National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) and its Companion Policy are facing the fifth round of amendments since implementation in September 2009. The Canadian Securities Administrators published proposed amendments to NI 31-103 and related instruments on December 5, 2013 [available here] which range from technical adjustments to more substantive measures intended to establish the regulatory approaches onlong-standing issues, resolve ambiguities and clarify regulatory intentions.
In addition to proposed amendments to NI 31-103, the CSA also propose amendments to National Instrument 33-109 Registration Information (NI 33-109) and its Companion Policy and National Instrument 52-107 Acceptable Accounting Principles and Auditing Standards and its Companion Policy. Proposed amendments to OSC Rule 33-506 (Commodity Futures Act) Registration Information and its Companion Policy mirror the amendments to the various registration related forms in NI 33-109.
The comment period on this latest package of proposed amendments ends March 5, 2014.
There is something for everyone in the proposed amendments.
- Exempt market dealers will be particularly impacted by the proposal to significantly limit the activities that they may conduct.
- CCOs of all categories of registered dealer (except investment dealers) will be subject to enhanced proficiency requirements.
- International portfolio managers will be able to rely on a new nationally-consistent “sub-adviser” exemption.
- Exempt international firms (international advisers and international dealers) will not be able to register in one province, while relying on the applicable registration exemptions in other jurisdictions.
- A short-term debt exemption will be available to certain financial institutions.
- Investment fund managers will need to report NAV adjustments using a new form.
- Firm representatives who serve on the boards of reporting issuers or have outside business activities, including “positions of influence”, will have enhanced disclosure obligations, as well as expectations on management of the conflicts of interest raised by these activities.
- All registrants will use updated registration-related forms to provide information to the regulators.
As with the existing iteration of NI 31-103, it is particularly important to review the new proposed provisions of the Companion Policy, which provide greater clarity on regulatory expectations, and in some cases, enhance the base requirements of rules.
Key Proposals at a Glance
Click here to view table.
Impact of the Proposed Amendments
We expect that the following four proposals and queries of the CSA will have the greatest impact on the applicable market participants, which is not to say that we believe the myriad of other proposals do not deserve a close review, and comment, where necessary. Pages 2 and 3 of this Bulletin briefly set out the expected impact of the proposed amendments on the various market participants. It will be important for affected market participants to carefully weigh the proposals against their business to determine whether or not the proposals make sense and do or do not have any unforeseen consequences. As we noted earlier, it is especially important that firms focus on the additional guidance provided for in the Companion Policy to ensure appropriate understanding of the impact of the proposed amendments.
Exempt Market Dealers
The proposed prohibitions on the types of trading businesses that can be carried on by exempt market dealers (EMDs) are not completely unexpected, given CSA Notice CSA Staff Notice 31-333 Follow-up to Broker Dealer Registration in the Exempt Market Dealer Category, but still the extent of the proposed changes, if adopted, will have a dramatic impact on many, if not most, EMDs.
The CSA propose to prohibit an EMD from trading in a security if the security is “listed, quoted or traded on a marketplace” and the trade in the security “does not require reliance on a further exemption from the prospectus requirement”. The CSA propose to explain in the Companion Policy that this means an EMD cannot participate in a distribution of securities offered under a prospectus and will not be permitted to directly or indirectly participate in a resale of securities traded on a domestic or foreign marketplace whether the transaction is on-exchange or off-exchange. This includes establishing an omnibus account with an investment dealer and trading securities for clients through that account. Significantly, the CSA propose to add the following statement to the guidance in the Companion Policy: These activities should be conducted by investment dealers.
The CSA also propose additional guidance in the Companion Policy that explains that EMDs will be permitted to participate in a “distribution of securities, including investment funds, made under an exemption from the prospectus requirement. The securities may be securities of a reporting issuer and may be listed or unlisted”. The EMD clients would have to be accredited investors or other investors where a prospectus exemption is available. Although this appears to be somewhat contradictory to the above-noted guidance, we consider that this clarifies that an EMD can only trade securities pursuant to a prospectus exemption and will not be permitted to trade “prospectus-qualified” securities.
The “exempt market” is not a defined term under Canadian securities legislation. But it is understood by industry that the exempt market generally encompasses two things: (i) trades in securities that are not sold under a prospectus subject to certain conditions, and (ii) trades in any type of security to investors who meet certain criteria.
Under Canada’s registration regime, EMDs are subject to robust registration requirements that include: proficiency and conduct requirements for individuals; capital, insurance, financial reporting, conflicts of interest management and other business conduct requirements; KYC, suitability assessment, client disclosure and account reporting, and complaint handling requirements in respect of both the firm and its registered individuals. The registration regime is intended to provide the appropriate investor protection for an investor either because the investor meets prescribed criteria, or because the security satisfies certain criteria. We question what investor protection objective is served by prohibiting an EMD from trading in a prospectus- qualified security – i.e. a security that can be traded with an investor that does not have to meet any prescribed criteria - with a client who does meet prescribed criteria?
With these proposed prohibitions on an EMD’s activities, the CSA appear to be signaling that there should be a line drawn in the sand between the “exempt market” and the “retail market”. That is, EMDs should be limited to trading in non-prospectus qualified securities, with investment dealers and mutual fund dealers having exclusive ability to trade in prospectus qualified securities.
We strongly urge further consultation on this important initiative, including a more substantive discussion about the goals of the CSA, as well as their investor protection concerns about the businesses presently conducted by many EMDs.
International Sub-Adviser Exemption and Repeal of Québec/Ontario Sub-Adviser Exemptions
A proposed nationally uniform “sub-adviser” exemption has been in the works for many years. OSC Rule 35-502 Non-Resident Advisers has long provided for a sub-adviser exemption to allow a non-resident firm to act as a sub-adviser to an Ontario registered adviser. Québec also has a blanket order with similar effect.
Avid followers of regulatory proposals will remember that a largely uniform national sub- adviser exemption was proposed for comment with the first publication of NI 31-103 in February 2007, but was dropped in the second publication for comment in February 2008. The good news with the 2013 version of the proposed sub-adviser exemption is that firstly, it is uniform and secondly, its provisions largely seem to be appropriate, including the fact that no regulatory filings are necessary by firms in order to rely on this exemption. However, we caution that the regulators now propose that firms can only rely on this exemption if they are not registered as an adviser in any of the Canadian jurisdictions, which means an international firm registered as an adviser in Ontario will not be able to act as a sub-adviser for a registered adviser in British Columbia in reliance on this exemption. This was always the position of the staff of Manitoba Securities Commission and it appears that they have been successful in persuading the other CSA members to follow suit. We consider that this is an inappropriate regulatory position that has more to do with provincial regulatory protectionism than investor protection. An obvious consequence of this position is that firms will be required to pay regulatory fees; firms relying on the sub-adviser exemption today do not pay any regulatory fees.
The only firms that will be able to rely on the exemption are non-Canadian firms that carry on the business of an adviser (and are appropriately registered) in their home jurisdiction. The other new concept to the sub-adviser exemption is a prohibition on the international sub-adviser having direct contact with clients, without a representative of the registered adviser or dealer being present, either in person, by telephone or “other real-time communications technology”.
We are not aware of many Canadian advisers who presently rely on the Ontario and Québec exemptions so as to act as a sub-adviser to a registered adviser (without being themselves registered in these provinces), but we urge any such firms to consider the fact that the Ontario and Quebéc exemptions will be repealed, which will leave them without any exemption from registration. There also may be firms relying on “sub-adviser exemption” orders from the other Canadian regulators, which will likely sunset within specified time-periods after the coming into force of this amendment.
International Adviser and International Dealer Exemption
With one exception (discussed below), no significant substantive changes are being proposed to the international adviser and international dealer registration exemptions, although the CSA propose to codify earlier blanket orders which change the existing drafting of these exemptions to allow these firms to trade with or advise “permitted clients”, as opposed to the more restrictive “Canadian permitted client”.
We caution firms relying on the international adviser and international dealer exemptions to review carefully the questions posed by the OSC regarding the use of these exemptions. Although little explanation is given as to the underlying regulatory issues that concern the Ontario regulator, the OSC has asked industry participants to specifically comment on whether these exemptions are being used for “unintended purposes”, such as advising or dealing with “permitted clients” who are located outside of Canada. The OSC explain they are concerned about these activities “potentially bringing disrepute” to Canadian capital markets, but give no further insights on their thinking.
As we pointed out above in connection with the international sub-adviser exemption, the CSA now propose to limit the availability of the international dealer and the international adviser exemption to firms that have no registration in the applicable category of registration in a Canadian jurisdiction. The effect of this change is that if an international adviser is registered as an adviser in Ontario, it will not be able to rely on the international adviser exemption to advise a permitted client in Québec or elsewhere in Canada. This scenario is today relatively common and we fail to understand the investor protection goals of the regulators in making this proposal.
Guidance Impacting (In Particular) Representatives
The CSA propose to amend the Companion Policy to provide additional guidance in the following areas that impact representatives, but also will impact a registrant firm’s compliance programs.
- Conflicts of interest that arise from representatives’ outside business activities
- Conflicts of interest that arise when representatives act as directors on boards of public or private corporations
- Conflicts of interest that arise when representatives are in “positions of influence” with volunteer or non-profit organizations
- The expected levels of proficiency – primarily experience levels – that advising and associate advising representatives must have before they can become registered. We believe this is an area that deserves special attention and further consultation, given the business structures that are prevalent in the industry, as well as the skill levels needed for, in particular, client service personnel, who must be registered to carry out at least some portions of their work. We know of many very qualified individuals who have had a difficult time (oft-times near impossible) persuading the regulatory staff of their proficiency and qualifications to act as an advising representative or associate advising representative. This is costly and, we believe, unnecessary.
We consider the comment process to provide an excellent opportunity to again raise issues around all of the above-noted topics in response to the additional guidance proposed by the CSA, since the previous CSA notices where similar guidance was provided were not published for any comment or consultation.
NI 31-103 – The “Gift That Keeps On Giving”
In the true spirit of the holiday season, the CSA have indicated that we can expect further proposed amendments to NI 31-103 at some unspecified date in the future. Specifically, the CSA indicated that they are considering, including through industry consultations:
- The recognition of additional examinations or inclusion of alternative proficiency requirements for registered individuals.
- Whether to propose additional requirements to enhance the existing regulatory framework for safeguarding clients’ assets (custody provisions).
The CSA also can be expected to come to a landing at some point during 2014 on the controversial proposals to mandate that registrant firms use OBSI as their independent dispute resolution service. No further information has been forthcoming from the CSA on this issue since the last publication (in November 2012) of the proposed amendments to NI 31-103 to mandate this form of dispute resolution. The many comment letters written in respect of the proposals are available on the OSC website, including our comment letter.
We would be pleased to assist you in providing comments to the CSA on any of the proposals that may affect you. The ability to formally comment on CSA proposals is an opportunity to help to shape future regulation that not only is in the best interests of investors, but also is appropriate for the financial services industry in Canada, by, among other things, avoiding significant unintended consequences.