The enforcement ladder, know-your-client and suitability

The ladder

Authority in Canadian securities regulation runs down five rungs, and enforcement runs down the same ones:

Statute            the Securities Act of a province
  → Regulator      the commission (OSC, ASC, BCSC …) — can act against ANYONE in the market
    → SRO          CIRO — disciplines its MEMBER FIRMS and their registered individuals
      → Dealer     supervises its own representatives; answers to CIRO and the regulator
        → Representative   registered individual; answers to all of the above

The distinction the paper tests is the reach of the two disciplinary bodies. The SRO can discipline only those who belong to it — member firms and the individuals registered through them. The statutory regulator can proceed against anyone — an issuer, a non-registrant, a tipper who has never worked in the industry — because its power comes from the statute, not from membership.

Worked example — the retiree's account

Marguerite, 71, opened an account at Northshore Securities in 2019. Her know-your-client record says: retired, income from a pension, objective income and capital preservation, horizon under five years, risk profile low. Her dealing representative, Daniel, has traded the account 140 times in the past year, mostly in speculative mining shares, generating $18,000 in commissions on a $300,000 account that has lost a fifth of its value. Her KYC form was never updated.

• CIRO disciplines Daniel (a registered individual) and can discipline Northshore (a member firm) for failing to supervise him. Its sanctions: fines, suspension, a permanent bar from registration.
• The OSC can also proceed against Daniel, and could reach a person CIRO cannot — say, an unregistered relative who was directing the trades.
• Northshore itself must have caught this: a 140-trade year in a low-risk income account is a supervision flag.

What Daniel did is churning: excessive trading to generate commissions. It is a suitability breach — each of those trades had to be suitable for Marguerite against her KYC record, and speculative mining shares in a low-risk income account are not.

Know your client — the six elements

NI 31-103 s. 13.2 requires a registrant to take reasonable steps to establish, for every client, their:

1. personal circumstances,
2. financial circumstances,
3. investment needs and objectives,
4. investment knowledge,
5. risk profile, and
6. investment time horizon —

together with the client's identity, whether they are an insider of a reporting issuer, and their creditworthiness if the firm is financing the purchase. The record must be kept current; a suitability judgement against a stale KYC form is a judgement against the wrong person.

Suitability — when, and against what

The suitability determination is made before the registrant opens the account, makes a trade, makes a recommendation or exercises discretion — that is, at the time of each action, against the current KYC record — and s. 13.3 requires that the action put the client's interest first. It is re-assessed when the client's information changes or a new representative takes over. A client's signature on an order does not make it suitable; the duty is the firm's, not the client's.

Conflicts of interest

Where a registrant's interest conflicts with the client's — a higher commission on one product, a security the firm underwrote — NI 31-103 s. 13.4 requires the conflict to be addressed in the best interest of the client, and avoided if it cannot be. Disclosure alone is not enough where the conflict is material.

Three misconducts to place

A representative recommends a speculative stock to a low-risk client — suitability, CIRO and the regulator. A dealer fails to supervise a representative's trading — the dealer, CIRO. An unregistered promoter manipulates a micro-cap's price — the regulator only; the SRO has no jurisdiction over a non-member.