Month: February 2020

Bulletin | Leap Year Edition | February 2020

In this bulletin:

  1. OSC Goes Its Own Way as CSA Finalizes Rule on Embedded Commissions
  2. If They Build It (Again), Will They Come? The CSA Proposes a Harmonized, Start-up Crowdfunding Regime
  3. CSA Re-Proposes Rules on Non-GAAP and Other Financial Measures Disclosure
  4. OPC Consults on Regulation of Artificial Intelligence
  5. Our Client-Focused Reforms in a Nutshell Publication Is Ready
  6. SEC Commissioner Pierce Leapfrogs Her Commission with Proposed Safe Harbour for Token Offerings

FAQ Corner: What are some things to watch out for when we describe our firm and its representatives in marketing materials or on social media?

In Brief: Is This the Very Model of a Modern SRO?

Click the link to access a PDF of our full, monthly bulletin summarizing these recent developments. >> Monthly Bulletin | Leap Year Edition | February 2020

Is This the Very Model of a Modern SRO?

On February 3, the Mutual Fund Dealers Association (MFDA) released A Proposal for a Modern SRO (Special Report) and an accompanying Guiding Framework. The MFDA recommends that the Canadian Securities Administrators (CSA) take over direct regulation of markets while giving up direct oversight of exempt market dealers (EMDs), scholarship plan dealers (SPDs), and certain portfolio managers to a new self-regulatory organization (NewCo). NewCo would take on direct responsibility for registration, business conduct, prudential oversight, policymaking and enforcement functions in relation to the registrants mentioned above, plus those currently overseen by the MFDA and the Investment Industry Regulatory Organization of Canada (IIROC).

The Special Report is just one perspective on whether and how to reform self-regulatory structures for capital market participants. The CSA plans to publish its own consultation paper on the self-regulatory structure later this year. We will monitor developments in this area and keep you informed.

February 28, 2020

FAQ Corner: What are some things to watch out for when we describe our firm and its representatives in marketing materials or on social media?

Answer:  Registrants have an obligation to deal fairly, honestly and in good faith with their clients. Among other things, this means that registrants must ensure that their marketing materials (and any representations that they make in social media) are clear, accurate and non-misleading and that any claims made in such materials are substantiated. In our experience, securities regulators continue to be concerned about:

  • Performance data (including use of hypothetical performance data, benchmarks, and performance composites);
  • Exaggerated and unsubstantiated claims (g. “We are a leading investment management firm”);
  • Holding out and the use of names (g. unregistered individuals using business titles that imply they are registered, failing to use the firm’s full legal name or registered trade name in marketing materials, or misleading, inaccurate or hard-to-substantiate testimonials); and
  • Inadequate policies, procedures and records in relation to marketing activities and social media.

Registrants also should be aware that there are specific rules about how they represent their registration status. In particular, subsection 44(1) of the Ontario Securities Act (Act) prohibits any person or company from representing that they are registered under the Act unless the representation is true and the representation specifies the relevant registration category or categories. OSC staff have emphasized that firms also should specify in which jurisdictions they are registered. In addition, section 46 of the Act prohibits everyone from representing that the Commission has passed in any way on the financial standing, fitness or conduct of a registrant.

AUM Law can help you stay on top of these requirements and regulators’ evolving expectations. For example, we can review your marketing materials and social media activities on an ad hoc or regular basis, review your marketing, social media and record-keeping policies and enhance them as needed, and provide compliance training to your staff. Please contact us if you would like to learn more.

February 28, 2020

SEC Commissioner Pierce Leapfrogs Her Commission with Proposed Safe Harbour for Token Offerings

Earlier this month, U.S. Securities and Exchange Commissioner Hester Pierce made a speech proposing a time-limited safe harbour for crypto asset token offerings to address what she sees as a regulatory  “Catch 22” in the digital asset sector. We think Commissioner Pierce’s speech is interesting because of the way she leapt out in front of the SEC’s policymaking framework with her proposal and because of the potential for her approach to influence Canadian securities regulators and market participants as well. The Canadian securities regulatory framework isn’t exactly the same as the U.S. framework, but there are enough similarities to make these developments south of the border of interest in Canada, too.

In the U.S. and Canada, the term “security” is defined very broadly to include, among other things, an “investment contract”. In determining whether an investment contract exists, regulators and courts in both countries usually consider, among other things, whether investors are participating in a common enterprise and relying upon others to profit from that enterprise. (For more information on the Canadian regulators’ approach, see our June 2018 bulletin article “CSA Staff Publish Follow-up Guidance on Token Offerings.”)

Explaining the regulatory Catch-22 and why she sees a need for regulatory relief, Commissioner Pierce stated:

“Would-be networks cannot get their tokens out into people’s hands because their tokens are potentially subject to the securities laws.  However, would-be networks cannot mature into a functional or decentralized network that is not dependent upon a single person or group to carry out the essential managerial or entrepreneurial efforts unless the tokens are distributed to and freely transferable among potential users, developers, and participants of the network.”

She then outlined a proposed safe harbour for “Initial Development Teams” to facilitate participation in, and the development of, a functional or decentralized network, exempt from the SEC’s registration requirements of U.S. federal securities laws for three years, so long as certain conditions are met and while remaining subject to federal securities anti-fraud laws. Among other requirements, the Initial Development Team would have to make certain information publicly available (e.g. regarding the source code, initial development team and certain other token holders, transaction history, token economics, plan of development, prior token sales, trading platforms, etc.)

The SEC has some leaping of its own to do if it wants to develop Commissioner Pierce’s proposal or take a different approach. AUM Law will monitor developments in this area and keep you informed. This changing regulatory landscape highlights the importance of obtaining legal advice if your business plans contemplate the use of crypto-currency. AUM Law has experience in this area, and we can help you navigate its regulatory challenges.

February 28, 2020

Our Client-Focused Reforms in a Nutshell Publication Is Ready

To make your life easier, we have consolidated the articles we’ve written to date on the client-focused reforms (CFRs) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations into a snappy, little(ish) guide, Client-Focused Reforms in a Nutshell. If you would like to receive a copy, please contact us and we’ll subscribe you to our publications (if you haven’t already signed up).

February 28, 2020

OPC Consults on Regulation of Artificial Intelligence

On January 28, the Office of the Privacy Commission (OPC) published its Proposals for Ensuring Appropriate Regulation of Artificial Intelligence (Consultation Paper). This work is a subset of a larger reform project focused on federal privacy laws. According to the Consultation Paper, the OPC believes that artificial intelligence (AI) presents fundamental challenges to all of the “foundational privacy principles” formulated in the Personal Information Protection and Electronic Documents Act (PIPEDA). The Consultation Paper outlines eleven proposals and related discussion questions for consideration, and requests feedback by March 13, 2020.

These AI-related potential reforms to privacy laws are at an early stage of development, but if adopted they likely will have a significant impact on how registered firms use AI in their development and delivery of products and services as well as their compliance systems and other internal controls. For example, reforms to PIPEDA might introduce provisions similar to those in the European Union’s General Data Protection Regulation (GDPR) that grant individuals the rights:

  • Not to be subject to automated decision-making, including profiling, except when an automated decision is necessary for a contract, authorized by law, or explicit consent is obtained; and
  • To object to having their personal information processed for direct marketing purposes.

Another proposal, if implemented, might require entities to inform individuals about the use of automated decision-making, the factors involved in the decision and, where the decision is “impactful”, information about the logic upon which the decision is based.

AUM Law will continue monitoring developments in this area and update you on the status of significant proposals. In the meantime, if you have any questions about the Consultation Paper and its potential impact on your operations, please contact us.

February 28, 2020

CSA Re-Proposes Rules on Non-GAAP and Other Financial Measures Disclosure

On February 13, the Canadian Securities Administrators (CSA) published a second notice and request for comments (Revised Proposal) on proposed National Instrument 52-112 Non-GAAP and Other Financial Measures Disclosure (NI 52-112) and a related companion policy. As we noted in our September 2018 article on the CSA’s first proposal, the regulators are concerned that many issuers disclose a range of non-GAAP financial measures that are not standardized, lack context when disclosed outside the issuer’s financial statements, lack transparency as to their calculation, and/or vary significantly by issuer or industry.

According to the Revised Proposal, many commenters supported the objectives underlying proposed NI 52-112. However, concerns were expressed about the scope and application of NI 52-112, the proposed definitions, and the increased regulatory burden associated with the new rule. The CSA has responded to those concerns by, among other things:

  • Limiting NI 52-112’s application to certain issuers (g. investment funds, “SEC foreign issuers” and “designated foreign issuers” will be exempt from the rule);
  • Exempting certain disclosure, financial measures and documents;
  • Narrowing and clarifying various definitions;
  • Limiting disclosures for capital management measures and total of segments measures;
  • Simplifying the prescribed disclosures for non-GAAP financial measures that are forward-looking information and for non-GAAP ratios;
  • Better aligning disclosure requirements with those adopted by other securities regulators; and
  • Seeking to reduce uncertainty by clarifying disclosure requirements and providing significant guidance.

Although investment funds and certain other issuers got their wish to be exempt from NI 52-112, non-reporting issuers that raise funds in reliance upon the offering memorandum (OM) exemption will be subject to the new rule.

Comments are due on the proposal by May 13, 2020. If you would like to discuss NI 52-112, please reach out to your usual AUM lawyer.

February 28, 2020

If They Build It (Again), Will They Come? The CSA Proposes a Harmonized, Start-up Crowdfunding Regime

On February 27, the Canadian Securities Administrators (CSA) published for comment proposed National Instrument 45-110 Start-up Crowdfunding Registration and Prospectus Exemptions (NI 45-110), as well as proposed start-up crowdfunding guides for businesses and funding portals (Guides). If adopted, NI 45-110 will replace the patchwork of local instruments and blanket orders that provide for prospectus and/or registration exemptions for start-up crowdfunding activities. The CSA is also considering whether to repeal Multilateral Instrument MI 45-108 Crowdfunding (described below), which is currently available in Ontario and a number of other provinces. In our first look at the proposed new regime, we describe below its key features and share our initial impressions.

Existing Framework: Start-ups and early stage issuers have raised capital under local crowdfunding blanket orders (Blanket Orders) that grant prospectus and registration exemptions in British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia. By contrast, to date no fundings have been completed under the prospectus and registration exemptions in Multilateral Instrument 45-108 Crowdfunding (MI 45-108), which is available in Alberta, Saskatchewan, Manitoba, Ontario, Québec, New Brunswick and Nova Scotia. There has been some fundraising under Alberta Securities Commission Rule 45-517 Prospectus Exemption for Start-up Businesses, which is similar to the Blanket Orders except that it doesn’t require use of a funding portal and doesn’t provide a registration exemption.

The Canadian securities regulatory framework for crowdfunding has been criticized for its complexity, lack of harmonization, low caps on fundraising, and regulatory costs. The CSA hopes that MI 45-110 will address these concerns while still providing adequate investor protection.

Proposed NI 45-110 differs from the existing regulatory framework in a number of ways, including the following:

  • Maximum aggregate proceeds: NI 45-110 will permit an issuer group to raise up to $1,000,000 every twelve months (on a rolling basis measured from the date the new offering closes). The existing Blanket Orders permit an issuer group to raise up to $250,000 up to two times per calendar year. MI 45-108 has a 12-month, rolling $1,500,000 cap. We expect that some issuers and portal operators will view the $1,000,000 limit as too low to make these exemptions attractive. The CSA has asked if investor protection concerns can be adequately addressed if the cap is raised to $1,500,000.
  • Maximum investment per purchaser: NI 45-110 will permit an investor to make an investment of up to $2,500 in an offering (or $5,000 if the investor obtains advice from a registered dealer that the investment is suitable for the purchaser). The existing Blanket Orders have a $1,500 limit (with BC, Alberta and Saskatchewan permitting $5,000 if the purchaser receives advice from a registered dealer that the investment is suitable). Existing MI 45-108 sets limits on how much a purchaser can invest in a given distribution and in all distributions made in reliance upon MI 45-108’s prospectus exemption in calendar year. The limits vary depending on the jurisdiction (e.g., Ontario has much higher limits) and the type of investor. We expect that some issuers and portal operators will view these investor-level caps as too low as well. The CSA has asked if caps at $5,000 (or $10,000 if the investor obtains suitability advice from a registered dealer) would be more appropriate.
  • Funding Portals Not Required to Register: NI 45-110, like the Blanket Orders but unlike MI 45-108, will not require funding portals to be registered. If NI 45-110 is adopted, the existing, exempt funding portals operating in some Canadian jurisdictions will be able to access Ontario investors and facilitate crowdfunding nationally.
  • Annual Working Capital Certification for Funding Portals: NI 45-110 introduces a new requirement for funding portals to provide regulators with a certificate that they have sufficient working capital to continue operations for at least the next twelve months.
  • Bad Actor Disqualification: NI 45-110 introduces a prohibition on a funding portal relying upon the start-up crowdfunding registration exemption if it or any of its principals is or has been the subject of certain proceedings in the last ten years related to a claim based in whole or in part on conduct involving fraud, theft, breach of trust or allegations of similar conduct.
  • Statutory Civil Liability: Under NI 45-110, issuers and, in some jurisdictions, the directors and executives signing the offering document, will be subject to statutory liability if the offering document contains a misrepresentation.

It will be interesting to see if market participants find the package of reforms in NI 45-110, in a naturally harmonized instrument, a more attractive mechanism for start-up crowdfunding. The comment period on proposed NI 45-110 will close on May 27, 2020. The CSA Members that have adopted the Blanket Orders will extend them so that they remain available until NI 45-110 is available. If you would like to discuss how proposed NI 45-110 might affect your business, please contact your usual lawyer at AUM Law.

February 28, 2020

OSC Goes Its Own Way as CSA Finalizes Rule on Embedded Commissions

On February 20, the Canadian Securities Administrators except the Ontario Securities Commission (Participating Jurisdictions) published a notice (Multilateral Notice) announcing amendments to National Instrument 81-105 Mutual Fund Sales Practices and related instruments to prohibit deferred sales charges (DSCs) for investment funds (Amendments). The OSC, like somebody who someone in Fleetwood Mac was dating unhappily, has decided to go its own way and restrict rather than ban DSCs outright. We’ve set out below the key features of the Participating Jurisdictions’ ban, and the OSC’s proposed restrictions, on DSCs.

A.  Participating Jurisdictions

  • In the Participating Jurisdictions, the Amendments will prohibit fund organizations from paying upfront sales commissions to dealers, which will result in the discontinuation of all DSC options.
  • The Amendments will take effect on June 1, 2022 (Effective Date). The redemption schedules for mutual fund investments purchased under a DSC option before the Effective Date will be allowed to run their course until their scheduled expiry.
  • As we discussed in our October 2019 bulletin, the conflict of interest provisions in the client-focused reforms (CFRs) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) come into effect on December 31, 2020. Regulators in the Participating Jurisdictions will exempt dealers from these new requirements as they apply to DSC options until the Effective Date. Instead, dealers will be required to comply with the conflict of interest provisions that are currently in effect under NI 31-103 in relation to DSC options.
  • Regulators in the Participating Jurisdictions view the discontinuance of the DSC option as a material change. So, for prospectuses that contemplate a DSC option, are receipted before the Effective Date, and lapse after the Effective Date, disclosure can be handled in one of two ways.
    • Option 1: Amend the simplified prospectus and fund facts documents as of the Effective Date to remove references to the DSC option.
    • Option 2: Include disclosure in simplified prospectus and fund facts documents indicating that the DSC option will not be available in the Participating Jurisdictions after the Effective Date.

B.  Proposed OSC Rule 81-502 – Restrictions on the Use of the Deferred Sale Charge Option for Mutual Funds

  • Proposed OSC Rule 81-502 is intended to address the “lock-in” effect associated with the DSC option and reduce the potential for miss-selling while continuing to allow dealers to offer the DSC option to clients with smaller accounts. Restrictions will be imposed at the investment fund manager (IFM) and dealer levels.
  • IFM-level restrictions: OSC Rule 81-502 will limit the redemption schedule to three years. Clients will be permitted to redeem up to 10% of their investment annually without redemption fees (on a cumulative basis). IFMs will have to create a separate DSC series so that investors who purchase funds on a no-load or front-end charge basis do not incur any costs related to financing the upfront commissions typically associated with the DSC option.
  • Dealer-level restrictions: Dealers won’t be able to sell funds with a DSC option to clients who are either aged 60 or over or have an investment horizon that is shorter than the DSC schedule. In addition, DSC option funds can only be sold to clients with accounts not exceeding $50,000, and clients will not be able to use borrowed money to buy mutual funds with a DSC option. Upfront commissions will be permitted only for new contributions to client accounts and no such commissions will be payable on reinvested distributions. Finally, no redemption fees will be payable in connection with investor redemptions in specified circumstances (g. involuntary loss of full-time employment, permanent disability, critical illness, or death).
  • Effective date: OSC Rule 81-502 is expected come into effect when the DSC ban comes into effect in the Participating Jurisdictions.
  • Conflict of interest: The OSC considers it a conflict of interest for registrants to accept upfront commissions associated with the sale of securities under a DSC option. Therefore, it expects registrants to address that conflict consistent with their obligations under NI 31-103, in its current state, and as amended by the CFRs, when those amendments take effect at the end of this year.
  • Deadline for comments: Comments are due on proposed OSC Rule 81-502 by May 21, 2020.

In light of the forthcoming ban on DSC options in most jurisdictions and the narrowly defined scope for them contemplated in OSC Rule 81-502, we imagine that fund organizations and dealers are assessing whether it will be worth it to continue DSC option funds in Ontario once the ban in the Participating Jurisdictions takes effect. If you would like to discuss how the Amendments and OSC Rule 81-502 might affect your business, please contact us.

February 28, 2020