On February 29, 2008, the Canadian securities administrators (CSA) released for a second comment period proposed National Instrument 31-103 Registration Requirements, along with a companion policy and for the first time, draft consequential amendments to, and proposed revocations of, over 20 other instruments. The most significant proposed amendments are to National Instrument 45-106 Prospectus and Registration Exemptions, National Instrument 33-109 Registration Information and National Instrument 31-102 National Registration Database and their related companion policies. This massive regulatory reform package is the CSA’s response to the over 260 comment letters received after the first publication of the CSA proposals in February 2007, as well as the CSA’s continued analysis of the implications of its proposed registration regime on existing securities regulation.
Proposed NI 31-103 and the other proposed rule amendments are designed to put in place a nationally harmonized and streamlined registration regime for firms and individuals. Once in force, NI 31-103 and the other rule amendments will significantly alter the status quo for financial services firms doing business in Canada. The rules will cover the requirements for firms and individuals to be registered with the various securities commissions, as well as the regulation of registrants’ activities in Canada, such as referral arrangements and registrantclient relationships. It is difficult to over-emphasize the implications of this reform package.
Proposed NI 31-103 and the other rule amendments can only come into force once provincial legislative amendments are passed due to the conceptual changes proposed by the CSA. Although this legislation is out of the control of the CSA, the CSA suggest that these amendments will be passed by the various provincial governments during 2008 and 2009, so that NI 31-103 and the other rule amendments can come into force by April 2009. It is apparent that there will not be uniformity in approach – most notably British Columbia, Manitoba and New Brunswick have taken a different tack in developing legislation, with Manitoba deciding to not follow the rest of Canada.
We highlight in this Investment Management Advisory some of the more important new 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 additional guidance and clarification of its application to certain firms
- A new category of "exempt market dealers", with different EMD regimes in each of British Columbia and Manitoba
- 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 closedend funds, mutual funds (pooled funds), scholarship plans and labour-sponsored investment funds
- 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 information pertaining to the registrant’s relationship with clients to be provided to certain clients
- Requirements for complaint handling procedures and identification and handling of conflicts of interest
- Exemptions from otherwise required conduct rules for registrants dealing with a new sub-set of accredited investors – to be known as "permitted clients", which will include institutions, certain corporations and ultra net high net worth investors
- The CSA have retreated from their earlier proposals around requiring registrants to share information about terminated employees, although the CSA still propose to require registrants to provide and obtain, as the case may be, prescribed information about individuals on transfers of registration.
UNDERSTANDING VERSION 2 OF THE REGISTRATION REFORM PROPOSALS
Comments on the new proposals are due by May 29, 2008. The CSA have indicated that they intend to move forward quickly in responding to comments and finalizing NI 31-103 and the other reform proposals. Understanding the Registration Reform Proposals and knowing how all the pieces fit together and how they will impact your business is vital. BLG will release additional Investment Management Advisories that will provide more insight into the new Proposals and explain their impact on various industry participants. BLG’s series on Registration Reform Keeping Reforms In Sight: Understanding Version 2 of the Registration Reform Proposals will be released over the coming weeks.
We intend to comment on proposed NI 31-103 and the other reform proposals by the comment deadline and would be pleased to assist you in providing comments. Making your views known through the formal comment process is critical in assisting with practical and realistic rule-making.
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 Canada’s 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.
Under NI 31-103 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" trading 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 trading 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.
The CSA have not been able to agree on a uniform approach to achieve the "business trigger" objective. The securities regulators in British Columbia and New Brunswick propose to achieve the desired outcomes through different terminology and rules, while Manitoba proposes to retain today’s "trade trigger" for dealers. This means that firms doing business in Manitoba must continue to monitor whether they have carried out a trade in Manitoba, and if so, whether a registration exemption exists, before deciding whether they need to be registered as a dealer in Manitoba.
NI 31-103 also will result in dramatically fewer categories of registration. Instead of today’s multitude of registration categories in the various provinces, 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 at all – 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.
The CSA clarify that a firm must register in more than one capacity if they are carrying out the applicable registrable activity – for example, a firm that manages pooled funds and distributes securities of those funds to its clients will have to be registered as an adviser (portfolio manager), an exempt market dealer and an investment fund manager. Also, a mutual fund dealer may only distribute mutual funds – if the dealer wishes to also distribute securities pursuant to prospectus exemptions and securities of scholarship plans, that dealer must also be registered as an exempt market dealer and a scholarship plan dealer, in addition to being registered as a mutual fund dealer.
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 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 and recognition of equivalent forms of insurance
- 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 provide to certain clients information on over 12 different prescribed elements of relationship disclosure
- Significantly enhanced initial firm registration requirements, including requirements to file business plans, policies and procedures manuals, issuer disclosure statements and proposed marketing materials
- "Permitted clients" may waive certain registrant activities, such as suitability analysis, which means that if so waived, a registrant does not need to review suitability for those clients.
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. Registration will be required only in the province where the manager of the investment fund is located. The CSA clarify in this second publication that managers of non-Canadian funds distributed in Canada do not need to be registered as investment fund managers, provided those managers do not direct the management of the fund from within a Canadian province.
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 reguatory financial statement 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, however the CSA now propose that investment fund managers will not be required to establish complaint handling procedures. Managers of investment funds that are subject to National Instrument 81-107 will also be exempt from the conflicts procedures set out in NI 31-103.
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 regulator and CCOs must meet prescribed proficiency requirements.
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 NI 45-106, 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. The publication for comment of the replacement for NI 45-106 is primarily due to the fact that the registration exemptions that the CSA propose to maintain have been brought into proposed NI 31-103, largely without change. Once in force, NI 45-106 will be primarily a prospectus exemption rule (although it will still have the title Prospectus and Registration Exemptions) – other clarifications that are unrelated to NI 31-103 have also been proposed by the CSA with the publication of replacements for NI 45-106 and NI 45-102 Resale of Securities.
With the first version of proposed NI 31-103, the CSA proposed the new registration category of exempt market dealer, as a national expansion of the "limited market dealer" registration category now in effect in Ontario and Newfoundland and Labrador, but with significant new requirements, including capital, proficiency, insurance and conduct requirements. Many of the comments received on the first version of proposed NI 31-103 strongly objected to this new EMD category of registration or pointed out perceived defects. The CSA have responded to these comments, among other things, by proposing to exempt EMDs from many of the applicable rules when those firms are dealing with "permitted clients" or when they are not handling client money or assets. In addition, the CSA clarify what EMDs may trade in – EMDs may trade in securities that may be distributed pursuant to prospectus exemptions, including securities that are qualified under a prospectus, but which are distributed by an EMD pursuant to a prospectus exemption. The regulators in British Columbia and Manitoba will allow EMDs operating only in British Columbia and Manitoba, as the case may be, to operate without registration, provided those firms are not registered in any other province or territory.
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 trading 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 non-resident 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
- Advising or trading with only prescribed clients – the list of prescribed clients now is similar to the list of permitted clients under Ontario Securities Commission Rule 35-502 Non-Resident Advisers
- Advising on or trading in only non-Canadian securities, other than incidentally
- Revenue limits from Canadian activities (for international portfolio managers).
The proposed prohibition contained in the first version of NI 31-103 that prevented the solicitation of new clients has been removed in response to comments.
Importantly, the CSA confirm that the "flow-through" theory of registrable activity is , for once and for all, gone. The OSC primarily espoused the flow-through theory – that is, a non-Canadian portfolio manager or a fund manager is considered to be carrying on portfolio management or fund management in Ontario if that entity advises or manages an investment fund that is distributed in Ontario. With the proposed repeal of OSC Rule 35-502, the legacy of former OSC Policy 4.8 will end. This means a non-Canadian fund manager or portfolio manager may distribute their funds in a Canadian province without fear of having to be registered in that province as an adviser or investment fund manager provided they distribute the funds via available prospectus exemptions and do not actually manage those funds in Canada.
Significant Changes to Registration Filings
With this second publication of NI 31-103, the CSA published for an initial comment period new and consequential amendments to NI 33-109 Registration Information. Among other significant changes, the CSA propose to only require registration applications from advising/trading officers, along with the chief executive officer, chief financial officer, or chief operating officer or their functional equivalents, of the firm. More junior officers that neither trade nor advise, or, for international firms, those officers that have no dealings in Canada, are excluded from the requirement to seek registration.
Several new forms have been introduced, including (i) a form to ensure more efficient reinstatement and transfer of registered individuals between registered firms (Form 33-109F7), and, (ii) a new standardized application form for firms (Form 33-109F6). Form 33-109F6 will replace the Form 3 or equivalent in all jurisdictions. Form 33-109F6 also contains a comprehensive list of all documents that are required to be submitted by a firm when applying for registration, replacing the previous patchwork of legislative references that varied from province to province.
Firms will also be required to submit much more detailed documentation and provide a much more in-depth analysis of its proposed securities-related activities with their initial application for registration, including
- A business plan for the next five years that includes prescribed information about products, services and fees
- A copy of the firm's Policies and Procedures Manual
- Proposed marketing material to be distributed by the firm
- A copy of the firm’s standard employment/agent agreement between itself and registered individuals, specifically identifying the compensation arrangements
- Nature and source of capital for firms less than 5 years old
- Where applicable, client-related documents, such as financial plans, investment policy statements and investment management agreements.
The revised proposals now include a transition timetable. Individual registrants who are registered in an existing and continuing category of registration will be grandfathered and will be automatically mapped onto the applicable categories on the National Registration Database. In addition, individual registrants who enjoy discretionary exemptions from certain proficiency requirements will also be grandfathered, as will currently-registered chief compliance officers. Firms (and individuals) whose businesses require them to be registered in one of the new categories of registration (investment fund manager or exempt market dealer and the applicable individual registration categories) will be required to apply for registration in their new registration categories within 6 months from when NI 31-103 comes into force. The conduct rules under NI 31-103 will go into effect immediately, although compliance with certain fit and proper requirements (including capital and insurance) will only be required by the end of the first year after the effective date.
Proposed NI 31-103 is part of the CSA’s overall Registration Reform Project. Other elements of this Project include implementing the three "core principles" of the Client Relationship Model and putting into place a "passport" system for registration that builds on the passport systems for prospectuses and exemption applications that come into force on March 17, 2008.
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 information requirements proposed in NI 31-103 are a manifestation of this principle. On February 21, 2008, the Investment Dealers Association of Canada (IDA) released for a 30-day comment period its proposals for the establishment and amendment of IDA rules to implement the core principles of the Client Relationship Model. The rule proposals relate to relationship disclosure, account cost disclosure, conflicts resolution disclosure, retail client suitability and account performance reporting. The Mutual Fund Dealers Association of Canada’s equivalent proposals are expected later this year.
The CSA’s proposals for a passport system for registration were not published with this set of reforms.
The CSA also suggest that their work to consider a regime to allow "incorporated salespersons" is still being conducted on a separate track. Other than this reference, the CSA do not otherwise discuss this issue, which we know to be very significant to many in the industry.
The CSA anticipates that NI 31-103 will be in effect by April 2009, assuming the legislative changes are implemented in time. While we believe that the overall reform changes will be a positive development, we are concerned that the CSA may be too hasty in implementing all elements of the reform package, without giving the industry sufficient time to absorb the proposals, many of which have just been published for the first time and without carefully considering the comments received on the proposals. Given that this reform package is among the largest in recent memory, we will be advocating for an adequate review period and more extensive transition to ease the burden of moving to the new regime.