Category: Regulatory Compliance

BLG’s Resource Corner

Our colleagues at Borden Ladner Gervais LLP publish a wealth of information every month. All are available on the BLG’s website, under Insights. Some selected Insights published in June that may be of interest to you include a primer on M&A in Canada, an update on privacy legislation in Ontario and an article and webinar on the future of Ontario’s new iGaming markets. For more information, please visit the following links:

June 30, 2021

FAQ Corner: What Procedures are Required Before My Firm Can Accept Referred Business from a Third-Party?

Answer: Canadian securities laws require that a registered firm manage material conflicts of interest in the best interests of its clients. The Canadian Securities Administrators have provided guidance that paid referral arrangements are an inherent conflict of interest which, in their experience, are almost always material. While much of the guidance then focuses on out-bound referral arrangements (a registered firm referring a client to a third-party in exchange for a referral fee), we believe the guidance can equally apply to an in-bound referral arrangement (a third-party, such as a wealth planner, referring a client to a registered PM). In order to manage this conflict of interest, in addition to compliant client disclosure, the registered firm should have procedures in place to verify that the proposed referral arrangement will serve its clients’ best interests. These procedures can include a due diligence review of the referrer’s reputation and level of service, and confirmation that the referrer: (i) is qualified to render its services and is not subject to any civil actions or regulatory or professional disciplinary matters, and (ii) does not hold itself out as providing services that it is not registered to provide. The registered firm must also of course determine that its services are suitable for the client. Importantly, the CSA have also provided that If a client pays more for the same, or substantially similar, products or services as a result of a referral arrangement, they will not consider the inherent conflict of interest to have been addressed in the best interest of the client.

June 30, 2021

FAQ Corner: Does Claiming Compliance with GIPS Standards Require Third-Party Verification?

Answer: GIPS standards are a recognized standard for calculating and presenting investment performance around the world. While Canadian securities laws do not require a firm to comply with GIPS standards, a firm may wish to do so in order, for example, to demonstrate a commitment to adhere to global best practices. Verification of compliance with GIPS standards by a qualified third-party is recommended as it provides comfort and reduces the risk of making an incorrect claim. That being said, external, third-party verification is not strictly required for a firm to claim compliance with GIPS standards. A firm can self-certify that it complies with GIPS standards and annually notify CFA Institute of its claim by June 30th in order to be included in CFA Institute’s List of Organizations Claiming Compliance with GIPS standards. CFA Institute does not represent or verify that the firms included on the list meet the GIPS standards or engage in the review, enforcement, or quality control of such firms.

June 30, 2021

FAQ Corner: Now that Joint Oversight Over Distributions of Non-Qualified Syndicated Mortgage Investments (NQSMIs) by FSRA and the OSC is Underway, What Should Firms Operating in this Space Keep in Mind?

Answer: As of July 1, 2021, the OSC will have regulatory oversight over the distribution of NQSMIs to persons that are not permitted clients. Firms distributing NQSMIs to investors that are not permitted clients will need to rely on another available prospectus exemption and will need to be registered as an exempt market dealer (EMD) or engage the services of a third-party EMD (or rely on an available exemption). FSRA will retain regulatory oversight over the distribution of NQSMIs to permitted clients (although there is no prohibition on EMDs distributing NQSMIs to permitted clients under the OSC’s regime).

FSRA requires the filing of a quarterly report containing certain data about each NQSMI with permitted clients. Firms that distribute NQSMIs in reliance on the “accredited investor” prospectus exemption or the “offering memorandum” prospectus exemption will need to file a report of exempt distribution with the OSC (and any other applicable securities regulators) within 10 days of the distribution. Issuers relying on the “offering memorandum” prospectus exemption will need to comply with certain supplemental disclosure obligations and will also need to prepare audited financial statements. Although there are no prescribed disclosure requirements for issuers relying on the “accredited investor” prospectus exemption, be aware that presentations and marketing materials could fall within the broad definition of “offering memorandum” which exposes the issuer to potential liability for misrepresentation and triggers the need to include a summary of applicable damages and rescission rights and to file a copy of the materials with the OSC within 10 days of the distribution.

EMDs distributing NQSMIs must comply with know-your-client, know-your-product and suitability obligations as well as conflicts of interest and client relationship disclosure. While the OSC does not require prescribed forms, the OSC expects registrants to perform a meaningful suitability assessment and to appropriately document that assessment. If you have any questions about the changes to the treatment of NQSMIs, please contact your usual lawyer at AUM Law.

June 30, 2021

New Brunswick Proposes Local Rule Impacting Funds in that Province

The Financial and Consumer Services Commission released proposed Local Rule 81-510 Self-Dealing on June 24 for a 60-day comment period. The stated purpose of the rule is to provide additional guidance regarding the meaning of certain terms used in Part 10 of the Securities Act (New Brunswick) which relates to self-dealing by mutual funds as well as insider trading. Part 10 of the Act already prohibits mutual funds formed in New Brunswick (or are reporting issuers in the Province) from taking certain actions without exemptive relief, such as the conflict of interest provisions which prohibit a mutual fund from, among other things, making an investment in any person in whom the mutual fund, alone or together with one or more related mutual funds, is a substantial security holder. Many of the new proposed definitions will be familiar to market participants as they relate to prohibited transactions for certain mutual funds, including the meaning of “significant interest” and “substantial security holder”, as they are very similar to those already in use by other provinces, including Ontario. The intention of the proposed rule is for New Brunswick’s approach to the provisions to be more consistent with that taken in many other Canadian jurisdictions, thereby reducing any confusion in the market.

June 30, 2021

Hello, Goodbye – CSA Grants Interim Relief for DSC Sales

As a follow-up to our article, All Together Now – OSC Joins DSC Ban, in the May 2021 AUM Law Bulletin, we can report that on June 23 the Canadian Securities Administrators (CSA) issued CSA Notice 31-360 Blanket Orders/Class Orders in respect of Transitional Relief Related to the Deferred Sales Charge Option in respect of Client Focused Reforms Enhanced Conflicts of Interest and Client First Suitability Provisions of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (the Notice).

The Notice states that each of the CSA jurisdictions have decided to grant relief by way of blanket orders (the Blanket Orders) to address the issue of overlapping periods between the implementation of the enhanced conflicts of interest and “client first” suitability requirements in the Client Focused Reforms (CFRs) and the implementation of the ban on deferred sales charges (DSCs). The enhanced conflicts of interest provisions of the CFRs come into effect on June 30, 2021 and the client first suitability provisions of the CFRs come into effect on December 31, 2021 whereas the DSC ban only comes into effect on June 1, 2022.

In respect of a trade in a security of an investment fund that results in the payment of an upfront sales commission and that is subject to a DSC, the Blanket Orders will provide registrants with an exemption from the enhanced conflicts requirements from June 30, 2021 to June 1, 2022 and with an exemption from the client first suitability requirement from December 31, 2021 to June 1, 2022. Without the Blanket Orders, a firm selling investment funds with DSCs until the ban on June 1, 2022 could be in contravention of the CFR requirements regarding conflicts of interest and suitability.

If you have any questions about the Notice or Blanket Orders, please contact your usual lawyer at AUM Law.

June 30, 2021

Start-Up Crowdfunding Exemptions are Revved up and Ready to Go

On June 23, the CSA announced the final publication of National Instrument 45-110 Start-Up Crowdfunding Registration and Prospectus Exemptions (NI 45-110), along with CSA Staff Notice 45-329 Guidance for using the start-up crowdfunding registration and prospectus exemptions. As previously noted in our February 2020 bulletin, NI 45-110 sets up a national framework to permit securities crowdfunding for start-up and early stage issuers and will replace the blanket orders that had been issued in a number of jurisdictions. A dealer registration exemption will be available for funding portals that facilitate online distributions by issuers that use the prospectus exemption set out in the National Instrument. The prospectus exemption will allow an issuer to distribute eligible securities through an online portal, and both the dealer and prospectus exemptions require the portal (even if already registered as an investment dealer or EMD) and the issuer to satisfy numerous conditions.

NI 45-110 was first published for comment in February 2020, and the final rule has been responsive to comments indicating that the individual investment limits were too low by increasing the limit from $5,000 to $10,000 for a purchaser who has obtained suitability advice from a registered dealer, and also increased the limit on aggregate proceeds raised by the issuer group in the last 12 months from $1 million to $1.5 million. While the CSA noted that numerous commentators had asked for further increases for issuers, in their view it is more appropriate for issuers to utilize the offering memorandum exemption in order to crowdfund larger amounts. The annual working capital certification (renamed to the financial resources certification) has become a semi-annual certification, and the prospectus exemption will not be available for issuers whose only operations are to identify and evaluate assets or a business with a view to completing an investment in, merger with, amalgamation with or acquisition of a business, or purchasing the securities of one or more other issuers. Some local amendments will also be made; for example, in Ontario, OSC Rule 13-502 Fees will be amended to classify an unregistered portal relying on the new exemption as an ‘unregistered capital markets participant’ (the same category as unregistered investment fund managers) and pay fees as such. NI 45-110, the related guides, and consequential amendments to other rules is expected to come into force September 21, 2021.

June 30, 2021

Changes to AML Rules – Effective on June 1, 2021

On June 1, 2021, amendments to the regulations under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act took effect. The amendments to the regulations were accompanied by revised and new FINTRAC guidance dated June 1, 2021. The amendments have the effect of closing gaps in the existing rules and addressing technological developments. Portfolio managers and exempt market dealers should review the revised guidance, consider if their policies and procedures should be updated and consider if their account opening forms should be revised.

By way of example only, the following are certain areas on which portfolio managers and exempt market dealers should focus attention. First, there is a new requirement to report a large virtual currency transaction, which should be reflected in a firm’s written policies and procedures. Second, the scope of the definitions of politically exposed persons and heads of international organizations was changed and there is a new requirement to gather the phone number of anyone uncovered during a third-party determination, which can both impact account opening forms. Finally, there is more prescriptive guidance in respect of beneficial ownership of entities and ongoing monitoring, which could warrant a change in how a firm conducts account monitoring.

June 30, 2021

Proposed Amendments to Regulatory Functions of the Bourse de Montreal Inc.

Clients who trade derivatives over the Bourse might be interested in proposals released in late May to amend Part 4 of the Rules of the Bourse that relate to its regulatory functions, including investigations, enforcement, and disciplinary actions. The proposed changes are intended to promote a robust regulatory framework by codifying current practices and enhancing the rules, where warranted, with best practices currently followed by other SROs and exchanges. For example, some of the changes relate to the general powers of the division to request information and the obligation of persons subject to information requests, as well as clarifying the steps required to initiate disciplinary proceedings and hearings, including summary proceedings in urgent circumstances. Comments are due on the proposal by July 26, 2021.

June 30, 2021

Reforms in Even Sharper Focus – IIROC and MFDA Publish Draft CFR Guidance

On June 21, both IIROC and the MFDA published proposed guidance regarding suitability that relate to the CSA’s client-focused reforms. IIROC’s Proposed Guidance on Know-your-client and Suitability Determination, applicable to investment dealers and their representatives, would replace its existing KYC and suitability guidance in its entirety, and is intended to conform in all material respects to the CFRs. The new guidance details IIROC’s expectations on the collection of KYC information, its interpretation of certain terms, its expectations on how dealers can in fact “put the client’s interest first” and confirms that KYC requirements are not one-size fits all but depend on a member’s business model, service offerings and clients. The requisite KYC information is divided into “essential facts” about an order, client and account which dealers must collect as gatekeepers to the capital markets (such as client ID), and KYC information needed for the suitability determination obligation (e.g. financial circumstances, risk profile, investment knowledge and investment time horizon). IIROC states that dealers should apply the guidance and the suitability determination requirement to all investment products offered, and not just securities. With respect to specific dealer models, the guidance notes that while the KYC obligation is generally the same for all accounts, some limited exceptions exist for accounts such as OEO or DEA accounts. The notice also addresses when it would be acceptable to collect and maintain one set of KYC information for multiple accounts (spoiler alert: the account beneficial owner must be the identical individual for all the accounts, for starters) and when separate account applications would be required. The suitability determination obligation not only applies before taking or recommending an investment action for a retail client, but notes that the order type, trading strategy, fee structure and method of financing must also be suitable (and put the client’s interests first). In the draft guidance, IIROC clarifies that it will not review suitability determinations in hindsight, but rather on the basis of what a reasonable dealer or registered individual would have done in the same circumstances.

For mutual fund dealers, the MFDA has published CFR Conforming Changes to MSN-0069 (Know-Your-Client and Suitability). The new draft guidance has been combined with prior guidance to ensure that it reflects the business models of MFDA members while still being consistent with new CSA guidance. The staff notice sets out the various types of KYC information that must be collected such as personal circumstances, investment knowledge, financial circumstances, investment needs and objectives, investment time horizon and risk profile, and explains how each can support a suitability determination. The draft updates its description of the situations where certain KYC information can be collected jointly for joint accounts. The guidance also focuses on the timing of suitability determinations, including with respect to bulk account transfers, and the meaning of an “investment action”. The inputs into a suitability determination have been updated, to include items such as a comparison of KYC information to the characteristics of the investments in the accounts, as well as KYP information, concentration and liquidity factors, and the potential and actual impact of costs. The guidance also confirms that members must have policies and procedures for both branch and head office staff relating to the opening of new accounts and updating of KYC information, which can not be solely an administrative exercise but a review of the information’s adequacy, reasonableness, consistency and uniformity. Specific guidance is reiterated with respect to the MFDA’s suggestion for supervisory policies and procedures to flag specific concentration limits (at 25% of a client’s total investments with the member and an additional limit of 10% of a client’s total investable assets) relating to any one security, sector or industry. Other changes to MSN-0069 include its scope, to ensure it applies to all business conducted through the facilities of a member (e.g. non-securities related investment products), removal of KYP guidance (which is now addressed by another staff notice) and other content found in other compliance bulletins, and the removal of examples of a KYC and suitability review on the basis that the requirements are well understood by members. The changes to the staff notice all support the requirement to ensure that before a member or approved person opens an account, makes a recommendation or takes any other investment action for a client it is suitable for the client and puts the client’s interests first, as required by the CFRs.

Comments on both proposals are due on August 20. If you have any questions or wish to comment on the proposals, please reach out to your usual lawyer at AUM Law.

June 30, 2021

What Comes Next: KYC, KYP and Suitability

As the June 30th deadline for the “part one” of the Client Focused Reforms passes us in the rear-view window and we go and enjoy our long weekend, we wanted to highlight some high-level considerations for “part two”. This “part two” mainly deals with the KYC/KYP and suitability requirements and changes to comply with the requirements must be made by December 31, 2021. The following are some high-level points/reminders for you to consider as we work towards that December deadline.

  1. Don’t Wait Until the Fall

Depending on your business model, “part two” may require some thoughtful planning and advance work. The earlier you start in mapping out how your firm will deal with the KYC/KYP and suitability requirements, the less stress you and your team may feel when the leaves start to change colour.

  1. Know Your Product – Documentation is King

At a high level, there will be an expectation that prior to investing in any position on behalf of a client, your firm will have completed documented due diligence on that investment. This due diligence documentation should include relevant structure, features, risks, initial and ongoing costs. The level of detail of your due diligence may vary depending on the nature of the product and your business model. Your firm will also have to monitor each investment product for significant changes. When significant changes in the investment product do occur, your firm may need to update your due diligence record. Your firm should be exploring or developing tools to ensure a due diligence standard is followed across your company.

  1. KYC – Knowing (more about) Your Client

You will need to have an updated KYC document ready for December 31, 2021. Each KYC document can be tailored based on the business model of your firm. You will also need to be able to evidence that your client has agreed that the collected KYC information is accurate (e.g. through the client signing the KYC form or a registered individual’s notes capturing the client interaction). Some items that may be changing on your KYC form include:

  • Outside Investment Information:

Certain business models may need to start asking clients about investments the client holds outside of your firm to create a better understanding of a client’s financial circumstances. This outside investment information gathering could be expected to be heightened for discretionary investment managers. Additionally, it could be expected where your firm may need to assess whether a proposed investment would lead to over-concentration in a security or sector.

  • Risk Capacity:

In addition to asking what your client’s risk tolerance is, as your firm likely has been doing for years, your firm will now be expected to professionally assess the client’s risk capacity. Put another way, risk tolerance speaks to the client’s preference for risk. Risk capacity is your firm’s assessment of how much risk a client should take on. Where there is a mismatch between a client’s risk tolerance and your firm’s risk capacity assessment, the client’s preference can prevail but only after you have a detailed and documented conversation with the client explaining your thought process and exploring alternative investment approaches.

  • KYC Updates:

The new rules specify minimum intervals when a client’s KYC information must be reviewed:

  • 12 months for managed accounts;
  • 12 months before making a trade or recommendation for exempt market dealers; and
  • 36 months for other cases.
    • Suitability – Documentation is King (Part 2):

Prior to taking any investment action on behalf of a client, your firm will need to document that this action is suitable for the client. In determining suitability, you will need to consider and assess the client’s KYC information, a reasonable range of alternatives available through your firm and the potential impact the investment action will have on the client. Please note that the inclusion of the language “of a reasonable range of alternatives available through your firm” dovetails with the need to have a standardized due diligence process throughout your firm as each registered individual will need to understand all products on your firm’s “shelf”.

Our experience thus far is that there are practical approaches and tailored solutions for each of the new “part 2” requirements. If you have any questions, please feel free to reach out to your usual lawyer at AUM Law.

June 30, 2021

Social Media and Market Manipulation

In case you missed it, the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) published a joint statement on February 1, 2021 around the time when trading in GameStop Corp., AMC Entertainment Holdings Inc., BlackBerry Ltd. and other out-of-favour stocks were hot topics. The CSA and IIROC stated that they were closely monitoring how extreme price movements of certain stocks were contributing to volatility in Canada’s capital markets.

Just prior to the CSA-IIROC joint statement, the U.S. Securities and Exchange Commission (SEC) published an investor alert on January 30, 2021 warning investors of the significant risks of short-term investing in individual stocks based on social media, especially in volatile markets and provided tips for long-term investing. Shortly after, the SEC suspended trading on February 11 of one of those stocks, SpectraScience Inc., and on February 26 the SEC suspended trading in 15 more companies because of questionable trading and social media activity. At that time, the SEC stated that is was proactively monitoring for suspicious activity tied to stock promotions on social media and reminded investors to exercise caution before investing in companies promoted on social media.

All registrants should ensure that they have policies and procedures in place relating to the social media activity of their employees, in part to ensure that securities regulations are being followed and that social media posts are not used inappropriately. The use of social media by registrants was discussed in AUM Law’s Social Media FAQ. Other guidance on the use of social media can be found in CSA Staff Notice 33-321 Cyber Security and Social Media and CSA Staff Notice 31-325 Marketing Practices of Portfolio Managers.

Issuers should also be aware of Proposed BC Instrument 51-519 Promotional Activity Disclosure Requirements reported in our May 2021 AUM Law Bulletin that would provide investors with improved transparency about the source and reliability of promotional activity. This is a continuation of the trend of increasing regulatory scrutiny on all types of social media activity including promotional activity by issuers. See also CSA Staff Notice 51-348 Staff’s Review of Social Media Used by Reporting Issuers.

AUM Law offers a fixed-fee social media review module where we can review your use of social media including considerations around possible misuse. If you are interested in learning more about how to train your staff about the appropriate use of social media, AUM Law is here to help.

June 30, 2021

Outside Business Activities (OBAs) Reporting Reminder

A recent settlement between an Alberta-based registrant and the Investment Industry Regulatory Organization of Canada (IIROC) presents a sharp reminder to all registrants about the importance of keeping their OBAs up to date.

In a June 4, 2021 settlement with IIROC, the registrant agreed to a $75,000 fine, a six-month suspension and an order to pay $5,000 in costs, in connection with a failure to disclose an OBA to his firm, which ultimately resulted in a conflict of interest arising between the registrant and several clients. According to the settlement, the registrant failed to notify his firm of his involvement in a property development business, in which a number of his clients also had a financial interest. Evidently, the business failed, and two of the registrant’s clients lost all, or a significant portion, of their investments. IIROC found that the registrant did not inform his firm of the OBA by downplaying his involvement, and that he failed to report, and address, a material conflict of interest with his clients.

As a refresher, as described in detail in Companion Policy 31-103 CP, registrants must disclose all outside business activities in Form 33-109F4 (or Form 33-109F5 for changes in outside business activities after registration). OBAs currently include any employment and business activities outside the registrant’s firm, all officer or director positions, and any other similar position, including positions of influence. Individual registrants under Ontario securities law are required to file OBA disclosure within 10 days of a new OBA or a change to an existing OBA.

On February 4, 2021, the Canadian Securities Administrators (CSA) released a number of proposed changes to certain initial and ongoing regulatory reporting requirements for registrants, including relating to the OBAs. The proposed changes seek to:

  • Change this term from “Outside Business Activities” to “Outside Activities”, to indicate that reportable activities include more than just a compensated position.
  • Provide a fairly comprehensive set of evaluation criteria to help registrants determine what is reportable to regulators and what is not.
  • Extend the reporting deadlines from 10 to 30 days.

For more details regarding these changes please see Outside Activities 2.0: Potential Burden Reduction Comes to Reporting of Registrant Information.

While the Ontario Securities Commission (OSC) has announced a moratorium on late fees for failing to disclose OBAs, starting retroactively on January 1, 2019 and ending on December 31, 2021, at the latest, the recent IIROC settlement brings into focus why registrants should continue to report all their OBAs in a timely and fulsome manner.

June 30, 2021