Securities Industry: Standards of Conduct & Ethics

Standards of Conduct and Ethics in the Securities Industry

• The chapter addresses the standards of conduct and ethics necessary to guide the behaviour of dealer members' representatives in the securities industry
• It explains how a code of ethics integrates industry rules through concepts like Know Your Client, Know Your Product, and duty of care

Key Terms

• Canadian Investment Regulatory Organization (CIRO): The national self-regulatory organization overseeing investment dealers, mutual fund dealers, and trading activity on Canadian debt and equity marketplaces
• Ethics: A set of values or morals that guide individual behaviour
• Duty of Care: The requirement to provide advice to clients fully, honestly, in good faith, and with the proper skills and knowledge
• Fiduciary duty: A higher standard of care imposed by common law, existing when someone trusts in the honest intentions of another with greater authority or expertise
• Know Your Client (KYC): The ethical requirement is to fully understand each client's situation
• Know Your Product (KYP): Before recommending a product, an RR must understand how it is constructed and how it is likely to perform in various market conditions
• Representative Registered (RR): A representative that is registered
• Suitability: Investment recommendations must be appropriate for the client

Introduction to Conduct and Ethics

• The securities industry relies on trust and confidence, requiring a strong personal code of ethics
• Registered Representatives' responsibilities are ethically comparable to those of professionals like doctors and lawyers, placing client interests first
• RRs must be aware of their function and liabilities in the securities industry
• Ethics go beyond simply complying with rules; guiding behaviour when rules are unclear or contradictory
• Acting unethically is possible while still complying with regulations

Standards of Conduct and Ethics

• CIRO oversees investment dealers, mutual fund dealers, and trading activity in Canada
• CIRO requires RRs to observe high standards of ethics and conduct when transacting business
• CIRO's expectations for RRs: Regulated persons must observe high standards of ethics, act openly and fairly, and avoid business conduct detrimental to the public interest

Employee Standards of Conduct

• Investment dealers have standards of conduct that require compliance, though wording may differ
• Representatives must maintain high ethical standards and act honourably
• Employee dealings must be fair, open, and equitable
• Business conduct should not harm the firm's reputation, be detrimental to the public interest, or diminish investor confidence
• Conduct that contravenes expected standards includes negligence, failure to comply with obligations, and unreasonable departure from ethical standards
• Penalties for unethical conduct include reprimands, fines, suspension, or termination

Ethics and Ethical Behaviour

• Ethics are values or morals that guide behaviour
• Morals are rules and habits of conduct based on society's standards of right and wrong
• Ethics is examining choices and making decisions within moral principles
• Ethical behaviour requires internally established moral judgments, going beyond regulatory requirements to do the right thing for the right reasons

Integrating Ethics with Industry Rules

• Ethical behaviour integrates rules to ensure the suitability of investment
• RRs have three obligations: understanding clients, understanding products, and acting honestly
• These obligations are the key to ensuring suitability and ethical conduct

Know Your Client (KYC)

• The KYC rule requires an understanding of each client's situation
• Suitability includes a client's financial situation, investment knowledge, objectives, time horizon, and risk profile
• Action is determined on a reasonable base that the action is suitable
• The dealer member must maintain records of client information, documenting it carefully on an account application
• The suitability extends beyond the specific products to make sure the account type, method of financing etc suits the client

Know Your Product (KYP)

• RRs must understand investment products before recommending them
• The KYP sets out the obligations of the firm and the registered individual to determine suitability

Product Due Diligence

• Dealer members must assess securities' aspects, approve securities for clients, and monitor them for changes
• A Dealer Member must not make securities available to clients unless the Dealer Member has taken. reasonable steps to assess the relevant aspects of the securities, including the securities' structure, features, risks, initial and ongoing costs and the impact of those costs, (I) approve the securities to be made available to clients, and (iii) monitor the securities for significant changes

Duty of Care

• RRs must provide advice with proper skills, knowledge, honesty, and in good faith
• Courts do not expect perfection or guarantee of an investment.
• Fiduciary duty is a higher standard when one person trusts another with greater authority
• RRs providing advice generally have a duty of care, but discretionary authority can create fiduciary duty
• RRs should always deal fairly, honestly, and in good faith

Standard of Care

• CIRO's expectations include Advisory Accounts, Order Execution – Only Accounts, and Discretionary Accounts and Managed Accounts
• Civil litigation may resolve disputes, with courts deciding if a fiduciary duty existed based on client vulnerability and reliance on RR advice

Rules of Thumb for Registered Representatives (RR)

• Securities industry lacks a formal code of ethics, but rules imply ethical standards Gather client information to understand their needs, goals, and risk tolerance Learn about products to ensure suitable recommendations Act honestly, fairly, and with trustworthiness Avoid conflicts of interest Conduct business professionally Maintain and improve professional knowledge Follow securities legislation and industry rules Hold client information confidentially

Case Study - Sally

• Sally violated KYC, KYP, and duty of care by recommending unsuitable products, failing to ascertain client awareness of risks, and engaging in unauthorized discretionary trading

Suggested Conduct for Sally's Case to Ensure Compliance

• RRs must ensure every transaction is suitable for the client by knowing both the client and the products
• Dealer members should have policies to ensure compliance and good business practice
• The dealer member failed due to lack of the appropriate training and supervision.

Chapter Summary

• As an RR, you must observe high standards of ethics and conduct
• These standards are integrated into the rules through the following obligations:
• KYC: Understand your client’s situation before making investment recommendations
• KYP: Understand the products you recommend
• Duty of care: Act honestly, in good faith, and in a professional manner
• Rules and regulations should be distilled into guidelines based on the obligations above
• The course explores application of standards, ethics, KYC, and product due diligence in dealings with clients and scenarios
• The subsequent chapter addresses ethical dilemmas and decision-making