Long awaited and much anticipated, National Instrument 31-103 Registration Requirements and Exemptions (NI 31-103) was published on July 17, 2009. Its effects on the investment management industry and on capital markets participants will be both broad and deep. NI 31- 103 will come into force on September 28, 2009, with affected persons having between one month and two years from the effective date to comply, according to their circumstance.
The Registration Reform Project
Commenced in 2005, the Registration Reform Project (RRP), which forms the background to NI 31-103, is an ambitious initiative of Canadian regulators to “harmonize, streamline and modernize” the country’s securities registration regime. It involves the efforts not only of the members of the Canadian Securities Administrators (CSA), but also of the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA). (IIROC and the MFDA are Self Regulatory Organizations, or SROs, recognized as such by the CSA.) The idea was to take the disparate registration rules that had grown up over time in these separate regulatory authorities and to replace them with a single set of rules that could be consistently applied across the country. The goal: an overall reduction in the regulatory burden for market participants and increased efficiency and administrative ease.
The New Business Trigger for Trading and Advising Registration
A key concept in NI 31-103 is that of the “business trigger” for registration. Under the regime in place today, securities legislation provides that only registered persons or companies can trade in a security or act as an underwriter or an advisor. So absent proper registration, or an exemption from registration, it is a contravention of securities laws for a person to advise in relation to or to trade in securities, regardless of their activity level or commercial interest. A complex maze of statutes, regulations and policy statements enumerate lists of persons, companies and types of trades that are exempt from the registration requirement. In many instances, exemptions exist but are “not available” in certain circumstances so that over time, the lists of exempt trades and traders became unwieldy and inconsistent from jurisdiction to jurisdiction and sometimes led to anomalous results. NI 31-103 replaces the so-called “trade trigger” for registration of dealers with the “business trigger.” Under the new regime, regulators look at the type of activity and “whether it is carried out for a business purpose” to determine if an individual or firm must register.
In determining whether someone is trading or advising in securities for a business purpose, regulators have indicated that the following factors will be relevant:
- engaging in activities similar to a registrant
- intermediating trades or acting as a market maker;
- directly or indirectly carrying on the activity with repetition, regularity or continuity;
- being, or expecting to be, remunerated or compensated; and
- directly or indirectly soliciting.
With some important exceptions, confining your activities so that you deal only with certain types of securities or certain types of investors will no longer shelter you from the registration requirement, which will be “universal”.
The scope of the “universal registration” principle is significantly curtailed in Alberta, British Columbia, Manitoba, the Northwest Territories, Nunavut and Yukon Territory. The securities authorities in those jurisdictions will issue an order exempting persons and companies from the dealer registration requirement when the person trades in securities in reliance on one of the following prospectus exemptions in National Instrument 45-106 Prospectus and Registration Exemptions (NI 45-106). Those exemptions are:
- accredited investor
- family, friends and business associates
- offering memorandum
- minimum investment amount ($150,000 exemption)
In order to rely on this order, persons and firms will have to meet certain conditions, including providing clients with a risk disclosure in a prescribed form and filing an information report with securities regulators.
New Registration Categories
Each of the regulatory jurisdictions, including the SROs, have had their own distinct set of registration categories, both for firms and for individuals. With all the local variations in terminology and in substance, there exist over a hundred different registration categories within Canada. In addition to being confusing and frustrating, this lack of consistency impedes the ability to conduct business nationally and to move across provincial and jurisdictional boundaries. This makes Canada an anomaly among other developed economies. NI 31-103 provides for a single set of registration categories for all CSA members, and registration categories for SRO members are expected to be closely harmonized.
Two groups of industry participants previously not subject to regulation in all jurisdictions are being brought under the regulatory umbrella. They are, broadly speaking, dealers in the exempt market and managers of investment funds.
In Ontario and Newfoundland and Labrador, regulators had earlier responded to concerns about the lack of regulatory oversight for capital markets participants dealing in the so-called exempt market. They introduced “universal registration,” and registration exemptions were made unavailable for dealers in prospectus-exempt securities, obliging them to obtain registration in some limited form, often as a Limited Market Dealer (LMD). NI 31-103 applies this requirement in a slightly enhanced form to all jurisdictions with the introduction of the Exempt Market Dealer (EMD) category. EMDs are dealers restricted to trading in securities that are distributed under a prospectus exemption or for which a prospectus exemption was available. As noted however, much of the status quo is preserved in the Northwestern jurisdictions. Also, so-called “exempt market intermediaries” will not have to register as EMDs as long as they limit their activities and meet other prescribed conditions.
Different considerations apply for investment fund managers, who have never previously been required to register in that capacity. Investment fund managers will be required to register if “acting as an investment fund manager” and the new business trigger will not apply. While many fund managers in fact are already registered as advisers, policy makers were concerned to see that investment fund managers were adequately staffed, organized and capitalized so that other important functions for which they are responsible are properly carried out. Such functions would include determining the net asset values of funds, ensuring that funds comply with their financial and other reporting obligations and overseeing the adequacy of transfer agency and investor recordkeeping.
Dealers and advisors who are currently registered will have to examine the rules applicable to their registration category under the new regime and determine what further steps are needed in the conduct of their businesses.
SRO Members and Membership
Registrants who are members of SROs will be exempt from certain provisions of NI 31-103 and will instead be governed by the by-laws of the applicable SRO. SROs are participating in the Registration Reform Project and are attempting to harmonize their by-laws with the provisions of NI 31-103.
Getting Registered: Fit and Proper Requirements
Any individual in the business of trading or advising in securities on behalf of a registered firm must be registered in the appropriate category. To be registered, an individual must demonstrate that he or she is “fit and proper”, or suitable for registration. In addition to being an honest person of good character, an individual will generally have to meet proficiency requirements, that have both an educational qualification component and an experience component.
A fund manager or non-registered dealer seeking registration under the new regime will need to be able to satisfy a number of conditions. Their firm will have to submit documents to regulators which support the viability of its business and its continued solvency. A registrant must meet conditions pertaining to:
- maintaining minimum excess working capital
- bonding or insurance in a prescribed amount, and which contains certain prescribedcoverages or clauses
- any repayment of certain subordinated debt.
In assessing fitness for registration, regulators consider whether the firm is able to carry out its obligations under securities legislation.
Maintaining Registration: Conduct Rules
SRO members will generally be subject to the conduct rules set out in the by-laws of the SRO. The rules that prescribe the manner in which registrants must deal with clients will not apply to investment fund managers, but will apply to advisers and exempt market dealers and other non-SRO dealers. The two cardinal principles in this area are “know your client” (KYC) and suitability. Registrants are obligated to obtain certain information about a client to establish the client’s identity, reputation and, if the firm is to provide some form of credit to the client, the client’s creditworthiness. In the case of clients who are corporations, partnerships or trusts, the registrant must ascertain the nature of the client’s business and the identity of the principals of the corporation, including anyone with a 10% or greater interest in the corporation, or the individuals exercising control of the partnership or trust, as the case may be.
Regulators consider that a cornerstone of investor protection is an informed investor. NI 31-103 is directed at getting certain information into the hands of the client so that the client understands and appreciates the nature of the relationship with the registrant. To that end, registrants who are not SRO members must provide a set of documents and disclosures which together make up the “relationship disclosure information” (RDI). To meet the RDI delivery obligation, registrants will have to provide, among other things, a description of the account type; a discussion of the products and services offered by the firm; a discussion of the relevant investment risks; a description of the conflicts of interest required to be disclosed; and a description of the costs that the client can expect to pay, and the compensation paid to the registered firm. SRO members will be under corresponding obligations under their SRO by-laws.
A Renewed Emphasis on Compliance
NI 31-103 also places a great deal of emphasis on compliance and the need for an adequate control environment within a registrant organization. Companion Policy 31-103 CP directs that “senior management and the board or partners should demonstrate a visible commitment to compliance”. It is a requirement for every registrant to “establish, maintain and apply policies and procedures that establish a compliance system” of controls and supervision. Such a compliance system should be able to detect material compliance breaches and to manage the registrant’s business risks in accordance with prudent business practice. Moreover, this system of controls is required to be documented through detailed written policies and procedures. The Companion Policy contains an extensive discussion of what regulators consider to be the elements of an effective compliance system. They include: internal controls to manage risks having to do with money laundering, trading, business interruption and hedging strategies; supervision and monitoring systems; adequate resources and training; the detailed policies and procedures mentioned above; and a log of compliance deficiencies and remedial action taken.
Every registrant is required to identify an individual who will be the firm’s “ultimate designated person” or UDP. The UDP, who must be registered in his or her individual capacity (but is not subject to any prescribed proficiency requirements as a condition of registration), is responsible for supervising the activities of the firm and ultimately for ensuring and promoting compliance with securities legislation within the firm. A registered firm must also have an individual registered as a chief compliance officer (CCO). The CCO’s responsibilities are less general than the UDP’s and are described in some detail. Among other things, the CCO is responsible for establishing and maintaining the firm’s compliance policies and procedures, monitoring and assessing the firm’s compliance system and reporting to the UDP any instances of non-compliance which create a risk of harm to a client or to the capital markets generally, or which appears to be part of a pattern. An individual will be eligible to be registered as a CCO only if he or she meets certain proficiency requirements.
All registrants must have procedures to handle complaints, meaning all customer complaints, and not just those relating to possible violations of securities laws. Regulators state that these provisions are “outcomebased requirements”, meaning that they will focus on the manner in which client complaints are resolved by the registrant, rather than on specifying the types of incidents that rise to the level of a complaint to which the instrument applies. Under NI 31-103, registered dealers and advisors must document and “fairly respond to each complaint” about a product or service a firm or a firm’s representative offers. An independent dispute resolution or mediation service must be made available at the firm’s expense.
Registrants may enter into referral arrangements with unregistered individuals, whereby the registrant agrees to pay compensation for a referral. A registrant must not participate in a referral arrangement unless the terms of the referral arrangement are set out in a written agreement between the registrant and the person making the referral. Written disclosure of the referral arrangement must be provided to the client before any services are provided. Such disclosure must include: the names of the parties, the purpose and material terms, any conflicts of interest, the method of calculating the referral fee and to the extent possible, the amount of the fee, the category of registration of each registrant and any other information that a reasonable client would consider important in evaluating the referral arrangement.
Transition to the New Regime
On the coming into force of NI 31-103, certain currently registered persons or companies will be automatically deemed to be registered in the appropriate corresponding category under the new regime. In Ontario and Newfoundland and Labrador, LMDs will be deemed to be registered as EMDs.
The rules contained in NI 31-103 will become applicable to registrants, new registrants and market participants in phases. Those who must register as investment fund managers for example will have one year to do so. Similarly, persons or companies who are not registered in any capacity under securities legislation will generally have one year to comply, and in all these cases will be able to continue carrying on their businesses during that time. However current registrants who have not designated a UDP or a CCO should note that they will have only three months after the effective date to do so.
The above outline highlights major features or areas of particular interest in connection with NI 31-103. It in no way purports to be a complete or comprehensive summary. Watch for further information on topics such as:
- Registering as an EMD – the Nuts and Bolts
- Requirements for Investment Fund Managers
- A Compliance System: What Should it Include
- International Dealers and Advisers
- Investor Protection Measures: RDI, Conflicts, Complaints Handling