On May 18, 2017, the Canadian Securities Administrators (“CSA”) released CSA Staff Notice 31-350
Guidance on Small Firms Compliance and Regulatory Obligations (“Staff Notice”).
The Staff Notice was the result of a two-year compliance review of 65 small firms, lasting from October 2014 to June 2016. The individual firms’ compliance was measured against the applicable securities legislation, including National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) and its Companion Policy (31-103CP).
The small firms fell into one or more of the following categories: investment fund managers (“IFM”), portfolio managers (“PM”) and exempt market dealers (“EMD”). The firms selected were primarily sole proprietorships or firms with one registered individual (i.e., one individual who was registered in a category that authorizes the individual to act as a dealer or an adviser on behalf of the registered firm, or in the case of an IFM, one individual registered as the chief compliance officer (“CCO”)).
The CSA’s review uncovered widespread deficiencies, including inadequate or missing business continuity plans (“BCPs”) (35% of firms), inadequate monitoring systems (71% with inadequate written policies), unfulfilled regulatory filing obligations (34%), non-compliant client statements (45%) and inadequate relationship disclosure materials (63%).
Business Continuity Planning
The CSA provided guidance focusing on managing risks related to business interruption and continuity, both which raise significant issues for many small firms. It noted that many of these firms need to:
- develop a BCP that is appropriate for their size and business model,
- designate an individual to execute the BCP (BCP executor); and,
- review their BCP annually.
The CSA found that small firms with only one individual and no support or administration staff may have to designate an individual external to the firm such as a spouse or legal counsel to act as BCP executor. The CSA may grant exemptive relief should the BCP executor be acting for more than one registered firm. When working with an external BCP executor, the CSA advises, depending on the firm’s business model:
- a written agreement is in place so that the BCP executor understands his or her responsibilities;
- the BCP executor is familiar with the firm’s BCP and is familiar with the firm’s business to properly wind down or temporarily manage it or facilitate the transfer of client accounts;
- a confidentiality agreement is in place if the BCP executor would have access to confidential client information and that the firm has properly pre-arranged client authorization to share this confidential information (e.g., in the relationship disclosure information documentation);
- if the BCP executor is another registrant, conflicts of interest between both firms have been considered (e.g., an external BCP executor could be managing clients of two firms in a scenario of temporary absence); and,
- the BCP executor understands securities legislation and is aware of costs (e.g., costs related to filing an application for exemptive relief).
The CSA stressed the importance of spelling out in the BCPs the importance of the business’ succession or wind-down procedures in the event of death, incapacitation or prolonged temporary absence of the sole registered individual and who is responsible for notifying the regulators. The CSA also noted, that where applicable, small firms should also have procedures to mitigate and recover from business interruptions, including how the firm will communicate with clients, key personnel, third-party service providers, and regulators (e.g., provide an alternate means of communication, and procedures to protect, backup and recover the firm’s books and records (e.g., as a result of a cyber-security incident or natural disaster).
Monitoring Systems:
While the CSA also observed that many small firms may not have the resources to make segregation duties possible, it cautioned that all firms must maintain records to accurately record business activities, financial affairs, and client transactions, and demonstrate the extent of a firm’s compliance with applicable requirements of securities legislation. The CSA also warned that firms must establish, maintain and apply policies and procedures that establish a system of controls and supervision in order to:
- provide reasonable assurance that the firm and each individual acting on its behalf comply with securities legislation; and,
- manage the risks associated with its business in accordance with prudent business practices.
Other Guidance:
The Staff Notice also provided guidance on these additional areas of concern:
- CCO Annual Reports – CSA Staff stress that it is important that a small firm’s CCO must assess the firm’s compliance structure on at least an annual basis. If no report has been filed, the CSA notes that questions may arise regarding the adequacy of the firm’s compliance system and how well it has complied with securities legislation and whether the CCO is adequately performing his or her responsibilities. CSA staff note that a small firm’s CCO can readily meet this reporting requirement by documenting this assessment in the firm’s board of directors’ minutes.
- Accounting Deficiencies: CSA staff found that some of the reviewed small firms were deficient in their accounting practices, applying the cash basis accounting method instead of the accrual basis accounting method. For example, firms were not accruing revenues as they were earned; instead, they were waiting for when cash was received to recognize revenues. The CSA urges that small firms should review the guidance provided in:
- sections 12.10 to 12.11 of NI 31-103CP
- section 2.7 of the Companion Policy to National Instrument 52-107 Acceptable Accounting Principles and Auditing Standards.
- Inadequate Excess Working Capital: The CSA staff review found that some firms had improperly completed Form 31-103F1 Calculation of Excess Working Capital. Probing further, CSA staff found some of the reviewed firms had inadequate excess working capital during the period covered by the compliance review. The review also found that many forms were improperly completed. Guidance on how to properly complete the Form is provided in sections 12.1 and 12.2 of NI 31-103 CP. The CSA also cautioned that firms should include procedures for when and if a working capital deficiency should occur, indicating who is responsible for rectifying the deficiency and how the deficiency would be reported to the applicable regulator as soon as possible.
In closing, the CSA notes that it will continue to monitor small firm compliance.
CSA Staff Notice 31-350 is available for download from the websites of participating jurisdictions.
For more information, please call Barbara Hendrickson at BAX Securities Law (416) 601 -1004.
This publication is not intended to constitute legal advice. No one should act on it or refrain from acting on it without consulting with a lawyer. BAX does not warrant or guarantee the accuracy or currency or completeness of the publication. No part of this publication may be reproduced without the prior written permission of BAX Securities Law.
