Chapter 3. The Canadian Regulatory Environment CSI GLOBAL EDUCATION INC. (2013) 3 1

Transcription

1 Chapter 3 The Canadian Regulatory Environment 3 1

2 3 The Canadian Regulatory Environment CHAPTER OUTLINE Who are the Regulators? Federal Regulators The Provincial Regulators The Self-Regulatory Organizations Investor Protection Funds Role of Arbitration Ombudsman for Banking Services and Investments What are the Principles of Securities Legislation? Full, True and Plain Disclosure Registration The National Registration Database (NRD) Know Your Client Rule Client Relationship Model (CRM) What are the Ethics of Trading? Examples of Unethical Practices Prohibited Sales Practices What are Public Company Disclosures and Investor Rights? Continuous Disclosure Statutory Rights for Investors Proxies and Proxy Solicitation 3 2

3 What are Takeover Bids and Insider Trading? Takeover Bids Insider Trading Summary LEARNING OBJECTIVES By the end of this chapter, you should be able to: 1. Identify and describe the agencies and legal entities through which the Canadian securities industry is regulated. 2. Evaluate the role the self-regulatory organizations (SROs) play in the regulatory process. 3. Discuss the principles that underlie securities legislation. 4. Identify unethical practices and conduct in securities trading. 5. Describe the rules for public company disclosure and the statutory rights of investors. 6. Explain how takeover bids and insider trading are regulated. GOALS OF REGULATION So far we have learned that fi nancial markets and fi nancial intermediaries developed over time to meet the ever-evolving needs of investors. While true, what we also need to consider are the ways in which industry regulation have evolved to protect investors and the industry itself. Although investor protection is the primary goal of securities regulation, it is not the only goal. The various Canadian regulatory bodies play a key role in fostering market integrity. What do we mean by market integrity? We have learned that productive investing takes place when savings are funnelled through the capital markets to the various products, for example, stocks and bonds, so that they are channelled into investments and projects that will yield the greatest benefi t. For this to happen effi ciently, investors must feel confi dent that they will be treated fairly and equally when participating in the capital markets. Ultimately, what this means is that individuals and institutions can invest with confi dence in open and fair capital markets. 3 3

4 How does the industry achieve this lofty goal? There are a variety of ways. The industry has developed high professional standards and educational programs to ensure the competence of industry employees. Investor protection funds are in place to protect individual investors in the unlikely event that a fi rm goes bankrupt. The regulatory bodies have the authority to prosecute individuals and fi rms that are suspected of wrongdoing. Also, they can impose penalties in the form of reprimands, fi nes, suspensions, and expulsion where fault has been proven. The focus of this chapter is an overview of the regulatory environment in Canada. We look at the role of the various regulatory bodies, the principles of regulation, and the rights of investors. KEY TERMS Arbitration Autorité des marchés fi nanciers (AMF) Benefi cial owner Canada Deposit Insurance Corporation (CDIC) Canadian Investor Protection Fund (CIPF) Canadian Securities Administrators (CSA) Director s circular Insiders Investment Advisors (IAs) Investment Representatives (IRs) Mutual Fund Dealer Association Investor Protection Corporation (MFDA IPC) Material change National Do Not Call List (DNCL) National policies National Registration Database (NRD) New Account Application Form Nominee Offi ce of the Superintendent of Financial Institutions (OSFI) Ombudsman for Banking Services and Investments (OBSI) Proxy Reporting issuer Right of action for damages Right of rescission Right of withdrawal Self-Regulatory Organizations (SROs) Takeover bid Universal Market Integrity Rules (UMIR) 3 4

5 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 5 WHO ARE THE REGULATORS? In this chapter, we examine the regulatory role played by federal regulators, the provincial securities regulators, the self-regulatory organizations (the SROs), and the various investor protection funds. Federal Regulators THE OFFICE OF THE SUPERINTENDENT OF FINANCIAL INSTITUTIONS The Office of the Superintendent of Financial Institutions (OSFI) is a regulatory body for all federally regulated financial institutions. OSFI is responsible for regulating and supervising: 153 deposit-taking institutions including banks, trust and loan companies, and cooperative credit associations 284 insurance companies, including life insurance companies, fraternal benefit societies and property & casualty insurance companies 29 foreign bank representative offices that are chartered, licensed or registered by the federal government 1,200 federally regulated pension plans. OSFI does not regulate the Canadian securities industry. CANADA DEPOSIT INSURANCE CORPORATION (CDIC) The Canada Deposit Insurance Corporation (CDIC) is a federal Crown Corporation that provides deposit insurance and contributes to the stability of Canada s financial system. CDIC insures eligible deposits up to $100,000 per depositor in each member institution (banks, trust companies and loan companies), and reimburses depositors for the amount of any insured deposits if a member institution fails. To be eligible for insurance, deposits must be held with a member institution in Canadian currency and payable in Canada. Term deposits must be repayable no later than five years from the date of deposit. The $100,000 maximum includes all insurable types of deposits you have with the same CDIC member. Deposits at different branches of the same member institution are not insured separately. Accounts and products insured by CDIC include: Savings and chequing accounts Guaranteed investment certificates (GICs) and other term deposits that mature in five years or less Money orders, certified cheques, traveller s cheques and bank drafts Accounts that hold realty taxes on mortgaged properties

6 3 6 CANADIAN SECURITIES COURSE VOLUME 1 These accounts and products must be held at a CDIC member and in Canadian dollars to be eligible for deposit insurance. CDIC does not insure: Mutual funds and stocks GICs and other term deposits that mature in more than five years Bonds and Treasury bills Debentures issued by governments, corporations, or chartered banks Deposits held in foreign currency It is possible to have more than $100,000 in deposits eligible for CDIC coverage, provided the deposits are held in more than one of CDIC s six deposit insurance categories. These categories include deposits held: in one name jointly in more than one name in a trust account in a registered retirement savings plan (RRSP) in a registered retirement income fund (RRIF) in a mortgage tax account Example: If a depositor has $80,000 cash on deposit in her own name and in the same institution $120,000 on deposit in a registered retirement savings plan, CDIC would insure her deposits in the amount of $180,000 ($80,000 fully covered for the cash deposit in her own name and a maximum of $100,000 covered for her registered retirement savings plan). Since 1967, CDIC has provided protection to depositors in 43 member institution failures. As of April 30, 2011, the CDIC insured more than $622 billion in deposits. The Provincial Regulators In Canada, the regulation of the securities business is a provincial responsibility. Each province and the three territories is responsible for creating the legislation and regulation under which the industry must operate. In several provinces, much of the day-to-day regulation is delegated to Securities Commissions. In other provinces, securities administrators, who are appointed by the province, take on the regulatory function. In Québec, the regulatory body is neither a securities commission nor a securities administrator and its power is not limited to the securities industry only. The Autorité des marchés financiers (AMF) is responsible for administering the regulatory framework for Québec s financial sector, notably in the areas of insurance, deposit insurance institutions, the distribution of financial products, financial services, and securities.

7 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 7 The 13 securities regulators of Canada s provinces and territories joined together to form the Canadian Securities Administrators (CSA), a forum to co-ordinate and harmonize regulation of the Canadian capital markets. The mission of the CSA is to give Canada a securities regulatory system that protects investors from unfair, improper or fraudulent practices and that fosters fair, efficient and vibrant capital markets. PROVINCIAL INSURANCE CORPORATIONS In each province, one or more organizations exist to protect the deposits of credit union members. This organization may be called a deposit insurance or deposit guarantee corporation or stabilization fund, corporation, board or central credit union. Terms and maximum coverage may vary by province, so it is important to check with your province to determine the specific coverage available. Table 3.1 gives an overview of terms and coverage in three Canadian provinces. TABLE 3.1 DEPOSIT INSURANCE CORPORATION OF SOME PROVINCES Province Deposit insurance corporation Maximum Amount Insured Financial institutions covered Accounts and products insured Ontario Deposit Insurance Corporation of Ontario $100,000 All credit unions and caisses populaires in the province The combined principal, interest, and dividends relating to that member s total deposits. RRSP or RRIF contracts and unique trust or joint accounts are separately insured British Columbia Credit Union Deposit Insurance Corporation (CUDIC) No limit to the amount insured All credit unions in the province Money on deposit Money invested in non-equity shares Accrued interest and declared and unpaid dividends Quebec Autorité des Marchés Financiers $100,000 All Caisses Populaires in the province Savings and chequing accounts; Guaranteed investment certifi cates (GICs) and other term deposits that mature in fi ve years from the date of deposit; Drafts, certifi ed cheques and travellers cheques

8 3 8 CANADIAN SECURITIES COURSE VOLUME 1 The Self-Regulatory Organizations Self-Regulatory Organizations (SROs) are private industry organizations that have been granted the privilege of regulating their own members by the provincial regulatory bodies. SROs are responsible for enforcement of their members conformity with securities legislation and have the power to prescribe their own rules of conduct and financial requirements for their members. SROs are delegated regulatory functions by the provincial regulatory bodies, and SRO by-laws and rules are designed to uphold the principles of securities legislation. The provincial securities commissions monitor the conduct of the SROs. They also review the rules of the SROs in the province to ensure that the SRO rules do not conflict with securities legislation and are in the public s interest. SRO regulations apply in addition to provincial regulations. If an SRO rule differs from a provincial rule, the most stringent rule of the two applies. Canadian SROs include the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA). Complete the following Online Learning Activity The Canadian Securities Industry Overview The securities industry is regulated by a number of provincial and selfregulatory bodies and a number of fi nancial intermediaries play important roles within the industry. This activity reviews the main stakeholders of the Canadian securities industry. Read the Canadian Securities Industry Overview. THE INVESTMENT INDUSTRY REGULATORY ORGANIZATION OF CANADA The Investment Industry Regulatory Organization of Canada (IIROC) was created through the consolidation of the Investment Dealers Association of Canada (IDA) and Market Regulation Services Inc. (RS). The new organization was approved by the CSA and officially launched on June 1, 2008 with a mandate to oversee all investment dealers and trading activity on debt and equity marketplaces in Canada. IIROC carries out its regulatory responsibilities through setting and enforcing rules regarding the proficiency, business and financial conduct of dealer member firms and their registered employees and through setting and enforcing market integrity rules regarding trading activity on Canadian equity marketplaces. IIROC s mandate is to set high quality regulatory and investment industry standards, protect investors and strengthen market integrity while maintaining efficient and competitive capital markets. IIROC plays the following roles: Financial Compliance: Includes monitoring dealer members to ensure they have enough capital to carry out their operations.

9 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 9 Business Conduct Compliance: Includes monitoring dealer members to ensure policies and procedures are in place to properly supervise the handling of client accounts. Registration: Responsibility for overseeing professional standards and educational programs designed to maintain the competence of industry employees. Enforcement: Includes responsibility for enforcing the rules and regulations that cover sales, business, and financial practices and trading activities of individuals and firms that are under IIROC s jurisdiction. IIROC also conducts market surveillance by regulating securities trading and market-related activities of participants on Canadian equity marketplaces. Market surveillance includes: Real time monitoring of trading activity on stock exchanges, the Natural Gas Exchange Inc., and Alternative Trading Systems across Canada. Ensuring dealer members comply with the timely disclosure of information by publiclytraded companies in Canada. Carrying out trading analysis and compliance with the Universal Market Integrity Rules (UMIR). THE INVESTMENT INDUSTRY ASSOCIATION OF CANADA The former IDA s mission was twofold: to act as the self-regulatory organization of the industry to protect investors and to act as a professional association for its members. On April 1, 2006, the professional association was separated from the SRO function and a new association was created, the Investment Industry Association of Canada (IIAC). The IIAC is a member-based professional association that represents the interests of market participants. The IIAC provides support and services that contribute to the success of their members. It also represents the investment industry s views and interests to federal and provincial governments and their agencies, and to other SROs. THE MUTUAL FUND DEALERS ASSOCIATION The Mutual Fund Dealers Association (MFDA) is the mutual fund industry s self-regulatory organization responsible for regulating the distribution and sales of mutual funds by its members in Canada. The MFDA does not regulate the mutual funds themselves, as this responsibility has remained with provincial securities commissions. The MFDA is recognized as an SRO by Alberta, British Columbia, Nova Scotia, Ontario, Saskatchewan, New Brunswick and Manitoba. The MFDA has the ability to admit members, to audit, to enforce rules and apply penalties.

10 3 10 CANADIAN SECURITIES COURSE VOLUME 1 Complete the following Online Learning Activity The Canadian Regulatory Environment: the Client-Advisor Relationship OSFI, CDIC, CSA, and SROs are regulators and agencies that regulate the securities industry in Canada. In this activity, you ll review your understanding of these agencies along with examples of their jurisdictions. You ll also use your knowledge to assess a situation in a case involving a client and his advisor. Review your understanding of the Canadian Regulatory Environment. Work through the Client-Advisor activity. Investor Protection Funds The securities industry offers the investing public protection against loss due to the financial failure of any firm in the self-regulatory system. To foster continuing confidence in the firmcustomer relationship, the industry created the Canadian Investor Protection Fund (CIPF) in 1969 and the Mutual Fund Dealer Association Investor Protection Corporation (MFDA IPC) in CANADIAN INVESTOR PROTECTION FUND The primary role of the CIPF is investor protection and its secondary role is overseeing the self-regulatory system. The secondary role provides a mechanism to help CIPF contain the risk associated with its primary role. The Fund protects eligible customers in the event of the insolvency of an IIROC dealer member. The CIPF does not cover customers losses that result from changing market values, and accounts held at mutual fund companies, banks and other firms that are not members of IIROC. The CIPF is sponsored solely by IIROC and funded by quarterly assessments on dealer members. As of December 2011 the CIPF had $650 million of resources to pay customers claims. Since its inception, the CIPF has paid claims totalling $36 million to eligible customers of 18 insolvent members. GENERAL ACCOUNT AND SEPARATE ACCOUNTS All accounts of a customer are covered either as part of the customer s general account or as a separate account. Accounts of a customer such as cash, margin, short sale, options, futures and foreign currency are combined and treated as one general account entitled to the maximum coverage. Joint accounts are presumed to be equally divided in value among each owner of the account. Separate accounts are accounts disclosed in the records that are treated as if they belonged to a separate customer, and they are each entitled to the maximum coverage. Each separate account held in the same capacity is combined to constitute a single separate account. For example, two

11 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 11 registered retirement accounts held for the benefit of the customer s retirement are combined into one separate account. Two trust accounts held for the benefit of different beneficiaries would not be combined into a single separate account. Examples of separate accounts include: The combination of all registered retirement plans such as RRSPs and registered retirement income funds (RRIFs), life income funds (LIFs), locked-in retirement accounts or plans (LIRAs or LIRSPs) and locked-in retirement income funds (LRIFs). Registered education savings plans (RESPs). Partnerships. Trusts. COVERAGE The CIPF covers customers losses of securities and cash balances that result from the insolvency (the inability to pay debts as they come due; also referred to as bankruptcy) of an IIROC dealer member, within the limits described below. Coverage provided for a customer s general account is limited to $1,000,000 for losses related to securities and cash balances. Separate accounts of customers are each entitled to the maximum coverage of $1,000,000 unless they are combined with other separate accounts. The maximum amount of financial loss that CIPF may pay to a customer is the shortfall between any available securities and cash that the customer is entitled at the date of insolvency and the distribution of any assets of the insolvent dealer member, less any amounts owed by the client to the member. Example: Judy has $2 million invested in securities and cash with ABC Investment Inc. when ABC declares bankruptcy. She did not owe any amount to ABC. At the time of bankruptcy, the market value of all accounts held by ABC was $100 million, but the amount available for distribution to clients after the bankruptcy was $80 million. Here s how CIPF determines their involvement: ABC has a shortfall of $20 million to cover client accounts. ABC can cover only 80% of Judy s account, or $1.6 million ($80 million divided by $100 million is 80% and 80% of $2 million is $1.6 million). The CIPF will step in to cover this shortfall up to the $1 million maximum per account. Judy will receive $1.6 million from ABC and $400,000 from the CIPF; no loss to her. Customers have 180 days to file a claim with the CIPF. The 180-day period commences on the date of bankruptcy, if applicable, or the date of insolvency as determined and communicated by the CIPF. In the event of the insolvency of a dealer member, CIPF would normally expect to petition the court under the Bankruptcy and Insolvency Act (BIA) to appoint a trustee to liquidate the firm and protect its customers. The trustee and CIPF will usually arrange to have customer accounts transferred in whole or in part to another CIPF dealer member. Customers whose accounts

12 3 12 CANADIAN SECURITIES COURSE VOLUME 1 are transferred are notified promptly to deal with the new firm or subsequently transfer their accounts to firms of their own choosing. This procedure minimizes disruption in customers trading activities and access to their assets. REGULATORY OVERSIGHT As well as protecting investors through the actual fund, CIPF provides regulatory oversight by working with the financial examiners and senior regulatory officials. Their role includes: anticipating and solving financial problems of dealer members, and helping to bring about an orderly wind-down of business if required. conducting an annual evaluation of the SRO s examination activities to ensure compliance with CIPF Minimum Standards. conducting financial examinations of dealer members to ensure compliance with the CIPF Minimum Standards. establishing and reviewing national standards for capital adequacy and liquidity, financial reporting, accounting records, segregation of clients fully and partly paid securities and insurance. co-ordinating surveillance and enforcement efforts of the examination staff. maintaining a close liaison with the panel of public firms approved to audit and report annually on dealer members. MUTUAL FUND DEALERS ASSOCIATION INVESTOR PROTECTION CORPORATION The MFDA Investor Protection Corporation (MFDA IPC) provides protection for eligible customers of insolvent MFDA member firms. The IPC does not cover customers losses that result from changing market values, unsuitable investments, or the default of an issuer of a mutual fund. The coverage provided is limited to $1,000,000 per customer account for losses related to securities, cash balances, segregated funds, and certain other property held in the account of a MFDA member firm. Following the structure of the CIPF, customer accounts are covered either as part of a general account or as a separate account. Each account is eligible for up to $1,000,000 in coverage. Separate accounts include registered retirement accounts, such as Registered Retirement Savings Plans (RRSPs) or Registered Retirement Income Funds (RRIFs). These accounts are combined into one separate account for coverage purposes. General and separate accounts held with one MFDA member firm are not combined with accounts customers might hold at another member firm. The MFDA is not recognized as a self-regulatory organization in the province of Québec. Consequently, the MFDA IPC coverage is not currently available to customers with accounts held in Québec MFDA member firms.

13 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 13 Role of Arbitration There are times when clients feel that they have been treated unfairly by a firm that is a member of an SRO. If, after discussing the problem with the firm, they still feel mistreated, clients have the option of suing the firm or requesting arbitration. Arbitration is a method of dispute resolution in which an independent arbitrator is chosen to: Listen to the facts and arguments of the parties to a dispute; Decide how the dispute should be resolved; and Decide what remedy, if any, should be imposed. SROs can only discipline member registrants and cannot order restitution to be made to clients. The SROs therefore offer dissatisfied investors the option of pursuing damages through arbitration rather than in court. Arbitration may also be cheaper and faster than a court action, particularly where smaller amounts of money are concerned. A client must receive an arbitration brochure when opening an account. If a written complaint has been received, a current brochure must be sent to the client. If a client requests arbitration from an SRO, the dealer member must accept both the process and the arbitrator s decision. To be eligible for arbitration, the dispute must meet the following criteria: Attempts must have been made to resolve the dispute with the investment dealer. The claim cannot exceed $100,000. The events in dispute must have originated after January 1, 1992 in British Columbia, after January 1, 1996 in Québec, after June 30, 1998 in Ontario, after July 1, 1999 in Alberta, Saskatchewan and Manitoba, and after June 30, 1999 in Newfoundland, Prince Edward Island, New Brunswick and Nova Scotia. Claims that do not fit within the dollar amount mentioned above may still be arbitrated if both parties agree to the process. The decision of the arbitrator is binding, and at the beginning of the arbitration process both parties must sign an agreement to give up the right to pursue the matter further in the courts. Ombudsman for Banking Services and Investments Another avenue for investors who feel that they have been treated unfairly is the Ombudsman for Banking Services and Investments (OBSI). OBSI is an independent organization that investigates customer complaints against financial services providers, including banks and other deposit-taking organizations, investment dealers, mutual fund dealers and mutual fund companies. It provides a prompt and impartial resolution of complaints that customers have been unable to resolve with their financial services provider. The OBSI is independent of the financial services industry. The process is not binding for either the investor or the financial services provider. However, member companies who do not agree to a recommendation by the Ombudsman will be publicly reported. To date no member has failed to follow the Ombudsman s recommendation.

14 3 14 CANADIAN SECURITIES COURSE VOLUME 1 WHAT ARE THE PRINCIPLES OF SECURITIES LEGISLATION? The securities industry has extensive legislation and regulation to protect the investor and to ensure high ethical standards. This protection flows from self-regulatory organizations (SROs) as well as the provincial securities regulators and administrators. Regulation is covered in much greater detail in CSI s The Conduct and Practices Handbook (CPH) course. Some of the basic concepts are covered here. Provincial securities acts are designed to regulate the underwriting, distribution and sale of securities, and to protect buyers and sellers of securities. The term act is used here to refer to the securities act or the securities-related legislation of a province. The term administrator is used to describe the securities regulatory authority of a province, whether it is a commission, registrar or other government official. No federal regulatory body for the securities industry exists in Canada, in contrast to the United States where the national Securities and Exchange Commission (SEC) has considerable regulatory authority. With increasing involvement in the investment business by federally regulated financial institutions such as banks, trusts and insurance companies, the number of National Policies issued by the CSA has increased. These National Policies attempt to create a regulatory environment that is harmonized throughout each and every provincial jurisdiction. Formal conferences of provincial administrators are held regularly and informal consultation and co-operation is continuous. Full, True and Plain Disclosure The general principle underlying Canadian securities legislation is full, true and plain disclosure of all pertinent facts by those offering the securities for sale to the public. Until disclosure is made to the satisfaction of the administrator concerned, it is illegal to offer such securities for public sale. As discussed earlier, such disclosure is normally made in a prospectus issued by the company and accepted for filing by the administrator concerned. The laws are designed to prevent, as far as possible, fraud and deceit and to protect the investor from his or her own naiveté due to a lack of information or undue selling pressure from investment service providers. Nevertheless, no legislation supplants the rule that one must investigate before one invests or recommends an investment. Generally, the acts use three basic methods to protect investors: registration of securities dealers and advisors, disclosure of facts necessary to make reasoned investment decisions and enforcement of the laws and policies. The industry also relies on the SROs for their members compliance to legislation. Registration Generally, every firm and all investment advisors (IAs) employed by such firms must be registered. As well as granting registrations, administrators have the power to suspend or cancel registration or otherwise discipline registrants. Investment advisors are licensed to give advice to clients.

15 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 15 All employees of IIROC dealer members who deal with the investing public must register with IIROC as well as with the applicable administrator. Such employees must meet IIROC s requirements for approval which include, as a minimum, completion of the Canadian Securities Course (CSC) and an examination based on the Conduct and Practices Handbook (CPH) course. New investment advisors must also complete a 90-day training program before they are permitted to deal with the public. After licensing, the registrant is subject to a six-month period of supervision by his or her supervisor. New registrants must also complete CSI s Wealth Management Essentials Course (WME) within 30 months of becoming licensed as an IA. Participation in the industry s Continuing Education program is also a condition of maintaining a licence. Applicants not giving any advice to clients may choose to be registered as investment representatives (IRs). The proficiency requirements for IRs are similar to those for IAs, with the exception of the length of the training period (30 days as opposed to 90 days) and the 30-month requirement. In order to become a Sales Manager, the candidate must successfully complete the Branch Managers Course (BMC). Within 18 months they must also complete the Effective Management Seminar (EMS). Both courses are offered by CSI. Firms may have full registration, allowing employees a fair amount of latitude in their dealings with the public. Some firms, such as mutual fund dealers, are restricted as to their permitted activities. IAs should be aware of any restrictions that apply to their firms. REGISTRATION CATEGORIES Dealer members have several job positions where individuals must be registered. National Instrument (NI) , Registration Requirements, and IIROC Rule 2900, Proficiency and Education, lists the registration categories within a dealer member, all of which are distinguished by their functions: Dealing Representative Trader Supervisor Executive Director Ultimate Designated Person Includes mutual fund representatives, investment representatives (or IRs), and registered representatives (also referred to as investment advisors or IAs). IAs are approved to give investment advice. Approved to enter orders into the trading systems of specifi c exchanges. Approved to supervise the business activities of other approved persons. Approved to participate in the executive management of a dealer member. Approved to sit on the Board of Directors of a dealer member or occupy a similar position in a dealer member not organized as a corporation. The Chief Executive Offi cer of a dealer member or person in a similar position, approved to have overall responsibility for the dealer member s compliance with laws and regulations, including IIROC Rules, governing its securities related activities.

16 3 16 CANADIAN SECURITIES COURSE VOLUME 1 Chief Financial Officer (CFO) Chief Compliance Officer (CCO) Approved to be responsible for ensuring that the dealer member complies with the fi nancial adequacy requirements of IIROC Rules. Approved to be responsible for ensuring that the dealer member has systems and controls reasonably designed to ensure its compliance with laws and regulations, including IIROC Rules, governing its business conduct. The National Registration Database (NRD) The National Registration Database (NRD) is a web-based system used by investment dealers and employees to file registration forms electronically when applying for approval by any one or more of the stock exchanges, the CSA or IIROC. The NRD is designed to enable a single electronic submission to satisfy all jurisdictions in Canada, rather than a registrant having to file separate registration forms in each jurisdiction. The NRD also allows regulators to verify registration status in other jurisdictions. Both the IA and the dealer member are required to notify the applicable SROs immediately in writing of any material changes in the original answers to the questions on the NRD application (e.g., change of address). Also, each dealer member is required to immediately report to the administrators and SROs to which it belongs, the termination of an IA. If the IA is dismissed for cause, a statement of the reasons for the dismissal must be reported. Know Your Client Rule The SROs require that dealer members and their investment advisors: Learn the essential facts relative to every client and to every order or account accepted the know your client rule. Ensure that the acceptance of any order for any account is within the bounds of good business practice. Ensure that recommendations made for any account are appropriate for the client and in keeping with his or her investment objectives, personal circumstances and tolerance to bearing risk the suitability principle. The first step in complying with this regulation is completion of a New Account Application Form (NAAF) prior to the acceptance of any order. A partner, director, officer or branch manager of the advisor s firm must approve the application prior to or promptly after the completion of the first transaction. Client Relationship Model (CRM) In 2012, IIROC introduced new requirements for dealer members as part of a project called the Client Relationship Model or CRM. CRM is part of a broader fundamental obligation of dealer members and their representatives to deal fairly, honestly and in good faith with clients.

17 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 17 IIROC s CRM reforms provide greater disclosure requirements for advisors which will enhance the standards they must meet when assessing the suitability of investments for their clients. The objective is increased transparency for investors surrounding the fees they pay, the services they receive, potential conflicts of interest and the performance of their accounts. RELATIONSHIP DISCLOSURE To better inform clients of the nature of their account, a dealer member must provide all clients with a relationship disclosure document that outlines the account relationship and services to be provided to the client. Some of the information that the relationship disclosure must cover includes: the types of products and services offered by the firm, the account relationship to which the client has consented, the process used by the firm to assess investment suitability and the client s KYC information, when account suitability will be reviewed, all fees and charges associated with operating, transacting and holding investments in the account, complaint handling procedures, and the reporting the client will receive, including when account statements and trade confirmations will be sent and a description of the firm s obligations to provide performance information. CONFLICTS OF INTEREST MANAGEMENT / DISCLOSURE Firms are required to develop and maintain policies and procedures to identify, disclose and address existing and potential material conflicts involving clients. All material conflict situations between an advisor and his or her clients and between the firm and its clients must be addressed by either: Avoiding the Conflict Any existing or potential material conflict of interest between the Approved Person and the client that cannot be addressed in a fair, equitable and transparent manner, and consistent with the best interests of the client or clients, must be avoided; Disclosing the Conflict A material conflict of interest situation that has not been avoided must be disclosed to the client in all cases where a reasonable client would expect to be informed; Otherwise Controlling the Conflict of Interest Situation In general, the only scenario under which a material conflict (that has not been avoided) would not be disclosed to the client would be where the Dealer Member has taken other steps to control the conflict of interest and has effectively ensured, with reasonable confidence, that the risk of loss to the client has been eliminated.

18 3 18 CANADIAN SECURITIES COURSE VOLUME 1 SUITABILITY ASSESSMENT The CRM Guidelines require that the suitability of an investment decision be conducted whenever any of the following trigger events occur: A trade is accepted A recommendation is made Securities are transferred or deposited to an account There is a change of representative, or portfolio manager responsible for the account; or There is a material change to the KYC information for the account CRM was approved by the CSA on March 22, 2012 and will be implemented in stages, effective from the approval date. WHAT ARE THE ETHICS OF TRADING? Ethical trading is of paramount importance to both the investing public and the users of the capital markets, the listing corporations. If trading on an exchange were considered unethical it would be impossible for corporations to raise the money they require for expansion and growth because the investing public would simply not participate. The exchanges and the SROs have developed extensive rules and regulations with the securities regulators to govern trading. Infractions may lead to fines, suspension, expulsion and even criminal charges. Unethical conduct may be defined as any omission, conduct, manner of doing business or negotiation, which in the opinion of the disciplinary body is not in the public interest nor in the interest of the exchange. Examples of Unethical Practices The following are examples of practices which are considered unethical: Any conduct which has the effect of deceiving the public, the buyer or the vendor as to the nature of any transaction price or value of such security; Creating or attempting to create a false or misleading appearance of active public trading in a security, e.g., fictitious orders for the same security placed with a variety of securities firms or a series of orders for one security in an attempt to create a false impression of market interest; Entering or attempting to enter into any scheme or arrangement to sell and repurchase a security in an effort to manipulate the market; Deliberately causing the last sale for the day in a security to be higher than warranted (window dressing);

19 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 19 Making a fictitious trade or giving or accepting an order which involves no change in the beneficial ownership of a security for the purposes of misleading the public; Confirming a transaction where no trade has been executed (bucketing); Improper solicitation of orders either by telephone or otherwise; High pressure or other selling techniques considered undesirable; Violation of any statute applicable to the sale of securities; Leading a client to believe that there is no risk through opening or trading in an account or purchasing a specific security; Making a practice of effecting a trade for the advisor s own account prior to effecting a trade for a client (front running); or Conduct that would bring the securities business, the exchanges, or IIROC into disrepute. A dealer member is responsible for the acts or omissions of all its employees. Conduct by an advisor considered unethical may be dealt with, in matters of discipline, as though it were also the conduct of the dealer member itself. Prohibited Sales Practices Securities legislation prohibiting certain types of selling activities exists for very good reasons. Unethical, dishonest, high-pressure operators will find that such regulations are designed to curb their style of selling. It is extremely important that all advisors study the rules applicable in their province and conform carefully to all the requirements. All changes in the law should be carefully noted, and the advisor should immediately conform to such changes. NATIONAL DO NOT CALL LIST Advisors often use the telephone as a tool to solicit new clients. By doing so, they are considered as telemarketers by the Canadian Radio-television and Telecommunications Commission (CRTC). The CRTC has established Rules that telemarketers and organizations that hire telemarketers must follow. They include requiring the telemarketer to subscribe to the National Do Not Call List (DNCL). The DNCL Rules prohibit telemarketers and clients of telemarketers from calling telephone numbers that have been registered on the DNCL for more than 31 days. All telemarketers and clients of telemarketers must follow these Rules unless they are making calls that are specifically exempted. Telemarketing is broadly defined and includes sales or prospecting calls. Telemarketing firms must remove or scrub their calling lists of persons included in the DNCL. Detailed information about the DNCL can be found on the CRTC s website:

20 3 20 CANADIAN SECURITIES COURSE VOLUME 1 Complete the following Online Learning Activity Employee Responsibilities In the investment industry there are three players: Investment Dealers, Investors and Employees. In this activity you ll have the opportunity to review what you ve learned about licensing requirements, Know Your Client and fi duciary a duty. Finally, work through the case we ve provided to check your understanding of the responsibilities of an advisor. Complete the Employee Responsibilities activity. WHAT ARE PUBLIC COMPANY DISCLOSURES AND INVESTOR RIGHTS? Securities legislation in each of the provinces requires the continuous disclosure of certain prescribed information concerning the business and affairs of public companies. This disclosure usually consists of periodic financial statements (including management discussion and analysis), insider trading reports, information circulars required in proxy solicitation, an annual information form (AIF), press releases and material change reports. The principle of disclosure is seen also in the requirements of the acts, regulations and policy statements of most provinces covering a distribution of securities. Generally, every person or corporation that sells or offers to sell to the public securities which have not previously been distributed to the public, or which come from a control position, is required to file with, and obtain the approval of, the administrator in the province. They must deliver to the purchaser a prospectus containing full, true and plain disclosure of all material facts related to the issue. Continuous Disclosure Once a reporting issuer has distributed securities, the issuer must comply with the timely and continuous public disclosure requirements of the acts. The primary disclosure requirements include issuing a press release and filing a material change report with the administrators if a material change occurs. A material change is a change in the business, operations or capital of an issuer that would reasonably be expected to have a significant effect on the market price or value of its securities. Issuers also must file with the administrators annual and interim financial statements meeting prescribed standards of disclosure. Companies are required to ensure that no selective disclosure of confidential material information occurs to third parties, such as during meetings with financial analysts or restricted conference calls with institutional investors. By taping all such discussions and reviewing the tapes immediately after all meetings or conference calls, a company can determine whether any previously undisclosed confidential material information was inadvertently disclosed. If it was, an immediate press release by one of its responsible officers should be released, and the appropriate regulators should be notified of the inadvertent disclosure.

21 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 21 While some securities legislation does not specifically require that the financial statements be sent directly to shareholders, provincial corporations legislation and stock exchange by-laws do make this a requirement. Most companies usually provide financial statements in the required form to all shareholders and send additional copies to the appropriate administrators. The financial disclosure provisions also require that the following information be sent to shareholders and administrators: Comparative audited annual financial statements within 120 days of the financial year-end for companies listed on the TSX Venture Exchange and 90 days for senior issuers on the TSX; Comparative unaudited quarterly interim financial statements within 60 days of the end of each of the first three quarters of the financial year for companies listed on the TSX Venture Exchange and 45 days for issuers on the TSX. Statutory Rights for Investors Canadian legislation provides three statutory rights for the purchaser of securities issued in Canada under prospectus requirements. RIGHT OF WITHDRAWAL The relevant securities legislation usually provides purchasers during a distribution by prospectus with a right of withdrawal from an agreement to purchase securities within two business days after receipt or deemed receipt of a prospectus and any amendment, by giving notice to the vendor or its agent. If a distribution that requires a prospectus is done without a prospectus, the purchaser in most provinces can revoke the transaction, subject to applicable time limits. RIGHT OF RESCISSION Most provinces give purchasers during a distribution by prospectus a right of rescission to rescind or cancel a contract for the purchase of securities, if the prospectus or amended prospectus offering the security contains a misrepresentation (e.g., an untrue statement of a material fact or an omission of a material fact). The right of rescission must be brought within 180 days of the date of the transaction. In most provinces, a purchaser alleging misrepresentation must choose between the remedy of rescission and damages. In Québec, rescission or revision of the price may be sought without affecting a purchaser s claim for damages. RIGHT OF ACTION FOR DAMAGES The acts of most provinces provide that the issuer, the directors of an issuer, the seller of a security, the underwriter who signs a certificate for a prospectus, and any other person who signs a prospectus, may be liable for damages if the prospectus contains a misrepresentation. The same right of action for damages applies to an expert (such as an auditor, lawyer, geologist or appraiser) whose report or opinion, or a summary thereof, containing a misrepresentation appears with his or her consent in a prospectus. Experts are not liable if the misrepresentation did not appear in their report or opinion. For example, liability will not arise against the underwriter or the directors if they act with due diligence by conducting an investigation sufficient to provide reasonable grounds for a belief that there has been no misrepresentation. If the person or

22 3 22 CANADIAN SECURITIES COURSE VOLUME 1 company can prove that the purchaser of the securities had knowledge of the misrepresentation, the claim may be considered invalid. The acts also provide certain limitations with respect to maximum liability that may be imposed and time limits during which an action may be brought. A misrepresentation in a prospectus may also be a criminal offence for both the issuer and any of its directors or officers who authorized, permitted or acquiesced in the making of the misrepresentation. Proxies and Proxy Solicitation Every shareholder who is registered on a company s books as owning shares is entitled to vote at the company s annual general meeting. Shareholders receive proxy resolution and voting materials and an information circular to inform them of issues for consideration at the annual meeting. The proxy form or information circular must contain, among other items, information on directors to be elected, management compensation, and any other matters of interest to management. However, it is not always possible for a shareholder to attend the annual meeting. In this case, shareholders have the option of completing a proxy form prior to the meeting. A proxy is a power of attorney given by a shareholder that gives a designated person the authority to vote the shareholder s stock. A proxy must be in writing and signed by the shareholder granting the proxy. If a shareholder does not vote or leaves the items on the proxy form unmarked, the ballot is automatically cast with management s viewpoint. It is therefore important for shareholders to read the resolutions and vote their proxy ballots. Proxy forms are available for viewing on SEDAR s (the System for Electronic Document Analysis and Retrieval) website at Most provinces require the management of a reporting issuer to solicit proxies from holders of its voting securities whenever it calls a shareholders meeting. These regulations were prompted by the realization that effective control of many companies is achieved through the use of proxies and that management could abuse its position in this area by soliciting proxies without proper disclosure. Shares are most often registered in street form; that is, in the name of a bank, investment dealer or the Canadian Depository for Securities, rather than the true beneficial owner of the shares. In such cases, the institution in whose name the securities are registered would be known as the nominee. To ensure that all shareholders receive or could receive corporate information, the administrators introduced a policy requiring the nominees to mail out to all beneficial holders of corporate securities materials relating to meetings as well as certain shareholder information and voting instruction forms. This policy was designed to ensure that non-registered holders have the same access to corporate information and the same voting privileges as registered holders. WHAT ARE TAKEOVER BIDS AND INSIDER TRADING? The securities legislation of most provinces contains provisions regulating takeover bids. Takeover bid legislation is basically designed to safeguard the position of shareholders of a company that is the target of a takeover by ensuring that each shareholder has a reasonable opportunity and adequate information to consider the bid.

23 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 23 Takeover Bids A takeover bid is an offer to the shareholders of a company to purchase the shares of the company that, with the offeror s already owned securities, will in total exceed 20% of the outstanding voting securities of the company. In a takeover situation, the company (or individual) making the offer, if successful, will obtain enough shares to control the targeted company. The definition includes an offer to purchase, an acceptance of an offer to sell, and a combination of the two. A takeover bid that is not exempted under the relevant act must comply with a number of rules including the following: The takeover bid must be sent to all holders in the province of the class of securities sought, including securities that are convertible into securities of that class prior to the expiry of the bid. The offeror shall deliver a takeover bid circular setting out certain prescribed information. This includes details about the bid, the offeror s holdings in the target company and its relation to management of the target company. A directors circular must be sent to the security holders of the target company within 15 days of the date of the bid. The board of directors of the target company is required to provide certain information and to include either a recommendation to accept or reject the takeover bid and the reason for their recommendation. If that is not done, then the board is required to issue a statement that they are unable to make or are not making a recommendation. If no recommendation is made, they must specify the reasons for not making a recommendation. Any securities taken up by the offeror under the bid must be paid for within three business days. A takeover bid is exempt from the above requirements in any of the following cases: It is made through the facilities of the exchange in accordance with the by-laws, regulations and policies of such exchange. It involves acquisitions which do not aggregate more than 5% of the securities of a class within a 12-month period and the price paid for any of the securities does not exceed the market price at the date of acquisition. It is an offer by way of private agreement with five or fewer security holders at a price not exceeding 115% of the market price of the securities. It is an offer to purchase shares in a private company. In Ontario only, it is an offer where the number of holders of securities subject to the bid does not exceed 50 and the securities held constitute in aggregate less than two per cent of the outstanding securities of that class. Under the acts, if a takeover bid circular is found to contain a misrepresentation and a security holder of the target company is deemed to have relied on this information to make an investment decision, that holder may elect to exercise a right to rescind the transaction. The investor also has a right of action for damages against the offeror, every director of the offeror, every expert

24 3 24 CANADIAN SECURITIES COURSE VOLUME 1 (but only with respect to reports, opinions or statements made by such expert) and each other person who signed a certificate in the circular. Similarly if a directors circular contains a misrepresentation and a security holder of the target company is deemed to have relied on this information, that holder has a right of action for damages against every director or officer who has signed the circular. It is also an offence for a person or company to make a statement in a takeover bid circular or directors circular that contains a misrepresentation. EARLY WARNING DISCLOSURE Most of the acts state that every person or company accumulating 10% or more of the outstanding voting securities of any class of a reporting issuer, or securities convertible into such securities, is required to issue a press release immediately. The purchaser must file the press release with the administrator and file a report within two business days with the administrator. The press release and report are to contain certain details of the acquisition including a statement of the purpose of the acquisition and any future intentions to increase ownership or control. After a formal bid is made for voting securities of a reporting issuer and before the expiry of the bid, every person or company, other than the offeror under the bid, acquiring five per cent or more of the securities of the class subject to the bid is required to issue a press release reporting this information. This press release must be issued no later than the opening of trading on the next business day, and a copy must be filed with the administrator. Insider Trading Most provinces and the federal act require insiders of a reporting issuer to file reports of their trading in its securities. This is based on the principle that shareholders and other interested persons should be regularly informed of the market activity of insiders. In addition, insiders who make use of undisclosed information must give an accounting of their profits and may be liable for damages. The general principles of the law relating to insiders are described below. However, when a practical problem arises, great care must be taken to determine which of the various corporations acts, federal or provincial, apply to the situation. Their provisions differ slightly. WHO ARE INSIDERS For the purposes of disclosure provisions of the acts, insiders are generally defined to include any of the following: A director or senior officer of the company, or a subsidiary; A person or company (excluding underwriters in the course of public distribution) beneficially owning, directly or indirectly, or controlling or directing more than 10% of the voting shares of the company; A director or senior officer of a company which is itself an insider of the company due to ownership, control or direction over more than 10% of the voting shares of the company involved; or A reporting issuer where it has purchased, redeemed or otherwise acquired any of its securities, for so long as it holds any of its securities.

25 THREE THE CANADIAN REGULATORY ENVIRONMENT 3 25 In some circumstances, insiders of Corporation A that has itself become an insider of Corporation B, may be deemed to be insiders of Corporation B. When dealing with trades relating to securities of a company that has been involved in such transactions, care should be taken to ascertain whether the persons involved are deemed under the relevant legislation to be insiders. INSIDER REPORTING Reports must state the extent of the insider s direct or indirect beneficial ownership of, or control or direction over, securities of the company. Thereafter, the insider must report to the administrators details of any change from the previous report within ten days of the change, or any trade. Securities firms should be aware that most acts require an insider who transfers (except for giving collateral for a debt) securities of a reporting issuer into the name of an agent, nominee or custodian to file a report with the administrator. All reports filed with the administrator are open for public inspection, and in some cases summaries are published in the administrator s regular publication. Failing to file an insider report or giving false or misleading information are offences under the acts and are usually punishable by a fine.

26 3 26 CANADIAN SECURITIES COURSE VOLUME 1 SUMMARY After reading this chapter, you should be able to: 1. Identify and describe the agencies and legal entities through which the Canadian securities industry is regulated. Each province is responsible for creating the legislation and regulation under which the securities industry must operate. This regulatory authority is usually delegated by the province to its own provincial securities commission or administrator. The Office of the Superintendent of Financial Institutions (OSFI) provides regulatory oversight for all federally regulated financial institutions, including banks and insurance, trust, loan and investment companies licensed or regulated by the federal government. The Canada Deposit Insurance Corporation (CDIC) is a federal Crown Corporation that protects eligible deposits from the financial failure of a member institution. Eligible deposits are insured for up to $100,000 per depositor in each member institution. 2. Evaluate the role self-regulatory organizations (SROs) play in the regulatory process. SROs are responsible for enforcing member conformity with securities legislation and they have the power to prescribe their own rules of conduct and financial requirements for their members. Canadian SROs include the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA). SRO regulation is divided between securities markets and the mutual funds distribution side. IIROC deals with all investment dealers and trading activity regulation on debt and equity marketplaces in Canada while the MFDA deals with the distribution side of the mutual fund industry. CIPF protects clients of IIROC dealer members against losses caused by the insolvency of an IIROC dealer member and the MFDA IPC protects clients of MFDA member firms against losses caused by the insolvency of an MFDA member firm. 3. Discuss the principles that underlie securities legislation. The general principle underlying securities legislation is that of full, true, and plain disclosure of all pertinent facts by those offering securities for sale to the public. Securities legislation is designed to protect investors through the registration of securities dealers and advisors, the disclosure of facts necessary to make reasoned investment decisions, and the enforcement of laws and policies.

27 THREE THE CANADIAN REGULATORY ENVIRONMENT Identify unethical practices and conduct in securities trading. Unethical conduct is defined as any omission, conduct, and manner of doing business or negotiation that in the opinion of the disciplinary body is not in the public interest or in the interest of the exchange. 5. Describe the rules for public company disclosure and the statutory rights of investors. After distributing securities to the public, a reporting issuer must comply with the timely and continuous public disclosure of information. Disclosure can include issuing a press release or filing a material change report when significant changes to the company s operations occur. Continuous disclosure also requires reporting issuers to regularly file annual and interim financial statements with provincial administrators. There are three statutory rights available to the purchaser of securities issued in Canada under prospectus requirements. The right of withdrawal gives the purchaser the right to withdraw from an agreement to purchase securities within two business days after the deemed receipt of the company s prospectus. The right of rescission gives the purchaser the right to cancel the purchase of securities if the prospectus contains a misrepresentation. The purchaser has 180 days after the purchase to take advantage of this right. If it is deemed that a prospectus contains a misrepresentation, the issuer, the directors of the issuer, the seller of the security, the underwriter, and any other person who signs off on the prospectus may be liable for damages under the right of action for damages. 6. Explain how takeover bids and insider trading are regulated. A takeover is considered a change in the controlling interest of a company. It is an offer to purchase the shares of the company that will in total exceed 20% of the outstanding voting securities of the company. Takeover bids are subject to a number of disclosure requirements. The reporting of trading activity by insiders of a reporting issuer is based on the principle that shareholders and other interested persons should be regularly informed of the market activity of insiders.

28 3 28 CANADIAN SECURITIES COURSE VOLUME 1 Online Frequently Asked Questions CSI has answered many frequently asked questions about this Chapter. Read through online Module 3 FAQs. Online Post-Module Assessment Once you have completed the chapter, take the Module 3 Post-Test.