On Thursday, October 16, 2014, the Canadian Securities Administrators (CSA) published amendments to National Instrument 31-103 – Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) and related instruments (collectively, the Amendments). The Amendments implement certain of the proposed amendments published for comment on December 5, 2013, with some modifications based on comments received. Subject to receiving ministerial approvals, most of the amendments will come into force on January 11, 2015. Amendments relating to the exempt market dealer (EMD) registration category (discussed below) will come into force on July 11, 2015.
The amendments include a number of significant changes, particularly for firms registered as EMDs and for firms that rely on both registrations and registration exemptions. The amendments will not have a significant impact on non-Canadian firms that rely exclusively on registration exemptions, such as the international dealer exemption, international adviser exemption or non-resident investment fund manager exemption.
This Osler Update summarizes the key impacts of the Amendments for registered and exempt firms.
Changes to EMD Category of Registration
As expected, the CSA is proceeding with the previously proposed changes to the EMD category of registration, putting to bed for good the issue of whether the CSA might back off from or water down the changes in the final version of the Amendments. These changes will be effective on July 11, 2015, giving existing EMDs a little over eight months to change their current business models or exit business lines altogether. These changes will also impact dealers registered in the restricted dealer category to conduct activities similar to an EMD.
The EMD changes will significantly restrict the activities that may be undertaken by an EMD by eliminating the ability of an EMD to trade listed securities except on a prospectus-exempt basis. Effectively, an EMD will only be able to engage in the distribution of securities on a prospectus-exempt (i.e., private placement) basis. This would include both new issues of securities as well as secondary market trades, and would apply to all securities, whether equity, debt or otherwise. If securities are listed, quoted or traded on a marketplace, an EMD will only be able to trade in those securities if a prospectus exemption is required for the trade. Again, this could apply to a private placement of newly issued equity securities by a listed company or a secondary sale of existing equity securities by a control person in reliance on the accredited investor exemption or another available prospectus exemption.
As a result of the EMD changes, many Canadian and non-Canadian dealers registered in the EMD category will be forced to change their business models or cease carrying on certain activities. Those dealers will need to conduct their activities on a registration-exempt basis or through a fully registered investment dealer. Alternatively, they could conclude that some or all of their activities are not subject to the dealer registration requirement. In the case of dealers who are only using the EMD registration for certain prime brokerage activities, they could decide to apply to the CSA for exemptive relief to permit such activities to be undertaken without dealer registration.
Exemption for Trades Through or to a Dealer
Dealer Registration Exemption for Trades Through a Registered Dealer
Currently, persons in the business of trading in securities are exempt from the dealer registration requirements if they make trades solely through a registered securities dealer. For example, some hedge fund managers engage a registered securities dealer to act as their distributor. This exemption is being amended, and will no longer be available to anyone who solicits or contacts directly any purchaser of securities in relation to a trade. It is not clear whether the change to this exemption will in fact change the current practice of unregistered persons engaging a Canadian dealer (or exempt international dealer) to trade securities, as the use of a third party dealer may help to establish that the unregistered person is not itself in the business of trading in securities, and therefore not in need of any dealer registration exemption.
Trades Through a Registered Dealer by a Registered Adviser
A new dealer registration exemption is being added to allow a registered adviser to trade without also being registered as a dealer, so long as the trades are executed through another party that is either registered as a dealer or operating under an exemption from the dealer registration requirement. The CSA has expressly stated that a portfolio manager may not use this exemption to trade units of a pooled fund it manages without involving a dealer or having another exemption available, such as the existing exemption that allows a fund’s adviser and investment fund manager to distribute units of the fund into a client’s managed account. It is not clear whether the adoption of this new exemption and the provision of this additional guidance will preclude registered advisers and exempt international advisers from trading securities incidentally to their activities as an adviser, on the basis that they are not in the business of trading in securities and therefore not subject to the dealer registration requirement.
Reliance on both a Registration and Registration Exemption
Under the amendments, a registered dealer, adviser or investment fund manager will not be permitted to rely on a registration exemption in NI 31-103 if it is permitted under its registration to conduct the same activities. For example, a non-Canadian firm will not be permitted to carry on business as a registered portfolio manager and also rely on the international adviser exemption or the international sub-adviser exemption (discussed in the following section). However, if a registered firm is not permitted to conduct an activity under its registration, but an exemption to conduct the activity is permitted, then the exemption can be relied upon. For example, a registered mutual fund dealer could rely on the registration exemption to trade specified debt (section 8.21 of NI 31-103).
Importantly, the restriction that prevents a firm from relying on both a registration and a registration exemption only applies to registration exemptions in NI 31-103. In Ontario, for example, certain registration exemptions are in the Securities Act (Ontario) (OSA) instead of NI 31-103. These exemptions include the specified debt exemption (subsection 35(1) of the OSA) and the generic advice exemption (section 34 of the OSA). In a somewhat strange result, this means that a registered portfolio manager can, in Ontario, rely on the OSA generic advice exemption but in all other provinces of Canada a registered portfolio manager will be prohibited from relying on the NI 31-103 generic advice exemption.
New Exemption for International Sub-Advisers
A new international sub-adviser exemption is being added to NI 31-103. Previously, sub-adviser registration relief was available in Ontario under Ontario Securities Commission Rule 35-502 Non-Resident Advisers, in Québec under decision No 2009-PDG-0191 and in other jurisdictions on a discretionary basis. In response to public comments, the CSA removed the proposed “chaperoning” condition which prohibited an international sub-adviser from having direct contact with a registered adviser’s or a registered dealer’s clients unless the registrant was present in person or by telephone.
One of the conditions of the new sub-adviser exemption is that the registered adviser or the registered dealer must enter into a written agreement with its clients that it is responsible for any loss that arises out of the failure of the sub-adviser to exercise the powers and discharge the duties of its office honestly, in good faith and in the best interests of the registrant and each of its clients for whose benefit the advice is, or portfolio management services are, to be provided, or to exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in the circumstances. The CSA requires that a registrant taking on this liability will conduct appropriate initial and ongoing due diligence on the sub-adviser and ensure that the investments are suitable for the registrant’s clients. In addition, the CSA requires that the registrant will maintain records of the due diligence conducted.
- Business Trigger to Start-Up Entities. New guidance clarifies the application of the business trigger to start-up entities and venture capital/private equity issuers.
- Additional Chief Compliance Officer Proficiency Requirements. New compliance experience has been added to the proficiency requirements of the chief compliance officer of a mutual fund dealer, scholarship plan dealer and exempt market dealer.
- Acquisition of Securities of Registrants (sections 11.9 and 11.10 notices). The notification process will be more streamlined, and there is new clarification as to which securities and asset acquisitions are subject to the notice requirement.
- Subordination Agreement entered to exclude Non-Current Related Party Debt from the Form 31-103F1 Excess Working Capital Calculation. Amendments require filing of an executed subordination agreement within a prescribed time.
- Conflicts of Interest and Outside Business Activities of Individuals. New guidance has been added for conflicts of interest and disclosure of outside business activities, including outside directorships and positions of influence.
- Amendments to Registration Forms under NI 31-103 and NI 33-109. The amendments impact Form 31-103F1 Calculation of Excess Working Capital and all registration forms under National Instrument 33-109 and add a new Form 31-103F4 Net Asset Value Adjustments for investment fund managers.