New Product Due Diligence Regulatory Review– Common Deficiencies and Requirements for Written Policies, Procedures and Controls

1. Common Deficiencies

2. Written Policies and Procedures

The review found that two of the fourteen Dealer Members tested did not have written policies.  Of those with written policies, many of the policies were deficient in some material aspect.  Some had no meaningful written procedures to accomplish the intent of their policies.  The following are some deficiencies in the written policies and procedures examined.

1. Absence of a clear definition of “new product”
   
   It is critical for a Dealer Member to capture all products that need to go through the due diligence process.  The definition of “new product” should include the criteria for determining when a product must be reviewed.  The Guidance Note contains detailed guidance on the scope of a proper definition and criteria that should trigger a review of products for both retail and institutional clients. The more complex and non-transparent products having features such as embedded derivatives, variable maturities, complex fee structures or opaque assets, should be captured in the definition and be subject to a due diligence review  The definition should also include details on when a modification to an existing product should be subject to the due diligence review process.
2. Absence of appropriate level of internal review
   
   As a minimum standard, the policy should call for a written “new product” proposal and provide for internal review by the Chief Compliance Officer.  Best practice would dictate the involvement of subject matter experts from all relevant areas of the firm. 
3. Absence of an adequate analytical framework for the consideration of whether the “new product” should be offered 
   
   The primary goal of every “new product” due diligence review should be to ensure that the right questions are asked by subject matter experts and satisfactorily answered.  That framework identifies issues that might be pursued, and highlights matters for training and marketing.  Please refer to the Guidance Note for a list of questions and considerations necessary for a proper analytical framework in the due diligence process. 
4. Absence of consideration of possible conflict of interest scenarios and how they should be addressed
   
   The following matters should be considered in the written policy and procedures document, and those procedures should be effectively implemented and supervised:

• Is the “new product” from a non-arm’s length manufacturer/issuer?
• Is it a product of a related or connected issuer? 
• Is it a proprietary product?
•  Are there additional incentives for sales staff? 
•  If so, what disclosures must be made? 

5. Proficiency issues should be reviewed as part of the due diligence process.  Any specific training issues should be documented on “new product” features and risks.  Advisors and supervisors must fully understand the product in order to support the suitability of any recommendations made to clients.  The policy should address the need to reassess training requirements on a continuing basis and provide for a review of any marketing materials. 
6. Absence of a process to monitor and review customer complaints regarding “new products”, and for monitoring compliance with any restrictions placed on the sale of the “new product”

A monitoring process that allows for customer, product or compliance issues to be escalated and acted upon at an early stage needs to be in place.  This will allow the firm to become aware of and address, any systemic issues that may be identified through complaints of a similar nature.

1. Operational issues and controls

The review of the controls underlying the firms’ policies and procedures found the following deficiencies.

1. Absence of adequate controls underlying written policies
   Some Dealer Members did not have a sufficient evidentiary record of controls supporting a “new product” due diligence process.  Dealer Members must be able to establish that they have a system of internal controls and supervision in support of investment suitability advice and recommendations for both retail and institutional clients, where applicable, with respect to “new products”.  Please refer to the Guidance Note for details of an acceptable control system.
2. Absence of control methods to capture sources of “new products”  
   At some firms, the due diligence process is triggered only when an advisor brings forward a “new product”.  Most firms have no controls for products that come in through transfer or client deposit.  The policy should capture all sources of “new product”. 
3. Absence of a standardized process requiring a written “new product” proposal for internal review
   Not all Dealer Members send all potential “new products” to a product due diligence committee.  The requirement for a written proposal would trigger a preliminary assessment of whether the proposed product or concept is a “new product” (including a material modification of an existing product) requiring further internal review, and be the first document in the paper trail for “new product” due diligence.
4. Absence of Product Due Diligence Committees
   Not all Dealer Members have a Product Due Diligence Committee.  Best practice would be a committee or working group consisting of representatives from all relevant departments of the firm and include members of senior management.  The legal, finance, marketing, sales and operations functions should be present, as well as the Chief Compliance Officer.  All concerns: suitability, restrictions on the sale of product (e.g. proficiency), risks and training needs should be documented as part of the deliberation process, and approvals should be conditional upon the requirement for periodic reassessment.      

5. Next Steps

Each of the Dealer Members participating in the regulatory review has received a letter reporting on IIROC’s findings at that firm and IIROC’s proposed corrective action.  IIROC will ensure that each of those firms undertake the necessary improvements to their product due diligence policies and procedures.

Effective immediately, IIROC Business Conduct Compliance will refer any significant and material deficiencies in the “new product” due diligence process encountered during examinations to IIROC’s Enforcement Department.

Dealer Members may refer any questions arising from this Guidance Note to the undersigned or the relevant IIROC Business Conduct Compliance Manager.