Compliance officers and branch managers should keep an eye on their reps for any evidence of outside business activity.

A look at several recent hearing notices issued by the Investments Industry Regulatory Organization of Canada (IIROC) shows the regulator taking registered persons to task when they sell products outside their registration mandates.

Among the actions pointed to in the IIROC reports were reps who:

  • Engaged in outside business activities without the prior knowledge or consent of his Member firm;
  • Facilitated client participation in various private placements that were conducted off the books and records of his employer and without the knowledge or consent of that IIROC member firm;

    Engaged in personal financial dealings with clients by participating in a private placement distribution with a group of clients, again without the firm’s knowledge or consent—and profited monetarily from those activities.

    Such actions are deemed generally detrimental to the public interest and also violate specific IIROC bylaws. In one of the cases, the registered rep being investigated failed to cooperate with IIROC personnel. In another, the rep was said to have been evasive and failed to provide complete and accurate information in accordance with IIROC’s requests.

    Regulators have become very concerned about off-book business, and other forms of outside business activity in the wake of the financial crisis and the Earl Jones scandal, which saw a non-registered person holding out as an advisor and alleging to conduct transactions on behalf of advisors.

    The aging of Canada’s population also generates concern as older investors tend to be viewed as easier prey for rogue advisors, and a large percentage of suitability complaints tend to originate with the sale of products or equities that are out of line with a client’s investment time horizon.

    One of the main issues for firms here is the fact that any transaction going around a firm’s books and records systems could be highly unsuitable to the individual investor. Aside from lack of licensure, the biggest single motivation for outside business activity is that compliance may have deemed a product or category unsuitable to the firm’s client base – or outside the expertise of the people at the firm who are responsible for vetting the shelf.

    This could result in an iron-clad suitability complaint, or worse action against the firm for failure to supervise the rep.

    According to some lawyers we talk with regularly, there are some simple ways to determine if a rep is conducting off-book transactions. Branch managers and other supervisors should keep an eye out for:

  • Brochures or other collateral materials that don’t relate to products the firm sells (either currently, or in the past);

  • Annotations to business cards that indicate the rep may be offering items the firm hasn’t approved;

  • A separate ledger or spreadsheet tracking inflows and outflows of monies that don’t appear related to the rep’s normal activities – some reps have even left these on folders within the firm’s computer network;

  • Correspondence from clients that refer to investment products or types the firm doesn’t sell;

    Any evidence of journalling or other lending arrangements with clients; and Any spikes in outgoing correspondence, e-mail or paper, that don’t appear to match the firm’s marketing efforts.