Product Due Diligence and Suitability: KYP

Product Due Diligence and Suitability Assessment

• Regulatory requirements exist for transactions, recommendations, and product types.
• Product Due Diligence and Suitability Assessment are related concepts.
• The topics apply for Registered Representatives.

Know Your Product (KYP)

• Understand the products that are being recommended or sold.
• Evaluate the products and strategies to see both are suitable for the client.
• KYC and KYP are critical concepts for Registered Representatives.
• Obligations extend to sales initiatives, training, and supervision for dealer members.
• As an RR, understanding these concepts is important to discuss them with the client.

Suitability of Investments and Investment Strategies

• During client discovery, match client needs to the risk-return of the security being recommended.
• Consider if a security is a new issue still in primary distribution.
• How long the product, company, or fund has been in existence
• Understanding of price fluctuations of the security, fund, or unit
• Research evaluation of the security or product to confirm what a RR feels about it.
• Confirming a firm has approved a product for purchase
• Determine if there are any additional training requirements for a product sale
• Understanding the company's track record, earnings, and dividend payments
• Determine how current, available, and reliable corporate and market information is
• Determine if the product is structured or synthetic.
• A purchase needs assessment if it's speculation.

Structured and Synthetic Products and Speculative Investments

• They require a greater understanding for investment returns.
• Both structured and synthetic products should be examined closely.
• Speculative investments have little to no history of earnings.
• Speculative investments are dependent on unpredictable future events.

Transaction Considerations and Suitability Standards

• Attributes and the client’s needs must be matched to variables in the nature of the trade.
• CIRO rules pertain to both accounts and individual orders.
• To match the attributes of a security to the client’s needs, ask these questions:
• Does the transaction involve a stock, bond, option, or futures contract?
• Is it a purchase or a sale?
• Is security being purchased with borrowed funds?
• What amount of risk is associated with the transaction?
• A thinly traded issue (i.e., an issue with little liquidity) being purchased?
• Short sale?
• Is the issue under investigation or review?
• Is it a hedge to protect an existing position, or is it speculative?
• All factors should be considered to properly evaluate suitability.
• RRs should answer "yes" to all the questions.

Dealer Member and Unsolicited Orders

• Obligations extend beyond the requirement to assess suitability.
• The intent is to provide added protection in situations where the risk profile of the client diverges over time.
• With unsolicited orders the advisor must advise against the order and recommend alternatives.
• Advisors must document any actions taken and not simply re-document.

Day Trading

• Determine if a day trading account is appropriate.
• Warn clients of the risks associated with day trading.
• Strict leverage limits via margin requirements must be implemented.

RR's Retail Responsibilities

• Provide each client with a copy of their KYC information at the time of the account opening.
• Consider elements, including the client's time horizon, current investment portfolio composition, and risk profile.
• Reassess suitability at the time of prescribed triggering events.
• Update the client’s KYC profile whenever there are significant changes to the account.

Case Study

• Ben accepts Sam's order without questioning, violating due care requirements.
• Ben should ascertain that Sam is aware of the risks with penny stocks.
• Ben has a duty to specify if the trade follows investment objectives.
• Ben must take measures such as recommending alternatives or refusing the order.

Suggested Compliance Conduct

• Make sure that every transaction is suitable for that client.
• Policies may require that RRs refuse unsuitable orders.
• It may be appropriate to contact a supervisor for additional discussion.
• Supervisors should document any conversation.
• Advise clients against unsuitable transactions based on account application.
• Update the account application.
• Clear the transaction with your supervisor before acceptance.
• If the order is accepted it should be marked “unsolicited”.

Rules for Recommendations

• An RR has a responsibility to ensure recommendations are competently made.
• Recommendations may be generated by the research department or otherwise based on relevant information.
• Before executing client trades, a balanced presentation disclosing all relevant information must be given.
• A RR must also make aware of new developments.
• The RR has a particular obligation to do their own research in cases where their research department does not follow.
• There can be no guarantees on future market price of a security if making a recommendation.
• Guarantees can not be made on future payments of dividends or interest.
• There can be no guarantees a client’s ability to sell a security at a stated price
• The recommendation should be based on any relevant facts.

Examples of Recommendations:

• Providing tailored information to a specific customer.
• Examining and client data to target investment-related information for the client.
• Promoting a specific security to a client.
• Taking into account a client's objectives with respect to a transaction.
• Entering an order online following an RR's telephone recommendation.
• Supplying a waiver, or charging a lower commission has no bearing in determining a recommendation.

Suitability Considerations for Institutional Accounts

• CIRO’s IDPC rules set out minimum standards for institutional account opening, operation, and supervision.
• The approach contained in the rules is flexible and will depend on the nature of business activities to determine the manner in approach is used.
• Most institutional clients make their own decisions, including evaluating product suitability.
• RR must establish an institutional client's level of sophistication from one product to another.
• Level of sophistication determines the suitability assessment owed to the client.
• There are Institutional clients with no suitability obligations if they're also permitted clients.
• It's crucial to categorize accurately.

Product Due Diligence

• There is regulatory to have a process to evaluate products.
• Products vary from guaranteed investment certificates (GICs) to more complex structures.
• Firms must also conduct an evaluation to determine if product should be placed on the product shelf and if it can be put up for sale.

Know Your Product (KYP) Obligation

• Before recommending any product, an RR must understand construction and how it is likely to perform in any market conditions.
• Clients have a rightful expectation of knowing what is being sold to them.
• Without this you can analyze suitability, nor explain the products risks/features.
• A client won't understand how you are executing a trade.

New Product Due Diligence

• A registered firm must take measures to assess and approve.
• Firms must monitor for significant changes.
• Policies, procedures, and controls relating to the KYP process in accordance with the firm's business model, securities offered, the proficiency of its registered individuals, and the nature of the relationships.
• Policies include assessing and approving securities available to clients, and monitoring changes to them.
• Guidance Note 3300-21-001, Product Due Diligence and Know-Your-Product, provides guidance to investment dealer members regarding the due diligence that must be conducted on all securities they make available to clients.
• CIRO considers the following a component: documented approval process, standardized for all securities, or alternatively for various defined categories of securities.

ETF Example

• A preliminary assessment by qualified staff to determine whether the proposed security is a new security or a significant change to an existing security, and the appropriate level of internal review and approval.
• For complex or novel securities, a detailed and documented review by an appropriately qualified and experienced committee or working group.
• Formal committee must include senior staff.
• Approved security must have post approval follow ups.
• Committee has done due diligence in the product evaluation.
• Members cannot rely on the work of others.
• Reliance is on issuers facts but only when not questionable.
• Illustrates the importance of dealer members and RRs knowing their new products.
• ETFs are similar to Mutual funds in their simplicity.
• High risk means RR needs keen awareness

Leveraged and Inverse Exchange-Traded Funds (ETFs)

• Guidance Note reminds members of sales practice obligations relating to leveraged and inverse ETFs.
• Leveraged ETFs are designed daily.
• Long term they differ.
• Unsuitable for retail investors with a long term volatile markets.
• Policies and procedures in place for supervisors.

Assessing Suitability for Leveraged and Inverse ETFs

• Dealers must determine suitability of transactions before recommending or accepting client orders
• RRs must ensure diligence.

Unsuitable Investments of Leveraged and Inverse ETFs

• Use due diligence.

Communication with the Public

• Present fair and balanced.
• No misleading.

Supervision for Leveraged and Inverse ETFs

• Supervise to ensure compliance.
• Provide appropriate product suitability analysis.
• Client-specific suitability analysis is a factor.
• Sales material must be accurate.

PPNs (Principal Protected Notes)

• Guidance Notes ensures expectation of Principal Protected Notes by Registered Investment Dealers.
• Regulators permit banks and other deposit-taking to be sold to certain PPNs.
• RR must conduct PPN sales as an employee.
• Dealer members provide policies to ensure oversight.

Distribution of Non Arm's Length Investment Products

• Dealer need to understand regulatory concerns.
• Concerns include: conduct, conflict, suitability and disclosure matters.
• Perform product due diligence.
• Identify any conflicts and assess.
• Assess client orders.

IIROC Targeted Examiner

• IIROC checks targeted examinations and have issued guides.
• Absent definitions of new products.
• Absent internal review.
• Absent consideration of profit.
• Absent a monitor.

Stanley Case Study and Prospectuses Exemptions

• RR didn't verify A and B.

Prospectuses Exemptions with Limited Capital

• Should be clear to RR.
• Need to know details and transaction conditions to sell or buy a business.
• Securities markets need a Prospectus.
• Securities should be sold at a company treasury.

New Issues/IPO's

• It's called IPO's when issuing for the first time.
• It outlines facts if purchase needs basing their decision.
• A company that's issuing into the market is a reporting issue.
• The prospectus might be less detailed for listing vs an IPO.

Public's Involvement in Offerings

• They may provide advice.
• Providing helps sell security.
• Purchases distribute individually.
• In cases the dealer acts as an agent with no guarantees.

Preliminary Propectus's

• Most issues require Preliminary and Final Propectus.
• Preliminary, a Red Herring (red ink) must cover the cover.
• Administrator needs approval
• Final Propectus should be in front of security purchase.
• Distributor can determine if any public interest exists.
• Preliminary may have exclude price auditor report.
• Distributors to maintain all reports.
• Administrator to determine defect, a revised version needs to be given.

Activities During Waiting Periods

• Solit expressions of interest must have copy.
• No other materials can be distributed.

Finalize Prospectus

• Needs to be complete details, and distribution.
• Has to be disclosed.
• Must have information.

Experts Signature

• They sign the Propectus for compliance.
• Propectus to all people being offered.
• Must reach them within 2 days of sale.

Stock Market Exemptions

• Where participation is restricted to individual's and that meets security rules.
• Or where securities are low risk.
• Market doesn't cover requirements for Filing, Involving or Reporting with regulators.

Nature and Specific Requirements, Exemptions, NI 45-106

• Exemptions avoid preparation in a costly way.
• Securities regulators expect one to buy and sell without needing to contain a Propectus.
• Purchases are restricted and you need to verify the amounts.

Selling Security Exempt

• Should take actions.

Exemptions Related for Raising and Reselling Capital.

• Trades are being restricted.

Investment Investors

• Accredited; financial investor, government, trust companies and weathly.
• Must sign form.
• Need evidence in supporting exemption.
• Doesn't exist in employees who restrictions.

Memorandum

• Issurer prepared memorandum.
• Purchase be signed, acknowledge the form.
• Propectus is not needed if cost is 150,000 payment in cash.

Crowdfunding in Canada

• Crowdfunding is the means to raise money.

First-Time Exemptions in Start Ups.

• No non-accredited group more than 2500 per distribution, group can't raise over 1,500,000.
• People need to sign risk.

Resale Trade Exemptions

• Generally you can sell acquired but can't sell until it has a season.

Hot Issues and Private Payments

• You need a great deal.
• Client priority is an issue.
• Clients should tell their availability through messages and mail.

Selling Away, or Cases outside

• RR outside doing business is not proper.

Takeover and Issuers Bids

• RR must find securities.

Takeover and Issuer Bids - Formal & Security Acts

• Its a bid over +20% in security.
• Should be equal opportunity.

Initial threshold - Early Warning Rule

• Accumulates to a take over bid, discloses immediately.
• They add obligation.
• You need to file release with administrator and repeat process with +2% change.

Early Legislation

• Acts and supplement NI 26-103 to NI 62-104.

Takeover Bid

• Securities deposited take 105 days.
• Rules must be followed.
• +50% share deposited.
• With 35 expire rule.

Security Holder with Deposits

• Security Holder can withdraw in certain circumstance at different times.
• Must provide the depository.
• They return shares to depositor.

Issuer Rules

• Similar to public but needs more.
• Provide the value on report and that must be summarized.
• Offers can occur in 35 days.
• Can take up to 10 days.

Summary

• RRs are required to know clients+products to give exotic products but must be suited appropriately.
• RR understand transactions.
• The Rules on issuer bids to buy share
• Next chapter learn order