The Ontario Securities Commission has approved proposed regulations that impose sales rules on dealers that offer day trading.

The proposed regulations, by the Investment Dealers Association of Canada, impose sales conduct requirements on investment dealers, “to ensure that they will only promote a day-trading strategy to suitable clients based on their risk tolerance and financial position, and impose margin requirements on all pattern day traders to address intra-day financial risk”, the OSC said on Monday.

The proposed rules were published for comment Oct. 31, 2003. The IDA received one comment letter, from Swift Trade Securities Inc., but no changes to the rules were required as a result.

The IDA says that the comment letter argued that the regulations should be applied to all firms, not just those that promote day trading strategies. It responds that it has decided that the rules should only apply to firms considered to be “promoting firms”. Under these proposals, that includes not only those firms who advertise that they provide a day trading service, but also firms who permit their registered salespersons to solicit day trading customers such that they “represent a significant portion of their clientele”.

“We believe this result strikes the appropriate balance between the level of day trading activity at the member firm and the costs of complying the day trading sales compliance requirements. Specifically, we do not believe it would be appropriate to require a member firm with few or no pattern day trader accounts to bear the costs of compliance with the requirements,” it says.

The comment letter also suggested that the IDA should be obliged to either apply the U.S. rules or apply similar day trading margin rules equally to all firms. The IDA says that the U.S. rules were taken into account when drafting the day trading proposals, but that it has chosen to apply different definitions.

The IDA says that the major difference between its proposed rules and the U.S. rules is that ‘non-promoting firms’ are not required to close the odd “pattern day trader” account they might find but rather are required to ensure that they are adequately margined to cover the intra-day risk in the account. This difference has necessitated changes to the U.S. definition of “pattern day trader” so the intra-day margin requirements may be efficiently applied to both promoting and non-promoting firms, it says.

Under the U.S. rule a “pattern day trader” is generally defined as an individual who performs at least four day trades within five business days. “It was not felt to be operationally efficient to apply this requirement in Canada,” the IDA says. “Rather, given that there are a number of other monthly account review requirements in our rules we felt it more appropriate to adopt a monthly standard, 20 day trades in a calendar month.”

“It is true that the proposed Canadian definition of “pattern day trader” is more complex than that set out in the equivalent U.S. rules but we believe it is fairer as well,” the IDA argues. “The proposed IDA definition of “pattern day trader” focuses the margin requirements on accounts with a sufficient number of material day trades to address accounts where material “free riding” would otherwise be taking place. We therefore believe that the proposed IDA definition, while more complex than the U.S., is more targeted to addressing material intra-day leverage/free-riding.”

The IDA also explains that it will allow a grace period for firms to get in compliance with the new rules. “The IDA always gives members adequate time to implement a rule and get approval where needed before a member will be held in violation of a rule,” it says.