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By: David Gilkes, EMDA Vice Chair and President ofNorth Star Compliance & Regulatory Solutions Inc.

One can only imagine what the introduction Ontario Securities Commission (OSC) staff will make when they call up clients to discuss their dealer or adviser. According to the Notice sent out by the OSC on June 4, 2012 those calls to clients will now be a standard tool when the OSC conducts a compliance fi eld review of a dealer or adviser. As a former regulator and investigator, I can see the value of obtaining information directly from clients – regulators may obtain a lot of useful information through interviews with clients:
  • regulators can verify the information on the Know Your Client form;
  • question whether the appropriate disclosure of risks and benefits of an investment product were presented to the investor;
  • obtain a view of the dealer from the client perspective to help assess conflicts of interest and any issue of investor confusion; and
  • investors will know that the OSC is looking out for their interests.
However, there are significant potential problems from regulators calling clients directly which raise questions the OSC has yet to answer:
  • clients have been known to misrepresent their financial holdings or income to their dealer - will they admit this to a regulator, or will they blame any discrepancy on the dealer?
  • OSC staff often rely on technical language unfamiliar to investors or capable of different meanings – will OSC staff verify that their questions are clearly understood by investors and that the investor responses make sense?
  • hindsight is perfect and market performance is always viewed in hindsight – will market risk problems be blamed on the dealer?
  • how will the OSC protect the potentially severe reputational damage caused to dealers, portfolio managers, or investment products, from calling around to clients and raising alarm among investors?
  • will the OSC calling clients increase the already heavy regulatory burden placed on registered dealers?
Addressing the potential for reputational harm to a dealer from the OSC placing calls to its clients, the OSC attempts to alleviate concerns by noting:

"…clients who are contacted by OSC staff will be informed that they are being contacted in the normal course of a compliance review of the firm, and that the call to them should not be interpreted as a sign of any misconduct by the firm.”

Despite these warm reassurances from OSC staff,investors are quite likely to think their dealer or a particular investment product is under investigation or there is some kind of problem and they need to take action. However sophisticated clients may be, the irrational behaviour of investors is well-documented and a misplaced word by
OSC staff could have serious consequences. The natural reaction of investors to these calls form regulators will likely harm the reputation of the firm under review.

The term ‘regulatory burden’ seems to have gone out of vogue but it should be a live and important concern. OSC compliance field reviews are long and burdensome affairs for a dealer or portfolio manager. A "quick” review is six months when all is said and done, and there are numerous examples of reviews taking a year or more. The impact on firms is significant, particularly small and medium sized firms where senior management and staff are taken away from running the firm to manage detailed information requests from OSC reviewers. How much more time will be added to reviews through calls to clients? How many OSC calls to a client will result in that client turning around
and calling the firm to seek reassurance about ‘whatever is going on over there’. I bet most will.

Firms should brace themselves for calls from concerned clients in upcoming months. The announcement about the new calls to clients came on the eve of the OSC announcing a compliance sweep focusing on the KYC, KYP and suitability practices of dealers and portfolio managers starting in June 2012.

I am hoping the OSC re-examines its review process to determine if it can be streamlined. If the OSC is adding new tools that it finds are beneficial to its reviews it should also consider whether other elements of the review can be reduced. If the present compliance field review process goes unchecked it is foreseeable that most reviews will take a full year to complete. This benefits no one, and causes a significant burden on registered firms. The OSC needs to demonstrate a continued commitment to striking a balance between investor protection and ‘regulatory burden’. And why has the OSC not sought out industry comment on how to best engage direct contact with clients in their review process before simply announcing this new highly intrusive regulatory tool?

For more information contact:

David Gilkes - davidgilkes@northstarcompliance.com

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