Notice and Proposed Rule: OSC Rule - 31-507 - SRO Membership - Securities Dealers and Brokers

NOTICE OF PROPOSED RULE 31-507

SRO MEMBERSHIP - SECURITIES DEALERS

Substance and Purpose of Proposed Rule

The purpose of the proposed Rule is to address certain regulatory issues that arise in connection with oversight of securities dealers.The proposed Rule requires all securities dealers to be members of a recognized self-regulatory organization or stock exchangerecognized by the Commission (a "SRO"). The proposed Rule conforms to the fundamental principle in paragraph 4 of section 2.1of the Securities Act (Ontario) (the "Act") under which the Commission should, subject to an appropriate system of supervision,use the enforcement capability and regulatory expertise of recognized self-regulatory organizations.

The proposed Rule is substantially similar in effect on all securities dealers as National Policy Statement No. 49 ("NP 49") was on"national dealers".

The 1989 National Regulatory Working Group

In May 1989, the Canadian Securities Administrators (the "CSA") created the National Regulatory Working Group, which tabledand made available to the public its Final Report entitled "Capital, Financial Reporting and Audit Requirements for theSecurities Industry" in December 1989 (the "NRWG Report"). Among the recommendations contained in that report was arecommendation that would require certain dealers and advisers to become members of a SRO and contribute to the CanadianInvestor Protection Fund ("CIPF"). This recommendation was partially adopted through the implementation of NP 49. The NRWGReport recommendation that all dealers be required to become members of a SRO is proposed to be implemented in the proposedRule and proposed Rule 31-506 SRO Membership - Mutual Fund Dealers.

The NRWG Report made a number of recommendations to the CSA to deal with the regulatory concerns expressed in the reportrelating to the lack of sufficient oversight of both dealers operating in multiple jurisdictions and advisers holding property of theirclients, particularly those advisers operating in multiple jurisdictions.

The CSA considered the recommendations, which included mandatory membership in a SRO, formalization of relationshipsbetween the Canadian securities regulatory authorities and SROs, information sharing arrangements between and among SROs andthe Canadian securities regulatory authorities, a lead regulator system of regulation for registrants where one regulatory body wouldhave jurisdiction over all registrants, increased oversight of SROs by the Canadian securities regulatory authorities, introduction ofnew regulations relating to internal control procedures, risk-based capital, segregation requirements and trade reporting, andimplementing revised early warning reporting to the Canadian securities regulatory authorities. In addition, the CSA consideredincreased direct regulation of dealers and advisers by the CSA and restricting the ability of registrants to hold client property.

Currently, the IDA is the only SRO recognized by the Commission. The IDA is a participating SRO in the Canadian InvestorProtection Fund (the "CIPF"), the industry funded investor compensation fund. CIPF covers losses of securities and cash balances,within prescribed limits, suffered by clients of a participating firm in case of that firm's insolvency. Regular levies assessed on firmsfinance CIPF. These levies are based on the firm's gross revenues. The client loss coverage provided by CIPF is much higher thanthat afforded by the Ontario Contingency Trust Fund to which securities dealers contribute.

Summary of Proposed Rule

The proposed Rule requires membership in a SRO recognized by the Commission. At the present time, the IDA is the only SROrecognized by the Commission for member regulation purposes. Membership in the IDA would require all securities dealers tomake contributions to CIPF.

Authority for Proposed Rule

The following sections of the Act provide the Commission with authority to adopt the proposed National Instrument. Paragraph143(1)1 of the Act authorizes the Commission to make rules prescribing requirements in respect of applications for registration andthe renewal, amendment, expiration or surrender of registration. Paragraph 143(1)2 of the Act authorizes the Commission to makerules prescribing conditions of registration or other requirements for registrants or any category or subcategory of registrant.

Alternatives Considered

The Commission considers increased reliance on the self-regulatory system to be consistent with the purposes of provincialsecurities legislation. SROs can bring industry expertise to bear on members and can apply uniform standards on a consistent basisacross provincial boundaries. They can react faster than government agencies to changes in market conditions and to activities andtrends of concern. As the system under NP 49 has worked well since its adoption in June 1993, the proposed Rule extends thesystem to all securities dealers. Under proposed Rule 31-506 SRO Membership - Mutual Fund Dealers, Ontario is, in effect, alsoextending NP 49 to all mutual fund dealers. Some CSA jurisdictions are considering taking the same approach as Ontario withrespect to both mutual fund dealers and securities dealers.

Unpublished Materials

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

Anticipated Costs and Benefits

There are substantial benefits involved in a self-regulatory organization system of regulation. A self-regulatory organization systemhelps to ensure compliance with regulatory requirements and also helps to provide consistent application and interpretation of theregulatory requirements.

Participants in the capital markets will benefit as additional levies are collected as a result of increased membership in CIPF to theextent that this provides an increased fund in the event of an insolvency of a member firm.

Clients of affected securities dealers will benefit from the protections afforded by a SRO system and the availability of CIPF asthose securities dealers are not currently required to be members of a SRO and do not currently contribute to the CIPF.

The proposed Rule will impose costs to securities dealers that are not currently members of a SRO and do not currently contributeto the CIPF. These costs will include fees for membership in the SRO as well as the levies of CIPF which are based on the level ofactivity in the capital markets, i.e. gross revenues of the participant.

Based on experience to date under NP 49, the Commission believes that the benefits of the proposed Rule justify the costs.

Comments

Interested parties are invited to make written submissions with respect to the proposed Rule. Submissions received by January 2,1998 will be considered.

Submissions should be sent to the Ontario Securities Commission in duplicate, as indicated below:

c/o 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 Actrequires that a summary of written comments received during the comment period be published, confidentiality of submission cannotbe maintained.

Questions may be referred to any of:

Tanis MacLaren

Associate General Counsel

Ontario Securities Commission

(416) 593-8259

Randee Pavalow

Policy Co-ordinator

Ontario Securities Commission

(416) 593-8257

Proposed Rule

The text of the proposed Rule follows, together with footnotes that are not part of the Rule but have been included to providebackground and explanation.

Dated: October 3, 1997.

ONTARIO SECURITIES COMMISSION RULE 31-507

SRO MEMBERSHIP - SECURITIES DEALERS_(1),(2)

PART 1 MEMBERSHIP REQUIRED

1.1 Membership Required - A securities dealer⁽³⁾ shall be a member of a self-regulatory organization recognized by theCommission under section 21.1 of the Act or a recognized stock exchange.

PART 2 EFFECTIVE DATE

2.1 This rule shall be effective on , 1998⁽⁴⁾ for an applicant for registration as a securities dealer.

2.2 This rule shall be effective for a securities dealer on the renewal of registration for the securities dealer after , 1999⁽⁵⁾.

PART 3 EXEMPTION

3.1 Exemption - The Director may grant an exemption to this Rule, in whole or in part, subject to such conditions or restrictions asmay be imposed in the exemption.

1.This Rule is new.

2.A general definition rule has been adopted as Rule 14-501 Definitions. It contains definitions of certain terms used in more thanone rule. Rule 14-501 also provides, among other things, that terms used in a rule and defined in Section 1 of the Securities Act orsubsection 1(2) of the Regulation will have the respective meaning given to them in the Securities Act or Regulation, as appropriate.

3.The term "securities dealer" is defined in Rule 14-501 as "a person or company registered under the Act in the category ofsecurities dealer".

4.The Commission expects this date to be six months after the Rule becomes effective.

5.The Commission expects this date to be eighteen months after the Rule becomes effective.