Canada: Proposed National Instrument 31-103: Impact On The Exempt Securities Market

Proposed National Instrument 31-103 Registration Requirements¹ will transform the registration regime in connection with the exempt distribution securities market, particularly in provinces outside of Ontario and Newfoundland and Labrador, where a system of universal registration is already in place.

Under the current securities regulatory regime, if a firm or individual wishes to distribute a prospectus-exempt security, the firm and/or individual must either register as a dealer or sales representative or rely upon a registration exemption, such as the "accredited investor" or the minimum purchase threshold exemptions set out in securities regulation, including National Instrument 45-106 Prospectus and Registration Exemptions. Finding a registration exemption is today not particularly difficult as many prospectus exemptions have a corresponding registration exemption – the policy reason behind such exemptions being that certain investors do not need the protection of the prospectus or registration regimes. However, in Ontario and Newfoundland and Labrador, if a firm is in the business of trading in securities, i.e. a "market intermediary", it cannot rely upon most registration exemptions and therefore must obtain a dealer registration.

With proposed NI 31-103, the Canadian securities regulators do not explicitly suggest that they intend to import a concept of universal registration to the rest of the country. However, the proposed introduction of a "business trigger" for registration for anyone in the business of dealing in securities and the creation of an "exempt market dealer" registration category, together with the elimination of some of the industry’s most treasured registration exemptions, including the accredited investor, offering memorandum and certain other registration exemptions currently set out in NI 45-106, will essentially ensure that anyone who deals with prospectus-exempt securities must be registered.

The British Columbia Securities Commission is contemplating opting out of the parts of proposed NI 31-103 that would require those who deal in securities within the exempt market to register as a dealer. The BCSC has determined that current practices in the exempt market in British Columbia are not problematic – the BCSC has also expressed concern about the costs to the industry of requiring registration and the impact on capital raising activities in the province.

The exempt market dealer category will look familiar to limited market dealers in Ontario and Newfoundland and Labrador, although the "fit and proper" requirements of this category will be more exacting. Like registrants in other categories, a registered exempt market dealer will be required to have a "dealing" representative (sales representative), who must meet certain educational requirements, an ultimate designated person and a qualified chief compliance officer. It will also have significant minimum capital requirements ($50,000) and insurance requirements. T2P 4H2

Under proposed NI 31-103 exempt market dealers will be permitted to deal in prospectus-exempt securities and in any security with persons to whom securities may be distributed on a prospectusexempt basis, including accredited investors. Nevertheless, if a firm is not in the business of dealing in securities, it will not be required to be registered. The current "trade trigger", which provides that entities cannot trade in a security unless they are registered as a dealer or are exempted from registration, is proposed to be replaced with a "business trigger", which provides that if the entity is in the business of dealing in securities, it is required to register as a dealer or be exempted from registration. A business trigger already exists in connection with advising in securities.

Pursuant to the "business trigger" proposed by NI 31-103, a registered portfolio manager that deals in the securities of its own pooled funds by trading those securities to a fully-managed account managed by it, would not be required to register as a dealer, unless the managed account was "created or used only to qualify for the exemption". The CSA intend to restrict the availability of the dealer registration exemption to portfolio managers whose primary business is managing fully managed accounts and who create pooled funds as an incidental part of that business to facilitate their management of those accounts. Pooled fund managers who primarily dedicate their efforts to managing pooled funds, as opposed to managing fully managed accounts, will not be permitted to rely on this registration exemption and therefore must be registered in three categories: portfolio manager, investment fund manager and exempt market dealer. Portfolio managers who create pooled funds entitled to rely on the dealer registration exemption will be required to be registered in two categories: portfolio manager and investment fund manager.

For more information on proposed NI 31-103, please see BLG’s Investment Management Advisory Canadian Securities Regulators Release Comprehensive Registration Rule for Comment released by our Investment Management Group on February 20, 2007. This Investment Management Advisory is one of eight in the series: Keeping Reforms in Sight: Understanding the Registration Reform Proposals. BLG’s Investment Management Advisories are available on our Website at www.blgcanada.com [click on Publications and then select Capital Markets to search current publications].

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.