Appendix B – Supervisory policies and procedures relating to leverage

  1. Minimum Controls

    The following are minimum controls that Dealers should have in place to identify and supervise the use of borrowing-to-invest strategies:
    • procedures designed to reasonably ensure that client accounts with positions financed by loans, can be identified and are subject to an account supervisory review:
      • Accounts with investment product positions that are financed by on-book and/or off-book loans (including situations where the Dealer or Registered Representative subsequently becomes aware of the use of an off-book borrowing-to-invest strategy), should be readily identifiable for supervisory review purposes,
      • The applicable Supervisor responsible for client account supervisory reviews should conduct specific reviews of accounts where investment product positions are financed by on-book and/or off-book loans,
    • procedures for the maintenance of the evidence of supervisory review,
    • procedures to ensure that accounts that include positions financed by any disclosed or identified third-party loans fall under this supervisory framework, and
    • procedures to ensure compliance with the requirements relating to permitted referral arrangements under NI 31-103.
  2. Red flags to identify undisclosed off-book leveraged strategies

    With respect to undisclosed off-book loans, Dealers should have in place procedures to identify red flags that may indicate the existence of off-book client loans and should follow up any such situations with questions and/or more testing, as appropriate. Examples of such red flags may include:
    • large investments or transfers in to client accounts (including deposits into margin accounts), where such amounts are inconsistent with the client’s “know your client” information, and inconsistent with the Registered Representative’s or the Dealer’s knowledge of the client’s individual circumstances or profile,
    • communications from lending institutions regarding the value of the client’s portfolio, or requests for duplicate statements,
    • referral fees paid to a Registered Representatives or the Dealer by a lending institution or an affiliate of the institution,
    • correspondence found in client files suggesting the use of undisclosed loans, and
    • client complaints relating to the use of a borrowing-to-invest strategy.
  3. Best Practices

    The following are some best practices that Dealers should consider in developing and implementing supervisory controls:
    • developing a borrowing-to-invest suitability checklist, or a similar document, to detail the appropriate client circumstances that might support the use of a borrowing-to-invest strategy,
    • developing procedures to periodically assess the financial performance and the ongoing suitability of accounts that use a borrowing-to-invest strategy and noting the steps to be followed for borrowing-to-invest accounts that have become unsuitable (advising the client, etc.). This should include a more enhanced/frequent review during periods of volatile market conditions,
    • developing detailed guidance for Registered Representatives to help ensure that they explain all risks before recommending or accepting the use of a borrowing-to-invest strategy and requesting that clients provide an acknowledgement that the risks have been explained and are understood,
    • including a process for specifically reviewing borrowing-to-invest accounts as part of the Dealer’s business location examinations,
    • developing procedures for the approval of Registered Representatives outside business activities with a view to capturing activities involving third party lenders,
    • developing supervisory policies:
      • requiring pre-approval of Registered Representatives before permitting the use of an off-book borrowing-to-invest strategy by their clients, and/or
      • requiring that all off-book borrowing-to-invest strategies (new loans or re-financings) be pre-approved by the Dealer,
    • including a review of lending practices at prior firms as part of the due diligence process performed regarding prospective Registered Representatives,
    • requesting that approved lenders provide reports of the lending business on record involving Dealer Registered Representatives, and
    • reviewing third-party remuneration captured in Dealer records for trends indicative of lending practices.