PORTFOLIO MANAGERS What You Need to Know Under the New Rules

Transcription

1 PORTFOLIO MANAGERS What You Need to Know Under the New Rules On July 17, 2009, the Canadian Securities Administrators (the CSA) published in final form their reforms to the registration regime in National Instrument Registration Requirements and Exemptions (NI ), along with certain consequential amendments to other securities laws (collectively, the new rules). Subject to ministerial approval requirements, NI will come into force on September 28, 2009 (the effective date). New Rules for Portfolio Managers NI recasts adviser registration in Canada, collapsing previous categories of adviser registration into a single category called portfolio manager (PM) and introducing a new category of restricted portfolio manager (Restricted PM). There are new capital and proficiency requirements, new individual registration categories and other material changes. Did You Know? o Effective September 28, 2009, all existing adviser registrants in all categories will automatically become registered in the new PM category. You don t have to apply for the new PM registration category. o The new PM registration involves higher capital and insurance requirements and new individual proficiency requirements. o PMs will be required to provide a client with relationship disclosure information before advising the client. o PMs will be required to make available an independent dispute resolution service, at the firm s expense, to resolve client complaints. o PMs that manage pooled funds will also require registration in the new category of investment fund manager (IFM), and may also require dealer registration, depending to whom the pooled fund is distributed. o Some of the new requirements will be phased in under transition rules, some changes require immediate action and some will not apply to those who are registered at the effective date.

2 Page 2 These and other important changes in the regulation of registered advisers under NI are discussed below in this issue. We can help you navigate your way. Registration of Firms Under the current regime, firms registered as advisers are registered in one or more of the following categories: investment counsel, portfolio manager, securities adviser, international adviser (in Ontario and Newfoundland and Labrador) and unrestricted practice adviser (in Quebec). Over time, the functional distinction between certain of these categories became blurred 1, while the utility of certain other categories became unclear. NI collapses all of the firm registration categories into the new PM category, and introduces the Restricted PM category to accommodate special situations where registration other than full PM registration is appropriate. In addition, NI provides for certain exemptions from the adviser registration requirement which render some of the existing registration categories unnecessary. The result is a simplified adviser registration system, and corresponding exemptions, which is essentially uniform across Canada. Effective September 28, 2009, all existing adviser registrants in all categories will automatically become registered in the new PM category. You don t have to apply for the new PM registration category. Certain firms will no longer need to be registered in any category of adviser registration, or may be a candidate for Restricted PM registration. A Restricted PM is permitted to provide advice subject to the terms and conditions imposed by the regulator. 2 The terms and conditions will depend on the nature of the business conducted by the firm. 1 For example, many adviser registrants today are registered in both the investment counsel category and the portfolio manager category, although these are separate categories of adviser registration in most jurisdictions. 2 For example, a Restricted PM may be restricted to providing advice limited to specific securities or securities of a specific class of issuers.

3 Page 3 Registration of Individuals Advising Individuals engaged in the business of advising at PM firms will require registration as either: o Advising representatives; or o Associate advising representatives. The category of associate advising representative is a new category for some provinces and territories. It is primarily intended to be an apprentice category for individuals who are working toward advising representative registration, but do not yet meet all the experience or education requirements. However, associate advising representatives are not required to move on to registration as an advising representative. They can remain as an associate advising representative indefinitely. As a result, this category offers some flexibility for accommodating individuals who engage in varying levels of advising activity. 3 All associate advising representatives must be supervised by an advising representative. Any advice they give must be preapproved by a designated supervisor. Compliance In addition to the traditional categories of individual registration for registered advisers, a PM must designate, and apply for registration of, an Ultimate Designated Person (UDP) and a Chief Compliance Officer (CCO). Depending on the size and structure of the firm, the UDP and CCO may be the same person. Ultimate Designated Person: The UDP s role is to promote compliance at the firm and oversee the effectiveness of the firm s compliance system. The UDP does not have to be involved in the day-to-day management of the compliance group. The designated UDP must be: the CEO, sole proprietor or equivalent of the firm; an officer in charge of the division of the firm, if the activity that requires the firm to register occurs only within that division; or (iii) an individual acting in a capacity similar to that of a CEO or an officer in charge of a division of the firm. No proficiency requirements are specified for the UDP function. Chief Compliance Officer: The CCO is required to: establish and maintain policies and procedures for assessing compliance by the firm, and individuals acting on its behalf, with securities legislation; monitor and assess compliance by the firm, and individuals acting on its behalf, with securities legislation; (iii) report to the UDP as soon as practicable if the CCO becomes aware of any circumstances indicating that the firm, 3 For example, the associate advising representative category accommodates individuals who provide specific advice to clients, but do not manage client portfolios without supervision.

4 Page 4 or any individual acting on behalf of the firm, is in non-compliance with securities legislation; and (iv) submit an annual report to the board of directors (or similar body or authority in a non-corporate structure) for the purpose of assessing compliance by the firm, and individuals acting on its behalf, with securities legislation. Proficiency requirements are specified for the CCO function. Permitted Individuals Under the new rules, the list of non-registered individuals who are required to file as permitted individuals is significantly reduced. The narrower definition of permitted individuals is aimed at the mind and management of the PM (i.e., those who have direct influence or control over the firm). The following persons are permitted individuals under National Instrument Registration Information (NI ): o a director, chief executive officer, chief financial officer, or chief operating officer of the PM, or a person who performs the functional equivalent of any of those positions, and o an individual who has beneficial ownership of, or direct or indirect control or direction over, 10 percent or more of the voting securities of the PM. All persons involved in a PM firm who fall within the category of permitted individuals are required to complete and file a Form F4 under NI , the same form submitted by all individuals who seek individual registration (such as the UDP and CCO). The purpose of the filing requirement is to ensure that permitted individuals are subject to review by the regulator as part of its oversight of a PM s fitness for registration. Adviser Registration Exemptions NI recasts and harmonizes the exemptions from the adviser registration requirement. Exemption for Dealer Without Discretionary Authority The adviser registration requirement does not apply to a registered dealer, or a dealing representative acting on behalf of the dealer, that advises a client in connection with a trade in a security. 4 Any advice rendered in the course of executing the trade is incidental to the trade itself. 4 As compared to exercising discretionary trading authority in respect of a managed account of the client, which would require adviser registration.

5 Page 5 Exemption for IIROC Members with Discretionary Authority NI retains the existing adviser registration exemption for registered dealers who are members of the Investment Industry Regulatory Organization of Canada (IIROC) that act as advisers in respect of their clients managed accounts through discretionary authority granted by the client and who are approved to perform that function by IIROC. 5 (iii) General Advice Exemption NI adds a new exemption from the adviser registration requirement for advice that does not purport to be tailored to the needs of the person or company receiving the advice. In general, the regulators would not consider advice to be tailored to the needs of the recipient if it: o is a general discussion of the merits and risks of the security; or o is delivered through investment newsletters, articles in general circulation newspapers or magazines, websites, , Internet chat rooms, bulletin boards, television or radio. This type of general advice can also be given at conferences. However, if a purpose of the conference is to solicit the audience and generate specific trades in specific securities, the regulators may consider the advice to be tailored (thereby triggering the adviser registration requirement) or they may consider the individual or firm giving the advice to be engaged in the business of trading in securities (thereby triggering the dealer registration requirement). If a person or company relying on the general advice exemption has a financial or other interest in the securities they recommend, they must disclose the interest to the recipient when they make the recommendation. (iv) International Adviser Exemption A non-canadian adviser may rely on the international adviser exemption to advise permitted clients provided the non-canadian adviser does not advise in Canada on securities of Canadian issuers, unless providing that advice is incidental to its providing advice on foreign securities. For a discussion of the international adviser exemption, please ask for our International Adviser Commentary and our International Dealer Commentary. 5 Proficiency requirements for the PM function under IIROC rules will be the same as under NI

6 Page 6 (v) Sub-Adviser Exemption The proposal to expand the Ontario-only sub-adviser exemption 6 across Canada in earlier versions of NI has not been continued in the final version of NI However, the sub-adviser exemption is being retained in Ontario pursuant to section 7.3 of OSC Rule Non-Resident Advisers for a period of two years while the CSA reviews the exemption. In the interim, the CSA are willing to provide discretionary exemptions from the adviser registration requirement for firms that act as sub-advisers to registrants. Dealer Registration Exemption Pooled Funds In addition to the adviser exemptions, there is an important dealer registration exemption available to a PM in connection with the distribution of securities of a nonprospectus qualified investment fund (pooled fund). A PM is not required to be registered as a dealer where: o the PM acts as the pooled fund s adviser and investment fund manager; and o the distribution of securities of the pooled fund is to a managed account of a client of the adviser. PMs operating under this exemption must also be registered as an IFM. So long as a PM continues to make proper reliance on this exemption, it will be exempted from complying with the higher capital requirement of the IFM registration. 7 For a discussion of IFM registration, please ask for our IFM Commentary. Limiting the distribution of the pooled fund securities to the managed accounts of the PM s clients distinguishes what is essentially an extension of the relationship between PM and client, on the one hand, from a type of distribution activity which would require a dealer registration, on the other hand. If a PM offers securities of its pooled fund to investors other than managed account clients, the PM will trigger a requirement to become registered as a dealer, likely in the category of exempt market dealer (EMD). For a discussion of EMD registration, please ask for our EMD Commentary. 6 The sub-adviser exemption permits a person or firm, not ordinarily resident in the jurisdiction, to provide advice to a registered adviser or to a dealer acting as a portfolio manager (i.e., that dealer is advising pursuant to the IIROC exemption) without the person or firm being registered in the jurisdiction as an adviser, provided certain conditions are met. 7 It will only need to satisfy the lower $25,000 minimum capital requirement applicable to PM registration.

7 Page 7 This exemption is not available if the managed account or pooled fund was created or is used primarily for the purpose of qualifying for the exemption. A PM must provide written notice to the regulator that they are relying on the dealer registration exemption within seven days of its first use of this exemption. Fit and Proper Standard, Conduct, and Conflict of Interest Requirements The regulators assess a firm s or individual s fitness for registration at the time of the initial application for registration. The main elements of fitness are proficiency, solvency and integrity. If the applicant does not satisfy the fitness criteria, registration will not be granted, or may be granted subject to terms and conditions. Thereafter, registered firms and individuals must continue to satisfy the fitness criteria. Conduct, conflicts of interest, and compliance procedures are also contemplated in NI Fit and Proper Standard PMs must meet the fit and proper standard. Non-compliance may result in registration being refused, the imposition of terms and conditions by the regulators, or the suspension of registration. Proficiency Requirements for Advising Representatives: Individuals applying for registration as advising representatives of a PM are required to satisfy one of the following: CFA charter and 12 months of relevant investment management experience 8 in the 36-month period before applying for registration; or Canadian Investment Manager (CIM) designation and 48 months of relevant investment management experience, 12 months of which was gained in the 36-month period before applying for registration. Proficiency Requirements for Associate Advising Representatives: Individuals applying for registration as associate advising representatives of a PM are required to satisfy one of the following: Completed Level 1 of the CFA program and 24 months of relevant investment management experience; or 8 In this section of the Commentary dealing with proficiencies, the phrase relevant investment management experience is used as described in the Companion Policy CP, where it states that individuals may gain relevant investment management experience through different types of work according to the level of specialization of the individual. That may include securities research and analysis experience or management of investment portfolios on a discretionary basis.

8 Page 8 CIM and 24 months of relevant investment management experience. Proficiency Requirements for CCO: The CCO is subject to a proficiency requirement. The CCO must meet one of the following three proficiency options. Option A o A CFA Charter or professional designation as a lawyer, Chartered Accountant, Certified General Accountant or Certified Management Accountant in a jurisdiction in Canada, a notary in Quebec, or the equivalent in a foreign jurisdiction; o Successful completion of the following exams the Canadian Securities Course Exam of CSI Global Education Inc. (CSI), and the PDO Exam ; 9 and o Either of the following 36 months of relevant securities experience while working at a registered dealer, a registered adviser or an investment fund manager, or provided professional services in the securities industry for 36 months and worked for an IFM for 12 months. Option B o Successful completion of the following exams the CSI s Canadian Securities Course Exam, and the PDO Exam; and o Either of the following five years of relevant experience at an investment dealer or a registered adviser, including 36 months in a compliance capacity, or five years of relevant experience at a Canadian financial institution in a compliance capacity relating to portfolio management and worked at a registered dealer or a registered adviser for 12 months. 9 PDO Exam means either (a) the Investment Funds Institute of Canada (IFIC) Officers, Partners and Directors Exam, or (b) CSI s Partners, Directors and Senior Officers Exam.

9 Page 9 Option C o Successful completion of the PDO Exam and meeting the proficiency requirements for an advising representative. Exemptions from the proficiency requirements may be obtained in cases where the regulator is satisfied that an individual s qualifications are equivalent to, or more appropriate in the circumstances than, the prescribed criteria. Capital Requirements: PMs are subject to capital requirements. A PM s excess working capital (calculated as prescribed and certified by management) must not be less than zero for two consecutive days, and the PM must maintain minimum capital of $25,000 at all times. Negative excess working capital at any time must be reported to the regulator as soon as possible. Insurance: PMs must maintain bonding or insurance coverage containing the following clauses fidelity, on premises, in transit, forgery or alternations and securities. The coverage must include either a double aggregate limit or a full reinstatement of coverage provision. The coverage required to be maintained by PMs depends on whether the PM holds or has access to clients assets. If not, the PM must maintain coverage in the amount of $50,000 for each clause. If so, the coverage must be in the greater of the following amounts for each clause: o 1% of assets under management or $25,000,000, whichever is less; o 1% of the PM s total assets or $25,000,000, whichever is less; o $200,000; and o the amount determined to be appropriate by a resolution of the directors (or individuals acting in a similar capacity). Changes to, claims under, or cancellation of such insurance policy must be reported in writing to the regulator as soon as possible. Financial Reporting: PMs must have an auditor and file, within 90 days of its year end: o annual financial statements (with an audit report), and o a completed Form F1 Calculation of Excess Working Capital (showing excess working capital as at the end of the financial year, with the comparative amount as at the end of the preceding financial year). PMs are not required to make quarterly filings.

10 Page 10 All financial statements are to be prepared in accordance with GAAP, but on an unconsolidated basis. Fiscal year-end changes, together with the reasons for the change, must also be reported to the regulator in writing within seven days following the change. Conduct Rules NI contains detailed and technical conduct requirements for all registrants, including PMs. The regulators consider compliance to be a firm-wide responsibility to be carried out in accordance with a documented compliance system which must address, among other things, the following elements. Compliance System: PMs must establish, maintain and apply policies and procedures that: o create a system of controls and supervision sufficient to provide reasonable assurance that the firm and each individual acting on its behalf complies with securities legislation, and o manage the risks associated with its business in accordance with prudent business practices. Account Opening and Client Documentation: Account opening and client documentation (including for KYC and suitability purposes) must be maintained and kept current. Unsuitable trades (in the firm s opinion acting reasonably) at a client s direction can be executed only if the client is first informed of their unsuitability (in the PM s opinion). Suitability exemptions are available for permitted clients who have provided a written waiver. Relationship Disclosure Information: PMs must provide relationship disclosure information before the PM first advises the client. All information that a reasonable investor would consider important about the client s relationship with the adviser must be disclosed. 10 Relationship disclosure information is not required to be given to permitted clients who have provided a written waiver, but it is required in respect of a managed account for permitted clients. Leverage disclosure: Where a client is using borrowed money to finance any part of the purchase of a security, a written statement of the risks of leverage must be provided to a client, with certain exceptions (including for permitted clients or where the proposed 10 For example, relationship disclosure information would include a discussion that identifies which products or services are offered by the firm, a discussion of the types of risk a client should consider when making an investment decision, a description of the conflicts of interest that the adviser is required to disclose under securities legislation, and disclosure of all costs for the operation of an account.

11 Page 11 purchase is on margin and the client s margin account is maintained at a registered firm in accordance with SRO margin rules). Client Assets: Client assets that are held by a PM must be segregated and held in trust for the client (in the case of cash, in a designated trust account at a Canadian financial institution, a Schedule III bank, or a member of IIROC; and in the case of securities, in accordance with certain requirements). Margin: PMs may not lend money, extend credit or permit clients to purchase securities on margin. Record-Keeping and Retention: Record-keeping is mandated, and certain client records must be kept for at least seven years from the date the record was created, and in a manner that permits the records to be provided to the regulator in a reasonable period of time. NI does not contain a prescriptive list of records that must be kept. Instead, it requires the retention of all records that demonstrate compliance with securities legislation. Account Activity Reporting: Unless the client has otherwise directed, the adviser must deliver to clients quarterly statements of account. Complaint Handling: PMs must document, and effectively and fairly respond to, each complaint made about any product or service offered by the PM or its representatives. PMs must also ensure that independent dispute resolution services or mediation services are made available to clients at the PM s expense. Referral Arrangements: NI restricts all registrants, including PMs, from participating in referral arrangements (i.e., referring clients) unless: o a written referral agreement exists between the PM and the person or company making the referral; and o the referred clients are provided with written disclosure setting out the key terms of the referral agreement. (iii) Conflicts of Interest NI consolidates a number of conflicts of interest requirements that previously appeared in various places in securities legislation. It requires a PM to make reasonable efforts to identify material conflicts of interest or potential conflicts of interest and, where the client, acting reasonably, would expect to be informed of such a conflict of interest, to disclose the nature and extent of the conflict of interest to the client. The CSA provide extensive guidance in Companion Policy CP on the application of the principals governing the conflicts of interest requirement.

12 Page 12 NI prohibits a PM from implementing certain types of transactions for investment portfolios managed by it. Among the types of transactions prohibited for a PM is the purchase or sale of a security between investment portfolios managed by the PM or other responsible persons. A PM is required to ensure fairness in the allocation of investment opportunities among its clients. Registrations in Multiple Categories If a firm is registered in more than one category, the firm need only meet the most stringent of the applicable capital and insurance requirements. 11 The capital and insurance requirements are not cumulative. The business of a PM may give rise to multiple registration requirements. For example, a PM that also manages a pooled fund will also have to register as an IFM. Further, a PM that manages a pooled fund and distributes units of the pooled fund to investors other than managed account clients of the PM will also have to register as a dealer. 12 Participation Fees In Ontario, firms registered as a PM are required to pay the capital markets participation fees under OSC Rule Fees. Annual fees are also applicable in other jurisdictions. No Renewal Process for Registration Under NI , registration does not have to be renewed annually, and will remain in effect until surrendered, suspended or revoked. Suspension and Revocation of Registration While registration does not have to be renewed annually, a PM firm's ability to continue carrying on registerable activities is contingent upon the firm continuing to meet the fit and proper standard. Similarly, an individual s ability to continue serving in the capacity of advising representative, associate advising representative, CCO, or UDP is 11 There is an exemption to the rule that a multiple-category registrant must satisfy the most stringent capital requirement. Where a PM is also registered as an IFM in circumstances in which it relies on the dealer registration exemption (described earlier in this Commentary), it is exempted from the $100,000 minimum capital requirement applicable to the IFM registration, meaning it need only satisfy the lower $25,000 minimum capital requirement applicable to PM registration. 12 If dealer registration is required, the exemption described in the previous note will not be available and the PM will be required to meet the highest applicable minimum capital requirement (i.e., $100,000).

13 Page 13 contingent on the individual continuing to meet the applicable fit and proper standard. Under NI , the regulators have a more immediate ability to suspend registration. In addition, a firm's registration will be suspended automatically if it fails to pay its annual fees within 30 days of the due date. Transition Requirements NI provides some transitional relief by allowing time after the effective date for meeting the new requirements. The transition periods that apply to PMs are as follows (with dates shown in brackets based on implementation of NI on September 28, 2009 as currently anticipated): General Transition Provisions: o A firm currently registered as an investment counsel, portfolio manager, portfolio manager/investment counsel or unrestricted practice adviser will be automatically registered in the new PM category. o 3 months (December 28, 2009) for the firm to designate its UDP and to apply for registration of the individual as UDP. o 3 months (December 28, 2009) for the firm to designate its CCO and to apply for registration of the individual as CCO. o 6 months (March 28, 2010) for the firm to satisfy bonding or insurance requirements. o 6 months (March 28, 2010) for the firm to comply with referral arrangements requirements. o 12 months (September 28, 2010) for the firm to deliver relationship disclosure information. o 12 months (September 28, 2010) for firms to satisfy capital requirements. o 24 months (September 28, 2011) for firm to ensure that independent dispute resolution or mediation services are made available to clients to resolve complaints. Specific Transition Rules for Individuals: o Individuals currently registered (and in each case who remain registered) as an advising representative of a portfolio manager and

14 an associate advising representative of a portfolio manager 13 will not be required to satisfy the new proficiency requirements. o Individuals designated on the National Registration Database as CCOs on the effective date will not be required to satisfy the new proficiency requirements. Page 14 Currently in Ontario, an associate advising representative may apply to upgrade to become an advising representative after three years with no requirement for additional course work. That is no longer the case under NI Under the new rules, if an individual is an associate advising representative in Ontario on September 28, 2009, that individual will need to meet the new proficiency criteria in order to become an advising representative. For any associate advising representative who currently has more than three years experience, it will be beneficial to apply to upgrade that individual to advising representative prior to September 28, 2009 to avoid the additional course work that will be required if upgrading is sought later. Other Registration Reforms NI and the new rules include other significant changes to registration requirements for dealers, advisers and investment fund managers in Canada. * * * * * The Registration & Compliance Alliance has the legal, regulatory, financial and operational experience and expertise to assist you with all aspects of registration and compliance under NI Getting the right people for the job will produce the best results. 13 Including an advising representative with terms and conditions on his or her registration that are equivalent to the scope of authority of an associate advising representative under NI

15 Page 15 We will be issuing further bulletins on other aspects of NI in the weeks to come. For further details, or if you have any questions concerning NI , please contact: Peter Dunne Leader, Registration & Compliance Practice Cassels Brock & Blackwell LLP David Gilkes Vice President Sutton Boyce Gilkes Regulatory Consulting Group Inc * * * * * This bulletin is published by the Registration & Compliance Alliance to keep our clients and friends informed of new and important legal, regulatory and compliance issues. It is not intended to provide legal advice as individual situations will differ and should be discussed with counsel Cassels Brock & Blackwell LLP. Cassels Brock and the CB logo are registered trade-marks of Cassels Brock & Blackwell LLP. The SBG logo is a trade-mark of Sutton Boyce Gilkes Regulatory Consulting Group Inc. All rights reserved.