On July 17, 2009 the Canadian Securities Administrators (the “CSA”) published in final form National Instrument 31-103 Registration Requirements and Exemptions (“NI 31-103”), its related companion policy and other related rules and amendments. The CSA has also announced that NI 31-103 is expected to come into force on or about September 28, 2009, subject to ministerial approvals in some jurisdictions (the “Effective Date”).
NI 31-103 will introduce a new category of registered dealer – the exempt market dealer (“EMD”) – in all provinces and territories of Canada. On the Effective Date, firms that are currently registered as limited market dealers (“LMDs”) in Ontario and Newfoundland & Labrador will be automatically registered in the category of EMD in those provinces. Individuals and firms engaged in the business of trading in securities on the basis of exemptions from the dealer registration requirement under securities laws in other provinces and territories, however, will be required to determine if they must apply to register as an EMD.
In addition, NI 31-103 will introduce new compliance obligations for LMDs. Currently, LMDs are exempt from certain of the so called “fit and proper requirements” under securities laws, including the requirement that salespersons achieve certain prescribed educational proficiencies and that firms maintain a prescribed minimum amount of insurance and working capital.
It may come as a surprise to some LMDs that, as registered dealers, they are currently subject to a number of ongoing compliance obligations. These compliance obligations include, among other things, conducting know-your-client (“KYC”) and suitability reviews for clients, maintaining and updating a policies and procedures manual and providing clients with a statement of policies and a trade confirmation following settlement of an exempt trade. The Ontario Securities Commission (“OSC”) reported that, among other deficiencies, nearly 80% of the LMDs it surveyed in a 2005 compliance review were not collecting and documenting KYC and suitability information from clients. The significantly increased regulation and oversight of EMDs is, in part, a response to the many deficiencies uncovered by the OSC in its compliance review.
The following is a description of some of the new fit and proper requirements and conduct rules to which LMDs will be subject following their transition to the EMD registration category on the Effective Date.
Fit and Proper Requirements
Following the Effective Date, at a minimum, a dealing representative (i.e. an individual that trades in a security) of an EMD will be required to have passed the Canadian Securities Course Exam (“CSCE”) or the Exempt Markets Products Exam (“EMPE”). In addition to completing the CSCE or EMPE, the chief compliance officer of an EMD will be required to have passed the Partners, Directors and Senior Officers Course Exam or the Officer’s, Partner’s and Directors’ Exam. In Ontario and Newfoundland & Labrador, dealing representatives and chief compliance officers that are registered on the Effective Date will be granted a one year transition period from the Effective Date to obtain the foregoing educational proficiencies. NI 31-103 states that passing both the U.S. Series 7 Exam and the New Entrants Exam will also be accepted in lieu of passing the CSCE. Further, the securities regulators will consider granting an exemption from passing the CSCE if they are satisfied that an individual has qualifications or relevant experience that are equivalent to, or more appropriate in the circumstances than, the CSCE.
EMDs will be subject to solvency requirements and must maintain bonding or insurance in at least the minimum amount applicable to the firm as prescribed under NI 31-103. EMDs that are not also registered as investment fund managers, will be required to maintain a minimum working capital of $50,000 while EMDs that are also registered investment fund managers must maintain a minimum working capital of $100,000. LMDs will have a one year transition period to comply with the new capital requirement and a six month transition period to comply with the new insurance requirement.
Financial Statements and Working Capital Calculations
No later than the 90th day after the end of its fiscal year, an EMD will be required to deliver to the applicable securities regulator (i) audited annual financial statements, and (ii) a comparative calculation of excess working capital (that is not less than zero) on Form 31-103F1 as at the end of the financial year and as at the end of the immediately preceding financial year, if any. An EMD will not be required to deliver financial statements or calculations of excess working capital on Form 31-103F1 for interim periods.
As will be required by all registered firms, an EMD must document and, in a manner that a reasonable investor would consider fair and effective, respond to each complaint made to the EMD about any product or service offered by the firm or a representative of the firm. An EMD must ensure that independent dispute resolution or mediation services are made available, at the firm’s expense, to a client to resolve a complaint made by the client about any trading or advising activity of the firm or one of its representatives. If a person or company makes a complaint to an EMD about any trading or advising activity of the firm or one of its representatives, the EMD must as soon as possible inform the person or company of how to contact and use the dispute resolution or mediation services which are provided to the firm’s clients.
Other than in Québec, all firms that are registered on the Effective Date (including registered LMDs) will have 24 months from the Effective Date to participate in independent dispute resolution or mediation services.
Exceptions for Permitted Clients
NI 31-103 provides exemptions from the conduct rules when an EMD is dealing with “permitted clients”. Permitted clients form a subset of “accredited investor” consisting primarily of institutional, corporate and very high net worth individuals. When dealing with permitted clients, registrants will be exempt from certain requirements relating to the KYC rule, except for information gathering to establish the identity (and, if needed, the reputation) of the client and whether the client is an insider of an issuer, and the suitability obligation. Those exemptions are subject to the permitted client having waived, in writing, compliance with such requirements and the registrant not acting as an advisor in respect of a managed account of the permitted client.