IIAC Retail/Integrated Member Considerations Checklist for CRM2 Market Value Rule

The impact of the CRM2 market value requirements will vary from firm to firm; service provider to service provider; and, if applicable, carrying broker to carrying broker. Below is a checklist of considerations members may use to prepare for and check their readiness for the CRM2 market value requirements. All preparations – development, testing, data cleansing and statement notation additions – should be in place no later than December 31, 2015.

❏ Read the IIROC market value requirements and related FAQs Where do I find them? For the definition of “market value”, see IIROC Rule 200.1(c); for further elaboration, see IIROC FAQs #s 13, 14, and 15.

❏ Understand the IIROC decision tree approach to security market valuation What is this? The IIROC market value definition is a series of decision points. IIROC expects this cascading process to be reflected in firms’ market valuation policy and/or firms’ historic/stale matrix. Your policy or matrix sets out the valuation techniques to be used as the time since the date of information used to value a security lengthens. Below is a high- level summary of the requirements as a rule of thumb:  1. Market value for liquid securities classes with adjustments, and after x days stale, then… Non-liquid valuation options  2.a Value using inputs other than published price quotations, and if none, then…  2.b Value using unobservable inputs/assumptions, and, if none, then…  2.c Cost, if data is lacking and/or there are many possible values, and if none, then… No-value options  3. Non-determinable (with notice), and after x months, or other information, then…  4. $0.

❏ Engage early with service providers/carrying brokers and any of their user groups to understand current functionality and planned changes Why? IIROC staff are clear that, while there is recognition there will be some “growing pains” when rule changes are implemented, examiners will expect firms to be knowledgeable about how their service provider and carrying broker, if applicable, will help firms meet the requirements.

❏ Find out what functionality your service provider and/or carrying broker will provide and understand the options available to your firm (for example, stale price logic to define current pricing, rules to distinguish different security classes/markets, wording for required statement notificationsi, etc.). Get a sense of any additional development or manual work that may be required internally to meet the requirements. There may need to be agreement on the approach to certain functionality aspects among all users of a common service provider or carrying broker.

❏ Understand data feed pricing parameters by asking your service provider or carrying broker for details about the data feeds you receiveii. Engage with other users of shared providers/carrying brokers to understand the options that may be available as a group with the data vendors. Note: Do not act on this checklist without professional advice. Page 1 ❏ Learn what automated reports your service provider or carrying broker might set up to help assess and track variances and tolerances. This will help your firm assess and refine your market valuation processes over time as required.

❏ Analyse client holdings, to assess potential “stale-dated” securities, bid/ask/last tolerances and the overall nature of the securities held How? Extract, or request your service provider or carrying broker for an extract of, data regarding current holdings, showing last traded price, bid and ask, the aging of the security prices as well as general characteristics about the security holdings. See Attachment 1 for a suggested model for your analysis of the tolerance levels of bid and ask prices as compared to last.

❏ Prepare your periodic market value (tolerance) testing plan Why now? The time you spend analyzing your data to see how much is out of date, variations by asset category, etc. can be a good time to start developing a periodic review plan and thinking about your firm’s aging matrix. ❏ After engaging with your service provider and/or carrying broker, you will know if they will be using ‘bid’/‘ask’ for liquid securities or ‘last traded price’iii. If ‘last traded price’, your firm is expected by IIROC to assess periodically that the ‘last traded price’ results in security market values that are materially the same as last bid or ask. The frequency of this periodic review may be a longer period (up to a year) while you complete other market valuation improvements but could be shortened (say, six months) if differences are material or your service provider or carrying broker has a review application that will allow you to focus quickly on problem areas.

❏ Firms also could consider what satisfactory percentages might be for a last traded price remaining “comparable” to last bid/ask. For liquid securities, it might be 10%; a higher tolerance might be appropriate for some part of the remainder (e.g., where the absolute price is low, say $10 or less, a higher percentage would apply).

❏ Your service provider or carrying broker will be able to identify the flags that you may be able to use to signal issues where you need to focus. Liquid/traded securities could be set at a five-day notice that should cover most unusual situations including holidays adjacent to weekends. For harder-to-value securities, you may be able to set flags to start requiring review after, say, a year for a new issue. For other securities in your market value aging matrix, your firm could start at six months and then reduce with experience to quarterly and then, if new data sources are found, monthly.

❏ Set timelines for achieving the new market value definition date of December 31, 2015 What are the key milestones? While the list below is provided in chronological order, your firm may also want to work back from the final implementation date to ensure your firm is able to meet the requirements. 1. [insert date] – Date by which your service provider (and carrying broker) need your decision(s)/sign-off on any systems solution for market value capture and to reflect “no active market” and “not determinable” notices. 2. [insert date] – Date for providing customization decisions to your service provider and carrying broker. Note: Do not act on this checklist without professional advice. Page 2 3. [insert date] – Date for any testing to begin. 4. [insert date] – Date to start amending/cleaning up data (Note: This can start now). 5. [insert date] – Date to implement (with contingency). 6. [December 31, 2015] – Last date to implement.

❏ Update or develop a securities market value policy How? Identify processes specific to your firm, including who is responsible for approvals or activities, and how your firm will evidence performance and supervision. Look at your current policy or consider the IIAC’s Securities Market Valuation Policy and Procedures Considerations. (Note: IIROC’s 2014/15 Annual Consolidated Compliance Report suggests dealers consider, when drafting procedures, not just the minimum requirements of Internal Control Policy Statements 2 – 8, but also sources that “may suggest a higher standard, including authoritative literature, comments made by internal or external auditors or by industry regulators, as well as industry practices”. Dealers can expect to be asked about this and may want to have an answer ready (business model, size, etc.).iv

❏ Learn what specific valuation approaches under the IIROC market value decision tree may be right for your firm. As large firms have a greater capacity in- house to value securities compared to smaller firms, they may do more estimation (categories 2.a, 2.b, and 2.c above) than smaller firms. A higher proportion of hard-to- value securities in online accounts may lead to resource challenges and different approaches. Nevertheless, as a minimum all firms are expected to have an approach covering the following:

Valuation Category Examples 1. Liquid markets E.g., shares and other exchange-traded securities, funds (Note: It is not easy (exchange-traded to define’ liquid’, as it can require looking at trading frequency, volumes, etc. securities, mutual Firms’ common data provider feeds may be the source of all quoted prices – funds) but firms must check if any are stale-dated based on their aging matrix.) Less liquid markets Restricted shares linked to underlying non-restricted shares (with or without a 2.a Inputs other than discount) published price Physical securities linked to underlying security (with or without a discount) quotes Grid to price OTC fixed income securities (for firms that have such desks) Non-exchange-traded private security linked to publicly-traded security (with 2.b Unobservable or without a discount) inputs/ Discount below national government debt for subnational debt assumptions “Historic” or “stale” price unless new negative information is known Option pricing model 2.c Cost E.g., new issues, flow-through shares Flow-through shares

Note: Do not act on this checklist without professional advice. Page 3 ❏ Identify acceptable data sources. The obvious ones are the data feeds from data aggregators such as SVC, IDC, etc. The data aggregators provide information on their sources and process, and you can obtain documentation regarding these from your service provider.

Note: It is likely that, at least at inception, these feeds will be considered the equivalent of Level or Category 1 – quoted prices. For private securities, different firms have different success rates in getting answers from issuers (valuations needed for the transfer of securities to registered plans has long been a problem). While some larger firms have additional resources to contact private issuers and assess information provided, others have received prices that seem widely at odds with the last known traded price or bid/ask, so caution must be exercised. Also, if a valuation is provided, it is usually done on a ‘client-specific’ use basis. Other firms have been able to get a last traded price of an arm’s-length transaction from an issue. In either of these cases, whereas the prices received may not be appropriate or permitted for use in the security master, they may still provide the basis for concluding an “older” market value remains reasonable. See IIAC’s Policy and Procedures for Valuation of Securities Considerations.

❏ Document your market value exception process. Identify when a senior officer or officers may be able to override the policy and matrix on rare occasions and specify the occasions. For example, you may accept having securities values stale-dated for a period of longer than your matrix provides at inception of the new definition, but it should be with appropriate sign-offs and documentation. There may be market disruptions, such as 9/11, when you may push out the 5-days for liquid traded securities to 10 days.

❏ Update, develop and implement a securities market value “aging” matrix What’s that? Firms are expected to have a process – matrix– to assess whether market values are sufficiently current. Some firms will have general security classes, possibly broken down by listed, OTC or house range (see Attachment 2). Other members will have an extensive stale-dating/valuation matrix, breaking it down by asset class and subcategory. Tip: IIAC have developed a minimum standard market value “aging” matrix, titled TARGET and SAMPLE Market Valuation Agin Matrix by Pricing Source. The matrix will offer members a structure against which to benchmark themselves.

❏ Update relevant written materials – balance plain language with protecting your firm from liability What materials? IIROC staff have said they expect relationship disclosures will warrant updating for new CRM2 disclosures. Members should consider other documentation as well. Client-facing wording, which should be reviewed by legal/compliance – should be concise and use simple terms. ❏ Systems-based notifications: Consider pop-ups for trades in less liquid securities (‘there is no active market for this security’). ❏ Account-statement-based notices: There are two required statements and other matters to consider.

Note: Do not act on this checklist without professional advice. Page 4 ❏ When price quotations are not available, use the statement: “There is no active market for this security so we have estimated its market value.” Or wording substantially similar. Note: Some firms are not comfortable ‘estimating’ the value of less liquid securities. Using some of the foregoing statement, a number of members may consider using a wording referencing IIROC rule requirements; while the statement is accurate, it has not been tested with IIROC for acceptability. “There is no active market for this security, and accurate valuation information is not available at this time so we are reporting a value following regulatory guidelines.” ❏ When there are no liquid or recent prices and it is hard to value the security (but, for example, the issuer is not defunct), use the statement “Market value not determinable.” ❏ Consider boilerplate disclosure referencing uncertainty in securities values (e.g., “The value you receive when selling or redeeming a security(ies) may be more or less than its(their) value on your statement.”).v ❏ Communications to advisors: Consider a session discussing with advisors the intent of the change, the measure of change clients will see and what written material may be helpful to clients. While there will be no difference in a security’s value pre- and post- the market value definition change, some securities may change from having a value to showing ND. While the client may know the value of the security was uncertain, it may still cause some consternation. ❏ Communications to clients: Think about what client-facing material, explaining the purpose of the regulatory change, would be helpful to clients. Consider explaining that: “The value of most client securities comes from market price data feeds from recognized exchanges and other sources [we] consider to be reliable. In the case of securities that do not trade frequently, or we may require third-party valuations; where these would be at the owner’s cost, and the costs can be significant, we use ND (non-determinable) or $0.” Tip: Members with an online option may wish to tell full-service clients who prefer to invest through the full-service arm that they have access to more current prices between statements if they want through the firm’s website – a value-added service. ❏ Relationship disclosure update: IIROC staff have said they expect updated relationship disclosures due to CRM2 changes. RDs without reference to market value may wish to consider adding a few sentences. For example: “The securities in your accounts are valued using, wherever possible, reputable independent pricing feeds that are consistent with industry standards of accuracy, timeliness, and completeness. Where data has not been updated in some time, we follow regulatory guidelines up to and including marking the value as ‘not-determinable’ (ND) and, after some period, $0. The value you receive when selling or redeeming a security(ies) may be more or less than its(their) value on your statement. Clients wishing for a security to be valued at their expense for personal purposes, for example, to satisfy Revenue Canada requirements, can speak to their advisor.” ❏ Account agreement wording: As account agreements are signed and relationship disclosure information may not be acknowledged in writing, members may wish to include some version of your firm’s market valuation practices (e.g., along the lines of the above wording) in account agreements.

❏ Check other liability issues with legal and tax operations

Note: Do not act on this checklist without professional advice. Page 5 What else? The combination of regulatory, investor advocate and media attention on CRM2 is likely to lead to new situations. The likelihood is that there will be a greater concern if a security is over-valued, however, there is also a risk if a security is marked to $0, disposed of to remove the asset from the account, and then is found to have value. While this has always been a risk, it’s a good time to review processes with your legal and tax advisors.

❏ Keep an eye open for sources of help Yes, please! The IIAC shares information through its committees and on its member-only site. The IIAC and its members are continuing to do work on hard-to-value securities in general, as well as reaching out to CPA Canada and the Toronto CFA Society on lower-cost options than full audits for smaller private issuers. Options to be kept apprised of any CRM2 developments include: ❏ Sign up for CRM2 Updates by e-mailing [email protected]. ❏ Visit our tools page by signing in and visiting CRM Help at Your Fingertips.

Note: Do not act on this checklist without professional advice. Page 6 Attachment 1

SAMPLE MODEL TO ASSESS VARIANCE BETWEEN BID, ASK AND LAST TRADED PRICE

This table was developed by a member firm and reviewed by IIAC CRM2 Market Value Working Group members, who agreed it was a useful tool to analyse variances between bid, ask and last for asset holdings. The sample results are a single firms, but included as information against which it may be interesting to benchmark.

< Ask to Bid 0.00 to 0.01 to 0.02 to 0.10 to 0.50 to 1.00 to 5.00 to 10.00 to % of Sample 50.0 Variance < .01 < .02 < .10 < .50 < 1.00 < 5.00 < 10.00 < 50.00 Total Results 0 Nil (0%) 19.1% >0%<10% 68.2% 10%<20% 3.7% 20%<30% 2.6% 30%<40% 1.8% 40%<50% 0.9% >50% 3.8%

< Last to Bid 0.00 to 0.01 to 0.02 to 0.10 to 0.50 to 1.00 to 5.00 to 10.00 to % of Sample 50.0 Variance < .01 < .02 < .10 < .50 < 1.00 < 5.00 < 10.00 < 50.00 Total Results 0 Nil (0%) 19.2% >0%<10% 78.2% 10%<20% 1.2% 20%<30% 0.5% 30%<40% 0.3% 40%<50% 0.1% >50% 0.6%

< Last to Ask 0.00 to 0.01 to 0.02 to 0.10 to 0.50 to 1.00 to 5.00 to 10.00 to % of Sample 50.0 Variance < .01 < .02 < .10 < .50 < 1.00 < 5.00 < 10.00 < 50.00 Total Results 0 Nil (0%) 19.1% >0%<10% 70.2% 10%<20% 2.8% 20%<30% 2.2% 30%<40% 1.5% 40%<50% 0.8% >50% 3.3%

Note: Do not act on this checklist without professional advice. Page 7 Attachment 2

SAMPLE MARKET VALUATION AGING MATRIX

• Note: This is for consideration purposes only and frequencies, maximum days, etc. do NOT reflect any firm’s current practices or such data from the industry market value aging matrix currently in preparation. See also alternative IIAC examples: Market Valuation Aging Matrix by Pricing Source (to be linked to when ready) and Market Valuation Aging Matrix by IIAC Asset Class Schema (to be linked to when ready). The IIAC Market Value Working Group will be seeking comments/non-disapproval of a Market Valuation Aging Matrix with “generous” timelines to allow firms to prepare and then there is an expectation that the timeliness will tighten as more experience with the greater specificity IIROC seeks continues. Max. Security Listed, OTC Primary Action Second Pricing Days Class & or House Pricing Pricing Method if Price Source Frequency Price Code Range Source Stale Reused SVC/Service IIROC Rule Listed Manual Daily 35 TBD Provider 200.1(c)(i)(A) Shares and SVC/Service IIROC Rule OTC Manual Daily 35 TBD Options(#) Provider 200.1(c)(i)(B), (C) IIROC Rule House range Manual N/A Ad hoc TBD TBD 200.1(c)(i)(C) SVC/Service IIROC Rule Listed Manual Daily 35 TBD Provider 200.1(c)(i)(A) SVC/Service IIROC Rule Bonds (#) OTC Manual Daily 35 TBD Provider 200.1(c)(i)(B), (C) IIROC Rule House range Manual N/A Ad hoc TBD TBD 200.1(c)(i)(C) Mutual Listed N/A N/A N/A N/A N/A N/A Funds SVC/Service IIROC Rule (excluding OTC Manual Daily 35 TBD ETFs, Provider 200.1(c)(i)(B) CEFs) House range N/A N/A N/A N/A N/A N/A Listed N/A N/A N/A N/A N/A N/A CCPCs, SVC/Service OTC # # # # # Other Provider Unlisted IIROC Rule House range Manual N/A Ad hoc 365 TBD 200.1(c)(i)(C) Complete as Listed desired (e.g., non- OTC traded options/ warrants House range valued at $0)

Exceptions to asset-class-specific market value aging matrix: • Trade halts: Usually will restart trading in short period so usual market value aging matrix likely to apply). • Cease-trade orders: Leave for x months, or mark ND; then mark to $0 after a further x months) • Delisted: Same as unlisted, but tag to monitor if still trades on bulletin board GICs: No change in current practice (face plus accrued interest)

Note: Do not act on this checklist without professional advice. Page 8 Endnotes

Note: Do not act on this checklist without professional advice. Page 9 i Notices under IIROC Rules include: “There is no active market for this security so we have estimated its market value.” (200.1(c)(ii)) and “Market value not determinable.” (200.1(c)(iii)). ii A number of members have identified questions with respect to certain aspects of various data feeds, including defaulting practices (where there are bid, ask and close prices) and timing questions (when market ‘snapshots’ are taken). These questions will be dealt with in time by members with their data providers, carrying brokers, service providers, and user groups. iii Bid/ask is identified as the general approach to market valuation in IIROC Rule 200.1(c) IIROC FAQs. iv IIROC Rule 2600, Internal Control Policy Statement 1, General Matters, requires firms to develop and maintain internal control policies and procedures to help management achieve the goal of reasonably ensuring the “orderly and efficient” conduct of the firm’s business. These policies must be reviewed and (re-)approved at least annually by appropriate executives. IIROC’s 2014/2015 Annual Consolidated Compliance Report said examiners continue to find internal control policies that inaccurately or inadequately describe the firm’s policies and procedures. The Report says some firms’ written procedures are copied, almost word-for-word from the minimum requirements in Rule 2600, Internal Control Policy Statements 2 through 8, with minimal description of procedures, identification of responsibilities and documentation of process performance and supervision. v This reference is from a FINRA/NASD document.