On August 25, 2015, the participating provinces and territory in the Cooperative Capital Markets Regulatory System achieved an important milestone towards implementation of the system by publishing a revised consultation draft of the uniform provincial and territorial capital markets act (now known as the Capital Markets Act), along with the drafts of the initial regulations proposed for adoption by the participating provinces and territory under the draft uniform act. These materials have been published for a 120-day public comment period.
This article is part of Gowlings' Guide to the Proposed Initial Regulations and related materials. In this segment of our guide, we discuss the proposed initial regulations relating to trades in securities of over-the-counter issuers. To view other sections of the guide, click here.
The participating provinces and territories are proposing to impose a number of requirements on investment dealers that trade in U.S. over-the-counter markets. These are set out in section 6 of CMRA Regulation 31-501 Registration Requirements, Exemptions and Related Matters and are based on conditions of registration published by the British Columbia Securities Commission for investment dealers that trade in the U.S. over-the-counter markets through a British Columbia office (or “OTC conditions of registration”). The adoption of the OTC conditions of registration will represent a change in Ontario.
Section 6 of CMRA Regulation 31-501 will require an investment dealer that trades in securities of “OTC issuers” to comply with the record keeping, data recording and other requirements summarized below.
“OTC issuers” are issuers who have (a) a class of over-the-counter quoted securities (being a class of securities that has been assigned a ticker symbol by the U.S. Financial Industry Regulatory Authority for use on any of the over-the-counter markets in the U.S.), other than American Depositary Receipts, and (b) no class of securities listed or quoted on a recognized exchange, or an exchange that is recognized for the purposes of CMRA Regulation 31-501.
The proposed requirements are as follows:
Monitoring, Recordkeeping and Reporting — Investment dealers are required to record and report data related to trading in securities of OTC issuers through an office in a participating province or territory. This includes commissions earned from trading securities of OTC issuers and deposits of securities of OTC issuers by insiders, control persons, founders, or persons involved in investor relations activities relating to the OTC issuer.
Establishing Beneficial Ownership — Prior to accepting an order to sell securities of an OTC issuer, investment dealers are required to identify the beneficial owner of those securities, including the identity of every individual who controls the beneficial owner where the beneficial owner is not a natural person, and to determine that person’s relationship with the OTC issuer.
Responsibility of Designated Individual — Investment dealers are required to designate an appropriately qualified individual to be responsible for managing and enforcing compliance with the applicable requirements in section 6 of CMRA Regulation 31-501. The physical deposit of share certificates of any OTC issuer would be prohibited without the approval of the designated individual.
An exemption from the requirements in section 6 of CMRA Regulation 31-501 is available for investment dealers that deliver a completed undertaking in prescribed form (Form 31-501F1Undertaking to the Authority of CMRA Regulation 31-501) acknowledging that the dealer will not trade securities of an OTC issuer through an office in a participating province or territory, except for certain permitted isolated trades.
Rationale behind the OTC conditions of registration
The British Columbia Securities Commission originally imposed the OTC conditions of registration in response to market participants with connections to British Columbia engaging in abusive market activities through over-the-counter markets in the U.S. The intention of the OTC conditions of registration was to allow dealers and the British Columbia Securities Commission to target some of the highest risk transactions, while having a minimum impact on legitimate trading.
By imposing the OTC conditions of registration on investment dealers operating out of any participating province or territory that trade in securities of OTC issuers, section 6 of CMRA Regulation 31-501 may help to discourage abusive and illegal over-the-counter market activity in the other participating provinces and territories.
How does section 6 of CMRA Regulation 31-501 differ from the OTC conditions of registration?
Section 6 of CMRA Regulation 31-501 adopts the OTC conditions of registration (including the isolated trade exemption), largely, in their current form as of March 2, 2015. The noteworthy changes that have been proposed include:
(a) Narrowing the definition of “OTC issuer”
The current definition of “OTC issuer” under the OTC conditions of registration makes reference to an issuer that has no class of securities listed or quoted on a number of specific exchanges, including, for example, the TSX, the TSXV and the NYSE. It is proposed that the references to the specific exchanges be removed and replaced with “recognized exchanges, or exchanges that are recognized for the purposes of this Regulation”. This change would limit the need to amend CMRA Regulation 31-501 as new exchanges are recognized and as existing exchanges amalgamate, change names or cease to exist. It would also allow the participating provinces and territories the flexibility to bring in foreign exchanges that are not recognized in any Canadian jurisdiction if they believe that listing on that exchange removes the risks relating to over-the-counter market trading.
(b) Expanding the definition of “OTC-quoted securities”
It is proposed that the current definition of “OTC-quoted securities” under the OTC conditions of registration (which names the OTC Bulletin Board and the pink sheets) be replaced with the definition of “OTC-quoted securities” in Multilateral Instrument 51-105 Issuers Quoted in the U.S. Over-the-Counter Markets (which refers to U.S. over-the-counter markets generally).
(c) Eliminating a condition relating to risk management
The OTC conditions of registration include a condition which requires dealers to effectively manage the risks of trading securities of OTC issuers through their supervision and compliance systems. It is proposed that this risk management condition not be carried forward, presumably in light of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, which already requires registered firms to manage risks associated with their business in accordance with prudent business practice.
(d) Clarifying the beneficial ownership requirement
The OTC conditions of registration require an investment dealer to not accept an order to sell securities of an OTC issuer until it makes the inquiries necessary to form a reasonable belief that it knows the identity of the beneficial owner of those securities. In contrast, subsection 6(4) of CMRA Regulation 31-501 prohibits a dealer from accepting the order until it makes these inquires, and receives the information, necessary to form such reasonable belief.
What are the implications for Ontario?
Ontario does not have a comparable rule to the OTC conditions of registration(1). As a result, compliance with the requirements under section 6 of CMRA Regulation 31-501 may have potentially significant operational consequences for investment dealers presently operating outside of British Columbia and therefore not currently subject to the OTC conditions of registration. Further, investment dealers operating in a participating province or territory (including those in British Columbia today) will need to consider the implications of the proposed expanded definition of “OTC-quoted securities” on their reporting obligations.