Notice of Proposed Changes to Proposed Rule: OSC Rule - 31-505 - Conditions of Registration

 

NOTICE OF PROPOSED CHANGES TO PROPOSED
RULE 31-505 CONDITIONS OF REGISTRATION AND
REVOCATION OF REGULATIONS

Substance and Purpose of Proposed Rule

On August 30, 1996, the Ontario Securities Commission published proposed Rule 31-505 together with a notice of proposed regulations to be revoked. Thisnotice relates to proposed changes to proposed Rule 31-505 arising from further consideration of the proposed Rule by the Commission.

The substance and purpose of the proposed Rule is to consolidate current requirements of the Regulation which establish conditions of registration with relatedrequirements arising from the administrative practice of the Director, and to expand such requirements in order to provide certainty for applicants for registrationand appropriate authority for certain enforcement matters for the Commission. In particular the Commission is using its rule making authority to reinstate in theproposed Rule the provisions of sections 221 and 222 of the Regulation. Subsection 222(1) of the Regulation was struck down in the decision of the OntarioCourt of Justice (Provincial Division) R. v. Haldenby (1994), 17 OSCB 4311 as outside the then regulation making power under the Securities Act (the "Act").

The proposed changes to the proposed Rule combine the concept of responsible person and compliance officer into one position and permit delegation ofadministrative functions relating to the combined position to certain persons.

Summary of Proposed Rule

Section 114 of the Regulation currently contains requirements relating to the opening and supervision of accounts by registered dealers and advisers. Theproposed Rule expands the scope of subsection 114(1) of the Regulation to require that the supervision relate to advice provided to clients. The procedures mustbe in writing and the registered dealer and adviser must send written notice to the Commission designating an individual responsible for opening new accountsand supervising trades made for or with clients and advice provided to clients.

The proposed Rule expands the current provision in subsection 114(2) of the Regulation to allow investment dealers or brokers to comply with the applicableby-law, rule, regulation, policy, procedure, interpretation or practice of the Investment Dealers Association or The Toronto Stock Exchange in satisfaction of therequirements of Part 1 of the proposed Rule respecting new accounts and account supervision.

The proposed Rule incorporates the requirement to know your client and assess suitability currently established in subsection 114(4) of the Regulation. Thisprovision has been expanded to ensure that individual registrants are also required to comply with the know your client and suitability rules.

The proposed Rule incorporates the exceptions to the know your client and suitability requirements of section 114 of the Regulation that relate to execution oftrades on the instructions of registered advisers and opening of accounts by registered advisers.

The proposed Rule incorporates the provisions currently contained in subsection 114(3) of the Regulation which require registrants to designate a personresponsible for the opening and supervision of accounts and the proposed change to the proposed Rule combines that provision with the provisions of section125 of the Regulation which require dealers and certain advisers to designate a compliance officer.

The proposed Rule expands each of these provisions to ensure that they relate to all categories of advisers.

The proposed Rule incorporates the provisions of sections 221 and 222 of the Regulation except as they applied to "registered directors" as section 25 of the Actdoes not contemplate the registration of directors.

The proposed Rule imposes an obligation on registered dealers and advisers to supervise their registered salespersons, officers and partners in accordance withOntario securities law and any supervisory terms or conditions imposed on their registered salespersons, officers or partners. The proposed Rule does not specifythe necessary level of supervision but does require that a branch manager be responsible for oversight of each branch either from within the branch or fromanother location.

Summary of Comments Received by the Commission

The Commission received the following comments on the Rule from the Canadian Bankers Association, Scotia Securities Inc., and Goodman, Phillips &Vineberg:

1. One commentator suggested that the Rule should contain a definition of "branch". The Commission has determined to defer the issue of defining branch inorder to attempt to coordinate a national regulatory response to the issue. The question of what constitutes a branch has risen in the context of the number ofbranch managers required by a particular firm. The Commission is considering the issue of supervision on a more broad basis and hopes to deal with that issue inthe context of a national registration rule.

2. A commentator suggested that it was unclear how the branch manager requirements in the Rule would apply to mutual fund dealers who operate brancheswithin the offices of affiliated financial institutions under the Principles of Regulation Re: Distribution of Mutual Funds by Financial Institution (1988), 11OSCB 4436 (the "Mutual Fund Principles"). The commentator suggested that a transitional period be provided if the status of the exemption from the branchmanager requirement under the Mutual Fund Principles was to be removed.

The Commission believes that it would be appropriate to exempt mutual fund dealers who are currently operating within the Mutual Fund Principles without abranch manager pending reformulation of the Mutual Fund Principles. The Rule has been amended by adding subsection 1.4(3) to provide the requisiteexemptive relief.

3. A commentator suggested that a registrant need not make inquiries as to a client's creditworthiness if the registrant is not financing the purchase of thesecurities either directly or through margin.

The Commission did not intend to change the application of section 114 of the Regulation in that regard and the Rule has been amended to clarify that no inquiryas to creditworthiness is necessary in the circumstances described above. See subsection 1.5(2) of the Rule.

Authority for Proposed Rule

The following provisions of the Act provide the Commission with authority to make the proposed Rule. Paragraph 143(1)1 of the Act authorizes theCommission to make rules prescribing requirements in respect of applications for registration and the renewal of registration. Paragraph 143(1)2 of the Actauthorizes the Commission to make rules prescribing conditions of registration or other requirements for registrants or any category or sub-category ofregistrant.

Alternatives Considered

The Commission is of the view that subsection 114(4) of the Regulation needs to be augmented in a manner that would expand its application to individualregistrants. The Commission is also of the view that the provisions of section 221 and 222 of the Regulation should be maintained. The Commission did notconsider any other alternatives to adoption of these requirements through the rule-making process.

Unpublished Materials

In proposing the Rule, the Commission has not relied on any significant unpublished study, report or other written materials.

Anticipated Costs and Benefits

There are substantial benefits relating to a self-regulatory system of regulation. It helps to ensure compliance with regulatory requirements at less expense to theGovernment and helps to provide consistent application and interpretation of regulatory requirements throughout Canada, to the extent they are harmonized.

Investors will benefit from an enforcement perspective as a result of the proposed Rule, which will permit the Commission to enforce the know your client andsuitability requirements against individual registrants.

Industry will benefit from the proposed Rule as it provides certainty regarding the Staff practice of requiring advisers to have compliance officers.

There are no incremental costs of compliance associated with the proposed Rule relative to the costs of compliance associated with the provisions of theRegulation to be replaced by the proposed Rule. The Commission is of the view that the incremental costs resulting from compliance with the provisions of theRule that expand upon those provisions of the Regulation are not significant.

Based on its experience in administering the provisions of the Regulation to be replaced by the proposed Rule, the Commission believes that the costs imposedby the proposed Rule are justified by the benefits.

Regulations to be Revoked

The Commission will revoke sections 114, 125, 221 and 222 of the Regulation.

Comments

Interested parties are invited to make written submissions with respect to the proposed Rule. Submissions received by February 24, 1998 will be considered.

Submissions should be made in duplicate to:

Daniel P. Iggers, Secretary

Ontario Securities Commission

20 Queen Street West

Suite 800, Box 55

Toronto, Ontario M5H 3S8

A diskette containing the submissions (in DOS or Windows format, preferably WordPerfect) should also be submitted. As the Act requires that a summary ofwritten comments received during the comment period be published, confidentiality of submissions cannot be maintained.

Questions may be referred to:

Nancy Ross

Legal Adviser, Registration

Ontario Securities Commission

(416) 593-8154

Proposed Rule

The text of the proposed Rule follows including the proposed changes.

DATED: January 23, 1998.

ONTARIO SECURITIES COMMISSION RULE 31-505

CONDITIONS OF REGISTRATION

PART 1 NEW ACCOUNTS AND SUPERVISION

1.1 Recognized Self-Regulatory Organization and Recognized Stock Exchange Member

(1) A member of The Toronto Stock Exchange may comply with a requirement of this Part by complying with a by-law, rule, regulation, policy, procedure,interpretation or practice of The Toronto Stock Exchange dealing with the same subject matter as that requirement that has been approved by the Commissionand published by The Toronto Stock Exchange.

(2) A member of the Investment Dealers Association of Canada may comply with a requirement of this Part by complying with a by-law, rule, regulation, policy,procedure, interpretation or practice of the Investment Dealers Association of Canada dealing with the same subject matter as that requirement that has beenapproved by the Commission and published by the Investment Dealers Association of Canada.

1.2 Dealing with Clients - A registered dealer or adviser shall establish and enforce written procedures for dealing with clients that conform with prudentbusiness practice and enable the dealer or adviser to serve its clients adequately.

1.3 Designation of Compliance Officer

(1) A registered dealer or adviser shall designate a registered partner or officer as the compliance officer who is responsible for discharging the obligations of theregistered dealer or adviser under Ontario securities law.

(2) The person designated under subsection (1) by a registered dealer or adviser shall also be responsible for opening each new account, supervising trades madefor or with each client and supervising advice provided to each client or, if a branch manager is designated under section 1.4, for supervising the branch manager.

(3) Despite subsections (1) and (2), the designated compliance officer may delegate administrative functions to an individual who meets the proficiencyrequirements under Rule 31-502 Proficiency Requirements for Registrants for a salesperson in the same category of registration as the dealer or an officer in thesame category of registration as the adviser, that has in each case designated the compliance officer.

(4) An applicant for registration or reinstatement of registration as a dealer or adviser shall deliver to the Commission, with the application, written notice of thename of the person proposed to be designated under subsection (1).

1.4 Branch Manager

(1) If a registered dealer or adviser operates a branch office, the registered dealer or adviser shall designate a branch manager for the branch who reports directlyto the compliance officer designated under section 1.3 and who is responsible for the branch for opening new accounts, supervising trades made for or with eachclient and supervising advice provided to each client.

(2) An applicant for registration or reinstatement of registration as a dealer or adviser that proposes to operate a branch office shall deliver to the Commission,with the application, written notice of the name of the person proposed to be designated under subsection (1).

(3) Despite subsection (1), a mutual fund dealer that has appointed an administration officer for a branch in accordance with the Policy of the Commissionentitled "Principles of Regulations Re: Distribution of Mutual Funds by Financial Institutions" is not required to designate a branch manager for the branch untilthe date on which the Commission makes a rule replacing the Policy.

1.5 Know your Client and Suitability

(1) A person or company that is registered as a dealer or adviser and an individual that is registered as a salesperson, officer or partner of a registered dealer or asan officer or partner of a registered adviser shall make such enquiries about each client of that registrant as

(a) subject to section 1.6, enable the registrant to establish the identity and the creditworthiness of the client, and the reputation of the client if information knownto the registrant causes doubt as to whether the client is of good reputation; and

(b) subject to section 1.7, are appropriate, in view of the nature of the client's investments and of the type of transaction being effected for the client's account, toascertain the general investment needs and objectives of the client and the suitability of a proposed purchase or sale of a security for the client.

(2) Despite paragraph (1)(a) a registrant is not required to make enquiries as to the creditworthiness of a client if the registrant is not financing the acquisition ofsecurities by the client.

1.6 Managed Accounts

(1) For each account with a registered dealer opened and traded by a registered adviser on behalf of a client, each of the dealer, and a salesperson, officer orpartner responsible for the account, shall determine that the adviser is creditworthy, but does not have any responsibility under paragraph 1.5(1)(a) if the adviserexecutes orders in the adviser's name or identifies its client by means of a code or symbols or guarantees the account.

(2) For each account with a registered dealer opened and traded by a registered adviser on behalf of a client with no agreement that payment of the account isguaranteed by the adviser, each of the dealer that executes orders in the name of the client, and a salesperson, officer or partner responsible for the account, doesnot have any responsibility under paragraph 1.5(1)(a), but shall obtain

(a) full information concerning the client to enable the registrant to establish the identity and the creditworthiness of the client; or

(b) from the adviser

(i) a letter confirming the familiarity of the adviser with applicable Ontario securities law, requirements of self-regulatory organizations and requirements of theadviser for account supervision, and

(ii) a written undertaking to make the investigations contemplated by those requirements and to advise, if known, whether the client is an insider of a reportingissuer or an employee, director, officer or partner of a person or company engaged in the securities business and the details of the relationship.

(3) An adviser shall for each account with a registered dealer opened and traded by the registered adviser on behalf of a client ask the client if the client is aninsider of a reporting issuer or an employee, director, officer or partner of a person or company engaged in the securities business and the details of therelationship.

1.7 Execution of Trades and Instruction - Paragraph 1.5(1)(b) does not apply to a registered dealer or a registered salesperson, partner or officer of aregistered dealer that executes a trade on the instruction of a registered adviser, another registered dealer or an Ontario financial institution.

PART 2 GENERAL DUTIES

2.1 General Duties

(1) A registered dealer or adviser shall deal fairly, honestly and in good faith with its clients.

(2) A registered salesperson, officer or partner of a registered dealer or a registered officer or partner of a registered adviser shall deal fairly, honestly and ingood faith with his or her clients.

(3) A registered salesperson, officer or partner of a registered dealer or a registered officer or partner of a registered adviser shall not act on behalf of the dealeror adviser in a transaction of the dealer or adviser that is not in compliance with Part XIII of the Regulation, National Instrument 33-105 Underwriting Conflictsor this Rule.

PART 3 SUPERVISORY TERMS

3.1 Supervisory Terms - A registered dealer shall supervise each of its registered salespersons, officers and partners and a registered adviser shall supervise eachof its registered officers and partners in accordance with Ontario securities law and terms or conditions imposed by the Director or the Commission on theregistration of the salesperson, officer or partner of the dealer or the officer or partner of the adviser requiring that the actions of the registered salesperson,officer or partner of the registered dealer or the registered officer or partner of the registered adviser be supervised in a particular manner.

PART 4 EXEMPTION

4.1 Exemption - The Director may grant an exemption to this Rule, in whole or in part, subject to such conditions or restrictions as may be imposed in theexemption.

ONTARIO SECURITIES COMMISSION RULE 31-505

CONDITIONS OF REGISTRATION

TABLE OF CONTENTS

PART TITLE PAGE

PART 1 NEW ACCOUNTS AND SUPERVISION

1.1 Recognized Self-Regulatory Organization and Recognized Stock Exchange Member

1.2 Dealing with Clients

1.3 Designation of Compliance Officer

1.4 Branch Manager

1.5 Know your Client and Suitability

1.6 Managed Accounts

1.7 Execution of Trades and Instruction

PART 2 GENERAL DUTIES

2.1 General Duties

PART 3 SUPERVISORY TERMS

3.1 Supervisory Terms

PART 4 EXEMPTION

4.1 Exemption