An update on registration initiatives, including the registration of online business models, and current trends in deficiencies and acceptable practices of market participants are the focus of OSC annual summary report.
Trends in registration, including online business models, and common deficiencies identified in compliance reviews are the focus of the Ontario Securities Commission’s (OSC) Annual Summary Report for Dealers, Advisers and Investment Fund Managers. The following summary highlights key points in the report. We recommend that market participants review in detail the portions of the report that may be applicable to their businesses.
Online Business Models
The report addresses the OSC’s recent experience in dealing with the increasing number of registrants proposing online business models and offers some practical tips. The OSC advises that firms proposing an online business model that is unique or complex should consider submitting a pre-file application. The same is true for firms that are seeking discretionary relief from registration requirements. In addition, firms seeking registration should be prepared to demonstrate to the OSC the proposed online portal/platform as part of the pre-registration interview.
The OSC also helpfully identifies some of the common deficiencies encountered in reviewing registration applications related to online business models. Notably, firms should ensure that they have carefully assessed the categories of registration that will be required, as many firms do not apply for registration in all of the registration categories that are applicable on the basis of their business plans and proposed activities. In addition, policies and procedures must address the “unique aspects” of an online portal.
The report addresses online crowdfunding portals under Multilateral Instrument 45-108 Crowdfunding (MI 45-108). The OSC reminds exempt market dealers and investment dealers that in order to rely on the crowdfunding exemption, a Form 33-109F5 Change of Registration Information is required to be filed to update the business activities disclosed on Form 33-109F6 Firm Registration. Entities that wish to register as an equity crowdfunding portal under MI 45-108 should be prepared to undergo a review which is similar to other firm applications, including interviews with key personnel of the firm.
Peer-to-Peer Lending and Other Lending Platforms
The OSC reiterates that “peer-to-peer” lending websites and other lending platforms that solicit lenders to fund loans and that match borrowers and lenders may require registration and that many such businesses have been identified as operating in Ontario without registration. The OSC advises operators of such businesses to consider whether registration and/or prospectus requirements apply.
Terms and Conditions on Registration
The report also reminds online advisers that they are subject to the normal conditions of registration for a portfolio manager. In particular, the report reminds online advisers that they must maintain an adequate number of advising representative and associate advising representatives to ensure that clients are provided with the appropriate level of service, attention and monitoring required in a discretionary portfolio management relationship. The OSC refers to online advisers because of their tendency to have very low minimum investment requirements (or none at all) while, according to the OSC, conventional portfolio managers have historically had very high account minimums.
The OSC began compliance reviews of Ontario-based online advisers in early 2016 and is currently in the process of completing those reviews. The OSC may publish additional guidance for online advisers, including the results of its compliance reviews.
Current Trends in Deficiencies and Acceptable Practices of Market Participants
The report provides market participants with an overview of common deficiencies identified in OSC compliance reviews. We have highlighted key findings contained in the report.
- Unregistered Exempt Firm - Changes to Registration Information. The OSC reminds unregistered exempt international firms, such as firms relying on the international dealer or adviser exemptions and non-resident investment fund managers relying on the permitted client registration exemption in Multilateral Instrument 32-102 Registration Exemptions for Non-Resident Investment Fund Managers, of the requirement to keep the OSC updated of any changes to information in the filed exemption reliance forms, including contact information and CCO and agent for service details. A firm must also advise the OSC in writing if it no longer has any securities business in Ontario and the date that it ceased to rely on the applicable exemption.
- Global CCO. A non-Canadian registered firm must not have a CCO for its Canadian operations that is different from the CCO for the rest of the firm’s business. The OSC reminds such firms that there should only be one individual with overall authority and responsibility for the compliance function for the firm as a whole. The OSC advises that it may consider exemptive relief from this requirement in certain situations.
- KYC and Suitability Requirements. The OSC highlights that the inadequate collection, documentation and updating of KYC and suitability information continues to be a “significant and common deficiency”. The specific issues encountered include not collecting and/or documenting a client’s financial circumstances, including risk tolerance, investment needs, investment objectives and time horizon and not updating KYC information at least annually.
- Client Testimonials. The inappropriate use of client testimonials is also a common issue identified by the OSC. Though client testimonials are not prohibited, they must be balanced, fair and not misleading and registrants should be able to substantiate all claims made in marketing materials.
- Supporting Documentation for Accredited Investor Exemption. According to the OSC, certain exempt market dealers are not maintaining adequate documentation to support reliance on the accredited investor prospectus exemption. Some of the particular issues identified are that exempt market dealers rely solely on a statement from the investor that the investor is an accredited investor without collecting information to support this statement and without educating the investor on the meaning of important concepts such as “financial assets” and net income.
- “Sponsored” Dealing Representatives. The OSC advises that dealing representatives that are employed by a third party issuer should act on behalf of the registered dealer in their role as dealing representative, and not hold themselves out as acting on behalf of their employing issuer.
- Captive Dealers. The OSC continues to express concern with firms that are registered solely in the exempt market dealer category that trade solely or primarily in the securities of a limited number of related or connected issuers i.e. captive dealers. Pre-registration reviews and compliance reviews of captive dealers will focus on how conflicts of interest are addressed.
- Investment Fund Manager (IFM) Lending Activities. The OSC reiterates that a serious conflict of interest emerges where an IFM lends money to an investment fund that it manages. An IFM may lend money to an investment fund on a short term basis and for the purpose of funding redemptions of its securities or meeting expenses incurred by the investment fund in the normal course of its business. The OSC recommends that IFMs develop policies and procedures outlining the parameters under which an IFM may lend money to the funds it manages and establishing how the IFM should monitor lending activities to ensure compliance.
- Self-Dealing Prohibition. Written consent must be obtained from each securityholder of an investment fund before the purchase of a security of an issuer in which a “responsible person” or an associate of a responsible person is a director. A “responsible person” includes, for example, the adviser, a partner, director or officer of the adviser and certain others involved in investment decision-making. Disclosure of such purchases must be made to all securityholders and the disclosure must be meaningful in order to allow for informed consent by securityholders. The OSC therefore recommends that policies and procedures be established to identify changes in outside business activities, officer positions and directorships by responsible persons and associates of responsible persons. For prospectus-qualified funds, the OSC suggests considering having the independent review committee review and approve such purchases.
The OSC also advises that it will be conducting compliance reviews to determine whether dealers are complying with the new prospectus exemptions, namely, the friends, family and business associates exemption, the offering memorandum exemption and the crowdfunding exemption.
For further information, please see OSC Staff Notice 33-747 Annual Summary Report for Dealers, Advisers and Investment Fund Managers.