This month, Staff of the OSC hosted a webinar and in-person information session on various topics of interest relating to firms registered as exempt market dealers (EMDs). Here are the key takeaways of what was discussed.

Know your limit and deal within it: what EMDs can and cannot do

Recent amendments to NI 31-103 and its companion policy, which come into force on December 4, 2017, have further clarified that EMDs cannot act as a dealer or underwriter in a distribution of securities qualified by a prospectus, including as a selling group member, when acting as agent in a special warrant transaction or once securities originally distributed under a prospectus exemption are no longer subject to resale restrictions. However, as an olive branch, Staff seemed to bless the practice of EMDs having a NI 31-103-compliant referral arrangement with IIROC firms to refer to them any trading that is not in respect of a private placement.

OSC staff clarified that EMDs can participate in a distribution by an issuer – including a reporting issuer – under a prospectus exemption (i.e., a private placement), even if the distribution is concurrent with a prospectus offering for the same class or type of securities. Staff noted that in such cases:

  • Investors do not receive statutory prospectus protections;
  • The securities of the private placement are subject to resale restrictions (typically four months);
  • A Form 45-106F1 may be required to be filed;
  • If an EMD wishes to use a prospectus as a marketing document (in the situation where there is a separate, concurrent offering of the same securities under a prospectus), the EMD should:
    • explain the implications of this to their client investing in the securities (e.g., investors in a private placement do not receive statutory prospectus protections, securities are not freely tradable, etc.) and
    • treat (at least in Ontario) the prospectus as an offering memorandum (for the private placement) for filing and other purposes under securities regulation.

The good, the bad and the ugly: EMDs and the new prospectus exemptions

As a result of targeted compliance reviews by the OSC of how EMDs are using the new family, friends and business associates (FFBA) and offering memorandum (OM) prospectus exemptions, Staff reminded EMDs of the following:

  • OM Exemption
    • It is available to reporting and non-reporting issuers but not investment funds;
    • There is a specified form of offering memorandum and all marketing materials are incorporated by reference into it;
    • It is not available for distributions of specified derivatives and structured finance products;
    • There is a specified risk acknowledgment form;
    • There are very specific investor qualifications and the EMD must ensure that all investors stay within the specified limits;
    • The issuer of the securities has various ongoing reporting requirements, including (for non-reporting issuers) audited annual financial statements, annual notice of use of proceeds, and notice of specified key events (i.e., events that signal a fundamental change to the issuer’s business);
    • Common compliance issues:
      • Lack of collection and documentation of information to assess compliance with applicable investment limits;
      • Failure to comply with applicable investment limits; and
      • Lack of compliance with risk acknowledgment forms.
  • FFBA Exemption
    • It is available to reporting and non-reporting issuers but not investment funds;
    • Allows issuers to raise capital from investors who are principals of the issuer or within the personal networks (i.e., friends, family or business associates) of principals of the issuer;
    • Who counts as family is defined (e.g., grandchild counts – cousins do not) but who counts as a friend or business associate is not defined (although there is guidance);
    • Both the executive officer and the purchaser must sign the specified risk acknowledgment form acknowledging that the eligible relationship exists;
    • Common compliance issues:
    • Lack of  information or adequate documentation regarding how a client qualified;
    • Processing trades for clients who do not qualify;
    • Ignoring relevant factors (e.g., length of time the investor has known the key individual, nature of relationship between the investor and the key individual);
    • Social media “friends” do not count; and
    • Use of incomplete or incorrect risk acknowledgment form.

In light of the above, Staff had the following suggested practices to ensure compliance with the conditions of the FFBA and OM prospectus exemptions:

  • Know, understand and provide training on the conditions of the prospectus exemptions being relied on;
  • Have a process in place to monitor transactions for non-eligible investors and eligible investors to prevent transactions exceeding investment limits in Ontario;
  • Make inquiries of clients and document information obtained on:
    • Whether the client meets certain definitions;
    • Other investments made under the OM exemption; and
    • Relationship between individuals for reliance on the FFBA exemption;
  • Have a process in place to review information obtained from clients for consistency with the terms of exemption relied on:
    • KYC information should align with definition of “eligible investor”;
  • Document determination of whether transaction is suitable or not; and
  • Establish policies and procedures to support compliance with the exemptions.  

Finally, Staff outlined some steps EMDs can take to ensure they are compliant with the conditions of the FFBA and OM exemptions:

  • Review the conditions of the OM and FFBA exemptions including the relevant regulatory guidance;
  • Provide in-house training sessions for dealing representatives;
  • Review your policies and procedures manual to confirm it includes sufficient and accurate information about the conditions to use these exemptions and the steps the firm will take;
  • Review your KYC process and determine if it demonstrates that your firm is taking reasonable steps to collect and document information about clients to support that they qualify and the basis for their qualification; and
  • Review the risk acknowledgement forms used and make sure that you are providing the correct forms to your clients.

(Epic) Fails: common EMD compliance findings

OSC Staff highlighted various common findings from their compliance reviews of EMDs, including:

  • Inadequate collection, documentation and updating of KYC forms and suitability information (it is the most significant deficiency identified);
  • Inadequate documentation to support assessment of products (i.e., not maintaining evidence they have conducted due diligence); 
  • Individuals trading without proper registration (firm is responsible for conduct of employees);
  • Inadequate or misleading marketing material (e.g., exaggerated and unsubstantiated claims);
  • Inadequate or no annual compliance report to the board;
  • Referral arrangements – inadequate disclosure or lack of agreements; and
  • Various errors in EMD and dealing representative applications for registration (e.g., inadequate firm insurance; misleading representative titles).  

What is coming down the pipe: Regulatory initiatives impacting EMDs

OSC Staff highlighted the following regulatory initiatives impacting EMDs:

  • Staff is currently conducting focused compliance reviews on firms doing business with senior clients;
  • Recent review of one-person and other small firms (see findings in CSA Staff Notice 31-350);
  • Marketing in public places (EMDs must provide clear, accurate and non-misleading marketing material to clients in ads in public places);
  • Recent cybersecurity guidance (see CSA Staff Notice 33-321); and
  • Whistleblower review (e.g., firms cannot have restrictive provisions in employment contracts, severance agreements, and confidentiality agreements).