Chapter 3- The Canadian Regulatory Environment

The Investment Industry Regulatory Organization of Canada (IIROC)

Oversees all investment dealers and trading activity on debt and equity marketplaces in Canada. Carries out regulatory responsibilities through setting and enforcing rules regarding proficiency, business and financial conduct of dealer member firms. Mandate is to set high quality regulatory and investment industry standards, protect investors, and strengthen market integrity while maintaining competitive markets.

Securities legislation requires continuous disclosure of certain information by public companies

Periodic Financial Statements, Insider Trading Reports, Annual Information Form (AIF).

Continuous Disclosure*

Primary disclosure requirements include issuing a press release and filling a material change report when material changes occur. A material change is a change in the business, operations or capital that could have a significant impact on market value for the security.

Canadian Investor Protection Fund (CIPF)

Primary role is investor protection, secondary role is overseeing the self-regulatory system. Protects eligible customers in the event of insolvency of an IIROC dealer member.

Provincial securities acts are designed to regulate underwriting, distribution/sales of securities, and buyers/sellers

The term act is used to refer to securities-related legislation. The term administrator is used to describe the securities regulatory authority.

There is no Federal regulatory body for the securities industry in Canada

US has the Securities and Exchange Commission, which has a lot of authority. The CSA has increased the number of national policies in response to the rise in activity of federally regulated financial institutions.

What are the Ethics of Trading?**

Unethical conduct may be defined as any omission, conduct, manner of doing business or negotiation, which in the opinion of the disciplinary body is not in the public interest nor the exchange's.

The National Registration Database (NRD)

Web-based system used by investment dealer and employees to file registration forms electronically when applying for approval by any one or more of the stock exchanges, the CSA, or IIROC.

Street Form

When shares are in the name of the underwriting bank/investment dealer instead of the true beneficial owner In this case, the institution is a nominee, and nominees are required to mail all necessary disclosures to the beneficial owners.

Insiders Include:

-A director/senior officer of the company. -A person/company beneficially owning more than 10% of the voting shares of the company -A director who has control/ownership over the company due to a >10% stake. -A reporting issuer who holds the securities.

Examples of Unethical Practices*

-Action that deceives the public or a party to the transaction. -Misrepresentation thorugh false or misleading trading. -Attempting to sell and repurchase a security to manipulate the market. -Deliberately causing the lasrt sale for the day to be higher than warranted (window drssing) -Confirming a trade that has not been executed (bucketing) -IA making a trade on their own account prior to effecting a trade for client (front running)

Regulatory Oversight- CIPF also provides this, their role includes:

-Anticipating and solving financial problems of dealer members. -Conducting an annual evaluation of the members and SRO's examination activities to ensure compliance with CIPF minimum standards. -Conducting financial examinations of dealer members to ensure compliance with CIPF minimum standards -Establishing/reviewing national standards for capacity adequacy and liquidity, reporting, etc. -Coordinating surveillance and enforcement. -Maintaining a close liaison with the panel of public firms approved to audit and report annually on dealer markets.

To be eligible for arbitration, the dispute must meet the following criteria:

-Attempts have been made to resolve the dispute. -The claim cannot exceed $100,000 -Must have happened after a certain date, depending on provincial jurisdiction.

Takeover bids that are not exempted must comply with a number of rules:

-Bid must be sent to all shareholders in the province, including convertibles. -Offeror shall deliver a takeover bid circular setting out certain prescribed information -A director's circular must be sent to security holders of the target within 15 days of the bid, and the BOD of the target must provide certain information including their recommendation. -Any securities taken up by the offeror must be paid for within 3 business days.

Gatekeepers must:

-Collect and record client information that is accurate and complete -Monitor activities in client accounts -Report any transactions or proposed transactions in clients accounts that are suspicious.

The financial disclosure provisions also require other information to be included:

-Comparative audited annual statements for companies listed on the TSX venture and TSX. -Comparative unaudited quarterly statements from TSXV, TSX.

Registration Categories (as they apply to dealer members)

-Dealing Representative- IR, IA -Trader -Supervisor -Executive -Director -Ultimate Designated Person- CEO of a dealer member -CFO- approved to be responsible for ensuring they comply with the financial requirements. -Chief Compliance Officer (CCO)- ensure they have necessary system and controls in place.

A takeover bid is exempt from the above requirements in any of the following cases:

-It is made through an exchange, and meets their by-laws, regulations etc. -It involves acquisitions which do not aggregate more than 5% of the securities of a class and the price paid does not exceed the market price. -It is a private offer with <5 security holders at a price <115% market value. -Offer to purchase shares in a private company

SROs require that dealer members and the IAs:

-Learn essential facts relative to every client and order -Ensure the acceptance of any order is within the bounds of good business practices. -Ensure the recommendations made for an account are client appropriate and adhere to their investment objectives (suitability principle).

Also conducts market surveillance including:

-Real time monitoring of trading on stock exchanges, ATOs, and Natural Gas Exchange Inc. across Canada. -Ensuring dealer members comply with timely disclosure of information. -Carrying out trading analysis and compliance with the Universal Market Integrity Rules (UMIR).

It is possible to have more than $100,000 in deposits eligible for CDIC coverage, provided the deposits are held in more than one of CDIC's six deposit insurance categories. These categories include deposits held:

-in one name -Jointly in more than one name -in a trust account -in a registered retirement savings plan (RRSP) -in a registered retirement income fund (RRIF) -in a mortgage tax account Ex- IF a depositor has $80,000 cash on deposit in her own name and in the same institution $120,000 on deposit in a registered retirement savings plan, CDIC would insure her deposits in the amount of $180,000 (80,000 fully covered for the cash deposit in the own name and a maximum of $100,000 covered for her registered retirement savings plan).

MFDA Investor Protection Corporation (MFDA IPC)

-provides protection for eligible customer of insolvent MFDA member firms. -Covers losses of up to $1,000,000 for relevant products (segregated funds, securities, cash), also categorize accounts as general or separate.

Generally the acts use three basic methods to protect investors:

1) Registration of securities dealers and advisors 2) Disclosure of facts necessary to make reasoned investment decisions. 3) Enforcement of the laws and policies.

Relationship Disclosure

A document that outlines the account relationship and services to be provided, including types of products, process, account type and review dates, fees, complaints procedures, etc.

What does/ does not CDIC insure?

Accounts/Products insured include: savings/chequing -Guaranteed Investment Certificates (GICSs) and other term deposits that mature in five years or less -money orders, certified cheques, traveller's cheques and bank drafts -Accounts that hold realty taxes on mortgaged properties These accounts and products must be held at a CDIC member and in Canadian dollars to be eligible for deposit insurance. CDIC does not insure: -Mutual funds and stocks -GICs and other term deposits that mature in more than five years -Bonds and Treasury Bills -Debentures issued by governments, corporations, or chartered banks -Deposits held in foreign currency

General Account and Separate Accounts

All accounts of a customer are covered either as part of the customer's general account or as a separate account: A general account is the combination of accounts holding cash, margin, short sales, options, futures, and foreign currency, and combined are entitled to the maximum coverage. Separate accounts are disclosed in the records that are treated as if they belong to a separate customer, and are each entitled to the maximum coverage, examples include: -RRSPs, RRIFs, LIFs, LIRAs, LRIFs -RESPs -Partnerships -Trusts

Ombudsman for Banking Services and Investments (OBSI)*

An independent organization that investigates customer complaints against financial services providers (banks, deposit-takers, investment fund/dealers, etc).

Takeover Bid

An offer to the shareholders to purchase the shares of the company, to in total exceed 20% and give the offeror control of the company.

Early Warning Disclosure

Anyone buying 10% or more of a company is required to issue a press release immediately, containing details of the acquisition.

Employees of IIROC need to be registered, new IAs must complete a 90-day training program before they are permitted to deal with the public and then must pass a wealth management course (WME)

Applicants not giving any advice may be registered as INvestment Representatives (IRs) Employees must receive further registration if they advance through the ranks.

Client Relationship Model (CRM)

CRM is part of a broader fundamental obligation of dealer members and their reps to deal honestly, fairly, and in good faith with clients. Provides greater disclosure, the objective is increased transparency for investors surrounding fees, services, conflicts of interest and account performance.

The Role of Arbitration*

Clients can sue or request arbitration if they believe that they have been mistreated by an SRO.

Conflicts of Interest Management/Disclosure

Develop and maintain policies to identify and deal with conflict in the following ways: -Avoiding the conflict if the material conflict of interest cannot be addressed fairly. -Disclosing the conflict if it cannot be avoided. -Controlling the conflict by eliminating risk of loss to the client.

Insider Trading

Most provinces and the Federal act require insiders of a reporting issuer to file reports of their trading in its securities. Based on the principle that shareholders and other interested person should be regularly informed of the market activity of insiders.

The Mutual Fund Dealers Association (MFDA)

Mutual fund's self regulatory body that regulates the distribution and sales of MFs- does not regulate the MFs themselves.

Registration*

Every firm and all IAs must be registered, administrators have the power to suspend/cancel registration.

IIROC plays the following Roles:

Financial Compliance: monitoring dealer members to ensure they have enough capital to carry out their operations. Business Conduct Compliance: monitoring dealer members to ensure policies and procedures are in place to properly supervise the handling of client accounts. Registration: overseeing professional standards and educational programs designed to maintain the competence of industry employees. Enforcement: enforcing the rules and regulations that cover sales, business, and financial practices and trading activities of individuals and firms that are under IIROC's jurisdiction.

Provincial Insurance Corporations

In each province, one or more organizations exist to protect the deposits of credit union members **See Chart in Module document. This organization may be called a deposit insurance or deposit guarantee corporation or stabilization fund, corporation, board or central credit union.

The Gatekeeper Role*

Include dealers and all of their employees, particularly front-line and supervisory employees.

Coverage example

Judy has $2 million invested in securities and cash with ABC investment Inc. when ABC declares bankruptcy. She did not owe any amount to ABC. At the time of bankruptcy, the market value of all accounts held by ABC was $100 million, but the amount available for distribution to clients after the bankruptcy was $80 million. Here's how CIPF determines their involvement: -ABC has a shortfall of $20 million to cover clients accounts. -ABC can cover only 80% of Judy's account, or $1.6 million ($80 million divided by $100 million is 80%, 80% of $2 million is $1.6 million). -The CIPF will step in to cover this shortfall up to the $1 million maximum per account. -Judy will receive $1.6 million from ABC and $400,000 from the CIPF; no loss to her.

The Investment Industry Association of Canada (IIAC)

Member-based association that represents the interests of the market participants by support and services to contribute to the success of its members.

The Self Regulatory Organizations (SROs)*

Private industry organizations that have been granted the privilege of regulating their own members by the provincial regulatory bodies. SROs are responsible for enforcing securities legislation and set out their own rules and requirements They are delegated functions and monitored by the provincial government.

Proxies and Proxy Solicitation*

Proxy is a power of attorney given by a shareholder that gives a designated person the authority to vote the shareholder's stock. Must be in writing and signed by the shareholder- if the shareholder does not vote, the ballot is cast with management's viewpoint.

Insider Reporting

Reports must indicate the extent of insiders' direct or indirect ownership of the securities of the company. An insider who transfers securities into the name of an agent, nominee or custodian must file a report with an administrator. -All reports filed to administrators are available to the public for inspection- failing to file a report or giving misleading information under the acts are punishable by a fine.

Full, True, Plain Disclosure*

Requirements for disclosure of all pertinent facts by public securities.

Right of Recession

Right to rescind or cancel a contract for the purchase of securities if the prospectus contains a misrepresentation.

What are the Principles of Securities Legislation?**

Securities industry has extensive legislation and regulation to protect the investor and to ensure high ethical standards.

National Do Not Call List (DNCL)

Since some advisors use the phone to solicit new clients, they are considered telemarketers and need to adhere to the regulation set out by the Canadian Radio-television and Telecommunications Commission (CRTC).

Canadian Securities Administrators (CSA)

The 13 securities regulators of Canada's provinces and territories joined together to form the CSA, a forum to coordinate regulation of the Canadian capital markets.

Coverage

The CIPF covers customers' losses of securities and cash balances that result from the insolvency of an IIROC dealer, given that: The general account is limited to $1,000,000 for losses relating to securities and cash balances- separated accounts for max coverage each unless they are combined with other separate accounts. The maximum amount of loss CIPF pays is the difference between cash securities owed by the company on the date of insolvency and the distribution of assets after bankruptcy, less any amounts owed by the client to the member. Clients have 180 days to file a claim with the CIPF

Suitability Assessment

The CRM requires that the suitability of an investment decision be conducted whenever a trade is accepted, a recommendation is made, etc.

Federal Regulators*

The Office of the Superintendent of Financial Institutions (OSFI) is a regulatory body for all federally regulated financial institutions. Regulate and supervises deposit-taking institutions, insurance companies, foreign bank representative offices, and pension plans. OSFI does not regulate the Canadian securities industry.

New Account Application Form (NAAF)

The first step in complying with this regulation is the completion of a NAAF, to be completed by a senior authority before the completion of the first transaction.

Right for Action of Damages

The issuer, seller, underwriter, and anyone else who signs the prospectus may be liable for damages if the prospectus contains a misrepresentation. An expert can also be held liable, but only if their consent appears in the prospectus. The claim for damages may also be invalid if the company can prove that the purchaser had knowledge of the misrepresentation.

Right of Withdrawal

The right of a purchaser to withdraw from an agreement within two business days of a prospectus by giving notice to the vendor.

Investor Protection Funds*

The securities industry offers protection against loss due to failure of a firm in the self-regulatory industry.

Canada Deposit Insurance Corporation (CDIC)

is a federal Crown Corporation that provides deposit insurance and contributes to the stability of Canada's financial system. Insure eligible deposits up to $100,000, and reimburses upon institution failure.