Sales and Trading Suitability Requirements

Suitability Requirements For Sales And Trading

• Registered Representatives (RRs) must understand product due diligence and suitability assessment
• RRs must understand the products they recommend
• RRs must evaluate products and their related investment strategies
• Know Your Product (KYP) is a critical concept for RRs, along with Know Your Client (KYC)
• Know Your Product (KYP) and Know Your Client (KYC) also apply to dealer members regarding sales initiatives, training, and supervision.

Identifying Suitability

• Matching a client's needs to the risk-return attributes of investments such as stocks, bonds, and mutual funds is an integral component
• Variables to consider include if the security is a new issue still in primary distribution

Transaction Considerations

• Suitability standards require matching a security's attributes with a client's needs in relation to the nature of the trade
• Canadian Investment Regulatory Organization (CIRO) rules apply to both accounts and individual orders
• Questions to ask to determine suitability:
• Does the proposed transaction involve a stock, bond, option, or futures contract?
• Is it a purchase or a sale?
• Is the security being purchased with borrowed funds?
• What amount of risk is associated with the transaction?
• Is it a large order in a thinly traded issue?
• Is it a short sale?
• Is the issue under investigation or review?
• Is it a hedge or is it speculative?
• Industry experts mostly agree that all factors must be considered to properly evaluate suitability
• Advisors must take appropriate measures to deal with unsuitable orders, including advising against the order and recommending suitable alternatives

Retail Sector Requirements

• RRs in the retail sector must supply each client with a copy of their KYC information at the time of the account opening
• RRs must also consider elements, including the client's time horizon, current investment portfolio composition, and risk profile, to assess suitability
• The client's KYC profile must also be updated whenever there are significant changes to the account.
• Suitability must be reassessed at the time of prescribed triggering events

Ben Case Study

• RR Ben accepted an order without questioning it and violated the requirements for due care from a client
• The client wanted to liquidate T-bills and purchase an speculative mining stock
• Ben failed to ensure the client was aware of the risks associated with speculative stocks
• Ben should have told the client the trade did not conform to the investment objectives that were specified

Ensuring Recommendations

• As an RR, you have a responsibility to ensure that recommendations are made competently based on relevant information
• A balanced presentation must be given to the client and must disclose all relevant positive and negative information
• The RR must also be aware of any new developments that may affect a client's investments
• Assurances or guarantees cannot be made in respect to:
• The future market price of a security
• Future payments of dividends or interest
• The client's ability to sell a security at a stated price (except for retractable or callable securities)
• The listing of a security on an exchange at a future date
• Whether a particular transaction is recommended depends on an analysis, should be based on whether a reasonable person would make such a recommendation in similar circumstances

Scenarios That Constitute A Recommendation Include

• Providing information that is individually tailored to a specific customer or class of customers
• Examining data on clients' habits, investment preferences, and past investment decisions, and using this information to target investment-related information
• Promoting a specific security or trading strategy
• A dealer member considering a client's objectives and financial situation
• Client placing order, and RR following up via telephone

Scenarios That Do Not Constitute A Recommendation Include

• Supplying a waiver or disclaimer that the provided information is not a recommendation
• Charging a lower commission
• Classifying a transaction as a buy or sell
• The fact that no previous relationship existed between the dealer member and the client

Suitability Considerations

• Ciro's IDPC rules set out minimal standards for institutional accounts, procedures, and customers

Institutional Clients

• Most institutional clients make their own investment decisions, including evaluating suitability

Institutional Client Definition

• An institutional client is defined in the IDPC rules as
• Acceptable counterparties
• Acceptable institutions
• Regulated entities
• Registrants (other than an individual registrant) under securities law
• A non-individual with total securities under administration or management exceeding $10 million

Know Your Product (KYP)

• The regulators require firms to have a process to evaluate which products are permitted for sale
• Regulators require that firms have a process to evaluate the basis upon which they are permitted for sale
• Firms may impose other obligations, including training, documentation, and supervision
• RRs must be able to explain new, complex, or structured products
• Without knowledge of the product, neither it's suitability nor the characteristics and risks can be explained

NI 31-103

• Under NI 31-103, firms cannot make securities available to clients until they have taken reasonable steps to assess their important aspects as well as approve them
• Firms must establish, maintain, and apply policies, procedures, and controls relating to the KYP process plus monitor the securities for significant changes

Product Due Diligence

• CIRO advises investment dealer members regarding the due diligence to be conducted on all securities made available to clients
• Effective product due diligence consists of a documented approval process, standardized for all or specific securities
• Should include a preliminary assessment by qualified staff, and a detailed documented review for complex securities
• A formal decision on the security by a new product committee or other authorized group that includes senior staff must be made

Key Deficiencies And Recommendations

• Key Deficiencies Discovered from IIROC (now CIRO) product due diligence included absence of
• A clear definition of "new product"
• An Appropriate level of internal review
• Consideration of proficiency, training, and marketing issues
• Formal process to monitor and review issues

Exchange-Traded Funds as an Example

• Exchange-traded funds (ETFs) provide a good illustration of the importance of members and RRs knowing their new products
• Some ETFs are complex structured products that use leverage and sophisticated strategies

Guidance Note 20-0086

• Guidance Note 20-0086 reminds members of their sales practice obligations relating to leveraged and inverse ETFs
• Leveraged and inverse ETFs are generally considered unsuitable for retail investors who desire to hold them for longer than one trading session

Registered Representatives

• Registered Representatives (RRs) must fully understand all factors to ensure transactions are suitable
• They must also grasp on the impact that market volatility will have when combined with the use of leverage

Sale Of Principal-Protected Notes

• Guidance Note 2500-21-003, provides CIRO's expectations with regard to the sale of PPN's by registered investment dealers
• Applicable regulators continue to permit certain specified PPNs to be sold with no KYC or suitability obligation by banks and other deposit-taking institutions

Distribution Of Non-Arm's Length Products

• Dealer members must be aware of regulatory concerns, including conduct-related matters, product review, conflict of interest, suitability, disclosure, and protection fund coverage
• CIRO's expectations of how dealers and their sales representatives should perform include the following steps:
• Perform product due 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
• If a proposed trade passes as suitable, it can be completed after confirming it complies with all SRO rules

Stanley Case

• Stanley, an RR neglected to verify the type of shares Felicia wanted the investment on
• Stanley failed to verify important details, and was held negligible

Ensuring Compliance

• Registered Representatives must apply due diligence in examining any investment opportunities
• Enlisting in a team will assist

New Issues

• When a company raises equity capital, it issues securities from its treasury
• When issuing securities for the first time, it's dubbed as an initial public offering (IPO) plus a prospectus must be filed with the regulators

Reporting Issuers

• A company that is issuing is called a reporting issuer, in which the prospectus may be less detailed as information is already available
• Underwriting takes place which is known when a company wants selling their brand new securities
• Different underwriting include bought deal and best efforts deal but under both must perform, but require an attempt

Preliminary Prospectus

• Most provinces dictate both must be issued, where a prominent warning states that the securities may not be sold until a receipt has been obtained
• The final decision to purchase the security should be based on facts only published
• One purpose of the preliminary prospectus is so the distributor is allowed a new issue to determine if the public has an interest
• Complying with legislation, they are not forced to include auditor’s report
• The underwriter must maintain a record containing all personnel

Permitted Activities

• The time between the issuance of a receipt is the waiting period, and underwriters can solicit potential purchasers

Not Permitted Activities

• It is forbidden to enter into new agreements
• Publications alerting the public are allowed, where it identifies price + security

Exempt Market

• The exempt market refers to the capital markets where participation is restricted to meet requirements + regulation

New Instrument 45-106

• New Instrument 45-106 outlines several major exemptions
• Includes Accredited Investors, Private Issuers and Family, Friends + Business Associates
• Includes offering Memorandum as well as Minimum Amounts
• The sell of exempt securities must take reasonable steps + verify the representations made by the purchaser

Exemptions and Requirements Related To Crowdfunding

• Designed to facilitate the orderly investment in Canadian companies
• To all investors, are however subject to the constraints of the following limits

Private Placement

• Private Placement are also crucial, in which is requires steps to confirm compliance before placement

Take-Over and Issuer Bids

• As an RR, processes the securities of another issuer + know their steps in order to advise properly
• A formal take-over bid is an offer to acquire 20% or more of the outstanding security
• Early warning rules are designed to alerts that it must be disclosed publicly.

Early Warning

• Requirements that extends, as well as the regulations,
• Cannot take up any time of the deposited securities unless
• Compliance of Securities may be withdrawn

Issuer Bids

• Issuer bids follow similarly to take-over bids, where provisions contain regulating securities, as well as required requirements
• Circular must be sent disclosing

Withdrawal

• A security may be withdrawn following if
• Take offer terms are changed with enough time
• Security holder may apply for the correct withdrawal

Erica Case and Conduct To Ensure Compliance

• Where Erica sold unregistered shares, may expose to civil liability
• Where to ensure all businesses, business is knowledge and with consent