Standards of Conduct and Ethics in Finance

Standards of Conduct and Ethics

• The securities industry relies heavily on trust and confidence, so high ethical standards and conduct are essential.
• Registered Representatives (RRs) have responsibilities to clients similar to those of doctors and lawyers, ethically obligated to prioritize client interests, as regulations often require.
• Ethics go further than simple compliance, guiding behavior when rules are unclear or contradictory.
• It's possible to comply with rules while still acting unethically.

Canadian Investment Regulatory Organization (CIRO)

• CIRO oversees investment and mutual fund dealers, plus trading activity on Canadian marketplaces.
• CIRO mandates that RRs must comply with rules but also maintain "high standards of ethics and conduct."
• Ethical considerations apply to actions and daily behavior of RRs.
• Maintaining ethics and conduct extends to Investment Representatives (IRs), Portfolio Managers (PMs), Associate Portfolio Managers (APMs), and Supervisors.
• CIRO's IDPC Rule section 1402 outlines expectations for RRs, requiring them to:
  • Maintain high ethical standards and conduct in their transactions.
  • Act fairly, openly, and equitably.
  • Avoid conduct detrimental to the public interest.
  • Avoid negligence or failure to comply with obligations.
  • Avoid departures from expected standards.
  • Avoid diminishing investor confidence.

Employee Standards of Conduct

• Investment dealers have conduct standards aligned with section 1402.
• Employee dealings with clients should be fair, open, and equitable.
• Business conduct should not damage the firm's reputation, harm public interest, or reduce investor confidence.
• Unacceptable conduct includes:
  • Negligence
  • Non-compliance with legal, regulatory, and contractual obligations, including CIRO's rules
  • Violations of securities commissions or firm rules
  • Unreasonable departures from conduct standards
• Penalties for violations range from reprimands and fines to suspension or termination.

Ethics and Ethical Behavior

• Ethics are guiding values or morals, while morals are societal rules of conduct.
• Ethics are a continuous process of decision-making based on moral principles.
• Ethical behavior goes beyond regulatory compliance, it requires internally established moral judgments.

Integrating Ethics with Industry Rules

• Ethical conduct integrates into industry rules through measures ensuring investment recommendation suitability.
• RRs have three obligations:
  • Understand clients' situations.
  • Understand recommended products.
  • Act honestly, in good faith, in a professional manner.
• Know Your Client (KYC) rule: Understanding each client’s situation is an ethical necessity.
• Suitability Factors: include client's financial situation, knowledge, objectives, time horizon, and risk profile.
• Before acting for a retail client, RRs must ensure the action is suitable for the client and prioritizes their interests.
• The information-gathering process is known as a discovery process.
• Dealer members must record client information, keeping it updated.
• Suitability goes beyond specific products, it also extends to account type, order type, trading strategy, and financing method.
• Know Your Product (KYP) obligation: RRs need to fully understand investment products before recommending them.

Product Due Diligence

• It is important to explain new, complex, or structured products.
• Clients have the right to understand what they are purchasing.
• Without proper knowledge, assessment of suitability and explanation of features and risks are not possible.
• Under IDPC Rule section 3301, Dealer Members must:
  • Assess securities' structure, features, and risks.
  • Approve securities for clients
  • Monitor securities for changes

Duty of Care

• Advice to clients must be honest and skillful, adhering to a duty of care.
• Courts don't expect perfection but require a reasonable application of skills and care.
• Fiduciary duty: exists when trust is placed in someone with greater authority or expertise.
• RRs generally have a duty of care, but could be held to a higher fiduciary standard, especially as PMs with discretionary authority. It is important to deal fairly, honestly and with good faith at all times.
• CIRO's expectations are in IDPC rules:
  • Rule section 3230: Advisory Accounts
  • Rule section 3240: Order Execution – Only Accounts
  • Rule section 3270: Discretionary Accounts and Managed Accounts
• Courts may determine a fiduciary duty was owed, based on client vulnerability and reliance on advice.

Rules of Thumb for Registered Representatives

• Industry lacks a formal ethics code, but rules imply ethical standards ("spirit of the law").
• Rules of thumb:

1. Gather information to understand client needs, goals, and risk tolerance.
2. Learn about products to ensure suitable recommendations.
3. Act honestly, fairly, and trustworthily.
4. Avoid conflicts of interest.
5. Conduct business professionally.
6. Improve professional knowledge.
7. Follow securities legislation and industry rules.
8. Hold client information confidentially.

Case Study: Sally

• RR Sally violated KYC, KYP, and duty of care by recommending a leveraged exchange-traded fund (LETF) she wasn't trained to sell to an elderly client who experienced a stroke shortly thereafter.
• Additionally, Sally engaged in unauthorized discretionary trading.
• A Registered Representative must ensure any products they recommend are suitable and that clients are aware of the associated risks.
• Dealer members should have appropriate policies and training programs.