Product Due Diligence and Suitability Assessment

Product Due Diligence and Suitability Assessment

• Registered Representatives (RRs) must understand product due diligence and suitability assessment.
• Regulatory requirements cover transactions, recommendations, and different product types.

Know Your Product (KYP) and Know Your Client (KYC)

• KYP has emerged with KYC, which are vital concepts for RRs.
• Obligations extend to dealer members regarding sales, training, and supervision.

Key Areas of Focus for RRs

• Need to understand the issuance of securities via prospectus, such as new issues.
• RRs must know about available prospectus exemptions for investors.
• RRs need to know about the rules and processes for issuers purchasing securities of another issuer or buying back their shares, such as in take-over bids or issuer bids.

Suitability of Investments and Investment Strategies

• The client discovery process fulfills Know Your Client (KYC) obligations.
• RRs must match a client’s needs to the risk-return attributes of investments like stocks, bonds, and mutual funds.
• Variables to consider include whether the security is a new issue, its history, and price fluctuations.
• Research department evaluations and compliance with firm policies must be considered.
• Company track records, corporate information reliability, and whether the product is structured or speculative should be considered.

Factors for Determining Suitability

• Consider if the proposed transaction involves stocks, bonds, options, or futures contracts.
• Determine if the transaction is a purchase or sale.
• Determine if borrowed funds are being used.
• The amount of risk, liquidity, and speculative nature of the transaction must be determined.
• Whether the issue is under investigation or review must be determined.
• Experts agree on considering these factors to properly evaluate suitability.
• All RRs must be able to confirm they have professionally analyzed each factor and can defend their analysis.

Compliance Beyond Recommendation

• Dealer member obligations extend beyond assessing suitability at the time of recommendation.
• This provides added protection when a client's risk profile diverges over time.
• For unsuitable unsolicited orders, advisors cannot just mark them as unsolicited.
• Advisors must advise against proceeding and suggest suitable alternatives.
• Actions taken must be documented, rather than simply re-documenting the account.

Day Trading Considerations

• It should be determined if a day trading account is appropriate
• Opening an order execution-only account should be considered for day trading clients
• Clients must be warned of the risks associated with day trading
• Opening an account requires strict leverage limits in the form of margin requirements

RRs Acting in the Retail Sector must

• Provide clients with a copy of their KYC information when opening the account
• Consider the client's time horizon, portfolio composition, and risk profile
• Reassess suitability upon triggering events
• Update the client's KYC profile when there are significant changes

Ben Case Study:

• Ben accepts an order from a 72-year-old retired client to liquidate T-bills for a penny mining stock without proper questioning
• Sam’s account objective was 100% income.
• Ben violated due care requirements because Sam was unaware of the nature of speculative stocks.
• Registered applications must be updated to reflect any change in investment objectives.
• Appropriate measures must be taken, such as recommending suitable alternatives or refusing the order.
• Policies may require refusing unsuitable orders or dealing with them carefully on a case-by-case basis, including informing a supervisor.
• Clients must be advised against unsuitable transactions.
• If they still insist, their objectives should be recorded, discussion should be documented, and the transaction must be cleared with a supervisor.

Recommendations & Due Diligence:

• RRs have a responsibility to make competent recommendations based on research or substantiated information.
• Before trading and disclosing all relevant information, both positive and negative, must be given to a client.
• RRs must do their own research when the research department doesn't follow a security.
• Guarantees regarding future market prices, dividends, or listing dates cannot be provided.
• Recommendations depend on analyzing all facts and circumstances.
• Examples of recommendations include tailored information, analyzing client data, and promoting strategies.

Factors not Indicating Recommendation

• Supplying a waiver is not a recommendation
• Charging a lower commission is not a recommendation
• Classifying a transaction as a buy or sell is not a recommendation
• The lack of prior relationships is not a recommendation

Institutional Account Considerations

• CIRO's IDPC rules set minimum standards for institutional account opening, operation, and supervision.
• The approach is flexible based on the dealer member, procedures, and its customers
• Business activities must be reviewed to determine the standards to be applied.

Institutional Clients and Suitability

• An institutional client is an acceptable counterparty, institution, regulated entity, registrant, or non-individual with over $10 million in securities under management.
• On the CIRO platform, individuals are retail clients, regardless of net worth or sophistication.
• Institutional clients typically decide on their own investments, but not all are knowledgeable.
• It must be ensured the level of sophistication of institutional clients determines the level of suitability assessment.
• Dealer members must conclude that institutional clients are capable of making independent investment decisions.
• Suitability obligations are not enforced for institutional clients who are also permitted clients who legally waive protections.

Product Due Diligence for RRs

• RRs must know their clients and the products they recommend.
• Regulators mandate that firms evaluate and permit products for sale.
• Simple products, such as GICs and mutual funds are sold with a prospectus

Product Evaluation

• Firms evaluate products, especially complex ones, before offering them
• Firms may impose training, documentation, and supervision obligations.
• RRs must understand product construction and performance in different market conditions.
• KYP is vital and should explain new or complex products.

Proper Knowledge

• Clients expect and have the right to know what they are purchasing.
• RRs cannot assess suitability or explain features/risks without adequate knowledge.
• Inability to explain prevents clients from instructing trades properly.

New Product Due Diligence

• NI 31-103 requires firms to assess and approve securities before offering them to clients, while monitoring for changes.
• Policies and controls are related to the KYP process and tailored to the firm, the individuals, and the client relationships.
• Effective product due diligence includes a documented, standardized approval process.

Effective Product Due Diligence Includes

• Assessing security is a new security or if an existing security is undergoing a significant change.
• Detailed review by a qualified committee for complex securities.
• Formal decision on securities made by a committee including senior staff.
• Post-approval follow-up, including monitoring complaints/grievances, training reassessment, compliance monitoring, and security reassessment.
• Dealer members must have proper due diligence and documentation.
• Committee members must have expertise, relying on issuer disclosures unless validity is questioned.

Exchange-Traded Funds (ETFs) as an example.

• RRs and firm knowing products.
• Leveraged ETFs using complex investment strategies are included.
• Highlighting importance is a must for RRs.
• One RR purchased leveraged ETFs for a client, and after a hearing, he was fined and suspended.

Leveraged & Inverse ETFs (LI ETFs)

• These are complex and designed to achieve daily investment objectives.
• Long-term performance can differ from daily objectives, making them unsuitable for retail investors.
• Sales practices for LI ETFs must have policies on suitability, communication, and supervision.
• Firms should assess suitability before accepting orders.
• RR reviewed account suitability including triggering events
• RR understand product features, risks, and benefits.

Unsuitable Investments

• It is the RR's due diligence to ensure that accepting orders are suitable for clients
• Clients must be advised against unsuitable orders

Communication with the Public.

• Communications must present fair and balanced pictures with risk and benefits
• Omissions can not occur

The supervision process

• Firms should have a supervisory system in place and it must ensure compliance
• Appropriate product suitability analysis must be completed.

The expectations for approval

• CIRO provides expectations, for selling principal-protected notes (PPNs)
• All sales must be sold through registered dealers, which include CIRO investments.
• Some RRs can be both financial institutions and investments.
• Features and risks are the same for all categories of PPNs
• Sales must be conducted in the RR's capacity as an employee or agent if the dealer member
• They must have adequate policies in order to ensure oversight.

Regulations related to the distribution process of Non-Arm's Length Investment Production

• Conduct related coverage suitability in this section's concerns include the following issues: interest, coverage, disclosure, product fund review, issuer scrutiny, and suitability
• The expectations of dealer members for the sales representatives is summarized in these three steps: distribute products, access whether they can be addressed, and perform product due diligence in the distribution process.

What may be completed for distribution

• Provided laws have identified conflicts
• And if the product is suitable for the client

5 Regulatory deficiencies

• Key deficiencies for the recommendation includes systemic issues, customer complaints, proficiency & training issues, and internal reviews

Failure to Apply Due Diligence (Stanley Case Study)

• Stanley fails to learn details about a company, and thus, failed to act in the client's best interest
• Registered representatives must apply due diligence in the investments made

Resources for Compliance

• RR should consult the firm’s research department and training for specialized products.
• Reading industry-relevant publications should be kept.
• When in doubt, contact a supervisor

New Issues and Prospectus Exemptions

• RRs must know a client’s situation and explain products, including complex ones.
• It is a must to understand how the business works in various conditions
• This includes various and specific types of investors, the issuance by securities of the prospectus and the new issues.

The meaning of (IPO) initial Public Offering and the new issue

• For the first time, a company is issuing securities
• When equity is raised and capital in the marketplace, it is also issuing securities in treasury.
• Prospectus must be filed with regulators
• Outlining a purchaser base decision to buy securities and can also be considered is that purchase is essentially, a mutual fund

Reporting issuer

• The issuance of additional securities into the marketplace is a company
• It can be less detailed in which a company might be considering to be an IPO
• It requires to be normal, for a process that can determine to be an exemption

Underwriting

• Dealer Members may be involved by offering many new types of securities or advice
• The actual distributor provides securities to individual investors
• In order to be able to fulfill orders, a best efforts order is the term for a deal on what is attempting through selling

Preliminary and Final Prospectus Filings

• Both are required by most provinces
• A "red herring Prospectus" is the filing for the red ink aspect of the prospectus filing.
• It contains a statement with being red ink "is subject to change" in regard to the amendment
• The security requires it to be accepted and for an administrator offer

Permitted Activities During the Waiting Period

• The underwriter requires it to be expressed from what is expressed when under solicitation
• Expressing that a copy of the person "is being solicited or not, requires to be provided"

What is restricted in the waiting period

• For an agreement with a client, a dealer member may not enter the information.
• The publication will consist of "the issuing and proposed identification"

Information for a final prospectus.

• Requires complete accurate information from which has been provided on request
• This relates to value and market pricing from what reasonably could be expected.

The List of information must include:

• The Price of the offering of Public
• A percentage of the sellers security holders
• A discount from which requires experts

Prospectus Exemptions:

• Refers to that place of the capital markets, which are restricted and identified
• States or has claims that " the residency cannot be in terms for Principal loss "

Exemption requirements applicable to the market

• Regulations for filing and preparing
• Must follow financial compliance reports
• Obligations involving a review that needs due diligence.

Avoiding prospectuses

• Regulators expect the required qualifications will ordinately be needed
• A seller must take reasonable steps
• Securities and trades are needed too to comply with these rules.

Exemptions Related to Raising Capital

• Exemptions in this category relate either to the nature of the securities or trade. Trades acquired under the are subject to resale restriction of the period and specific exemption rules apply to certain investors such as certain investors

Accredited investors consist of:

• Funds , governments, regulated pension funds
• Must also sign a "risk acknowledgement form"

Exemptions consist of:

• A Private issuer or family Member exemption

Reselling & trading exemptions

• Reselling: Unless otherwise exempted unless they previously "acquire security and cannot exempt one being sold, resale can be restricted"

Rules for Hot Deals and Placement:

• CIRO does requires certain actions be had and done
• Which also does include employees and also requires if there were to be restrictions, to not " buy ahead "
• Priorities should be in mind for what can't happen, for these restrictions

Erica Case Study:

• Erica believes the transactions are a private arrangement, but the clients may believe she is acting as the dealer member’s representative.
• Erica must have a good standing with the proper supervisor for taking client requests
• Otherwise, this can mean that the registered representative is creating a " selling away " situation
• With the proper supervisor present, one can confirm the " correct " procedures are being adhered to

Take-Over and Issuer Bids Introduction

• As a RR, you must also understand when the issuers buy up the securities or buy its own shares but also " know the advise "
• An offer for taking up equity or securities must consist of at least 20% when trying to take up such a bid. They offer a safeguard with equal opportunity.

When in a Early Warning:

• Securities legislation has a threshold. That alerts the public.
• It must give an alert for the public or person if something leads something else.

The legislation

• Extends to convertible or change when they can no longer meet the 2% requirements

Conditions for applying securities from which have been obtained in bids.

• Conditions that are to be waived
• The security amount must be " outstanding bid "
• A period of 105 or more amount of days

The rights for withdrawal

• If the shares are taken over, the person has the right to 3 days to withdraw, if unpaid
• Any securities must be given 10 days from what is required
• The " with drawl " may withdraw with notice, which will then be required by the shareholder.

Restrictions on Issuers

• The restrictions require if all provinces are in conflict, to be offered and the circular required for disclosures for everything to be " transparent "
• Issuer Bids, as they have been defined, consist of being included after requirements " that doesn't cause debt "
• Disclosure also must be made for the " valuations or security to provide "

Exemptions from Regulations

• To recognize that the issuer may provide a requirement based on previous filings
• With this, public press must be offered through its security.