Individuals and firms who distribute exempt-market securities are scrambling to meet the new requirements they’ll face beginning Sept. 28. In fact, some are even moving out of the exempt-securities realm altogether as they assess the drastic regulatory reforms associated with National Instrument 31-103.
The new regulations include widespread changes for exempt-market dealers. EMDs include those who distribute prospectus-exempt securities such as hedge funds, principal-protected notes and limited partnerships, as well as those who work with accredited investors.
“This is the one area of NI 31-103 that is a really bold change,” says Geoffrey Ritchie, executive director of the Toronto-based Exempt Market Dealers Association of Canada. “It’s a huge transition.”
Most of NI 31-103’s new regulations came into effect on Sept. 28, 2009. However, existing EMD firms and reps had one year to comply with some of the requirements. Regulators are warning that registrants who fail to meet the looming deadline could face immediate suspension until they comply.
For firms dealing in exempt securities, the upcoming deadline includes new capital requirements, beefed-up disclosure rules and new filing requirements for financial statements. Dealing reps at these firms, meanwhile, face new proficiency requirements under which they must successfully complete either the Canadian securities course offered by Toronto-based CSI Global Education Inc. or the more specialized exempt-market products course offered by the Investment Funds Institute of Canada‘s IFSE Institute.
Chief compliance officers with EMDs are also required to complete one of these two courses, along with either IFSE’s officers, partners and directors course or CSI’s partners, directors and senior officers course.
The new proficiency requirements are intended to protect investors, according to the Ontario Securities Commission, by ensuring that reps who deal with the exempt market meet minimum qualifications.
“It’s essentially a way for the commissions to set a baseline to ensure that individuals at least have some book knowledge to back up their industry experience,” says Jonathan Heymann, president of Toronto-based compliance consulting firm Wychcrest Compliance Services Inc. and a former OSC employee. “I think [regulators] found that there was just way too much leeway.”
The new requirements essentially bring EMDs in line with the other categories of registration, Heymann adds. Dealers in the exempt market in Ontario and in Newfoundland and Labrador were previously required to register as “limited market dealers”; but the LMD category of registration did not have prescribed proficiency requirements. In all other provinces, no level of registration has previously been required for firms and representatives dealing in prospectus-exempt securities.
@page_break@The EMDA considers the new rules to be positive for the industry, says Ritchie: “…particularly in how we position the EMD within the three categories of dealers. I think it’s created a more capable, more solid and, hopefully, more significant dealer category.”
But not all EMD reps are thrilled about the new requirements. Many have been in the industry for years and have gained widespread knowledge and experience — with or without completing the courses now required.
“A lot of them will think, ‘Why do I need to do it anyway? I have 30 years of experience’,” Heymann says. He believes the regulators should have grandfathered existing EMD reps under the new rules and required only new industry entrants to meet the proficiency requirements. “That would have made things a lot more straightforward.”
Those reps who have yet to earn their proficiency are now making last-ditch efforts to meet the deadline. Institutions offering EMD products exam preparation courses have seen a spike in registration in recent weeks.
“It’s one of our busiest seminars now,” says Gerry Ramos, vice president of training and development with Toronto-based Foran Financial Institute, referring to the firm’s new three-day EMD products exam prep seminar. He adds that the seminar has been particularly popular among mutual fund reps who distribute exempt securities.
Preparing for the IFSE Institute’s EMD products exam can be time-consuming, Ramos adds, because it covers a range of diverse securities that fall into the category. IFSE recommends students spend three to six months studying for the exam.
Industry-watchers say there will inevitably be some individuals that fail to meet the requirements by Sept. 28, probably because of time constraints or, in some cases, a lack of awareness of the requirements. Says Ramos: “I think there are still a lot of firms out there that probably don’t even know that they should be getting licensed.”
Awareness of the new rules is likely to be particularly low in provinces other than Ontario and Newfoundland, where firms and reps dealing in exempt securities have never faced these types of regulatory requirements, he adds: “If people haven’t had to be registered before, they really don’t know.”
The Canadian Securities Admin-istrators has published several notices on the new rules. But getting them out to the firms it affects is challenging for regulators because they don’t have a clear picture of which firms are engaged in the distribution of exempt securities.
“You don’t necessarily know who’s acting in those jurisdictions — they’re not registered entities,” explains Ritchie. “So, reaching out to them and explaining what may be the registration or regulatory impact is very difficult.”
Those who are familiar with the new requirements are gauging the ways their business is affected, and some are reconsidering whether to remain active in the EMD realm. With a variety of new costs and compliance efforts associated with the new regulations, some EMDs have already exited the market, Heymann says. For example, small firms, or firms for which exempt securities were supplementary to their primary operations, may not be able to justify the new costs, he says: “There’s a fair number that will have shut down, simply because it wasn’t the main focus of their business activities.”
But new firms may also be drawn to the EMD market under the new registration regime, attracted by the broader scope of the category, Ritchie says: “It’s now a full-fledged dealer category, fully regulated with all of the licensing, capital and insurance requirements of any other dealer. This actually opens up all kinds of opportunities for EMDs.” IE