Gatekeeper obligations expansively interpreted

The British Columbia Securities Commission (BCSC) has remitted a decision back to a CIRO Hearing Panel in Re Englesby and Nishimura¹. We previously wrote about the CIRO Hearing Panel’s original decision in our article, “Limits to gatekeeper obligations”. The BCSC found that the CIRO Hearing Panel proceeded on an incorrect principle, made an error in law, and failed to adequately consider the public interest in dismissing the disciplinary action. In doing so, the BCSC provided general guidance on gatekeeper obligations and the ability of CIRO staff to appeal CIRO decisions.

What you need to know

• Gatekeeper obligations: What constitutes a red flag trigger, reasonable client inquiries, and reasonable actions in response to information from inquiries is highly fact dependent.
  
  • Anything unusual or out of the ordinary with respect to a client or client account may be a red flag and trigger an obligation to make inquiries of the client. The inquiries must be reasonable in light of the facts, and the actions taken in response to the information from the inquiries must also be reasonable.
  • The facts of the case provide an example of something that is an “obvious” red flag requiring inquiry when the value and nature of account trading activity and profits are inconsistent with the account information (e.g., the value of the trading far exceeds the net worth or income recorded for the account) or the historical investment patterns for the client. A registrant cannot rely on hypothetical explanations for the disconnect and must make actual inquiries of the client. 
• Ability to appeal: CIRO staff can appeal decisions of CIRO hearing panels to the British Columbia Securities Commission.

The decision

Background

CIRO staff filed an application for review of a CIRO Hearing Panel’s decision dismissing a disciplinary action brought against two registered individuals (the Respondents), alleging that they failed to comply with gatekeeper obligations. The CIRO Hearing Panel had found that there was no evidence that the Respondents had breached their gatekeeper obligations as alleged by CIRO staff. Following CIRO’s application for review, the Respondents brought their own application to strike CIRO’s application, arguing that CIRO staff were not “directly affected” by the decision and therefore could not apply for review.

Gatekeeper obligations

The BCSC found that the CIRO Hearing Panel made an error in analyzing whether the Respondents had breached their gatekeeping obligations². Although the BCSC did not take issue with the three-step approach adopted by the CIRO Hearing Panel³, the BCSC stated that there are other equally valid ways to approach the analysis in determining whether a registrant breached their gatekeeping obligations⁴. The BCSC found that the Panel erred at the first step of the analysis in determining what triggered a registrant’s duty to make client inquiries.

At first instance, the CIRO Hearing Panel had found that if an advisor becomes aware of client trading activity that appears out of the ordinary but, based on their experience, concludes that there is a possible reasonable explanation, then the advisor’s gatekeeper obligations may have been fulfilled⁵. In contrast, the BCSC found that it was not appropriate for registrants to rely on possible, hypothetical explanations to fulfil a gatekeeper concern⁶. Instead, registrants need to make reasonable inquiries of their clients and take reasonable steps based on the information gathered in response to those inquiries.

Applying this to the facts of this case, the CIRO Hearing Panel erred in finding that it was sufficient for the Respondents to obtain information updating a client’s occupation from a non-financial job to a financial consultant for venture companies and concluding that changes in the client’s net worth and liquid assets “might well have resulted” from that change in occupation⁷. The BCSC found that the Panel should have, instead, asked whether a reasonable registrant would have made further inquiries of the client⁸.

The BCSC also made clear that registrant gatekeeping obligations are broad. They are not limited to a specific set of circumstances or areas of the industry⁹. We anticipate that this decision will encourage new enforcement cases related to alleged breaches of registrants’ gatekeeping obligations in light of this decision and other recent CIRO decisions in gatekeeping cases¹⁰. Registrants should continue to exercise vigilance in making and documenting inquiries and actions taken in response to red flags.

Standing of CIRO

Section 28 of the Securities Act (BC) allows the executive director of the BC Securities Commission or a person “directly affected” by a CIRO panel decision to apply for review of it. The Alberta Court of Appeal had previously found that IIROC’s predecessor (the IDA) could not appeal a decision of its District Council because it was not “directly affected” by the decision and, instead, effectively appealed its own decision. The BCSC took a different approach. The BCSC focused on the practical independence of CIRO hearing panels. The BCSC concluded that there is a sufficient degree of separation between CIRO staff and its hearing panels such that staff appealing a decision of a hearing panel do not constitute CIRO appealing its own decision¹¹.

With respect to whether CIRO was directly affected by the decision of the Panel, the BCSC found it was. The BCSC reasoned that it would be counter-intuitive to suggest that a party as significant as enforcement staff or, in the words of the BCSC, the “administrative prosecutor”, could be precluded from seeking a review of a decision made by an “institutionally independent” decision maker. The BCSC concluded that CIRO was directly affected by the Panel’s decision and could apply for review¹².