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

NOTICE OF PROPOSED CHANGES TO

PROPOSED RULE 31-507

SRO MEMBERSHIP - SECURITIES DEALERS AND BROKERS

Substance and Purpose of Proposed Rule

The purpose of the proposed Rule is to address certain regulatory issues thatarise in connection with oversight of securities dealers and brokers. Theproposed Rule requires all securities dealers and brokers to be members of aself-regulatory organization recognized by the Commission (a "SRO") undersection 21.1 of the Act. The Commission has recognized the InvestmentDealers Association of Canada (the "IDA") under section 21.1 of the Act. It iscontemplated that the Commission will consider recognition of the Mutual FundDealers Association (the "MFDA") as a SRO under section 21.1 in late 2000 orearly 2001. The proposed Rule conforms to the fundamental principle inparagraph 4 of section 2.1 of the Securities Act (Ontario) (the "Act") under whichthe Commission should, subject to an appropriate system of supervision, use theenforcement capability and regulatory expertise of recognized self-regulatoryorganizations.

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

The 1989 National Regulatory Working Group

In May 1989, the Canadian Securities Administrators (the "CSA") created theNational Regulatory Working Group, which tabled and made available to thepublic its Final Report entitled "Capital, Financial Reporting and AuditRequirements for the Securities Industry" in December 1989 (the "NRWGReport"). Among the recommendations contained in that report was arecommendation that would require certain dealers and advisers to becomemembers of a SRO and contribute to the Canadian Investor Protection Fund("CIPF"). This recommendation was partially adopted through theimplementation of NP 49. The NRWG Report recommendation that all dealersbe required to become members of a SRO is proposed to be implemented in theproposed Rule and proposed Rule 31-506 SRO Membership - Mutual FundDealers.

The NRWG Report made a number of recommendations to the CSA to deal withthe regulatory concerns expressed in the report relating to the lack of sufficientoversight of both dealers operating in multiple jurisdictions and advisers holdingproperty of their clients, particularly those advisers operating in multiplejurisdictions.

The CSA considered the recommendations, which included mandatorymembership in a SRO, formalization of relationships between the Canadiansecurities regulatory authorities and SROs, information sharing arrangementsbetween and among SROs and the Canadian securities regulatory authorities, alead regulator system of regulation for registrants where one regulatory bodywould have jurisdiction over all registrants, increased oversight of SROs by theCanadian securities regulatory authorities, introduction of new regulationsrelating to internal control procedures, risk-based capital, segregationrequirements and trade reporting, and implementing revised early warningreporting to the Canadian securities regulatory authorities. In addition, the CSAconsidered increased direct regulation of dealers and advisers by the CSA andrestricting the ability of registrants to hold client property.

Currently, the IDA is the only SRO recognized by the Commission. The IDA is aparticipating SRO in 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 firms finance CIPF. These levies are based on thefirm's gross revenues. The client loss coverage provided by CIPF is muchhigher than that afforded by the Ontario Contingency Trust Fund to whichsecurities dealers contribute.

The Rule was originally published for comment on October 3, 1997,subsequently revised and republished for comment on June 19, 1998.

Summary of Proposed Rule

The proposed Rule requires membership in a SRO recognized by theCommission. At the present time, the IDA is the only SRO recognized by theCommission for member regulation purposes. Membership in the IDA wouldrequire all member dealers to make contributions to CIPF.

The Rule is expected to become effective on December 1, 2000. Applicants forregistration as a securities dealer or broker after the effective date will berequired to be SRO members three months after the effective date (March 1,2001). An existing securities dealer or broker registrant must become a SROmember as of the date of their first renewal of their registration following threemonths after the effective date (March 1, 2001). An existing securities dealer orbroker registrant must also provide the SRO with notice of its intention to makean application for membership by January 1, 2001.

The Rule stipulates that a securities dealer or a broker with a head office locatedin Ontario must be subject to the prime audit jurisdiction of the SRO recognizedby the Commission.

The Director may grant an exemption under the Rule.

Summary of Changes to the Rule

The 1998 publication of the Rule connected the date of membership to thesecurities dealer or broker financial statement filing date. The current rule usesthe renewal of registration as the trigger date for SRO membership for existingregistrants.

The Rule has also been changed to add a requirement that securities dealersand brokers that intend to become members of a SRO provide notice of theirintention to the SRO shortly after the Rule becomes effective. This date isexpected to be January 1, 2001.

Timing of the Rule

It is anticipated that the Rule will become effective on December 1, 2000.The Rule will apply to all applicants for registration as securities dealers orbrokers three months after the effective date (March 1, 2001). It is expectedthat existing registrants will be required to become members of a SRO asof their first renewal of registration following three months after theeffective date (March 1, 2001) and no later than March 1, 2002. This is ashorter time line than previously contemplated by the Rule.

A securities dealer or broker that does not wish to become a member ofthe IDA as of the applicable date, must either surrender its registration orre-register in another category. Those securities dealers, for example, thatwould prefer to become mutual fund dealers and therefore be subject toRule 31-506 rather than this Rule, must re-register as mutual fund dealersbefore their first renewal of registration after March 1, 2001.

Registrants should begin to plan for the transition under this Ruleimmediately. Registrants should be aware that the processing ofmembership applications at the IDA requires adequate review and may takesome time. The Director has the authority to grant exemptions from theRule and may also consider applications for temporary exemption incertain circumstances.

Summary of Written Comments Received by the Commission

One comment letter was received in response to publication on June 1, 1998.The dealer is a securities dealer providing day trading facilities to its customers.The dealer felt that no consideration has been given to the proposed Rule'simpact on the electronic day trading industry in Canada and recommended thata specific exemption be built into the rule for dealers operating an electronic daytrading service who provide their customers with insurance coverage equal orsuperior in quantum to that provided by CIPF, or for dealers who are members ofthe NASD. Further, in the view of this dealer, the IDA would require substantialchanges to a day trading firm's business in order to accept it as a member. TheIDA's requirement to review each trade would impose an immense administrativeburden and prevent the quick execution of trades. Costs would increase at theexpense of the client. Finally, since the dealer is competing with IDA membersto a greater extent than any other type of registrant, including discount brokers,it would be inappropriate for dealer's competitors to be regulating it.

The Commission has given careful consideration to the costs that will result fromthe implementation of mandatory SRO membership. The Commission is of theview that the benefits of SRO membership to the public and to the industryoutweigh such costs. In the Commission's view exceptional situations should beconsidered on a case by case basis and a securities dealer or broker thatbelieves it is in an exceptional position may make an application to the Directorfor an exemption under section 4.1 of the Rule.

Authority for Proposed Rule

The following sections of the Act provide the Commission with authority to adoptthe proposed Rule. Paragraph 143(1)1 of the Act authorizes the Commission tomake rules prescribing requirements in respect of applications for registrationand the renewal, amendment, expiration or surrender of registration. Paragraph143(1)2 of the Act authorizes the Commission to make rules prescribingconditions of registration or other requirements for registrants or any category orsubcategory of registrant.

Alternatives Considered

The Commission considers increased reliance on the self-regulatory system tobe consistent with the purposes of provincial securities legislation. SROs canbring industry expertise to bear on members and can apply uniform standards ona consistent basis across provincial boundaries. They can react faster thangovernment agencies to changes in market conditions and to activities andtrends of concern. As the system under NP 49 has worked well since itsadoption in June 1993, the proposed Rule extends the system to all securitiesdealers and brokers. Under proposed Rule 31-506 SRO Membership - MutualFund Dealers, Ontario is, in effect, also extending NP 49 to all mutual funddealers. Some CSA jurisdictions are considering taking the same approach asOntario.

Unpublished Materials

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

Anticipated Costs and Benefits

There are substantial benefits involved in a self-regulatory organization systemof regulation. A self-regulatory organization system helps to ensure compliancewith regulatory requirements and also helps to provide consistent applicationand interpretation of the regulatory requirements.

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

Clients of affected dealers will benefit from the protections afforded by a SROsystem and the availability of CIPF for those dealers that are not currentlyrequired to be members of a SRO and do not currently contribute to the CIPF.

The proposed Rule will impose costs to dealers that are not currently membersof a SRO and do not currently contribute to the CIPF. These costs will includefees for membership in the SRO as well as the levies of CIPF which are basedon the level of activity in the capital markets, i.e. gross revenues of theparticipant. Brokers already contribute to CIPF as a result of their membershipin The Toronto Stock Exchange.

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

Comments

Interested parties are invited to make written submissions with respect to theproposed Rule. Submissions received by May 14, 2000 will be considered.

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

c/o John Stevenson, 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, preferablyWordPerfect) should also be submitted. As the Act requires that a summary ofwritten comments received during the comment period be published,confidentiality of submission cannot be maintained.

Questions may be referred to either:

Jennifer Elliott
Legal Counsel, Market Regulation
Ontario Securities Commission
(416) 593-8109

Randee Pavalow
Manager, Market Regulation
Ontario Securities Commission
(416) 593-8257

Proposed Rule

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

Dated: April 14, 2000.

ONTARIO SECURITIES

COMMISSION RULE 31-507

SRO MEMBERSHIP - SECURITIES DEALERS AND BROKERS⁽¹⁾, ⁽²⁾

 

PART 1 MEMBERSHIP REQUIRED

1.1 Membership Required

(1) A securities dealer⁽³⁾ shall be a member of a SRO⁽⁴⁾recognized by the Commission under section 21.1 of theAct.

(2) A broker⁽⁵⁾ shall be a member of a SRO recognized by theCommission under section 21.1 of the Act.

1.2 Primary Audit Jurisdiction - A securities dealer or a broker thathas its head office located in Ontario shall be subject to the primaryaudit jurisdiction of the SRO recognized by the Commission ofwhich it is a member.

PART 2 EFFECTIVE DATE

2.1 This Rule shall be effective on , 2001⁽⁶⁾ for an applicant forregistration as a securities dealer or broker.

2.2 This Rule shall be effective for a securities dealer on the renewalof registration for the securities dealer after , 2001.⁽⁷⁾

2.3 This Rule shall be effective for a broker on the renewal ofregistration for the broker after , 2001.⁽⁸⁾

PART 3 NOTICE TO SRO

3.1 Notice - Every registered securities dealer or broker that intendsto make an application for membership in a SRO pursuant to thisRule shall give the SRO written notice of its intention no later than, 2001.⁽⁹⁾

PART 4 EXEMPTION

4.1 Exemption - The Director may grant an exemption to this Rule, inwhole or in part, subject to such conditions or restrictions as maybe imposed in the exemption.

1. This Rule is new.

2. A general definition rule has been adopted as Rule 14-501 Definitions. Itcontains definitions of certain terms used in more than one rule. Rule 14-501also provides, among other things, that terms used in a rule and defined inSection 1 of the Securities Act or subsection 1(2) of the Regulation will have therespective meaning given to them in the Securities Act or Regulation, asappropriate. A national definition rule has also been adopted as Rule 14-101Definitions. It contains definitions of certain terms used in more than oneNational Instrument. National Instrument 14-101 also provides that a term usedin a National Instrument and defined in the statute relating to securities of theapplicable jurisdiction, the definition of which is not restricted to a specificportion of the statute, will have the meaning given to it in the statute relating tosecurities of that jurisdiction. National Instrument 14-101 also provides that aprovision in a National Instrument that specifically refers by name to ajurisdiction, other than the local jurisdiction shall not have any affect in the localjurisdiction, unless otherwise stated in the provision.

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

4. The term "SRO" is defined in National Instrument 14-101 Definitions as "a self-regulatory organization, a self-regulatory body or an exchange". TheCommission has recognized the Investment Dealers Association of Canadaunder section 21.1 of the Act.

5. The term "broker" is defined in Rule 14-501 as "a person or companyregistered under the Act in the category of broker".

6. The Commission expects this date to be March 1, 2001.

7. The Commission expects this date to be March 1, 2001.

8. The Commission expects this date to be March 1, 2001.

9. The Commission expects this date to be January 1, 2001.