Copyright 2009, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, October 2009
Canada's new dealer registration rules came into force on September 28, 2009. The rules, consisting of National Instrument 31-103 – Registration Requirements and Exemptions (NI31-103) and a large number of other new and related rules, policies and statutory amendments, represent the culmination of a lengthy effort by the Canadian securities administrators (CSA) to harmonize and simplify the registration regime across Canada. The new rules will regulate the registration of persons engaged in the business of trading or advising in securities or that are investment fund managers. The rules also prescribe detailed, and in some cases new, requirements relating to proficiency, solvency, compliance and insurance requirements, as well as prescribing detailed operational requirements on registrants. The rules include a number of transitional, or "grandfathering", provisions that will postpone the application of many of the rules for periods of time from three months to up to two years.
The new rules will affect the manner in which private placements are undertaken across Canada, affecting issuers and both Canadian and non-Canadian dealers. This bulletin is designed to identify a number of these issues.
There are three significant changes to the registration regime that are being implemented under the new rules that will affect the private placement market.
- the advent of the so-called "business trigger" that will form the basis of determining the need for a firm or individual to register as a dealer or adviser. Under the old regime, the requirement to be registered as a dealer was triggered by a person engaged in a "trade" of securities; this is being replaced by the requirement to be registered only if a person is "engaged in the business of trading" in securities;
- the implementation of the requirement across Canada (with one exemption noted below) that any person that is engaged in the business of trading in securities will be required to register as a dealer, even if that trade is made on a prospectus-exempt basis. Before September 28, except in Ontario and Newfoundland and Labrador, many of the exemptions from the requirements to provide a prospectus and the requirement to be registered as a dealer on a given trade were identical, meaning that persons or firms that are not registered as dealers could participate in prospectus-exempt, or private placement, trades. Under the new rules, in many cases, only registered dealers will be able to participate in many prospectus-exempt trades; and
- the development of a new category of dealer registration for those firms that wish to restrict their activities to the private placement market; under the new rules, such firms may be registered as "exempt market dealers" (EMDs). The EMD category will be newly available in all Canadian provinces, and in Ontario and Newfoundland and Labrador will replace the former category of limited market dealer available to those whose activities were so restricted. The category of EMD carries with it, however, significantly more onerous requirements than were historically applicable to the limited market dealer category.
IMPLICATIONS FOR VARIOUS MARKET PARTICIPANTS
Dealers Not Previously Registered
Transitional Relief. A firm that has been acting as a dealer in the exempt market in a province or territory other than Ontario or Newfoundland and Labrador and wishes to continue such activities may do so in that jurisdiction until September 27, 2010 (or until an application for EMD made before September 27, 2010 is resolved by the regulators).
However, the CSA have preserved many of the existing dealer registration exemptions until March 27, 2010, providing some transitional relief for dealers that will not have been active in a given jurisdiction. Therefore, an unregistered dealer that has not been active in a jurisdiction before September 28, 2009 may continue to rely on those exemptions until March 27, 2010 but thereafter may not engage in any activities constituting trading in that jurisdiction until it is registered as an EMD.
However, in Ontario and in Newfoundland and Labrador, a dealer that has been engaged in the business of trading in securities in those provinces should already have been registered there. A firm will therefore not be able to conduct activities in those provinces in the private placement market until it is registered as an EMD.
Long-term Alternatives. Unregistered dealers will have three options available to them on a long-term basis in relation to their trading activities in the private placement market.
First, they can become registered as an EMD, which will require compliance with all of the requirements applicable to EMDs, many of which were not historically applicable to limited market dealers, including:
- Supervision. EMDs will be required to appoint and register an ultimate designated person (UDP) and a chief compliance officer (CCO) to oversee and supervise the business of the dealer.
- Proficiency. There are no proficiency requirements for the UDP. However, the CCO must pass either certain course or exam requirements. Further, each dealing representative of an EMD must also satisfy certain course or exam requirements. A new Exempt Market Products exam is being introduced for this sector.
- Financial Requirements. An EMD will be required to maintain a minimum excess working capital of C$50,000. In addition, the dealer must maintain specified types of bonding or insurance in prescribed amounts and must deliver to the securities commissions its audited annual financial statements.
- Operational Requirements. An EMD must establish, maintain and apply policies and procedures that establish a system of internal controls and supervision.
- Client Relationship Requirements. An EMD must continue to comply with the "know your client" and suitability obligations (other than in respect of "permitted clients" who have waived the suitability obligation) and have policies in place to deal with conflicts of interest. However, EMDs are restricted from lending to clients or providing margin, and must establish a system for handling client complaints, involving an independent dispute resolution service. In addition, EMDs are required to provide a considerable amount of new disclosure to clients, including disclosure about conflicts of interest, referrals and costs of holding accounts.
Second, they may be able to avail themselves of the "Northwestern Exemption". The securities commissions in the provinces of British Columbia, Alberta, Manitoba (and possibly Saskatchewan) and the three territories are proposing to issue blanket relief that, in effect, would preserve the existing private placement regime for certain dealers. Under the proposed blanket relief, dealers that act only in the exempt market in those jurisdictions will not be required to register to continue their activities so long as they are not registered in any other jurisdiction (either Canadian or foreign), do not provide suitability advice leading to the trade, do not otherwise provide and have not previously provided financial services to the purchaser (except in British Columbia), do not hold or have access to the purchaser's assets, provide a risk disclosure in prescribed form to the purchaser and file an information report with the applicable securities commission. This blanket relief will be only in respect of certain exemptions – the accredited investor, family, friends and business associates, offering memorandum and minimum investment amount exemptions.
Third, they may be elect to remain unregistered, although this will require them to cease trading activities.
Timing Of Application
We note that a firm's timing in making application for status as an EMD will be limited by the requirement contained in the application form that the firm include with the application audited annual financial years dated no more than 90 days prior to the date of application. For firms with a calendar year end, this provision would appear to have the effect of delaying possible applications until the first quarter of 2010.
Former Limited Market Dealers
Firms that were registered as limited market dealers in Ontario and Newfoundland and Labrador were automatically re-registered as EMDs on September 28, 2009.
Transitional Relief. Former limited market dealers may avail themselves of certain transitional relief designed to allow them time to achieve compliance with the new requirements. In particular, EMDs will have:
- three months to apply for the necessary registration of the UDP and CCO;
- six months to obtain the necessary bonding or insurance;
- six months to comply with the new referral arrangement requirements;
- 12 months to commence compliance with the new requirements to deliver audited annual financial statements to the regulators;
- 12 months to comply with the new client disclosure requirements;
- 12 months to put in place the required working capital;
- 24 months to satisfy requirements on independent dispute resolution and mediation services; and
- 24 months to commence delivery of client account statements as required in the new rule.
In addition, former limited market dealers may avail themselves of transitional arrangements similar to those described above for unregistered firms. A former limited market dealer may continue to use the traditional dealer exemptions remaining in NI45-106 for six months in all jurisdictions, and thereafter continue to act for 12 months in the exempt market in jurisdictions in which it has already been active prior to September 28, 2009, but not in jurisdictions in which it has not been active until it registers in those jurisdictions.
Long-Term Alternatives. Former limited market dealers have fewer options than some unregistered firms. Ultimately, they must comply with the new requirements applicable to EMDs, or give up their registration. EMDs may not avail themselves of the "Northwestern Exemption" as that exemption will not be available to any person that is registered in any jurisdiction.
Personnel Issues. We have encountered some ambiguities in the new rules relating to the applicability of transitional rules to trading representatives of EMDs. Trading representatives were not subject to proficiency requirements under the limited market dealer regime, but are now subject to exam requirements as trading representatives of an EMD. The new rules provide for a 12-month transition period for persons already registered with a former limited market dealer to satisfy such requirements. New persons hired by the EMD as a trading representative in Ontario must immediately satisfy the proficiency requirements. However, it is unclear what rules are applicable in the case of an EMD hiring a trading representative in a jurisdiction in which the EMD is active but is not yet itself required to be registered.
Limitations On Activities Of Exempt Market Dealers
EMDs will be permitted:
- to act as a dealer by trading a security that is distributed under an exemption from the prospectus requirement;
- to act as a dealer by trading a security that, if the trade were a distribution, would be exempt from the prospectus requirements; and
- to act as an underwriter in respect of a distribution of securities that is made under an exemption from the prospectus requirements.
The phrase "under an exemption" has already raised some issues of interpretation. We understand that staff of the OSC are interpreting these provisions to permit EMDs to distribute securities under a prospectus as long as it is not acting as an underwriter and if the distribution could have been made under an exemption, e.g., an EMD can sell securities under a prospectus to an accredited investor purchasing as principal.
The position of most non-investment fund issuers in relation to their ability to effect private placements in Canada is not dramatically changed by the new rules. However, there are a number of issues that they should consider.
Status of Issuer. In conjunction with the introduction of the "business trigger", the CSA have provided some guidance on their interpretation of the phrase "engaged in the business of trading in securities", and include such factors as engaging in activities similar to a registrant, intermediating trades, carrying on activities with repetition and regularity and being, or expecting to be, remunerated or compensated. The CSA state that issuers of securities that do not hold themselves out as being in the business of trading of securities, and do not satisfy these criteria will not be regarded as being in the business of trading in securities. However, issuers that frequently trade in securities (presumably either through issuance of their own securities or trading as part of their business), that solicit investors actively or that act as an intermediary by investing client money in securities (such as an investment fund) may have to register. However, the CSA invite issuers to consider whether they can use an exemption from the registration requirement that is available if they sell their securities through registered dealers.
This issue will represent a change after March 27, 2010 in the private placement market in provinces other than Ontario and Newfoundland and Labrador, as an issuer that is considered to be in the business of engaging in trading in securities will be required to either become registered in the future in order to continue to issue securities, or else effect distributions only through a registered dealer. Prior to March 27, 2010, such an issuer may issue securities directly to purchasers not in Ontario or Newfoundland and Labrador in reliance on the traditional prospectus and registration exemptions.
Investment Fund Issuers. The status of investment fund issuers is theoretically similar to that of other issuers, except that the Ontario Securities Commission has in recent years taken the view that all investment funds are in the business of trading in securities and therefore must be registered to distribute its own securities or else distribute such securities through a properly registered dealer. As with non-investment fund issuers, this issue will arise in provinces other than Ontario and Newfoundland and Labrador after March 27, 2010.
Use of Non-Canadian Dealers and Possible Limitation of Purchaser Base of an Offering. An issuer that uses non-Canadian dealers to distribute securities under a private placement in Canada will need to ensure that the new rules do not reduce the types of purchasers that may participate in the offering due to new restrictions on the permitted activities of the dealer. As described in our July 2009 Blakes Bulletin on Securities Regulation: Registration Exemptions Finalized for International Dealers and Advisers, non-Canadian dealers relying on the international dealer exemption are restricted to dealing only with "permitted clients", which is a smaller group than "accredited investors". This issue will arise after March 27, 2010 when the existing dealer exemptions in provinces other than Ontario and Newfoundland and Labrador expire.
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.