On July 17, 2009, the Canadian Securities Administrators (the “CSA”) released the final version of National Instrument 31-103 - Registration Requirements and Exemptions (“NI 31-103” or the “Instrument”), along with Companion Policy 31- 103CP - Registration Requirements and Exemptions (the “Companion Policy”) and accompanying amendments to related instruments, policies and forms. Originally published in February 2007 with a revised version published in February 2008, the long awaited reforms are designed to nationally harmonize and streamline the registration regime for firms and individuals. NI 31-103 replaces multiple sets of rules contained in individual provincial and territorial securities acts, regulations, rules and policy statements with one consolidated national rule. NI 31-103 will come into force on September 28, 2009 (the “Implementation Date”). Implementation is subject to the approval of the provincial and territorial governments and the concurrent implementation of amendments to provincial and territorial securities legislation. In Ontario, it should be noted that NI 31-103 excludes certain provisions which are intended to be incorporated directly in the Securities Act (Ontario) (and which are stated as being not materially different from the provisions in the Instrument).
In this bulletin, we will provide an overview of the new registration rules and the important changes which will affect industry participants in the transition to the new regime.
I. Key Changes To Registration Rules
“Business” Registration Trigger
NI 31-103 establishes a new threshold for determining whether a firm or individual is required to be registered as a dealer or adviser. Under the old rules, registration as a dealer was generally required for those who “trade” in a security. The CSA have replaced this “trade” trigger with a “business” trigger. The result is that anyone who is “in the business” of dealing in securities as principal or agent must register as a dealer in the applicable category, and persons “in the business” of advising in securities must register as an adviser. An important new category of registration, investment fund manager, is not subject to the business trigger test for registration. For the purposes of the Instrument, a person or company acting as an investment fund manager will generally require registration or an exemption from the registration requirement.
In determining whether or not a person is “in the business” and therefore required to register as a dealer or adviser, the Companion Policy provides a non-exhaustive list of factors which will be taken into consideration, such as whether an individual or firm (i) engages in activities similar to a registrant (i.e. promoting securities or stating in any way that the individual or firm will buy or sell securities), (ii) engages in intermediating trades or acting as a market maker, (iii) directly or indirectly carries on the activity with repetition, regularity or continuity, (iv) receives or expects to receive remuneration for the activity, or (v) directly or indirectly solicits securities transactions or offers advice.
Categories of Registration
NI 31-103 significantly reduces the overall number of categories of registration. The former categories of registration which will be eliminated as of the Implementation Date include international dealer, limited market dealer (to be replaced by the exempt market dealer category, discussed below), foreign dealer, international adviser, securities adviser, security issuer and investment counsel.
The following is a brief description of the new categories of registrants under NI 31-103.
Investment Dealer – permitted to deal in any security.
Mutual Fund Dealer – restricted to dealing solely in a security of a mutual fund.
Scholarship Plan Dealer – restricted to dealing solely in a security of a scholarship plan, educational plan or educational trust.
Exempt Market Dealer – restricted to dealing in prospectus-exempt securities and with persons to whom prospectus-exempt distributions can be made (e.g. accredited investors). Unlike current limited market dealers, an exempt market dealer would be permitted to trade in prospectus-qualified securities to such qualified purchasers. Alberta, British Columbia, Manitoba, the Northwest Territories, Nunavut and the Yukon Territory will introduce an order exempting individuals and firms from the dealer registration requirement when they trade securities that are being distributed pursuant to certain exemptions in National Instrument 45-106 – Prospectus and Registration Exemptions (including the accredited investor exemption) where certain conditions have been met. Saskatchewan is considering whether it will adopt this exemption and will release a separate notice when it has made its decision.
Restricted Dealer – limited to dealing activities that do not fall within the other firm categories. The regulator will attach terms and conditions on the registration restricting that dealer’s proposed activity.
Portfolio Manager – permitted to advise with respect to any security.
Restricted Portfolio Manager – restricted to advising others with respect to specified securities, types or classes of securities, or specified industries.
The sub-adviser exemption of OSC Rule 35-502 – Non Resident Advisers which was to be repealed by an exemption in the Instrument is being retained separately instead in the rule while the CSA studies the exemption further.
Investment Fund Manager – a new category which will apply to managers of all investment funds (both public and private) other than private investment clubs.
For all of the registration categories there will be no renewal requirement, but registered firms must pay fees on an annual basis to maintain their registration and the registration of individuals acting on their behalf. A firm’s registration will be automatically suspended in certain circumstances, such as upon a failure to pay such annual fees within 30 days of the deadline.
Exemptions from the Registration Requirements
The CSA have attempted to include most of the available exemptions from the dealer and adviser registration requirements in the Instrument. By and large, the exemptions reflect the adoption of the business trigger, activities which are subject to another regulatory regime or which (in the opinion of the CSA) do not pose risks to investors or the markets.
Registration Categories for Individuals
In addition to the types of registration categories available to firms, NI 31-103 requires each registrant to have an individual registered as an Ultimate Designated Person (“UDP”). The UDP must be the chief executive officer of the firm, sole proprietor or equivalent, and is responsible for ensuring that policies and procedures for the discharge of the registrant’s obligations under securities legislation are implemented. Registrants under NI 31-103 must also have an individual registered as the Chief Compliance Officer (“CCO”), an operating officer who reports to the UDP and is responsible for the day-to-day monitoring of the registrant’s compliance system, including establishing compliance policies and procedures and reporting on the firm’s compliance with securities legislation. In order to obtain registration as a CCO, the designated individual must meet the proficiency requirements for this designation set out in the Instrument. The UDP and the CCO may be the same person, provided that the person meets the requirements for each designation. There can usually only be one CCO for each firm.
Registrants in the category of portfolio manager are required to have at least one individual registered an “advising representative”. The advising representative is permitted to act as an adviser in respect of a security that the individual’s sponsoring firm is permitted to advise on. NI 31-103 also provides an “associate advising representative” category, which is intended for individuals working towards full adviser registration but do not yet meet all the experience or education requirements, as well as those who do not intend to become full advising representatives. The advice of associate advising representatives must be pre-approved by a designated advising representative and the registrant is required to retain satisfactory records of such pre-approval.
It is important to note that non-trading or non-advising officers will no longer be required to be registered unless they are “permitted individuals” (e.g. the CEO, CFO, COO or shareholders owning 10 per cent or more of the voting securities of a firm). Such “permitted individuals” will be required under National Instrument 33-109 – Registration Information to submit filings to regulators. The definition of “permitted individual” has been amended to capture only the “mind and management” of the firm, excluding individuals who have “officer” titles but do not influence the overall direction of the firm. This will result in deregistration for many officers who were registered under the former regime. The regulators will be sending lists of registered officers to firms to assist them in removing officers where registration is no longer required. To avoid being charged National Registration Database user fees for such individuals, they should be removed from the National Registration Database by December 31, 2009.
Firms and individuals carrying on more than one type of registerable activity will generally be required to obtain registration in each of the applicable categories, however such persons will generally only have to meet the most stringent insurance and capital requirements (i.e. the requirements are not cumulative).
The CSA have significantly expanded the application of the “permitted client” concept which was introduced in the 2008 proposed version of the Instrument. The “permitted client” category is a sub-set of “accredited investor” definition that includes certain institutional and corporate investors and very high net worth individuals. Registrants who deal with permitted clients may be exempt from certain conduct obligations (such as the requirement to make a suitability determination or provide relationship disclosure information, if the permitted client has waived those requirements). The definition of “permitted client” has been broadened from the 2008 proposals to include investment funds that are managed by a person or company registered as an investment fund manager under the securities legislation of a jurisdiction of Canada, wholly-owned subsidiaries of Canadian pension plans, corporations having net assets of at least $25 million (reduced from $100 million of shareholders’ equity in the 2008 proposals), and non-incorporated companies, partnerships and trusts.
II. Transitional Matters Of Note
The CSA will convert existing categories of registration for firms and individuals to the new registration categories as of the Implementation Date. As mentioned above, other categories, such as securities issuer and international dealer, have been eliminated. There are different transition timelines for the various categories.
Exempt Market Dealers
Those currently registered as limited market dealers in Ontario or Newfoundland and Labrador will become exempt market dealers in those provinces. Firms that were not previously registered as a limited market dealer, but which are currently active and now need to be registered as an exempt market dealer, will have 12 months to apply for registration and comply with the requirements. There is no transition period available for firms which are not active in the exempt market prior to the Implementation Date. Of note is that under the Instrument, there is no longer any distinction in treatment between exempt market dealers on the basis of whether or not they handle, hold or have access to client assets. The final version of the Instrument eliminates a proposal contained in the 2008 version that would have exempted those exempt market dealers with access to client assets from certain conduct requirements.
For firms registered as limited market dealers prior to the Implementation Date, the following transition timelines apply.
The proposed rules have a significant impact on international dealers. Previously, “international dealer” was a category of registration in Ontario and Newfoundland and Labrador. This category will be revoked immediately as of the Implementation Date under NI 31-103. Under the new regime, an “international dealer” exemption is in place to allow non-resident dealers to operate in Canada, with limitations. To rely on the exemption, an international dealer is restricted to trading with “permitted clients” and with respect to “foreign securities”. Non-resident dealers that want to have wider access to Canadian markets will need to obtain the appropriate registration. Firms formerly registered as international dealers who seek to operate under the exemption have one month from the Implementation Date to submit a completed Form 31-103F2 – Submission to Jurisdiction and Appointment of Agent for Service. Firms relying on the international dealer exemption must continue to pay participation fees in Ontario on the same basis that they currently provide as registrants. Firms relying on the international dealer exemption (other than in Ontario) will have to provide an annual notice to the regulator that they are using this exemption (instead of a notice when they stop relying on the exemption as was proposed in prior drafts of the Instrument). In addition, an international dealer must provide notice to its Canadian clients disclosing, amongst other things, that it is not registered. There are also restrictions on the holding of client assets by international dealers.
Under NI 31-103, “portfolio manager” is the sole general category of adviser registration. The registration requirement applies to advisers who give “specific advice”. The Companion Policy states that advice is specific when it is tailored to the needs and circumstances of a client or potential client.
In the past certain CSA members have taken the view that persons and companies who provided investment advice to a fund established under the laws of another jurisdiction would be required to register as an adviser (or rely on an exemption from registration) in each jurisdiction where securities of the fund were sold on the basis that the advice to the fund “flowed through” to the investors. NI 31-103 has abandoned this “flow-through” interpretation. Under the Instrument, the adviser to a fund must only register as a portfolio manager in the province or territory where the fund is established, regardless of where the fund’s investors are located.
For firms registered as advisers prior to the Implementation Date, the following transition timelines apply.
As noted above, the category of “international adviser” in Ontario will be eliminated under NI 31-103. This will mean that all persons performing advisory activities in Canada, even if resident outside of Canada, will need to register as a full portfolio manager unless they are able to rely on the exemption from registration for international advisers contained in NI 31-103. The exemption contained in the Instrument will only be available to companies that have no establishment, officers, employees or agents in Canada. In addition, an international adviser must be registered under the securities legislation of the jurisdiction in which its head office or principal place of business is located, and must engage in the business of a portfolio manager in that jurisdiction. The exemption from registration set forth in NI 31-103 reduces the types of “permitted clients” for whom an international adviser is currently permitted to provide services, and decreases the percentage of revenue that an international adviser is permitted to derive from its portfolio management activities in Canada to 10 per cent (the previous limit under the applicable Ontario Rule was 25 per cent).
The CSA has provided for a 12 month transition period, during which international advisers must decide whether they wish to continue to operate under the above-mentioned exemption or apply for registration as a portfolio manager. While considering their options, Ontario registered international advisers will continue to operate under OSC Rule 35-502 – Non Resident Advisers. Similarly, for foreign advisers registered in other provinces under other registration categories (such as “portfolio manager and investment counsel – foreign”), they may continue to operate under those conditions for a 12 month period. Firms formerly registered under the category of international adviser who seek to operate under the exemption will have 12 months from the Implementation Date to submit a completed Form 31-103F2 – Submission to Jurisdiction and Appointment of Agent for Service. Firms relying on the international adviser exemption must continue to pay participation fees in Ontario on the same basis that they currently provide as registrants. Such firms will have to provide annual notice to the regulator that they are using the exemption. In addition, Ontario will require international advisers acting as a portfolio manager of a fund to disclose the difficulty of enforcing certain rights against the adviser in offering documents. Similar to international dealers, an international adviser must provide specified notice to Canadian clients and its holding of client assets is restricted.
Investment Fund Managers
Investment fund managers with a head office in Canada that have been active prior to the Implementation Date will have 12 months to apply for registration in the jurisdiction where their head office is located, and 24 months for registration in the other applicable Canadian jurisdictions or if located outside Canada. The CSA have announced that they plan to publish for comment during the next year a proposal to explain under what circumstances an investment fund manager that has a head office outside Canada would need to register or where investment fund managers with a head office in one Canadian jurisdiction will be required to register in others.
The Companion Policy clarifies that an investment fund manager may advertise a fund it manages to the general public without being registered as an adviser, and may promote the fund to registered dealers without being registered as a dealer.
Persons registered as investment fund managers will be subject to a minimum capital requirement of $100,000 and must not have excess working capital of less than zero (the minimum capital requirements are higher than for advisers and dealers). Bonding or insurance is required as prescribed by the Instrument, and for each prescribed clause must be maintained in an amount equal to the maximum of (i) one percent of assets under management or $25,000,000, whichever is less; (ii) one percent of the investment manager’s total assets or $25,000,000, whichever is less; (iii) $200,000; and (iv) the amount determined to be appropriate by a resolution of the investment fund manager’s directors.
Registered investment fund managers must appoint a UDP and a CCO, the latter of which must meet the necessary proficiency requirements. While registered investment fund managers are not subject to certain conduct requirements such as “know your client” or suitability requirements, they must adhere to certain other rules, including the rules concerning client relationship disclosure, conflicts of interest (other than with respect to funds subject to National Instrument 81-107 – Independent Review Committee for Investment Funds), and the delivery of quarterly and annual audited financial statements.
The Companion Policy states that funds organized as limited partnerships should consider which entity or entities may need to be registered as an investment fund manager. Multiple registrations may not be necessary if each general partner of an affiliated group enters into a contract with a single registered investment fund manager within the group.
With respect to venture capital and private equity management companies, the Companion Policy states that where such firms are actively involved in the management of companies they invest in (examples including representation on the board of directors, direct involvement in the appointment of managers and a say in material management decisions), they would not typically trigger the “business” registration criteria. If actively involved in the management of the companies it invests in, the investment portfolio of a venture capital or private equity firm would generally not be considered an investment fund, and the firm would not need to register as an investment fund manager. Similarly, such a firm would not typically have to register as a dealer if its activities relating to raising and investing money are occasional and uncompensated, nor register as a portfolio manager if the advice provided in connection with the purchase and sale of companies is incidental to the firm’s active management of these companies. Because such business models vary, the CSA have indicated that they anticipate providing supplemental guidance on this matter at a later date.
III. Enhanced Compliance Requirements for Registrants
To further strengthen the CSA’s goal of ensuring that qualified firms and individuals are providing advising, trading and investment fund management services in the Canadian capital markets, NI 31-103 introduces comprehensive fitness standards for persons to obtain and maintain registration. These standards are intended to address the integrity, competency and financial solvency of each registrant.
Under NI 31-103, the minimum proficiency requirements for registrants will change from a course-based to an exam-based approach, in recognition of the fact that a proposed registrant’s past experience may have adequately prepared them to successfully complete an examination without the necessity of completing the accompanying course. Individuals registered in more than one category are required to meet the highest level of proficiency for all categories. The proficiency requirements for investment dealers are, and will continue to be, set by the Investment Industry Regulatory Organization of Canada (“IIROC”). The proficiency requirements for representatives of mutual fund dealers are identical to those set by the Mutual Fund Dealers Association of Canada (“MFDA”) but are included in the Instrument because the registration of these representatives has not been delegated to the MFDA and the MFDA does not review proficiency for dealing representatives of mutual fund dealers.
The deadline for applying for registration upon completing examinations is 36 months, but the time limitation does not apply if the individual was registered in the same category in a jurisdiction of Canada or if the individual gained 12 months of relevant securities industry experience during the 36 month period before the date the individual applied for registration.
While there were previously no mandated proficiency requirements to obtain registration in the category of limited market dealer, NI 31-103 will require that all dealing representatives of an exempt market dealer pass one of the Canadian Securities Exam and the Exempt Market Products Exam prepared by the IFSE Institute. The CCO of an exempt market dealer will need to meet these requirements in addition to the requirement that they successfully complete the Partners, Directors and Senior Officers Course Exam. Alternatively, persons who qualify to act as advising representatives and a CCO of a portfolio manager would also qualify.
The CCO of a registered investment fund manager may qualify through meeting those requirements needed for a chief compliance officer of a portfolio manager. Alternative proficiency includes (i) passing the Canadian Investment Funds Exam, the Canadian Securities Course Exam or the Investment Funds in Canada Course Exam; (ii) passing the Partners, Directors and Senior Officers Course Exam; and (iii) five years of relevant securities experience while working at a registered dealer, registered adviser or an investment fund manager, including 36 months in a compliance capacity. While the 2008 version of the Instrument proposed consecutive lengths of employment in determining relevant experience, the word “consecutive” has been removed in the final Instrument.
Minimum Capital and Insurance Requirements
Registered investment dealers and portfolio managers will be familiar with the requirements to maintain minimum capital and insurance coverage under existing securities legislation. NI 31-103 will expand these requirements to exempt market dealers and investment fund managers, and change the requirements for all registrants to reflect a more “risk-based approach”. The new minimum capital requirements under NI 31-103 will generally increase for most registrants, other than portfolio managers that hold client assets. This could have a significant impact on smaller exempt market dealers and investment fund managers and act as a barrier to entry for new participants in these markets. The minimum capital requirements for a registered adviser that is not also a registered dealer or a registered investment fund manager is $25,000. For a registered dealer (including an exempt market dealer) that is not also a registered investment fund manager, the minimum capital requirement will be $50,000. The minimum capital requirement for an investment fund manager will be $100,000. A registered firm must calculate its excess working capital using Form 31-103F1 – Calculation of Excess Working Capital (“Form 31-103F1”). If excess working capital is less than or equal to zero, it must be reported to the applicable regulatory authorities immediately. Excess working capital must not be less than zero for two consecutive days.
With respect to insurance, the method of determining the minimum amount of insurance coverage required is proposed to be based on a formula, rather than a flat amount. Registrants must maintain bonding or insurance that provides for a double aggregate limit or a full reinstatement of coverage. In addition, a registered firm may not maintain bonding or insurance that benefits, or names as an insured, another person or company unless the bond provides that the registered firm has the right to claim directly against the insurer in respect of losses, among other restrictions.
With respect to books and records, NI 31-103 does not prescribe the exact form to be maintained by a registrant. The current record-keeping requirements will be replaced with a general obligation to maintain an effective record-keeping system to accurately record business activities and client transactions and demonstrate compliance with applicable laws. Records must be kept for at least seven years and include material contracts, reconciliations of bank statements and securities positions, as well as all client correspondence. Firms must maintain notes of oral communications with clients and all e-mail, regular mail, fax and other written communications with clients to the extent these communications could have an impact on the client’s account or the client’s relationship with the firm.
NI 31-103 also mandates that registrants file their financial statements with the regulators on a more frequent basis than is currently the case (and now on an unconsolidated basis). Registered dealers will be required to file audited statements and completed Form 31-103F1 (showing calculation of excess working capital) within 90 days of their fiscal year end and unaudited quarterly financial statements and completed Form 31-103F1 within 30 days of the end of the applicable quarter. Exempt market dealers do not have to make quarterly filings. Registered advisers have to meet these same annual filing requirements, but are not required to make quarterly filings. Persons registered as investment fund managers will be required to file annual audited financial statements and completed Form 31-103F1 within 90 days of their fiscal year end and unaudited quarterly financial statements and completed Form 31-103F1 within 30 days of the end of the applicable quarter. Investment fund managers will also be required to include in their reports a description of any net asset value adjustment made during the year (or relevant quarter).
Regulation of Referral Arrangements
NI 31-103 also introduces harmonized requirements relating to referral arrangements for registrants. Registrants wishing to enter into a referral arrangement will be required to provide specified written disclosure of the arrangement to clients and enter into a written agreement clarifying the roles and responsibilities of both the referring party and the recipient of the referral. NI 31-103 will require registrants to disclose specific information about referral arrangements, including the purpose and material terms of the arrangement and the method of calculating the referral fee. The Instrument also mandates disclosure of any information about the referral arrangement that a reasonable client would consider important in order to evaluate the referral arrangement.
Other conduct rules for advisers and dealers (including exempt market dealers) relate to know-your-client obligations, which requires a registrant to learn about each client and keep the information current, including information related to investment objectives, investment knowledge and experience, risk tolerance, investment time frame, employment status, income level and net worth. The CSA note that registrants should collect information concerning the nature of a prospective client’s business, control structure and specified beneficial ownership for clients that are not individuals.
NI 31-103 also introduces requirements for the handling of complaints. All registered dealers and advisers must document and fairly respond to each complaint and ensure that independent dispute resolution services or mediation services are made available at the firm’s expense.
Another new requirement for registrants (other than investment fund managers) is the requirement to prepare and deliver to clients a ‘relationship disclosure document' that must include 12 different elements, including a description of the nature or type of the client’s account, the products and services offered, the types of risk to consider and a statement that the firm has an obligation to assess the suitability of investments for the client. These requirements do not apply with respect to “permitted clients” where they have been waived by the permitted client in writing and the registrant does not act as an adviser to a managed account of the permitted client. The document may also describe a prospective client’s responsibilities, such as providing accurate information to the registrant firm and informing the registrant of changes that could reasonably result in a change to the type of investments that are appropriate for that client.
Registered dealers must deliver a statement to a client at least once every three months which is to include information as prescribed by NI 31-103. Registered advisers must also do so, except if a client has requested otherwise. Registered dealers (other than mutual fund dealers) are required to deliver a statement at the end of a month if a client requests monthly statements or if a transaction was effected in the account (other than a transaction made under an automatic withdrawal plan or an automatic payment plan, including a dividend reinvestment plan).
Conflicts of Interest
The proposals contained in NI 31-103 are intended to harmonize rules relating to conflicts of interest and impose an overarching standard that registrants must identify and deal with all conflicts. Conflicts may be adequately dealt with in certain instances through client disclosure or through control mechanisms such as an independent review committee. If a reasonable investor would expect to be informed of a conflict, a registered firm must disclose the conflict in a timely manner. The Companion Policy gives the example of a registered firm that trades in, or recommends securities of, a related or connected issuer. The registered firm should prepare and maintain a list of related issuers and make it available to clients, while providing clients with disclosure about specific conflicts as they arise. Some conflicts, however, may be of such a nature that they should be avoided altogether, such as those that will lead to actual or a high risk of harm occurring to either clients or the capital markets.
While transition periods are provided for many of the new requirements imposed by the Instrument, it is important for registered firms to continue their planning and preparation of documents at this time, particularly with respect to items such as new insurance requirements which may take some time to research and implement. Firms that are currently registered as international dealers and international advisers must determine whether they can rely on the exemptions from registration provided in the Instrument following the Implementation Date or if they will need to apply for registration in the applicable category.
Finally, exempt market dealers and investment fund managers requiring registration may wish to make the necessary adjustments to their capitalization and contractual arrangements to conform to the requirements of the Instrument, consider preparing registration applications and ensure that their personnel meet the applicable proficiency requirements well in advance of the expiration of the transitional periods.