Investment Suitability: CIRO Guidelines

Chapter Overview

• This chapter covers product due diligence and suitability assessment, regulatory requirements for transactions and recommendations, and different types of products.
• Discusses transaction-related topics relevant to Registered Representatives (RRs).

Suitability of Investments and Investment Strategies

• Registered Representatives must match client needs to the risk-return attributes of investments.
• Important variables include whether the security is a new issue, its track record, and if it's speculative.
• Rules from the Canadian Investment Regulatory Organization (CIRO) apply to both accounts and individual orders.
• Considerations include stocks, bonds, options, futures contracts, margin use, risk amount, liquidity, short sales, and speculative intent.
• Advisors provide added protection in situations where a client's risk profile and account portfolio diverge over time.
• Advisors who receive unsolicited orders that are unsuitable must advise against them and recommend alternatives, documenting their actions.
• For clients intending to day trade, accounts should be assessed for appropriateness and risks, and leverage limits must be implemented.
• RRs in the retail sector have to provide KYC information, consider client time horizon and risk profile, reassess suitability at triggering events, and update KYC profiles to account for significant changes.

Case study | Ben

• RR Ben took an order to liquidate T-bills and invest in a speculative stock from a 72-year-old client wanting a 100% income.
• By accepting this order, Ben violated due care, as he required a duty to ascertain that his client named Sam was aware of the risks associated with speculative stocks given Sam's significant departure from his established low risk strategy
• He must ensure compliance by advising clients against unsuitable transactions, documenting changes to investment objectives, and clearing trades with supervisors/compliance departments.

Rules Regarding Recommendations

• RRs must ensure the recommendations to clients are competently made
• Recommendations can be generated by a research department or be based on information that can be substantiated
• Before a client executes a trade, the client must be given a balanced presentation that discloses all relevant data.
• RRs must be aware of new developments that may affect a client's investments
• Guarantees regarding the future market price of a security, future payments of dividends or interest and the listing of a security are prohibited
• Whether a transaction is recommended relies on the analysis of all relevant facts and circumstances of each case
• Providing individually tailored information, examining client data, promoting strategies, considering client objectives, and a client ordering online are all considered providing recommendations.
• Giving a waiver or charging lower commission is not providing a recommendation
• Discount brokers may still be considered providing recommendations depending on facts

Suitability Considerations for Institutional Accounts

• CIRO's IDPC rules set minimum standards for institutional account opening, operation, and supervision.
• The approach is flexible and is dependent on the dealer member, its procedures and its customers.
• An institutional client is defined as acceptable counterparties, acceptable institutions, regulated entities, registrants, or non-individual with securities under management exceeding $10 million.
• CIRO considers all individuals retail clients, regardless of net worth or sophistication.
• Advisors ensure that clients are accurately categorized so that they are not charged suitability obligations that do not apply to them

Product Due Diligence

• RRs must know the products they introduce and recommend
• Regulators require firms to evaluate which products are permitted for sale and document on what basis
• Must understand how a product is constructed and how it performs in various market conditions (Know Your Product (KYP)).
• Complex or structured products require especially proper explanation.

New Product Due Diligence

• Registered firms must assess and approve securities before making them available to clients and monitor them for significant changes (per NI 31-103).
• Firms should have appropriate processes for assessing and approving securities, as well as monitoring for significant changes (KYP process).
• CIRO follows a documented approval process, a preliminary assessment, a documented review and follow-up and assesses the appropriateness of a security
• The dealer member must perform due diligence and have appropriate measures in place
• Exchange-traded Funds (ETFs) are similar to mutual funds, but more complicated
• There was a case where a RR purchased high-risk securities for a client needing GICs and was fined $40000 and suspended for 6 months

Leveraged and Inverse Exchange-Traded Funds

• Certain funds are highly complex financial instruments that achieve their goals on a daily basis
• Longer periods of time will differ from stated objectives and are generally considered unsuitable for retail investors who stay volatile in the market for a longer period of time
• RRs must determine the suitability of transactions before recommending/accepting a client's order
• Before accepting a client's order, RR must fully understand the client's position
• Sales materials must give a fair and balanced picture of the risks and benefits
• Member dealers must have a supervisory system in place to ensure compliance with rules/securities laws

Sale of Principal-Protected Notes by Approved Persons

• CIRO acknowledges that regulators allow PPNS to be sold with no KYC or suitability obligations by banks. However, must be sold only through registered investment dealers

Distribution of Non-Arm's Length Investment Products

• Regulatory concerns are on conduct, issuer scrutiny, product review, conflicts of interest, suitability, disclosure and protection fund coverage
• Dealer members and sales representatives are expected to perform product due diligence, identify conflicts, and assess suitability
• IIROC (now CIRO) did a review and issued key deficiencies like, not defining new product, not having an internal review and not having training and marketing issues

Case study | Stanley

• RR Stanley received a call from client Felicia regarding speculating on an auto part manufacturer
• Stanley learned through a research source, two weeks after buying Class B shares, that the takeover was aimed at voting shares and that Felicia did not profit
• Stanley was negligent and failed to act in Felicia's best interest and will be held responsible
• RRs must apply diligence in investing appropriate and recommended recommendations
• The firm's research departments can compile up-to-date data on various companies

New Issues and Prospectus Exemptions

• RRs need the knowledge and ability to explain products sold
• Explain how transactions work in various conditions
• New issues occur when securities are issued from the company treasury and proceeds go to the company, a prospectus first gets filed with the regulators

New Issues, Reporting Issuers and Underwriting

When a company is issuing securities for the first time an issuer files a prospectus with regulators to facilitate an initial public offering (IPO).

Preliminary Prospectus

• Most provinces mandate that both preliminary as well as final prospectuses be filed
• The preliminary prospectus, called red herring prospectus, needs a statement (in red) indicating that it is not in its final form.
• Final purchase decision relies on the final prospectus
• The distributor also needs to see the amount of public interest while being reviewed
• Agent/underwriter need persons receiving the preliminary prospetus
• When the info changes, a revised preliminary needs to be sent
• Waiting Period: Period from receipt to a final prospectus
• Underwriters can solicit interest from potential buyers and give information if solicited/unsolicited

Final Prospectus and Material Facts

• A final prospectus involves complete information needed for a security being distributed
• A material fact is when the fact affects the market price or value
• Prospectuses must be accompanied by the consent of experts, appraisers and lawyers to indicate compliance
• Sent to all purchasers within the second business day

Propectus Exemptions

• The Exempt market is when participation is restricted to certain individuals and securities of lower risk that are residents of a territory
• There is no need to file financial/other reports with regulatory requirements

Exemptions Related to Raising Capital

• Purchases are generally subject to resale restrictions like hold periods
• Sellers of exempt must take reasonable steps
• Exemptions relate to the nature of the securities, the trades, or the resale
• Trades acquired are subject to restricted period of resale
• Accredited investors: Financial, institutions, certain regulated, investors who own over a million, must sign a risk acknowledegment form

Private Issuers, Family Friend and Business, Offering Memorandum

• Private Issuer: Limited to people to 50 shareholders and restrictions on transfers
• Family friends and business associates: Allows issuers to distribute to executives, associates as well as other members
• Offering Memorandum: Issuers must prepare a document that follows prescribed form or right of action, retained for eight years.
• Minimum Amount: Not required if the purchaser is 150,000, restricted to non-individuals

Exemptions Related to Crowdfunding

• Regulators introduced crowdfunding for early stage companies
• Investors have to sign a risk assessment
• Single non-accredited can't give more than 2500 per distribution and 1,500,000 on average
• 48 hours to withdraw

Resale or First Trade Exemption and Hot Issues / Private Placements

• Unless exempted, security cannot be sold until seasoning (restricted) is passed
• Hot issues happens when there is a great demand on securities
• Client priority is relevant in this, excluding dealer/institutional member employees
• Priority is also in private placements and general availability

Erica Case Study | Erica

• RR Erica with client Antoinette, is approached for equity investment in Toyco Inc.
• Erica is impressed by profit and invests 10,000 of her own money for shares
• Erica then has 5 more clients invest with checks payable to Toyco, receives certificates and felt she had no need to advise her supervisor
• She may be acting on part of a dealer's arrangement and exposing clients to unknown risks and civil liability
• Private can be typically ricker and can be a conflict of interest
• Firms need to knowledge and consent to any arrangements

Take-Over and Issuer Bids

• As an RR must understand rules and processes involving issuers purchasing securities of each other or buying back shares, to give proper advice.

TAKE-OVER BIDS

• A formal take-over bid is an offer to acquire at least 20% of the equity securities of a target company, provisions are the Acts
• There needs to be equal opportunity for all shareholders to make an informed decision.

EARLY WARNING RULES

• Securities legislation provides for early warning for accumulating stocks that can be a take-over
• Disclose with a press when the company accumulates 10 percent or more of a voting company
• Issue and file a press to the administrator when rising over 2 percent and repeated until rising over 20

TAKE-OVER BID RULES

• The offeror need wait to be deposited for at least 105 days
• All the terms have been waived
• More than 50 has been deposited and not withdrawed

WITHDRAWAL RIGHTS

Shareholders depositing shares may withdraw in these circumstances

• any time before the bid expires being 35 or 105
• After 45 when the offfer has not been taken up
• After 3 days when purchasing hasn't paid
• A circular sent to security holders must disclose such
• Reasons for the bid
• Benefits to insiders
• The issuer's dividend policy
• any prior valuations made in 24 months

ISSUER BIDS

• With takeoff, asks all provinces contain certain things relating issuer bids like offers made by issuers to get securities An issuer bid must present a circular that reveals
• Reasons for the bid
• Benefits to insiders
• Issuer's dividend policy
• Valuations in past 24

NORMAL COURSE ISSUER BIDS

• an issuer's bid won't from the provisions if with an Exchange rules
• Submit with an exchange
• Issuing press releases