PMAC meeting update BCSC Examination February 15, 2011 Michael Sorbo, CFA Manager, Examinations Janice Leung, CA CFA Senior Securities Examiner 1
Today’s topics � Annual report card & key exam activities � Top 2010 examination findings � Compliance tips � CSA Compliance Committee � CSA Marketing sweep 2
Is there a new normal? Chaos is come again. Shakespeare, Othello � The only time I really ever lost money was when I broke � my own rules. Jesse Livermore, to his son There is nothing unique about the crash of ’29. It is � something that happens about every 20-30 years, because that is the length of financial memory. It is about the length of time needed for a new set of suckers to come and imagine that they have a new and wonderful fix on the future. John Kenneth Galbraith 3
2010 Annual report card and examination findings 4
BC’s regulatory landscape Outside Total # of BC based Outside based Total # of Category BC based based firms representatives representatives representatives Portfolio manager 78 307 385 311 151 455 Investment fund 11 9 20 0 0 0 manager Scholarship plan 0 7 7 0 896 896 dealer Exempt market 14 87 101 36 48 84 dealer Restricted dealer 3 1 4 9 0 9 5
Common adviser deficiencies � lack of a formal top-down compliance program – need for “tone at the top” � ineffective compliance procedures to support policies and strategic goals � In 53% of reviews, we saw that firms did not establish well thought-out or stress-tested disaster recovery and business continuity plans � In 40% of reviews, firms did not manage the conflicts of interest and personal trading adequately. � In 40% of reviews, firms did not adequately disclose fees, affiliations or services adequately � Controls and records to support the management of personal trading practices remains an issue � A large number of firms had poor marketing policies, supervision and approval of advertising and inadequate verification of stats represented. 6
Compliance tips – questions to ask? � Are clear procedures set out for compliance policies? � Did your program detect any actual compliance problems? If not, why not? � Have you learned from past lessons, examinations, or errors? � Are your compliance problems resolved swiftly, with quality, and ethically? � Does your staff talk candidly about compliance issues, and would they escalate potential issues to compliance staff in a forthright fashion? � Do you have active orientation and training programs? � Are your disclosures designed to meet the new requirements set out in NI 31-103? � Is risk management linked into your compliance program? � Does your staff understand and follow the firm’s code of ethics 7
Top deficiencies by frequency - 1 to 8 Top Deficiencies by Frequency 2010 2009 Rank Type of deficiency Advisers only All 1 Policies and procedures 73% 85% 2 Know-your-client and suitability 60% 70% 3 Disaster recovery and business continuity 53% 45% 4 Capital monitoring 47% 50% 5 Conflict of interest and personal trading 40% 50% 6 Disclosures 40% 45% 7 Advertising, marketing and holding out 40% 15% 8 Compliance officer function 33% 15% 8
Top deficiencies by frequency – 9 to 17 Top Deficiencies by Frequency 2010 2009 Rank Type of deficiency Advisers only All 9 Trade execution 27% 5% 10 Compliance program 20% 10% 11 Registration administration 27% 20% 12 Records 20% 30% 13 Performance presentation/ benchmarking 20% 15% 14 Fund records, trading and administration 20% 0% 15 Fund advertising and perf. presentation 20% 5% 16 Insider and early warning reporting 13% 0% 17 Anti-money-laundering procedures 13% 5% 9
Compliance tips – annual review 1. Conduct a regular review of your compliance programs . Review of your current compliance programs is always a major area of focus in our registration and examination process. The CFA Institute has come out with the 10th edition of � the Standards of Practice Handbook contains the CFA Institute Code of Ethics and Standards of Professional Conduct with related guidance and examples illustrating application in day-to-day situations. 10
Compliance tips – keep current 2. Maintain knowledge of current regulation. In some recent examinations, we found compliance officers were not familiar with current disclosure requirements. While we understand that NI 31-103 set out many new requirements and changes from previous rules, we expect firms to be proactive in learning the new regulatory requirements and to update programs and practices accordingly. 11
Compliance tips –be proactive 3. Learn your lessons from past examinations. All examinations include a review of how past deficiencies were resolved, and whether you followed through with your plans. In some recent reviews, we found some firms have been too casual about ensuring prior deficiencies were resolved. For example, new policies and procedures were not enforced and compliance action plans fell short of being completed. 12
Compliance tips –review controls 4. Update your management procedures: Advising firms and dealers face numerous risks. Many of your firms are managed on a line-of-business basis with a variety of business segments, as determined by the products and services provided. Firms may also face risks generated by affiliated firms such as business partners, brokers, and custodians. In many cases a comprehensive review of management information and quality controls is not regularly conducted. This could also be done annually as part of a risk assessment process. 13
Compliance tips –reporting on suitability 5. Update your KYC information: Examiners select a sample of client files to review whether firms documented KYC information. Consider: � Are investment strategies or solutions clear? � Are they tailored to the client? � Do they explain the reasons for the recommendations and how they relate to the customers objectives? � Have you clearly documented client objectives, needs, priorities, relevant existing investments, implementation plans? � Do you have tools to assist with rebalancing? 14
These firms all had so-called “good” compliance programs � Long-term Capital Management collapsed in 2000 � Lehman Brothers Holdings collapsed in September 15, 2008 � SEC receives emails warning Bernard Madoff’s investment vehicle is a Ponzi scheme in May 2003 � Aramanth Advisers loses over $6 billion in a week in September 2006 � Bear Stearns collapses in March 2008 –sold to JP Morgan for $2.21 per share � Merrill Lynch told to Bank of America for $50 billion 15
Where do compliance programs fail? � We tend to perceive what we expect to perceive? R. Heuers- Intelligence Analysis � I have a policy manual = therefore I have a good program � The compliance program operates in “silos”; is not integrated � The program is not proactive but reactive � They are not put into a visible or written structure; cannot be easily defined � They fail to consider out-lying potential risks � They miss the spirit of the law and do not enforce “ethical behavior” � They are not adapative, but static (same old model) 16
CSA Compliance Committee � Committee mandate � Co-ordination between regulators � Current projects 17
2010 CSA Marketing Sweep � Six provinces participating � Ten firms selected in BC Five for field exams � Five for desk review � � Publication of a CSA Staff Notice in Spring 2011 18
Marketing guidance � Fair, true, complete, adequate disclosure � Suggested practices – CFA Institute’s Global Investment Performance Standards (GIPS) � Compliance with GIPS is voluntary 19
Common Marketing Deficiencies 1. Minimal or no policies and procedures 2. Use of overly promotional and unsubstantiated language 3. Presentation of hypothetical performance data 4. Linking of previous firm’s performance with current firm performance 20
Common Marketing Deficiencies Policies and procedures Develop policies and procedures for the: Proper calculation of performance figures � Construction of composites � Selection of appropriate benchmarks � Disclosures provided to clients � GIPS requires firms to document policies and procedures used in establishing and maintaining compliance with GIPS. 21
Common Marketing Deficiencies Unsubstantiated and overly promotional language � “proven performance” � “proven track record” � “best performing fund in Canada” � “precedent setting” Discuss and disclose the assumptions behind your “proven” performance. Also show the source of your claims. 22
Common Marketing Deficiencies Hypothetical performance data � Includes back-tested and model numbers � GIPS allows presentation of hypothetical data, but only as supplemental information � Hypothetical performance should never be linked to the actual performance � Disclosures must be very clear that the presentation is of hypothetical performance 23
Common Marketing Deficiencies Previous firm performance GIPS has four conditions to allow linking previous � firm performance to current firm performance GIPS states that performance belongs to firm NOT � to the individual GIPS has stringent record-keeping requirements � GIPS allows presentation of previous firm � performance as supplemental information 24
Questions? 25
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