In mid-July 2012, the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC), the self-regulatory organization for investment dealers in Canada, outlined their proposals to create a new category of IIROC member – restricted dealer member – and to migrate certain U.S.-based firms currently registered as exempt market dealers (EMD) to this new dealer category. CSA Staff Notice 31-331 Follow-Up to Broker-Dealer Registration in the Exempt Market Dealer Category (CSA Staff Notice 31-331) and IIROC Notice 12-0217 IIROC Concept Proposal – Restricted Dealer Member Proposal (IIROC Concept Proposal) available here and here set out the regulators' views on the appropriate regulatory regime for EMDs who are carrying on so-called "brokerage activities". Comments on the IIROC Concept Proposal are due by October 9, 2012 (90 days after publication).
Staff of the Ontario Securities Commission first signalled concerns about exempt market dealers (EMD) carrying on "brokerage activities" that they viewed as akin to those activities carried on by IIROC-member investment dealers in the context of registration applications being considered during 2011. This uneasiness resulted in CSA Notice 31-327 Broker-Dealer Registration in the Exempt Market Dealer Category being released in September 2011. The CSA highlighted that the EMD category of registration was being used by dealers "involved in brokerage activities, including trading securities on an exchange, or entering into arrangements similar to introducing-carrying broker activities" rather than what they viewed as the intended, or "more appropriate", activity of an EMD which was to participate in the distribution of prospectus-exempt, off-exchange securities. The CSA's concerns were heightened by the fact that certain broker-dealer firms registered in the United States and members of the Financial Industry Regulatory Authority (FINRA), had obtained registration as EMDs (or had applied for such registration) and also had obtained (or applied for) certain exemptions which facilitated these firms carrying on brokerage activities in Canada. The CSA explained that they would conduct further consultation, but in the meantime, the OSC staff confirmed that they would only grant conditional registration to any FINRA broker-dealers applying for registration as an EMD.
Following the publication of CSA Notice 31-327, the CSA conducted a survey of all EMD firms to determine the extent to which those EMDs were carrying on brokerage activities. The CSA confirmed in CSA Staff Notice 31-331 that their primary focus is on FINRA member broker-dealer firms that are conducting brokerage activities in Canada.
The message from the CSA is very clear. IIROC should oversee any registered dealer that is conducting brokerage activities – even those dealers, like EMDs, that deal only with accredited investors – because IIROC rules and supervision specifically govern exchange trading practices and address the risks associated with brokerage activities. The CSA emphasize that their overall objective is to ensure consistent regulation of similar activities, which they feel is compromised if EMDs are permitted to carry on brokerage activities without having to be within the jurisdiction of IIROC.
IIROC's Proposed "Restricted Dealer" Member Category
If the regime described in the IIROC Concept Proposal is introduced, any firm that carries on "brokerage activities" in Canada, whether with clients that are "accredited investors", "permitted clients" or otherwise, will need to be registered as an investment dealer and become a member of IIROC. U.S. broker-dealers which are FINRA members may qualify to become a "restricted dealer member" of IIROC, provided they comply with the conditions to such membership. Firms presently registered as EMDs and carrying on these activities will be required to change their registration to that of investment dealer and apply for membership with IIROC pursuant to an accelerated membership application process alluded to in the IIROC Concept Proposal.
Although the overall objective of the CSA and IIROC is clearly stated, the Concept Proposal raises questions. Amendments to applicable rules of the CSA, including National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31- 103), and to IIROC rules will be required in order to move forward with this proposed regime, and we would expect that these further regulatory publications will provide further clarification.
What does it mean to carry on "brokerage activities"?
Neither the CSA nor IIROC provide for a specific definition of "brokerage activities", although the IIROC Concept Proposal lists activities that are being conducted by U.S. broker-dealers and FINRA members (registered in Canada as EMDs), including securities brokerage and trading, prime brokerage and securities lending, execution, clearing and settlement services and related record keeping services, and custody of customer funds and securities. It is not clear why these activities are problematic when they are being provided only to accredited investors (which is the case for all EMDs), nor is it clear exactly which activities cause concern and for what reason.
Which EMDs and firms will these proposals capture?
As noted previously, the CSA clearly intend any firm which is carrying on "brokerage activities" in Canada to be registered as an investment dealer and a member of IIROC. However, the IIROC Concept Proposal only specifically addresses U.S. registered broker-dealers that are FINRA-members. It is only these firms that will qualify for the proposed "restricted dealer" membership category. Neither the CSA nor IIROC refer to other EMDs, including domestic firms that may be carrying on these activities. These firms presumably would need to cease conducting "brokerage activities" or upgrade their registration to that of "investment dealer" and be subject to the complete IIROC rules-book.
Who can apply for IIROC membership as a "restricted dealer"?
A "restricted dealer" IIROC member can only be a firm registered as a broker-dealer in the United States and a FINRA member. The firm must also be a member of the Securities Investor Protection Corporation (SIPC). Perhaps as a result of the fallout from the bankruptcies of US futures dealers including MF Global and Peregrine Financial Group, and the adverse effects on certain Canadian clients from these events, IIROC, by limiting the restricted dealer member category to FINRA members with SIPC coverage, has clearly excluded US futures commission merchants from being able to seek membership in this category.
What requirements will apply to "restricted dealers"?
Firms in the "restricted dealer" membership category will be exempt from a number of IIROC's financial operations rules, including requirements governing financial reporting, minimum capital, minimum insurance coverage and margin, on the condition that the firm complies with the comparable FINRA requirements. Firms will not be required to join the Canadian Investor Protection Fund (CIPF), given that they must be members of SIPC (client disclosure of the differences between CIPF and SIPC must be provided). Furthermore, partners, directors, officers, employees and agents of these firms would be exempt from IIROC's minimum proficiency requirements, with the exception of those seeking approval as a registered representative or an investment representative. Individuals that are already registered as a dealing representative of a registered EMD, who would be registered as an RR or IR of the firm as an IIROC member, would be given a one-year transition period to complete the courses required to meet the proficiency requirements. IIROC intends to provide an exemption from its rules requiring a physical presence in Canada.
What conditions will apply to "restricted dealer" IIROC members?
Restricted dealer members will be restricted to dealing with only certain types of retail customers, in recognition of the fact that these firms will not be subject to all of IIROC's rules. The IIROC Concept Proposal suggests that the "accredited investor" threshold for retail customers may be too low for purposes of the proposed restricted dealer member category and IIROC specifically requests comment on the types of clients that a restricted dealer should be permitted to service under this new category.
Restricted dealers may also be subject to a de minimis threshold for doing business in Canada and will not be able to rely on any other registration exemption, including the international dealer exemption provided for in NI 31-103.
It is not clear to what extent, for example, restricted dealer members of IIROC could act as underwriters (and therefore sign an underwriters' certificate in a prospectus), given that EMDs can act as underwriters only for prospectus exempt offerings (including an offering of securities qualified by prospectus where the portion underwritten by an EMD is limited for distribution to accredited investors).
How different will this regime be from the international dealer exemption provided for in NI 31-103?
NI 31-103 provides for an "international dealer" exemption, which is available to U.S. FINRA members. There are virtually no requirements in order to rely on this exemption, other than having to appoint an agent for service, make prescribed filings and fee payments. The only limitations to relying on this exemption are that firms can only deal with "permitted clients" [institutional clients and ultra high net worth individuals] and only in predominantly "foreign securities". This begs the question as to what the substantive difference will be between firms relying on the international dealer exemption and firms that are "restricted dealer" members of IIROC, particularly if IIROC restricts these firms to only dealing with "permitted clients". What firms will apply to become "restricted dealer" members and for what purpose?
Will this proposal create a level playing field?
The IIROC Concept Proposal discusses the policy need for the proposed "restricted dealer" member category in terms of creating a level playing field for firms conducting "brokerage activities" in Canada.
Comments due on the IIROC Concept Proposal – October 9, 2012
Comments on the IIROC Concept Proposal are due by October 9, 2012 – in particular IIROC is seeking specific comment on the following elements of the IIROC Concept Proposal:
- Should the proposal be implemented as a "grandfathering" solution to deal with existing registered EMDs who carry on "brokerage activities" or should it apply more broadly to allow for new entrants?
- Is a de minimis threshold important? If so, what threshold should apply?
- Should "restricted dealer" firms be restricted from dealing with only "permitted clients" and not the full panoply of "accredited investors"?
These proposals are important for the securities industry in Canada. Please contact the authors of this Bulletin, your usual lawyer in BLG's Investment Management group or the leaders of BLG's Investment Management group noted below if you have any questions about the proposals for a "restricted dealer" member category and how it may affect you or if you would like our assistance in providing your comments in response to the IIROC Concept Proposal.
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