TD Waterhouse Private Investment Counsel Inc.
Headnote
Multilateral Instrument 11-102 Passport System and National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions. Effective June 4, 2018 -- Temporary relief from the requirement in paragraph 14.5.3(a) of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (the Custodial Records Requirement) for registered firms to take reasonable steps to ensure that cash and securities of each client or investment fund are held by a qualified custodian using an account number or other designation in the records of the qualified custodian sufficient to show that the beneficial ownership of the cash or securities of the client or investment fund is vested in that client or investment fund -- The registered firm will continue its historical relationship with a "Canadian custodian" who will hold client assets on an omnibus basis in accordance with section 14.6 of NI 31-103 as that provision reads on June 3, 2018 -- Clients will receive relationship disclosure information outlining the risks and benefits of this custodial arrangement -- this relief expires when the registered firm complies with the Custodial Records Requirement or in three years.
Applicable Legislative Provisions
Multilateral Instrument 11-102 Passport System, s. 4.7.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, ss. 1.1, 14.2(2)(a.1), 14.2(2)(a.2), 14.5.2(5), 14.5.3(a), 14.6 and 15.1.
June 1, 2018
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF TD WATERHOUSE PRIVATE INVESTMENT COUNSEL INC. (the Filer)
DECISION
Background
On June 4, 2018, amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) will come into effect that will enhance the custody requirements applicable to registered advisers, dealers and investment fund managers that are not members of a self-regulatory organization (SRO) such as the Investment Industry Regulatory Organization of Canada or the Mutual Fund Dealers Association of Canada (the Custody Amendments). SRO member firms will comply with the custodial regimes of their respective SRO. The Custody Amendments address potential intermediary risks when registered firms that are not members of an SRO are involved in the custody of client assets; enhance the protection of client assets; and codify existing custodial best practices of registered firms that are not members of an SRO.
The principal regulator in the Jurisdiction has received an application from the Filer for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for relief from the requirement in paragraph 14.5.3(a) of NI 31-103 that will come into effect on June 4, 2018 (the Custodial Records Requirement), pursuant to section 15.1 of NI 31-103, to permit the Filer's client accounts custodied with CIBC Mellon Trust Company (CIBC Mellon) to continue to be held as part of an omnibus custody arrangement between the Filer and CIBC Mellon (the Omnibus Custody Arrangement) for an interim period of time until the Filer can comply with the Custodial Records Requirement (the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
a) the Ontario Securities Commission is the principal regulator for this application, and
b) the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon by the Filers in each jurisdiction of Canada outside of Ontario (together with Ontario, the Jurisdictions).
Interpretation
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
Representations
The decision is based on the following facts represented by the Filer:
1. The Filer is a corporation incorporated under the Canada Business Corporations Act. Its head office is located in Toronto, Ontario.
2. The Filer is registered as adviser in the category of portfolio manager and as a dealer in the category of exempt market dealer in all provinces and territories of Canada.
3. The Filer provides high net worth clients with customized investment strategies through the exercise of discretionary investment authority that is granted to the Filer by such clients. The Filer invests its clients' assets in various securities and products (which could be prospectus-qualified or prospectus-exempt) including investment funds managed by its affiliate, TD Asset Management Inc. (TDAM). Certain portfolio management functions, including effecting portfolio transactions, are arranged by TDAM on behalf of the Filer.
4. As of the date of this decision, the Filer's business has approximately 45,000 client accounts representing approximately $28.5 billion in assets under management.
5. The vast majority of the Filer's client accounts (as of the date of this decision, approximately 98%) are part of the Omnibus Custody Arrangement. CIBC Mellon is a custodian that meets the definition of "Canadian custodian" in section 1.1 of NI 31-103 that will be in effect on June 4, 2018. The Omnibus Custody Arrangement complies with section 14.6 of NI 31-103 as this provision reads on June 3, 2018. In this regard, the records of CIBC Mellon reflect that the assets held by CIBC Mellon are held in the name of the Filer in trust for the clients of the Filer. Individual client accounts and holdings are not reflected in the custodial records maintained by CIBC Mellon for the Filer. The holdings of individual client accounts are fully reflected in the Filer's client account records.
6. The remaining client assets managed by the Filer (as of the date of this decision, approximately 2%) are custodied in accordance with the Custodial Records Requirement and those assets are held by The Canada Trust Company (TCTC), an affiliate of the Filer, and RBC Investor Services Trust (RBC). Accordingly, the Exemption Sought is not being requested in respect of assets held in the custody of TCTC or RBC.
7. On July 27, 2017 the Canadian securities administrators published amendments to NI 31-103 that enhance the custody requirements for registered advisers, dealers and investment fund managers that are not members of SROs. These amendments, including the Custodial Records Requirement, come into effect on June 4, 2018.
8. In the absence of the Exemption Sought, the Custodial Records Requirement would require the Filer to transition, effective June 4, 2018, the client accounts that are held as part of the Omnibus Custody Arrangement to a custodial arrangement where the beneficial ownership of each client account is fully-disclosed in the records of the qualified custodian holding those client assets (a Fully-Disclosed Custody Arrangement).
9. In particular, the Filer is in the process of taking reasonable steps to ensure that cash and securities of each client are held by a qualified custodian using an account number or other designation in the records of the qualified custodian sufficient to show that the beneficial ownership of the cash or securities of the client is vested in that client, as required by the Custodial Records Requirement. However, after careful consideration including analysis by a multi-disciplinary committee established by the Filer to study the implications of the Custodial Records Requirement, the Filer has determined that the conversion of its Omnibus Custodial Arrangement to a Fully-Disclosed Custody Arrangement that meets the Custodial Records Requirement cannot be achieved prior to June 4, 2018 without exposing client accounts to operational risk.
10. The Filer's current portfolio management system that supports the client accounts custodied at CIBC Mellon has been extensively customized and does not have the capability to integrate with a separate fully-disclosed client account custodial system. The existing technological system and set up with CIBC Mellon does not allow for the Omnibus Custodial Arrangement to be "converted" to a Fully-Disclosed Custody Arrangement without significant changes to the system.
11. Given the current limitations of its portfolio management system, the Filer will design and implement a new portfolio management system that addresses connectivity issues with the custodian for functionality on trade execution and settlement process, performance reporting, account holding and transaction reporting.
12. During the interim period where the Omnibus Custodial Arrangement is utilized, the following client protection measures will be, or will remain, in place:
(a) CIBC Mellon is the custodian for these client accounts and CIBC Mellon is a Canadian custodian as defined in section 1.1 of NI 31-103 as that provision reads on June 4, 2018;
(b) except as permitted by this decision, the Filer complies with the Custody Amendments which includes delivering relationship disclosure information to the Filer's clients that describes the risks and benefits to the Filer's clients arising from their assets being held under the Omnibus Custodial Arrangement (a historical custodial arrangement that is not otherwise permitted by the Custody Amendments and which will only be continued on a temporary basis);
(c) the Filer conducts daily reconciliations between its separate fully-disclosed client account records and the omnibus records of CIBC Mellon, and retains records of the results of these reconciliations;
(d) the Filer completes a monthly review of its reconciliation process which includes an internal certification of account reconciliations, and retains records of the results of these reconciliations;
(e) the Filer ensures that CIBC Mellon completes an annual internal control report in accordance with International Standards on Assurance Engagements (ISAE 3402) or similar standards, providing evidence of independent oversight and reassurance on the quality and controls of the Omnibus Custodial Arrangement; and
(f) the Filer's clients continue to receive account statements detailing their individual holdings.
13. The Filer intends to change its principal custodian from CIBC Mellon to TD Waterhouse Canada Inc. (TD Waterhouse), an affiliate of the Filer and an investment dealer that is a dealer member of IIROC. TD Waterhouse meets, or expects to meet, the definition of "Canadian custodian" in section 1.1 of NI 31-103 that will be in effect on June 4, 2018.
14. Compared to the Filer, TD Waterhouse has in place more scalable technology systems and tools relating to, among other things, client statements and other reporting that the Filer can leverage, without duplication of efforts, if the Filer's clients also become clients of TD Waterhouse, acting as custodian.
15. In setting up the custodial relationship with TD Waterhouse as custodian, the Filer intends to organize its business and affairs so that it can follow the guidance provided by the Canadian securities administrators in CSA Staff Notice 31-347 Guidance for Portfolio Managers for Servicing Arrangements with IIROC Dealer Members, particularly the items set out under "Requirements and CSA staff's expectations for PMDSAs" in the Staff Notice. These items include the Filer maintaining its own records of its clients' investment positions and trades; entering into an agreement with TD Waterhouse that includes the key terms identified in this guidance (among others); providing necessary relationship disclosure information including key responsibilities under the agreement with TD Waterhouse; knowing how to satisfy the Filer's additional statement obligations to a client when following this staff guidance; and being aware of the circumstances when this staff guidance cannot be relied upon.
16. Although TD Waterhouse and the Filer are affiliates by virtue of being wholly owned subsidiaries of The Toronto-Dominion Bank, the Filer believes that TD Waterhouse is functionally independent from the Filer for purposes of NI 31-103 because:
(a) each of the Filer and TD Waterhouse have different business lines supported by independent systems and controls;
(b) each of the Filer and the division of TD Waterhouse that acts as custodian of client assets for the Filer have substantially different senior management teams and different boards, and a different UDP and CCO;
(c) the custodial activities will be performed by personnel that are separate and independent from the Filer.
17. Due to the large and broad scale changes that the Filer will be implementing during the interim period of this decision, the Filer will provide a semi-annual progress report to the Deputy Director or Manager in the Compliance and Registrant Regulation Branch of the Ontario Securities Commission (the OSC Manager) on the implementation of the Fully-Disclosed Custody Arrangement that will comply with the Custodial Records Requirement.
Decision
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision. Effective June 4, 2018, the decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:
(i) any cash and securities of a client or investment fund that is held in an account in the name of the Filer is held separate and apart from the Filer's own property and held by CIBC Mellon (a "Canadian custodian" as defined in section 1.1. of NI 31-103) in a designated trust account in trust for clients or investment funds of the Filer;
(ii) the Filer conducts daily reconciliations between its separate fully-disclosed client account records and the omnibus records of CIBC Mellon, and retains records of the results of these reconciliations;
(iii) the Filer completes a monthly review of its reconciliation process which includes an internal certification of account reconciliations, and retains records of the results of these reconciliations;
(iv) the Filer ensures that CIBC Mellon completes an annual internal control report in accordance with International Standards on Assurance Engagements (ISAE 3402) or similar standards, providing evidence of independent oversight and reassurance on the quality and controls of the Omnibus Custodial Arrangement;
(v) the Filer's clients continue to receive account statements detailing their individual holdings;
(vi) the Filer provides a semi-annual progress report to the OSC Manager on the implementation of the Fully-Disclosed Custody Arrangement that will comply with the Custodial Records Requirement; and
(vii) the Exemption Sought will no longer be available in any jurisdiction of Canada after the date that is the earlier of:
A. the date on which the Filer implements a Fully-Disclosed Custody Arrangement that complies with the Custodial Records Requirement; and
B. the date that is three years after the date of this decision.