Over the past two years, financial services firms that are dealers, advisers and/or investment fund managers have implemented much of the dramatic changes to the Canadian regulatory landscape brought about by National Instrument 31-103 Registration Requirements and Exemptions and the related registration and prospectus exemption rules. Although many of the deadlines have passed, the need to focus on compliance continues. The purpose of this Bulletin is to help registrants' senior management, boards of directors, CCOs and compliance staff understand what will be important during 2011.
KEEPING TRACK OF REGULATORY CHANGES
During 2010, two proposals to amend NI 31-103 and related rules were published for comment. The Canadian Securities Administrators are considering the comments made on the proposals and can be expected to publish either revised proposals or final rules during 2011.
- The "first year amendments" published in June 2010 - comment period ended September 30, 2010.
- The investment fund manager registration amendments published in October 2010 – comment period ended January 13, 2011.
Investment dealers (IIROC members) and mutual fund dealers (MFDA members) will also want to monitor the transition to the final "client relationship model" rules of their respective SROs.
- Revised drafts of the proposed IIROC rules – Proposals to implement the core principles of the Client Relationship Model – were published for comment January 7, 2011 [available here]. The comment period ends March 7, 2011.
- Final rules of the MFDA relating to proficiency requirements, performance reporting, complaint handling and relationship information disclosure are now in force, but transition periods apply. See MR – 0075 Relationship Disclosure – December 3, 2010 [available here] and the revised MFDA Rules.
The CSA have also indicated that they continue to work on other matters, such as cost disclosure and performance reporting, a "sub-adviser" exemption for portfolio managers, capital accumulation plans and reporting to regulators about complaints. It is conceivable that at least one additional rule proposal will be published for comment in 2011.
UNDERSTANDING REGULATORY EXPECTATIONS
The CSA expect that registrants review their compliance systems, as well as their written policies and procedures, to ensure they are kept up-to-date and reflect regulatory expectations. We strongly recommend that registrants review and update their written policies and procedures during 2011, particularly if this was not done in advance of the changes brought about by NI 31-103. Inadequate written policies and procedures and compliance systems are perennial deficiencies noted by the various members of the CSA.
Reports published during 2010 by the respective registrant regulation and compliance staff at the Ontario Securities Commission and the British Columbia Securities Commission [available here and here] detail the findings of staff regarding common compliance issues noted during audits of registrants. Significant subject areas noted in these reports include
- Referral arrangements and confusion over responsibilities for the client
- Misleading sales communications and advertising
- Best execution practices
- Risk management controls and business continuity plans
- Inappropriate use of side letters and preferential treatment given to one or more investors in a fund
- Responsibility for valuation and error correction.
WHAT'S IMPORTANT FOR 2011
The regulatory developments and compliance matters that will require attention during 2011 are outlined below. For ease of reference, we provide links to the Investment Management Bulletins of Borden Ladner Gervais LLP (BLG) that provide additional information and to applicable regulatory notices.
The Autorité des marchés financiers and the Chambre de la sécurité financière have regulatory jurisdiction over mutual fund dealers operating in Québec. References in this Bulletin to MFDA rules should be read as including the Québec regulations applicable to mutual fund dealers.
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Change-over to IFRS Applies to all registrants |
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For financial years commencing on or after January 1, 2011, registrants domiciled in Canada must prepare and file audited financial statements with the applicable CSA members in accordance with IFRS, but on a non-consolidated basis. Under a transition provision, annual and interim financial statements for a financial year beginning in 2011 that comply with IFRS may exclude comparative information for the preceding year or period. In addition, registrants will have a 15-day extension to the deadline for filing the first interim financial information and completed Form 31-103F1 that are required to be filed in the first year of adopting IFRS for the first interim financial period beginning on or after January 1, 2011. Registrants that are not based in Canada have options available to them. Financial statements can be prepared in accordance with IFRS, U.S. Generally Accepted Accounting Principles, accounting principles that meet the disclosure requirements of the applicable foreign regulatory authority governing the registrant in its home country or accounting principles that cover substantially the same core subject matter as Canadian GAAP. Financial statements must, however, be prepared and filed on a non-consolidated basis. |
For financial years commencing on or after January 1, 2011, with some transition. Amendments to NI 31-103 relating to IFRS in force as of January 1, 2011. See also National Instrument 52-107 Acceptable Accounting Principles and Auditing Standards. |
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Insurance Applies to all non-SRO registrants |
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Registrants are expected to monitor insurance coverage on a regular basis to ensure that it meets the new formula-based requirements set out in NI 31-103. |
New insurance requirements were effective as of March 28, 2010. |
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Capital and Financial Reporting, including NAV Adjustments Reporting Applies to all non-SRO registrants |
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Registrants must file a completed Form 31-103F1 (the working capital form) with each required financial statement filing after September 28, 2010, with the Form 31-103F1 based on non-consolidated financial information. Registrants are expected to monitor working capital on a regular basis – monthly, if not daily. If excess working capital (as calculated using Form 31-103F1) is ever less than zero, the registrant must immediately notify its principal regulator. Excess working capital cannot be less than zero for more than 2 consecutive days. An investment fund manager will be required to commence the required quarterly financial reporting to its principal regulator immediately upon becoming registered in such capacity. Monitoring of adjustments to net asset value of investment funds must also be in place as soon as the firm is registered, given the need to report to the principal regulator any NAV adjustments during each applicable financial period. Investment fund managers will be expected to have a policy in place that defines material errors in calculating NAV. The CSA have confirmed that IFIC's guidance in its Bulletin 22 (as updated in December 2009) may be used. |
New excess working capital and financial reporting requirements were effective as of September 28, 2010. |
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Referral Arrangements Applies to all registrants |
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Registrants will be expected to monitor new business arrangements to identify referral arrangements (as defined in NI 31-103) and as applicable, put in place required contractual provisions and ensure clients are given the required disclosure. |
Referral arrangement requirements were effective as of March 28, 2010. |
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Exempt Market Trading Activities Applies to dealers (firms "in the business of trading in securities") |
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A registrant in the business of trading in securities in the exempt market (i.e. an exempt market dealer) can only conduct such trading in those provinces/territories where it is registered as a dealer or where it applied for registration by September 28, 2010 (and was previously operating in that jurisdiction). All dealing representatives must be registered in the applicable provinces/territories and must meet the proficiency required by NI 31-103. |
Requirements for proficiency and registration were effective as of September 28, 2010. |
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Trading in Pooled Funds – Updated Offering Documents and Subscription Agreements Applies to EMDs and investment fund managers of pooled funds |
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An investment fund manager for pooled funds may distribute securities of those funds to qualified investors resident in provinces/territories where it is also registered as an exempt market dealer and may also continue to accept orders for those funds from dealers which are registered in the jurisdictions where the investors are located. Because of the changes associated with the new registration requirements, the offering documents and subscription agreements for pooled funds may be out of date, inaccurate or missing essential information. It will be important to update these documents to ensure accurate information and adequate protections. Firms managing pooled funds need to monitor the prospectus exemptions used to distribute these securities, and file offering memoranda and reports of exempt trades (when required) with the applicable regulators. Exempt trade reports may be made once a year so long as they relate only to certain exemptions, are filed within 30 days of the year end of the applicable funds and the applicable filing fees paid. These requirements are not new. |
New regime was effective as of September 28, 2009 and 2010. |
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Advising Activities – Portfolio Management Applies to advisers (portfolio managers) |
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A registered adviser must comply with the new requirements for insider reporting regarding securities of Canadian reporting issuers and use of client commissions (soft dollars) that came into force during 2010. NI 55-104 Insider Reporting Requirements and Exemptions and amendments to NI 62-103 The Early Warning System and Related Take-over Bid and Insider Reporting Issues. Unless an adviser is an "eligible institutional investor" able to rely on the alternative reporting and exemptions under NI 62-103, insider trading reports must be filed within 5 days of a change in shareholdings. NI 23-102 Use of Client Brokerage Commissions. Clients of advisers using client brokerage commissions to acquire the goods and services permitted by NI 23-102 must receive mandated disclosure on an annual basis, as well as when they first open an account. Account opening documents and advisory agreements will likely need modification to reflect the new requirements. |
NI 55-104 was effective as of April 30, 2010, and shorter deadlines for filing insider trading reports were effective as of October 31, 2010. NI 23-102 was effective as of June 30, 2010, with a transition period for disclosure to existing clients ended December 31, 2010. |
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Relationship Disclosure Information Applies to all non-SRO registrants(not IFMS). SRO members must comply with rules of applicable SRO. |
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Firms are required to provide clients with specified "relationship disclosure information" before conducting business with those clients. Account opening documents and agreements will likely need modification to reflect the new requirements. The disclosure should be reviewed periodically to ensure continued accuracy and compliance with the requirements. Certain "permitted clients" can waive receipt of relationship disclosure information, but only if done in writing. Registered mutual fund dealers and investment dealers will be required to comply with the rules of their respective SRO and may take advantage of the applicable transition periods. |
RDI disclosure requirements were effective as of September 28, 2010. |
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Suitability, know-your-client and know-your-product Applies to all non-SRO registrants (not IFMS). SRO members must comply with revised rules of applicable SRO. |
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Firms must collect expanded "KYC" information from clients and ensure that all recommendations are suitable for clients, unless those clients are "permitted clients" and waive, in writing, the necessity of a suitability review. This exemption does not apply to managed accounts. Account opening documents and agreements will likely need modification to reflect the new requirements. Regular suitability monitoring should be implemented within the firm. In addition, registrants must implement procedures to ensure that they meet the regulatory expectations that firms and their representatives understand the investments being recommended to clients (know-your-product). Registered mutual fund dealers and investment dealers must comply with the rules of their respective SRO, changes to which have been developed as part of the client relationship model. |
Requirements were effective as of September 28, 2009. |
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CSA Staff Notice 33-315 Suitability Obligation and Know Your Product September 2009 [available here]. |
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Client Statements Applies to all registrants. SRO members must also comply with revised rules of applicable SRO. |
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Registered firms must comply with the requirements for client statements set out in NI 31-103, which may mean modifying existing statement formatting to ensure that the prescribed information is provided. |
Requirements were effective as of September 28, 2009, although registered mutual fund dealers have a 2-year transition period for quarterly statements (transition period ends September 28, 2011). |
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Information about the Firm, Permitted Individuals and Representatives Applies to all registrants |
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NI 33-109 Registration Information altered the requirements for notifying the regulators about changes to the information on file about the registered firm, "permitted individuals" and/or registered representatives. It is critical to ensure that the CCO or other applicable staff receive information about changes and understand the deadlines (which range from 7 to 30 calendar days) so that the necessary notifications can be made. Some regulators have the authority to (and will) levy late filing fees, and may also impose additional terms and conditions to a firm's registration if such filings are either not made or repeatedly made late. New requirements are in place when representatives leave one firm to join another. |
Requirements were effective as of September 28, 2009. |
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Mortgage Investment Entities |
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Firms that manage, administer or trade in securities of certain investment vehicles known as "mortgage investment entities", including MICs and syndicated mortgage firms, have an exemption from the requirement to apply to become registered as investment fund managers and/or advisers under relief granted by each applicable CSA member in 2010. No exemptions were granted from the requirement to be registered as a dealer except in British Columbia. |
Exemptions end on March 31, 2011 – June 30, 2011 in British Columbia. |
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CSA Staff Notice 31-322 Extension of Omnibus/Blanket Order Exempting Mortgage Investment Entities From the Requirement to Register as Investment Fund Managers and Advisers December 2010 [available here]. |
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Manage and Disclose Conflicts of Interest Applies to all registrants |
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NI 31-103 sets out detailed requirements for registrants to identify, manage and disclose conflicts of interest that could impact the services provided to clients. A good compliance regime would list all of the conflicts of interest that have been identified to date, as well as set out how those conflicts are managed in the best interests of clients, including, where necessary, disclosure to clients of such conflicts. It is also important to have policies and procedures ensuring that the firm and its staff are conscious of the need to identify future conflicts of interest and develop tools to manage them. |
Requirements were effective as of September 28, 2009. |
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Reporting on Compliance to the Board Applies to all registrants |
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A CCO is required to report annually to the firm's board of directors on compliance. It is important to document that this reporting has been done. |
Requirement was effective as of September 28, 2009. |
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Complaint Handling and Dispute Resolution Applies to all non-SRO registrants (other than IFMS). SRO members must comply with revised rules of applicable SRO. |
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A registered firm's compliance system must establish policies and procedures for client complaints handling that meet the rules and regulatory expectations set out in NI 31-103. The Securities Act (Québec) sets out the required complaint handling requirements for clients residing in Québec. Complaints (within the meaning of NI 31-103) must be identified and handled by appropriate staff. Because registered investment fund managers are not subject to complaint handling rules – firms registered in multiple categories will need to consider the nature of the complaint received. After September 28, 2011, firms will also be required to make available, at the expense of the firm, "independent dispute resolution" or "mediation services" to those clients residing outside of Québec whose complaints cannot be resolved internally. Clients must be told about the availability of dispute resolution or mediation in the firm's relationship disclosure information and again when they first make a complaint. No additional guidance has been given by the CSA on their expectations regarding dispute resolution, which means that firms will be free to choose which independent dispute resolution service to offer to clients, which can range from formal arbitration to more simple (and cost-effective) mediation services. Clients residing in Québec must be informed that upon request their file will be transferred to the Autorité des marchés financiers who will examine the complaint and may act as mediator if the parties agree. |
Requirements relating to complaint handling were effective as of September 28, 2009. Requirements relating to independent dispute resolution for clients located outside of Québec will be effective as of September 28, 2011. |
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Use of Social Media Applies to all registrants, with particular application to IIROC members |
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Firms using social media for advertising or other purposes need to consider the overlay of applicable securities regulation. Guidance can be found in IIROC's proposed guidelines concerning social media in its draft Guidance Notice MR0281 Guidelines for the review, supervision and retention of advertisements, sales literature and correspondence released for comment on February 7, 2011 [available here] |
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Canada's Anti-Spam Legislation Applies to all Registrant |
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Bill C-28 (formerly known as Fighting Internet and Wireless Spam Act ) is expected to come into force during 2011. This legislation will affect how firms market and advertise to clients and prospects using unsolicited commercial electronic messages (aka spam). Privacy issues will also be important. |
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Reliance on International Dealer or Adviser Exemptions |
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Non-Canadian firms wishing to trade with or advise "permitted clients" on securities in a Canadian province or territory without being registered in the jurisdiction must meet the conditions to rely on the international dealer or international adviser exemptions provided for in NI 31-103. If a firm wishes to continually rely on such exemptions in a province or territory, then it must annually notify the applicable regulator of such fact. Regulatory fees are payable in Ontario and Saskatchewan. Firms relying on the international dealer or international adviser exemptions are subject to AML requirements including the requirements to file anti-terrorist financing reports with the applicable members of the CSA (see below). |
Exemptions were available as of September 28, 2009. Fee deadlines in Ontario – December 1 and December 31. |
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Anti-Money Laundering and Anti-Terrorism Financing Legislation and Reporting `Applies to all registrants and firms relying on the international dealer or adviser exemptions. |
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The AML compliance requirements for registrants, including dealers, advisers and investment fund managers, were significantly expanded in the last amendments to the federal AML legislation. Compliance systems should reflect these requirements and procedures established that ensure that the additional processes noted below are met:
Various reports must be filed with principal securities regulators with respect to monitoring of client base regarding terrorist financing. |
AML legislative amendments were effective as of June 2008. |
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CSA Staff Notice 31-317 (revised) Reporting Obligations Related to Terrorist Financing July 2010 [available here]. |
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Use of Derivatives Applies to all Registrants |
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Firms that use derivative instruments as part of their strategies need to be aware of the various government and securities regulatory initiatives that either are in force or proposed for such instruments. Additional registrations may be necessary under legislation in force in Ontario, Manitoba and Québec. |
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CSA Consultation Paper 91-401 Over-the-Counter Derivatives Regulation in Canada published in November 2010 [available here]. |
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Public Mutual Funds – Disclosure Applies to investment fund managers – no requirements apply to dealers at present |
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Managers of publicly-offered mutual funds must prepare and file the required fund facts documents for each class or series of a mutual fund pursuant to amendments to NI 81-101 Mutual Fund Prospectus Disclosure that came into force on January 1, 2011. |
NI 81-101 rule amendments were effective as of January 1, 2011.
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Public Investment Funds – Management |
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OSC staff released notices during 2010 that set out guidance about several aspects relating to disclosure and/or management of publicly-offered investment funds. Amendments to NI 81-102 Mutual Funds (modernization rules) published for comment in June 2010 are expected to be finalized in 2011. |
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OSC Staff Notice 81-710 Approvals for Change in Control of a Mutual Fund Manager and Change of a Mutual Fund Manager under National Instrument 81-102 Mutual Funds May 2010 [available here]. OSC Staff Notice 81-711 Closed-End Investment Fund Conversions to Open-End Mutual Funds October 2010 [available here]. OSC Staff Notice 81-712 2010 Investment Funds Branch Report October 2010 [available here]. |
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BLG'S FOCUS ON COMPLIANCE Our more detailed newsletters on NI 31-103 and other regulatory developments will help you keep a focus on compliance during 2011. All of our newsletters are available on our website at blg.com and you may also access them through the following links: National Instrument 31-103 – At a Glance August 2009. National Instrument 31-103 – The First Six Months – What's Next? April 2010. |
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
