The Canadian securities regulators (CSA) have published for comment long-awaited proposed new rules designed to put in place a revised, nationally harmonized and streamlined registration regime for firms and individuals. The comment period for proposed National Instrument 31-103 Registration Requirements ends on June 20, 2007.
Proposed NI 31-103 is an ambitious set of rules that will significantly alter the status quo for registrants in Canada. It represents the CSA’s first-ever comprehensive national reformulation of the Canadian registration regime. The rules under proposed NI 31-103 cover the requirements for firms and individuals to be registered with the various securities commissions in Canada, as well as certain more controversial elements associated with the regulation of registrants in Canada, such as regulation of referral arrangements and registrant-client relationships. To be completely effective, proposed NI 31-103 must be complemented by proposed legislative amendments, which are under consideration by the various provincial governments, but which were not published with proposed NI 31-103.
NI 31-103, once in force, will replace the myriad sets of rules contained today in individual provincial securities acts, regulations, rules and policy statements with one consolidated national rule. The fact that registration requirements will be pulled together into one rule will have a largely positive impact on firms and individuals doing securities-related business in Canada. However, through NI 31-103, the CSA propose significant new rules that will, to varying degrees, impact virtually every financial services firm doing business in Canada.
We highlight in this Investment Management Advisory some of the more important proposals and point out the potential impact on registrants doing business in Canada, including
- A new concept of a "business trigger" for determining whether or not a firm must be registered, including clarification of its application to certain firms
- A new category of "exempt market dealers" and a simplified slate of registration categories
- A national system of mobility exemptions for registered Canadian advisers and exemptions for non-Canadian advisers and dealers doing business with specified clients in Canada
- A new category of registration for investment fund managers, including managers of public and privately offered closed-end funds, mutual funds (pooled funds), scholarship plans and labour-sponsored investment funds, with exemptions for "international investment fund managers"
- New requirements for individuals acting as the chief compliance officer and/or the "ultimate designated person" for a firm and an articulation of regulatory expectations for compliance systems for registrants
- Prescribed disclosure documenting the registrant’s relationship with clients to be provided in a relationship disclosure document
- Requirements for complaint handling procedures and identification and handling of conflicts of interest.
We intend to comment on proposed NI 31-103 by the comment deadline and would be pleased to assist you in providing comments. Notwithstanding that the CSA have consulted with industry before releasing proposed NI 31-103, making your views known through the formal comment process is critical in assisting with practical and realistic rule-making.
Please plan to attend one of BLG’s Symposiums on Registration Reform: March 5 in Toronto, March 8 in Vancouver and March 12 in Montréal, where BLG’s experts and invited guests will discuss what the Registration Reform Proposals will mean for you.
The Core Elements of Registration
Proposed NI 31-103 reinforces the CSA’s central objective of ensuring that only qualified firms and individuals provide advising and trading services in the Canadian capital markets. Registration will be granted by a securities regulator if the applicant is deemed suitable and meets the so-called "fit and proper" standards of registration: proficiency, integrity and financial solvency. Once registered, the registrant (firm and individual) must meet on-going conduct requirements, such as dealing fairly, honestly and in good faith with clients, dealing appropriately with conflicts of interest, ensuring that clients’ investments are suitable for those clients, maintaining adequate capital and so on.
Proposed NI 31-103 will establish these core registration elements, but the test for determining whether a firm or individual is required to be registered will depend on the new concept of the "business trigger", that is, whether the firm or individual is "in the business of" dealing in securities as principal or agent, advising others about acquiring or disposing of securities or managing investment funds. The CSA intend that this new business trigger will result in
- Fewer activities requiring registration, particularly for firms and individuals "dealing in securities"
- Streamlined exemptions from registration, since fewer activities will trigger the requirement for registration
- Additional regulation over an important sub-set of industry participants, namely, investment fund managers.
Proposed NI 31-103 also will result in dramatically fewer categories of registration. Instead of today’s multitude of registration categories in the various provinces, proposed NI 31-103 will require registration of investment dealers, mutual fund dealers, scholarship plan dealers, exempt market dealers, "restricted" dealers (being dealers that can trade only in specified securities), investment fund managers, portfolio managers and "restricted" portfolio managers (being portfolio managers providing advice on specified securities). All categories of registrants will be subject to capital, insurance, record-keeping, proficiency requirements etc.
Registration with the CSA will be "permanent", subject to annual payment of fees, compliance with on-going fit and proper and conduct requirements and the ability of the Director of the applicable securities regulator to revoke registration or impose conditions on registration at any time.
Critical Proposed Changes for Registered Dealers and Advisers
Firms that today are registered as dealers and advisers will continue to be required to be registered, albeit in potentially different categories of registration: investment dealer, mutual fund dealer, restricted dealer, scholarship plan dealer, exempt market dealer, portfolio manager, restricted portfolio manager or investment fund manager. Several categories of registration will be eliminated including, international dealer, limited market dealer, foreign dealer, international adviser, securities adviser and investment counsel. All existing registrants and financial services firms will need to analyse the impact of the "business trigger" on whether they need to continue to be registered or conversely whether they should be registered – we expect this trigger to have the largest impact on firms and individuals that today carry on isolated trading or advising activities, but are not otherwise "in the business of trading" in securities.
Significant proposed changes to the registration requirements for dealers and advisers include
- Proficiency requirements for non-SRO registrants, such as new proficiency requirements for advising representatives, including associate advising representatives and client relationship managers, and for the chief compliance officer for a firm
- Designation of an "ultimate designated person"
- New minimum capital requirements, which will be an increase in minimum capital requirements for most non-SRO registrants, other than for portfolio managers that hold client assets
- Modernized insurance requirements for non-SRO registrants, with a formula for calculating insurance limits, rather than a flat rate
- New guidelines for account opening and know-your-client information, record-keeping, client assets, account activity reporting, compliance regimes and complaint handling
- New requirements for non-SRO registrants to prepare and deliver to non-accredited investor clients a relationship disclosure document that responds to over 12 different prescribed elements
- Significantly enhanced initial firm registration requirements, including requirements to file business plans, policies and procedures manuals, issuer disclosure statements and proposed marketing materials.
Proposed NI 31-103 contemplates a national system of "mobility" registration exemptions available to those registrants who wish to continue to deal with or advise clients with whom they have a pre-existing relationship and who move to another Canadian province or territory.
New Registration Proposals – Investment Fund Managers
Legislative amendments proposed to be made in conjunction with the coming into force of proposed NI 31-103 will require firms in the business of managing an investment fund to register in the new category of investment fund manager. This registration requirement will apply to managers of all investment funds distributed in a Canadian province, whether via prospectus or pursuant to prospectus exemptions and registration will be required in the province where the investment fund is located. It will apply to non-Canadian fund managers who distribute their investment funds in Canada, although an exemption is proposed for "international investment fund managers". If a non-Canadian fund manager has no Canadian establishment or representatives resident in Canada, and is in the business of acting as a portfolio manager in its home country, it will be exempt from registration if the investment fund being distributed in Canada is offered primarily outside of Canada and is only distributed in Canada through registered dealers and pursuant to applicable prospectus exemptions.
As with other registrants, investment fund managers will be subject to the CSA’s fit and proper and conduct requirements, including minimum capital requirements of $100,000, a financial institution bond and quarterly financial statement regulatory reporting. Many of the new proposals described in this Advisory for registered dealers and portfolio managers will apply also to investment fund managers, including the compliance and supervision expectations.
Compliance and Supervision Expectations
Proposed NI 31-103 outlines the CSA’s expectations for registrants of all categories to ensure compliance with applicable securities regulations and to manage business risks. All registrants will be required to establish a "system of controls and supervision", which must be documented in the form of written policies and procedures. The CSA have indicated that they intend to make "principles-based rules" in this area, and hence proposed NI 31-103 does not prescribe specifics for an effective compliance system or appropriate supervision, but instead the CSA describe their views on the elements of an effective compliance system in the proposed companion policy to proposed NI 31-103. All registrants must appoint an appropriately qualified "ultimate designated person" and a chief compliance officer. These individuals will be registered with the applicable securities regulators.
The CSA propose to regulate referral arrangements through proposed NI 31-103. Registrants wishing to enter into referral arrangements will be required to:
- Provide specified written disclosure of the referral arrangements
- Establish clear lines of authority for compliance with securities regulation
- Enter into written agreements clarifying the roles and responsibilities of both the referring party and the recipient of the referral.
Referral arrangements entered into before proposed NI 31-103 comes into force will be required to adhere to the new rules, if referral fees continue to be paid under the arrangement after the effective date of NI 31-103.
Registration Exemptions and the Exempt Market
As a result of the proposed business trigger, the number of registration exemptions which are currently detailed in securities legislation, including National Instrument 45-106 Prospectus and Registration Exemptions, will be significantly reduced. The CSA have concluded that many of the existing dealer registration exemptions are based on a trade trigger and are therefore not necessary under a business trigger.
Exempt market dealer is proposed to be a new category of registration in all Canadian provinces and territories and is a national expansion of the "limited market dealer" registration category today in effect in Ontario and Newfoundland and Labrador. Exempt market dealers will be restricted to dealing in prospectus-exempt securities with persons to whom prospectus-exempt distributions can be made, including accredited investors, and will be subject to proficiency, insurance and capital requirements.
Proposed NI 31-103 will continue to allow non-Canadian advisers and dealers to be registered in a Canadian province or territory in order to carry on their particular advising or dealing activities. All applicable requirements for registrants will apply to a registered non-Canadian firm and in addition, it must provide a specified disclosure statement to clients outlining its nonresident status. Non-Canadian firms also may rely on proposed exemptions from registration provided they comply with the conditions to the exemptions, which include, among others
- No solicitation of new clients in a Canadian province or territory (for international portfolio managers)
- Advising on or dealing with only prescribed clients and in only non-Canadian securities, other than incidentally
- Revenue limits from Canadian activities (for international portfolio managers).
Impact of Proposed NI 31-103 on Provincial Regulation
Certain of the concepts provided for in proposed NI 31-103 will require amendments to provincial securities legislation. For example, various CSA members indicate that amendments to securities legislation is required in their provinces to properly implement the "permanent" registration regime and the "business trigger" contemplated in proposed NI 31-103. Registration of fund managers will only be required when legislative amendments come into force. In most cases, these legislative amendments are underway, but the proposed changes were not published along with NI 31-103.
In Québec, the new regime proposed by NI 31-103 will have significant consequences on the regulatory framework which currently applies not only to registrants governed by the Québec Securities Act, but also to those registrants governed by the Act respecting the Distribution of Financial Products and Services (the Distribution Act). In order to achieve the harmonization objective inherent in proposed NI 31-103, the Authorité des marchés financiers (AMF) proposes that mutual fund dealers, scholarship plan dealers and investment contract firms, as well as their representatives, no longer be governed by the Distribution Act, but instead be transitioned over to be governed by the Québec Securities Act and proposed NI 31-103. This will have important implications for mutual fund dealers in Québec, including the requirements to maintain the minimum capital contemplated by proposed NI 31-103. The AMF plans to carry out extensive public consultations during 2007 to determine the future of self-regulation of mutual fund dealers in Québec.
Transition —What’s Next?
Proposed NI 31-103 can be expected to have a transition timetable once the new rules come into force, which the CSA somewhat ambitiously anticipates being some time in 2008.
The CSA also explain what is not contained in the CSA proposals. The Proposed NI 31-103 does not address the concept of allowing salespersons for registered dealers to operate through incorporated entities, although the CSA’s efforts to come to a consensus in this area continues.
Proposed NI 31-103 is the second initiative in the CSA’s Registration Reform Project. As outlined on the CSA’s Registration Reform Project website – www.rrp-info.ca - the first initiative was the institution of the National Registration System, which has been in force since April 2005. The third initiative is the implementation of the three "core principles" of the Fair Dealing Model, which was first published for comment in January 2004. The Fair Dealing Model is now known as the "Client Relationship Model". The Client Relationship Model involves the CSA’s work with the Canadian self-regulatory organizations to ensure "clarity and transparency regarding relationships"—the relationship disclosure document proposed in NI 31-103 is a manifestation of this principle. Various elements of the Client Relationship Model are expected to be proposed by the SROs for comment by their members later this year. The fourth initiative of the Registration Reform Project will be amendments to the National Registration Database (NRD) instruments, which are expected to be published later this year.
We provide a full range of legal services, including advice and assistance on becoming and continuing to be registered with the Canadian securities regulators and/or members of the SROs. Our services for our clients have included developing and designing, as well as reviewing and assessing, compliance procedures and practices relating to regulatory and internal policy requirements, assisting in building or strengthening compliance capability, conducting audits and investigations, identifying operational problems and devising appropriate solutions and responding to regulatory developments. We have assisted many registrants regarding their compliance functions and structures, including developing their policies, practices and procedures. We also provide advice on structuring investment funds and offerings of investment funds, including hedge funds, pursuant to private placements and public offerings within Canada to comply with Canadian securities laws.
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.