Proposed NI 31-103 - Registration Requirements removes current limited market dealer category and introduces exempt market dealer category in its place.
In late February, 2007, the CSA published for comment proposed NI 31-103 – Registration Requirements (the Proposed Registration Rule) and accompanying companion policy (Companion Policy). The impetus for the Proposed Registration Rule is the harmonization and streamlining of the registration regime across all of the CSA jurisdictions by, among other things, moving away from the "trade trigger" towards a "business trigger" for dealer registration, and introducing several new categories of registration while removing others. One of the implications of these changes is that the current limited market dealer (LMD) category will cease to exist, and (except perhaps in British Columbia) an exempt market dealer (EMD) category will take its place. Further, in conjunction with moving towards a "business trigger" for dealer registration, the CSA propose to repeal the dealer registration exemptions currently contained in NI 45-106 – Prospectus and Registration Exemptions, including (except perhaps in British Columbia) the accredited investor exemption which will, however, remain available for prospectus exemption purposes.
Registration as an exempt market dealer
Under the Proposed Registration Rule, exempt market dealers will be restricted to:
- dealing in securities being distributed under an exemption from prospectus requirements (the most common is a distribution to accredited investors acting as principal); or
- dealing with persons to whom a security may be distributed under an exemption from prospectus requirements (such as accredited investors acting as principal).
All persons or companies who are EMDs will be required to register and to comply with certain prescribed fit and proper requirements, conduct rules and conflict of interest standards.
Exemption from registration
The Proposed Registration Rule contemplates a new "mobility exemption" which would in some circumstances allow a firm and a representative to continue to deal with a small number of relocating clients who move to another province without the EMD having to get registered in that other province. The transfer of a representative from one firm to another will also be regulated.
Registration requirement for UDPs and CCOs
The Proposed Registration Rule introduces two further categories of registration for all registrants, including EMDs, namely the Ultimate Designated Person (UDP) and the Chief Compliance Officer (CCO). UDP's role is to ensure that the registrant complies with applicable securities regulations and that written compliance policies and procedures are developmd and implemented. While the actual form of compliance system to be implemented is not prescribed in the Proposed Registration Rule, the Companion Policy gives guidance on what the CSA view as an effective compliance framework. The designated UDP should be the CEO of the EMD, but does not necessarily need to be someone who is involved in day-to-day compliance matters. No proficiency requirements are specified for the UDP function.
The CCO is responsible for the management and supervision of the day-to-day monitoring of compliance with the EMD’s compliance system. Accordingly, the CCO (who must be an officer or partner of the EMD) will be subject to certain proficiency requirements as described below. The CCO must report directly to the board of directors as necessary and at least annually.
While the CSA would prefer that the UDP and CCO roles be performed by different individuals, they do recognize that this may not always be practical. Depending on the size and structure of the EMD, the CSA would permit the UDP and CCO function to be performed by the same individual (who may also be registered in other registration categories), provided they meet the requirements for all designations and are registered separately for each.
Fit and proper, conduct and conflict of interest requirements
EMDs and their personnel will need to demonstrate integrity and competence, and the firm will need to satisfy the regulator as to its solvency. Conflicts of interest and compliance procedures are also contemplated in the Proposed Registration Rule.
Fit and proper requirements
EMD’s will be required to meet the following fit and proper requirements. Non-compliance may result in the imposition of terms and conditions by the securities regulators, or revocation or suspension of registration:
- Proficiency: EMD personnel will need to satisfy proficiency requirements, which will generally be exam-based, rather than course-based. Representatives can qualify, among other ways, by passing the CS (Canadian Securities) Exam and either the CPH (Conduct and Practices Handbook) Exam or the PDO (Partners, Directors and Senior Officers) Exam. While an UDP does not need to satisfy proficiency requirements, a CCO of an EMD can qualify, among other ways, by passing the CS Exam and the PDO Exam.
- Capital requirements: EMDs will have to satisfy capital requirements. This means that their excess working capital (calculated as prescribed, via Form 31-103F1 – Calculation of excess working capital, and certified by management) must not be less than zero, and their minimum capital must be $50,000.
Excess working capital must be calculated within 20 days after each month end. Negative excess working capital at any time must be reported to the regulator as soon as practicable. Under Form 31-103F1, "excess working capital" is calculated according to the following formula:
- Insurance : EMDs will need to have specified insurance, namely a financial institution bond (with fidelity, on premises, in transit, forgery or alterations and securities coverage, and either a double aggregate limit or a full reinstatement of coverage provision) in the greater of: (1) $50,000 per employee, agent and representative or $200,000, whichever is less; (2) 1% of total clients assets held or accessible by the dealer or $25,000,000, whichever is less; (3) 1% of the dealer’s total assets or $25,000,000, whichever is less; and (4) the amount determined by its board of directors. Changes, claims or cancellation of such insurance policy will need to be reported in writing to the regulator as soon as practicable.
- Financial records : EMDs will need to have an auditor (for annual purposes and to be on standby to deliver an audit or review report as and when requested by the regulator), and will be required to deliver annual financial statements (with the audit report and a completed Form 31-103F1 within 90 days of year end. Unaudited quarterly financial statements and a completed Form 31-103F1 are required to be filed within 30 days following the completion of the 1st, 2nd and 3rd quarters.
All financial statements are to be prepared in accordance with GAAP but on an unconsolidated basis, and a special form of audit report for regulatory purposes (known as a s. 5600 report) will be required. Fiscal year end changes, together with the reasons for the change, must also be reported to the regulator in writing as soon as practicable following the change.
The Proposed Registration Rule and Companion Policy contain detailed and technical conduct requirements for all registrants, including EMD’s. The CSA consider compliance to be a firm-wide responsibility to be carried out in accordance with a documented compliance system which must address, among others, the following elements:
Account opening and client documentation: Account opening and client documentation (including for know-your-client and suitability purposes) must be maintained and kept current. Unsuitable trades (in the firm’s opinion, acting reasonably) at a client’s direction can be executed only if the client is first informed of their unsuitability (in the EMD’s opinion). Know your client and suitability exemptions are available for certain specified institutional clients.
Leverage disclosure: Where a client is using borrowed money to finance any part of the purchase of a security, a written acknowledgement of the risks of leverage must be obtained from the client, with certain exceptions (including for accredited investors or where the proposed purchase is on margin and the client’s margin account is maintained in accordance with SRO margin rules).
Client assets: Client assets that are held by an EMD must be segregated and held in trust for the client (in the case of cash in a designated trust account with certain types of Canadian financial institution, and in the case of securities in accordance with certain requirements). For clients with multiple accounts, free credit balances must be applied against derivative (e.g. options) account debit balances absent written instructions to the contrary from the client. As well, special additional requirements, including regarding custody of client assets and disclosure to clients, will apply to non-resident EMDs.
Margin: EMDs may not "lend or extend credit" to clients or permit clients to purchase securities on margin (the rationale for this is not explained).
Record keeping and account activity reporting: Record-keeping is mandated, and certain client records must be kept for at least 7 years, and for at least 2 years in a readily accessible form to provide to regulators promptly. The Proposed Registration Rule does not contain a prescriptive list of records that must be kept, instead requiring all records that demonstrate compliance with securities legislation to be retained. Trade confirmations are required, with related party disclosure, if applicable, and other specified disclosure, as are account statements.
Complaint handling: EMDs will also be required to have policies and procedures on complaint handling, and must participate in a dispute resolution service to mediate disputes.
New reporting requirements: An annual report must be submitted to the securities regulators within two months of year end detailing the EMD’s complaints handling policy, and the number and nature of complaints received.
Conflicts of interest
Conflicts of interest must be identified and managed fairly and in the best interests of clients, and conflict of interest disclosure is prescribed in certain cases, including with respect to trades and offerings involving securities of related entities (research reports involving such securities are severely circumscribed). Referral arrangements are also regulated, including from a disclosure and diligence perspective, as are "tied selling" and unnecessary mandatory financial institution settlement arrangements. If firms outsource, they are expected to do so via written agreements with third parties reviewed with appropriate due diligence.
Suspension and revocation of registration
Registration as an EMD does not have to be renewed annually, and will remain in effect until suspended or terminated by certain "triggering events", including non-payment of annual fees and failure to comply with the fit and proper requirements and conduct rules. Revocation of an EMD’s registration triggers an automatic suspension of the registration of all of its representatives. The Companion Policy states that there is no opportunity to be heard in the case of an automatic suspension, and a suspended EMD must immediately cease all activity requiring registration.
The Proposed Registration Rule does not impose filing or participation fees. The only reference to fees is in the context of the suspension or revocation of registration (non-payment of fees is one of the triggering events for a revocation or termination of registration). Currently, Ontario is the only CSA jurisdiction which requires market participants to pay an annual capital markets participation fee. It remains to be seen whether and to what extent other CSA jurisdictions will follow Ontario’s lead, and how the interplay between fees and registration is regulated.
Implementation and transition
The Proposed Registration Rule and Companion Policy were published by the CSA on February 23, 2007, and remain open for comment until June 20, 2007. The CSA have indicated that they intend to move quickly in finalizing and implementing the Proposed Registration Rule, and this is anticipated sometime in 2008. Implementation of the Proposed Registration Rule will require amendments to provincial securities laws and regulations, proposed drafts for which have not yet been published in any jurisdiction with the exception of Alberta. A transition timetable is also yet to be published.
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