On July 26, 2024, the Ontario Securities Commission (the "OSC") published its annual OSC Staff Notice 33-756 – Summary Report for Dealers, Advisers and Investment Fund Managers (the "Report") for the 2023-2024 fiscal year. This year's report was prepared by the Registration, Inspections and Examinations Division of the OSC (the "RIE") (formerly known as the Compliance and Registrant Regulation Branch).
Consistent with past years, the Report provides guidance on compliance and registration requirements registrants should be aware of, with a particular focus on the implementation of Client Focused Reforms ("CFRs") and newly registered firms which are considered high-risk.
The Report highlights deficiencies and guidance in the following areas (please also refer to our separate blog post for issues and guidance noted in the Report specific to crypto asset trading platforms):
Fund of Fund Structures:
In reviewing fund of fund structures, the OSC notes that an analysis must be undertaken by Investment Fund Managers ("IFMs") to determine if there is any 'advising' taking place at the top fund level, requiring a Portfolio Manager ("PM") to be appointed for the top fund. This is so regardless of whether the investment fund holds only one portfolio security – especially when there are investment decisions such as timing of new investments into the bottom fund, managing redemption requests, determining distributions from the top fund and cash management.
Registerable Activities conducted by Unregistered Firms:
The Report noted concerns with arrangements entered into by PMs with unrelated third-parties for IFM services in which the IFM was restricted from performing its duties or it had inappropriately delegated responsibilities to the PM. As noted in our blog post last year, such arrangements are not in compliance with securities laws as only the IFM can direct the business, operations or affairs of an investment fund. The Report recommends that IFMs and PMs perform a thorough review of all business agreements to verify that the roles and responsibilities of each party align with their registration category, and ensure that any registerable activity performed by each party is executed as permitted under its registration category.
Excessive Outsourcing – Applicable to all Registered Firms
The OSC noted that it has seen business models in which all compliance functions, including a firm's compliance system, were provided by a third-party entity, resulting in significant compliance deficiencies thus requiring firms to alter their business models and enter into terms and conditions with the OSC to address such deficiencies.
The Report emphasizes that firms should not outsource all compliance functions and chief compliance officer ("CCO") responsibilities to third-party service providers, such as a compliance consulting firm. It is the registered firms that remain responsible and are accountable under securities law for all compliance functions. Please see CSA Staff Notice 31-358 Guidance on Registration Requirements for Chief Compliance Officers for guidance on how to maintain an effective compliance system, including when having a shared CCO model.
Conflicts in Registrant Acquisition Transactions:
The Report notes that notices of proposed ownership changes (i.e. 11.9 or 11.10 notices under NI 31-103) often did not describe how material conflicts of interest in a proposed acquisition will be addressed in the best interest of clients. For example, proposed transactions in which the target firm is receiving a higher payout tied to the number of its clients moving to the acquiring firm is a material conflict of interest which should be adequately disclosed to clients. In particular, the financial incentive and quantum should be disclosed, along with offering clients the choice of staying with the target, moving to the acquiring firm or closing their account and moving to another adviser or dealer.
Referral Arrangements between PMs and Unregistered Firms:
Registrants must not delegate PM activities to unregistered parties in referral arrangements. To address this, firms should establish a written referral agreement which clearly sets out each party's roles and responsibilities, develop written policies and procedures to monitor the referral agent, provide training to referral agents on how to properly conduct referrals, not delegate any PM activities that require registration to unregistered referral agents and ensure that all fees relating to registerable activities must be paid directly to the registered firm and not an unregistered referral agent.
Issuer-Sponsored Dealing Representatives:
In cases of the issuer-sponsored Dealing Representative ("DR") business model in which a DR works for an issuer (or its affiliate) and is registered with an "independent" EMD firm to market the issuer's securities, the OSC has noted concerns with this business model due to the inherent material conflict of interest to only sell securities of the connected issuer. Accordingly, the OSC has imposed terms and conditions on registrants using this business model, including the issuer being required to contract with the EMD firm, compensation of the DR must be through the EMD firm and the issuer cannot sponsor a DR that is a member of the C-Suite of the issuer.
The OSC requires that firms submit a Form 33-103F5 before they implement this model, and registered dealers should specify whether the DR will be issuer-sponsored with the EMD firm under Item 10 of Form 33-109F4.
Capital Markets Participation Fees:
The OSC observed that certain firms made deductions for revenue by incorrectly categorizing them as outside of capital market activities. Similarly, some firms incorrectly calculated their Ontario percentage in accordance with OSC Rule 13-502. OSC recommends that participants should review the definition of "capital markets activities" and "Ontario percentage" to avoid understating their revenue to lower their capital markets participation fees.
As a reminder, capital market activities include those activities for which registration or an exemption is required and the revenue calculation amount is not dependent on where the revenue was earned in or if the clients are in Ontario. The Report also notes that advisory services such as corporate advisory, mergers and acquisitions or investment banking advisory services may be considered capital markets activities depending on the facts.
"Ontario percentage" is dependent on whether a firm has a permanent establishment in Ontario, in Ontario and elsewhere, or whether all permanent establishments are outside Ontario. Since the term "permanent establishment" is defined by the Canadian Revenue Agency, firms should also obtain tax advice when making this determination.
Other deficiencies:
The Report identified other areas of deficiencies as well which registrants should be aware of, including:
- inadequate collection of trusted contact person ("TCP") information from clients, as firms should take reasonable steps to attempt to collect TCP information from all clients, not just senior and vulnerable clients;
- misleading awards and contest-rankings, as firms and registered individuals must not use such awards or rankings in client-facing interactions and communications (e.g. websites or LinkedIn profiles);
- conducting registerable activities and availing foreign advisors exemption;
- complying with the recent disclosure requirements in National Instrument 45-106 Prospectus Exemptions when relying on the offering memorandum prospectus exemption for issuers engaged in "real estate activities" and those that are "collective investment vehicles";
- overinclusion of related party receivables as current assets, as the receivables should be collected within 12 months and readily convertible into cash in order to meet the definition of a "current asset" and be included on line 2 of the Form 31-103F1; and
- incomplete applications for new firm applicants and inadequate information for the OSC to assess the suitability of the management of the applicant.
OSC INITIATIVES IMPACTING REGISTRANTS – The following are some key new regulatory initiatives noted in the Report:
Independent Dispute Resolution:
On November 30, 2023, the CSA published a proposed framework which will likely designate OBSI as an independent dispute resolution service to issue binding decisions on matters related to the investment industry. The CSA is currently reviewing industry comments on the proposed framework.
Proprietary trading (day-trading) firms:
In relation to some market players such as day-trading firms who may not appear to be dealers in the traditional sense or rely on the registration exemption in section 8.5 of NI 31-103, the Report mentions that the business trigger test in section 1.3 of NI 31-103 needs to be considered to assess whether dealer registration is required. OSC has clarified in the Report that day-trading firms cannot rely on the registration exemption in section 8.5 of NI 31-103 if they have direct electronic access to marketplaces unless they are registered as an investment dealer. The Report mentions that a matter is currently pending before the Capital Markets Tribunal against a day-trading firm that is unregistered.
Exempt Market Dealer participation in prospectus offerings:
In a market-friendly effort, the OSC allowed Exempt Market Dealer ("EMDs") to act as a member of a selling group in the distribution of securities under a prospectus, subject to conditions as set out in a blanket order issued in June 2024. Other jurisdictions (Alberta, British Columbia, Nova Scotia, Ontario, Québec and Saskatchewan) have undertaken a similar approach and issued similar blanket orders. To access this benefit, regulatory filings are required, including a Form 33-109F5.
Fostering Innovation:
As reported in our coverage of OSC's Strategic Plan for 2024-2030, OSC intends to cultivate innovation in the capital market of the province. In May 2024, a series of initiatives were announced to support early-stage capital raising, as part of the OSC TestLab program. These include: the Angel Investor Group Registration Exemption, the Early-Stage Business Registration Exemption and the Self-Certified Investor Prospectus Exemption.
COMMENTS ON REGISTRANT MISCONDUCT OVER THE PAST YEAR
Annual Trends and Highlights:
Regulatory actions saw an uptick in the past year involving imposition of terms and conditions and denial of registration. The Report notes that this is partially due to non-disclosure of material previously undisclosed reportable events by registrants and individuals not being truthful or cooperative with their sponsoring firms.
Regulatory Action:
The Report notes that the OSC will recommend that terms and conditions be placed on the registration of a firm in situations where there are instances of inadequate compliance system, compliance deficiencies, or supervision and control deficiencies which can expose investors to a risk or harm. Such terms can require the firm to hire a compliance consultant to develop a compliance plan to address the deficiencies, engage a monitor to review their business activities, or impose business restrictions until deficiencies are addressed.
Other Regulatory Actions:
- Failure to comply with working capital or audited financial statement requirements: Firms can expect regulatory actions if they do not bring themselves promptly into compliance or if they are repeatedly deficient in annual or interim financial filings.
- Failure by registered individuals and applicants to be truthful with sponsoring firms: The Registrant Conduct Team has identified instances of untruthful or misleading information about applicants' previous employment with a former sponsoring firm. Such facts are considered during the OSC's assessment of the applicant's suitability for registration and can encroach negatively on an applicant's integrity.
- Director's decisions and settlements: OSC has published key decisions involving matters of importance to OSC and can be a source of crucial practical information on the application of securities law. The Report highlights that two decisions were published in contested proceedings, two decisions in uncontested recommendations of suspension of firms, and three were approved settlement agreements.
The Report functions as a comprehensive resource outlining the core priorities of the RIE and OSC. It also acts as a reminder for registrants to recognize the multitude of rules and regulations in the area of securities law. That said, the Report is not an all-inclusive document and working with legal counsel is advisable before engaging in an activity which might be a registrable activity to properly address compliance requirements.
To view the original article click here
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.