional security to the market this is a reporting issuer This is normally not detailed as the public has access to the reporting issuer details

• Dealer members may provide advice to help the issuer set and sell new security

• Dealer members are underwriting in this case

• The dealer may purchase the partially or wholly distributed portions

• This is known as a bought deal

• The dealer can also act as an agent

• This is known as a best efforts deal

Preliminary Prospectus

• Most provinces need both a preliminary and final prospectus to be filed
• Preliminary/red herring prospectus states:
  • It has been filed
  • It is not in final form
  • Subject to changes
  • Securities may not be sold nor can offers be accepted until until the administrative office has a receipt of the Prospectus
• Clients need to understand the finality of these prospectuses
• The purpose is to allow the distributor to:
  • Determines interests
  • Is reviewed by administrator
  • Before pricing/distribution of distribution amounts
• Must comply substantially with the requirements of securities legislation
• All of this will only contain necessary requirements
• May lack price information or report from auditor
• Agent must maintain security person sending prospectus, which need to be corrected if altered

Timeline Activities During the Waiting Period

• Waiting period happens between the release of a security product before the final prospectus is received
• Underwriters will have to ask for expression of interest during this period along with the preliminary prospectus

Timeline Activites After the Waiting Period

• Most situations relating to the the issuance of the securities are prohibited during this waiting period
• Except for advertising, publishing, offering a price In order for each prospect to be fairly valued

Final prospectus

• The final prospectus must have complete details in order to ensure full transparency of what is going to be distributed

What Must Be Disclosed

• Any fact that is expected to significantly affect value or price in security

• All must include: · Public Release Value · Proceeds of Insurance · Reductions with Underwriting · Additional in the process information

• Has to be signed by experts in the same field who have complied and agreed their own expertise

• A mailing of the final prospectus has to be sent to buyers

Prospectus Exemptions

• Also known as a exempt market:

  • Portion of capital markets of individuals who follow requirements in province they live in

• Considered to have a very low chance of loss in principle when it comes to the issuing of the securities and risk

• As long as there securities these companies in question, do not comply with, including:

• Preparing security/filing

  • Due Diligence Review with underwriter
    • Filing financial markets and other info with insurance regulators in security.

Rules by virtue of each nature for all those who meet requirements:

Issuers can now avoid expensive preparations, Securities can expect requalification or stats from the party who sold, with needing recourse in information

Exemption in category include for Nature/Resell:

Traders/Investors can follow under provision

• Trades and Investors are restricted at first

• List of type of issues for any investors: · Investors with accreditations, in Governments- they include companies who can take care of pensions

  • Wealthy investors sign risk and get approved

Requirements of Private Issuer

• Requirements include restrictions to companies as shareholders
• Securities must be eligible without

Family Friends and Associates

• They will be able to distribute securities by directors executive officers and controllers

Minimum investment from clients

• Includes the amount and the client
• Offering memorandum has to be in specific form

Crowdfunding exemptions:

• Security, is for early risers with securities
• Allows online funds, investors can receive
• Max Non accredited, is 2500
• 1,500, issuers

Resale or first trade exemptions:

This can resell after its set

Placement for Hot and Private Issues

• A good faith is needed to get investors to support issues with security and public to ensure that they're not buying ahead from non public investors

• Priority client is what matters in this case

• Terms of Definition apply to employees who work and do the purchase/sale for customers

• Client priority is needed and has to be communicated They can be accepted when the issue needs to announce releases. Clients come first

ERICA CASE STUDY

• Erica sold it away her clients believes she represents

• Is a risk and Civil action is to occur

• Knowledge is needed and written Supervision will take place with action, documentation and confirmation is to be made

• Underwritings To see what fits you best as to when the risk has happened With appropriate measures and knowledge

• Need all compliance codes and practices has happened

Take-Over and Issuer Bids

• When members and the other buy securities you'll know what you'll get

• Will let the the shareholders, the target company be safe with a equal opportunity to be told something

• Initial thresholds, before bid is early warring:

• This accumulates stock to potential customers

• One must disclose facts the second a press release to get involved.

• The person will have to release another until a further press administrator takes 2% to release requirements Offer must be there for 105 days unless given circumstance is there

Withdrawal to Securities

• The people will have to be offered with what they can win by bid and offer
• Under the the next day it the bid

Issuer bids

• Security owners who hold it must release some information

• Similar value is with overbit Will be sent to security to holders

• Reasons

• Benefits

• Values

• Issuers

• This allows offer to the expiries and conditions

• A circular can be prepared with intentions given in the next mailing.

Key Points

• Registered representatives must know the client and products they'll recommend
• Need take over and buy share etc
• Also need issuance to give to investors