Compliance roundup: September 2014

CSA proposal threatens privacy of proprietary trading strategies

This April, CSA proposed amendments to NI 21-101 – Marketplace Operation, and NI 23-101 – Trading Rules. The changes would allow debt market researchers to access order and trade information, including market participants’ identifiers.

The move worries the Investment Industry Association of Canada (IIAC).

Barbara Amsden, IIAC managing director, submitted a comment letter explaining that, if adopted, the amendments could jeopardize the confidentiality of proprietary trading strategies.

“Providing order and trading information to third parties is akin to a third party in the IT industry getting access to proprietary code, and efforts to protect information in such cases are well understood. A market participant’s intellectual property is a commercial right with value that is protected through extensive investments in technology, information security and contracts.”

A researcher could observe a firm’s strategy and then apply it for his or her benefit. Amsden notes, however, that the proposals don’t appear to threaten client privacy.

The regulators’ intentions, she adds, are perfectly reasonable: market research enhances transparency. But CSA needs to find the right balance “between the needs of investors, issuers/users of capital, [and] the intermediaries between them and markets in which they operate.” Allowing third parties access to trade information “may lead to a curtailment in market participation,” Amsden says, as firms may flee, fearing their strategies will fall into unauthorized hands.

Amsden’s been in contact with regulators, and says they’ve been receptive to IIAC’s objections. As a result, she’s not as troubled now as she was when the proposals first dropped. But there’s still a ways to go before the industry’s key concerns are addressed.

IIROC reassesses proficiency requirements

Key dates

• September 22 – Phase 2 of CSA’s fund modernization amendments comes into force
• September 30 – Amendments to NI 52-108 – Auditor Oversight come into force
• November 17 – Comment period closes for IIROC’s proficiency requirement consultation

For nearly a decade, the Canadian Securities Institute (CSI) has been the exclusive course provider for IIROC’s proficiency requirements. Their agreement expires in January 2016.

IIROC recently released a consultation paper to gauge industry sentiment on whether it should renew CSI’s contract or consider alternatives. While it seems outwardly routine, but one expert says the paper touches on bigger issues.

“This is linked to the best-interest standard,” says Rebecca Cowdery, a partner at Borden Ladner Gervais in Toronto. And it’s part of a broader overhaul that IIROC’s been implementing.

The first step was enhancing KYC, KYP and suitability. That’s about five years in the making, she notes. “Then they started working on disclosure with CRM to make sure investors understand the type of relationship they have with the firm and the advisor, ensuring they understand their accounts, performance and the cost.”

Proficiency is the third prong. “Do advisors have the right proficiency to provide the financial advice and planning that’s needed? This is particularly important in today’s society, where older Canadians may have no safety net or pension.”

Cowdery wonders if IIROC’s reassessment of proficiency requirements, combined with CRM and the enhancements to KYC, KYP and suitability, will be enough to push the best-interest standard off the regulatory agenda.

There are good reasons to view a best-interest standard or fiduciary duty for advisors as unnecessary, she says. We already have a robust regulatory regime with KYC, KYP, suitability and CRM2, she explains. Enhanced proficiency requirements would be one more reason to question the need for fundamentally reshaping the advisor-client relationship.

“A fiduciary standard means you’re a trustee. When [someone] goes to [her] broker to place a trade to buy a mutual fund, does [she] really think that guy is [her] fiduciary? That’s why I believe the whole discussion is misguided. I don’t know what people would be doing differently. If someone said, ‘Tomorrow, everyone’s on a best-interest standard,’ what does that mean for the advisor?’ It’s almost as if we’ve forgotten we’ve got KYC, KYP, suitability and all the CRM2 disclosure.”

Fund modernization amendments in force

Phase 2 of CSA’s fund modernization project comes into force September 22. The main aim is to tighten the rules for public closed-end funds.

“These are restrictions in the Securities Act that have been around since the 1960s,” notes Rebecca Cowdery, a partner at Borden Ladner Gervais (BLG) in Toronto. “They’ve only applied to public mutual funds until now.”

But it’s not a blanket application of mutual fund rules to closed-end funds, she adds. And it’s not just closed-end funds that are affected: regulators also tightened restrictions for mutual funds.

A key change for closed-end funds deals with mortgage and real estate investing. These funds “will not be permitted to purchase real property, mortgages (other than guaranteed mortgages) or an interest in a loan syndication or loan participation if the purchase would require the fund to assume any responsibilities in administering the loan in relation to the borrower,” explains a BLG bulletin Cowdery co-authored.

Funds that already have mortgage investments can benefit from grandfathering provisions.

The bulletin adds that some MICs are classified as investment funds; in these cases, “the amendments could have a significant impact on their strategies if they invest in mortgages other than guaranteed mortgages.”

Beginning March 21, 2016, mutual funds won’t be able to invest in closed-end funds, except those that meet regulators’ definition of an Index Participation Unit (IPU). That generally means funds that track garden-variety market indices.

So, mutual funds will only be able to invest in other mutual funds subject to NI 81-102 and NI 81-101 (unless the fund’s an IPU). Expect the prohibition, adds the BLG bulletin, to limit the range of investment options for mutual funds.

CSA report on issuers shows disclosure problems persist

This summer, CSA released the results of its continuous disclosure reviews for the fiscal year ended March 31, 2014. Full reviews dropped significantly: “During fiscal 2014, a total of 991 reviews (221 full reviews and 770 issue-oriented reviews) were conducted,” down 26% from 2013, the report explains.

David Surat, a partner at Borden Ladner Gervais in Toronto, says CSA’s reviews are important for advisors. “You want to know that regulators are looking at continuous disclosure and holding issuers to account. The reduction may indicate resource constraints at the regulators, because they’ve had quite a heavy policy load over the last few years. But we can’t know for sure if that’s the reason.”

CSA says the cuts are part of its plan. “The decrease […] can be primarily attributed to a change in our review focus. A higher number of IORs were conducted in fiscal 2013, where the main objective was to monitor quality of disclosure, observe trends and conduct research. In fiscal 2014, we focused on obtaining more substantive outcomes.” It adds: “Although the number of reviews conducted in fiscal 2014 decreased, the total number of review outcomes resulting from our reviews has remained fairly consistent with fiscal 2013.”

Key stats from the report:

• 16% (2% in fiscal 2013) of the reviews resulted in reporting issuers being alerted to specific areas where disclosure enhancements should be considered;
• 9% (5% in fiscal 2013) of issuers were either cease-traded, placed on a default list or referred to enforcement;
• 14% (14% in fiscal 2013) of the reviews resulted in reporting issuers being required to amend or re-file certain continuous disclosure documents;
• 37% (26% in fiscal 2013) of the reviews resulted in “prospective changes,” requiring reporting issuers to make enhancements to their disclosure in future filings; and,
• 24% (53% in fiscal 2013) of issuers were not required to make any changes or additional filings.

Surat also notes that advisors may be especially interested in the report’s section on executive compensation. “A number of issuers […] did not include sufficient explanation […] as to how each element of compensation is tied to each [executive’s] performance,” the report says.

“In many cases, [they] did not fully describe how executive compensation decisions were made. This was of particular concern with regard to performance goals and similar conditions.”