Proposed NI 31-103 Registration Requirements requires investment fund managers to register and comply with prescribed proficiency, capital and conduct standards.
Currently, investment fund managers that administer an investment fund but do not advise or trade are generally not required to be registered. However, the Canadian Securities Administrators (CSA) are proposing an investment fund manager registration that encompasses the managers of all public and private mutual funds and non-redeemable investment funds, labour-sponsored investment funds, scholarship plans, pooled funds and hedge funds.
The key elements of this new category of registration include: (a) a registration requirement for a person or company acting as an investment fund manager; (b) two new categories of individual registration requiring all registered firms to designate an individual as the ultimate designated person (UDP) and the chief compliance officer (CCO); (c) proficiency requirements for the CCO (but not the UDP) of an investment fund manager; (d) insurance requirements; (e) a $100,000 minimum excess working capital requirement (for non-SRO members); and (f) conduct rules for investment fund managers.
Registration for investment fund managers
The requirement to register an as investment fund manager is contemplated by the recently released proposed National Instrument 31-103 – Registration Requirements (the Proposed Registration Rule) and accompanying companion policy (Companion Policy), which will be implemented by a change to the Securities Act in each jurisdiction. All persons or companies who are "investment fund managers" will be required to register and to comply with prescribed fit and proper requirements, conduct rules and conflicts of interest standards.
The CSA intend that firms carrying on more than one type of activity will be required to register and comply with the requirements of multiple categories, as applicable. Although the Proposed Registration Rule is unclear on the definition of investment fund manager (further guidance is anticipated), the Companion Policy indicates that the management of an investment fund includes "administering" the fund, which may include information gathering, performance reporting and handling client assets, but does not include acting as portfolio manager for the fund.
While neither private equity nor venture capital funds are expressly addressed in the Proposed Registration Rule, the Companion Policy gives some guidance in respect of registration requirements for general partners, specifically in the portfolio manager context. For example, if the general partner is making investment decisions for the limited partners who rely primarily on the general partner’s expertise in selecting investments in securities, that could trigger a requirement to register as a portfolio manager. Conversely, the Companion Policy indicates that a registration requirement will not necessarily be triggered in cases where, for example, a limited partnership is operating as a venture capital fund and the general partner’s role is to select companies in which it will participate in active management and development (with the rationale that the purchase and eventual sale of these securities is incidental to the operational business activity of the limited partnership).
In their notice to the Proposed Registration Rule, the CSA indicate that investment fund managers must be registered in the Canadian jurisdiction in which the fund is "located". Given the international investment fund manager exemption (discussed below), it is unclear whether a presence in Canada is required in order to trigger registration requirements, and no guidance is given in relation to determining the location or the process of registration generally. Registration as an investment fund manager 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 on-going fit and proper and conduct requirements.
Additional new individual categories of registration — UDPs and CCOs
The Proposed Registration Rule introduces two new individual categories of registration for all registrants including investment fund managers, namely the UDP and the CCO.
The UDP's role is to ensure that the registrant complies with applicable securities regulations and that written compliance policies and procedures are developed and implemented. The designated UDP must be the CEO of the registered firm, a senior officer responsible for the division within the firm which is carrying on investment fund activity, or someone with a similar function, but does not necessarily need to be someone who is involved in the day-to-day compliance management of the group. 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 registrant’s compliance system. Accordingly, the CCO (who must be an officer or partner of the registered firm, or, if applicable, the sole proprietor), will be subject to the same proficiency requirements as required for the CCO of a portfolio manager (discussed below).
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, particularly for smaller investment fund managers and sole proprietors. Depending on the size and structure of the investment fund manager, the CSA would permit the UDP and CCO function to be performed by the same individual (who may also be required to be registered in the dealing or advising categories), provided they meet the requirements for all designations and are registered separately for each.
Fit and proper, conduct and conflicts of interest requirements
Registered investment fund managers must comply with many of the fit and proper requirements, conduct rules and conflicts of interest provisions set out in the Proposed Registration Rule.
Exemptions for Members of Self-Regulatory Organizations (SRO)
Certain requirements in the Proposed Registration Rule (for example, the proficiency and solvency requirements) will not apply to investment fund managers who are members of the IDA or an MFD SRO.
Fit and proper requirements
The cornerstones of the registration fit and proper requirements are proficiency, solvency and integrity. Non-compliance may result in the imposition of terms and conditions, or revocation or suspension of registration.
- Proficiency: There are no proficiency requirements for a UDP, but a CCO of an investment fund manager must comply with the same proficiency requirements as provided for the CCO of a portfolio manager. Accordingly, the CCO of an investment fund manager must:
- Capital requirements: All non-SRO registered investment fund managers will be required to have a minimum excess working capital of not less than $100,000 (considerably more than the minimum capital requirement for non-SRO advisers and dealers). Excess working capital must be calculated as at the end of each month by completing Form 31-103F1 – Calculation of excess working capital within 20 days following the end of the month, and the regulator must be notified if the excess working capital is ever calculated to be less than zero.
- Insurance: Investment fund managers will be required to maintain a financial institution bond in the greater of the following amounts: (a) the amount which is the lesser of 1% of the assets under management or $25,000,000; (b) $200,000, and (c) any other amount determined necessary by the directors of the investment fund manager. As a minimum, insurance must be maintained by way of a financial institution bond with a double aggregate limit or a provision for full reinstatement of coverage, and must include the clauses specified in Appendix A of the Proposed Registration Rule (fidelity, on premises, in transit, forgery, alterations, and securities clauses). The regulator must be notified in writing of any change in, claim made under, or cancellation of the financial institution bond.
- Financial records: Non-SRO registered investment fund managers will be required to appoint an auditor and to deliver annual financial statements with the audit report within 90 days of year end and quarterly financial statement within 30 days following the completion of the first, second and third fiscal 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 section 5600 report) is required. The annual and quarterly financial statements must each be accompanied by a completed Form 31-103F1.
- NAV adjustments: The quarterly and annual financial statements must be accompanied by a description of any net asset value adjustment made during the relevant period, including a description of the cause of the adjustment, its dollar amount, and the effect of the adjustment on NAV per unit or share and any corrections made to purchase and sale transactions affecting either the investment fund or security holders of the investment fund.
have previously been registered as an advising representative of a portfolio manager,
obtained professional designation as a lawyer or chartered accountant in Canada and be in good standing;
passed the Canadian Securities Exam and the Partners, Directors and Senior Officers Exam; and
either been employed for three years as a registered dealer or adviser or provided professional services to the securities industry for three consecutive years and been employed by a registered dealer or registered adviser for 12 consecutive months; or
passed the Canadian Securities Exam and the Partners, Directors and Senior Officers Exam; and
either been employed for five consecutive years by a registered dealer or adviser (including three years under the supervision of the CCO), or been employed for five consecutive years by a regulated financial intermediary and employed by a registered dealer or registered adviser for 12 consecutive months.
The Proposed Registration Rule and Companion Policy contain detailed and technical conduct requirements for all registrants, not all of which apply to investment fund managers. The conduct rules which do apply to investment fund managers include:
- Client assets: Investment fund managers will be required to hold securities or other client property in trust separately from their own property.
- Record keeping: Investment fund managers will be required to maintain records to accurately record their business activities, financial affairs and client transactions, as well as to demonstrate regulatory compliance. Records must be safeguarded and be kept in durable form. Activity records (which include, inter alia, trade confirmation statements, records of dividends and interest paid and communications between the investment fund manager and the client) must be kept for seven years from the date of the activity.
- Compliance: Investment fund managers will be required to establish, maintain and enforce appropriate systems to achieve compliance with securities legislation and to manage the risks associated with conducting its business in conformity with prudent business practices. The compliance measures must be documented in the form of written policies and procedures, and the CCO must report directly to the board of directors on securities compliance at least annually.
- Complaint handling: Investment fund managers must establish and implement complaint handling procedures, including procedures for recording and investigating complaints and policies for the resolution of disputes concerning the firm’s products or services. In addition, non-SRO registered investment fund managers will be required to participate in a dispute resolution service which mirrors similar requirements of the SROs.
- New reporting requirements: Investment fund managers must submit an annual report within 2 months of year end to the securities regulators detailing their complaints handling policy, and the number and nature of complaints received.
Conflicts of interest
The Proposed Registration Rule consolidates and streamlines conflict of interest provisions, requiring investment fund managers to implement procedures and internal structures for managing and disclosing conflicts of interest in a fair, equitable and transparent manner. 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).
Exemptions from registration
The Proposed Registration Rule contains limited exemptions from the registration requirement for, among others, "international investment fund managers", who will be exempt if the securities of the fund are:
- primarily offered outside of Canada;
- only distributed in Canada through a registered dealer; and
- distributed in Canada in reliance upon an exemption from the prospectus requirement.
An "international investment fund manager" is an investment fund manager that has no establishment in Canada or officers, employees or agents resident in Canada, and engages in the business of a portfolio manager in the jurisdiction in which its head office or principal place of business is located.
There is a similar exemption from the requirement to register as an adviser for an "international portfolio manager" advising an investment fund. It is unclear whether the inclusion of that international portfolio manager registration exemption when advising an investment fund is a sign that the CSA are moving towards the approach currently taken by Ontario with the "look through" analysis reflected in OSC Rule 35-502 – Non-Resident Advisers (under which portfolio managers of an investment fund sold to investors in Ontario are treated as advisers who must be registered as such in Ontario unless an exemption is available).
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 (including currently unregistered investment fund managers) 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 remian 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 anticiapted 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 except Alberta. A transition timetable is also yet to be published.
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