Trading Regulations and Settlement

Trading, Settlement, and Prohibited Activities Overview

• This section explores the mechanics of security order placement, the implications of order types, and the rules for sales and trading practices
• It also covers settlement and delivery, securities transfer, and error handling

Key Terms

• All-or-none order: An order that must be executed in its entirety or not at all, with no partial fills allowed
• Ask price: The lowest price at which a seller is willing to sell a security
• Best-efforts basis: An agreement where the underwriter commits to making their best effort to sell as many securities as possible but does not guarantee the sale of all of them
• Bid price: The highest price a buyer is willing to pay for a security
• Churning: Executing multiple transactions in a client's account solely to increase the RR's remuneration
• Client priority rule: Requires that client orders take precedence over orders from partners, directors, officers, RRs, and employees of the same dealer member
• Day order: An order to buy or sell that expires at the end of the trading day if not executed
• Fails: Securities not delivered by the settlement date
• Fill-or-kill order: An order that must be filled immediately as much as possible, and the remaining balance is cancelled
• Firewall: Information barriers that separate individuals making investment decisions from those with potentially market-moving inside information
• Frontrunning: Taking advantage of a client's order by trading ahead of it
• Gatekeeper: Registrants must not facilitate breaches of securities laws or regulations
• Grey or watch list: Securities that may have something potentially occurring and have restricted dissemination
• Inside information: Material non-public information about a company's securities
• Insider trading: Trading based on material non-public information
• Limit order: An order to buy or sell a security at a specific price or better
• Market order: An order to buy or sell securities at the prevailing market price
• Material information: Information about a material change that could significantly impact the market price of securities
• Minimum quotation spread: The minimum acceptable range between bid and ask prices
• Odd lot: An order for less than a standard trading unit
• Restricted list: Sales and trading staff are under specific restrictions for particular securities
• Short sale: Selling stock that the seller does not own
• Standard trading unit: The quantity of a security that makes up a standard trading unit
• Stop-loss order: An order to sell when the limit price is below the existing market price
• Suspicious transaction: Transactions with reasonable grounds to suspect a money laundering offence
• Settlement: The act of transferring securities to the buyer’s account and transferring cash to the seller’s account
• Tipping: Passing non public information to someone
• Wash trade: A trade that gives a false impression of trading activity

How Securities Are Traded

• The three components of a trade are the standard trading unit, the settlement period, and the minimum quotation spread

Standard Trading Units

• Defined in the Universal Market Integrity Rules (UMIR) and by Canadian Investment Regulatory Organization (CIRO) rules
• Unit sizes for listed securities:
  • 1,000 units for securities priced less than $0.10 per unit
  • 500 units for securities priced at $0.10 or more, but less than $1.00
  • 100 units for securities priced at $1.00 or more
• Orders not in multiples of standard trading units are considered odd lots

Settlement Period

• Refers to the transfer to the buyer's account and the transfer of cash to the seller's account
• It is the time between a securities transaction and ownership transfer
• The settlement period varies with the type of security
• Most securities settle trade date plus one business day.
• As of 2024, North American capital markets shortened the standard settlement cycle for most securities trades to one day after the trade date

Minimum Quotation Spreads

• These are the minimum acceptable differences between bid and ask prices
• When selling, clients receive the bid price
• When buying, clients pay the ask price
• Minimum quotation spreads are set by exchanges, for TSX and TSX Venture
  • It is $0.005 for securities selling under $0.50
  • It is $0.01 for securities selling at $0.50 and over

Placing an Order

• RRs must comply with firm procedures and industry rules for order submission
• RRs must ensure order correctness, and clients must confirm accuracy for non-discretionary accounts
• To be valid, each order ticket must include:
  • Client name or account number
  • Quantity and security description (symbol)
  • The price (e.g., limit, market, or on-stop)
  • Whether the order is professional (PRO), non-client (N-C), or employee (EMP)
  • Notation if the order is a short sale or discretionary
• Clarity and accuracy are paramount in completing order forms to avoid errors
• Follow these guidelines to avoid errors:
  • Enter information clearly
  • Repeat orders back to the client
  • Look up stock symbol and write the full security name if unsure
  • Note whether it is a buy or sell order
  • Ensure correct order form use
  • Verify security description accuracy
• Repeat each order back to the client to avoid misunderstandings
• Clearly specify the security type being traded (e.g., Class A, B common, warrants, or rights)
• Sales assistants must understand the firm's order entry system and be comfortable with it

Types of Orders

• Two order types are, duration and price, and if no special or other terms are attached
• Duration: How long is the order valid for?
• Price restrictions: Have any limits been set on the price?
• Special instructions: Are there any special conditions attached to the order?
• Other: Are there any changes to the original order or is the client a PRO?

Orders Categorized by Duration

• Day order:
  • It expires at the end of the trading day
  • Example: "Buy 100 shares of XYZ for my account at $10 or less."
• Good till canceled (GTC) order:
  • It remains in effect until executed or cancelled
  • TSX GTC orders expire 90 calendar days after entry
  • Example: "Sell 100 shares of XYZ whenever the price reaches $20 or more."
• Good till date (GTD) order:
  • It is valid until filled, cancelled, or until the close of business on a specified expiry date
  • GTD orders are useful for clients who may be hard to reach or on vacation
  • Example: "Sell 100 shares of XYZ if the price reaches $20 or more on or before March 30."

Orders Categorized by Price

• Market order:
  • It is an order to buy or sell at the prevailing market price
  • In other words, there is no price limit
  • Example: "Buy 100 shares of XYZ Inc. at market."
• Limit order:
  • It is to buy or sell a security at a better price
  • A limit buy order lets one purchase shares at the limit price or lower
  • A limit sell order permits the sale of shares at the limit price or higher
  • Example: "Buy 100 XYZ Inc. at $20 or less"
• On stop sell order:
  • Often called a stop-loss order
  • It is with a sell order where the limit price is below the existing market price
  • Triggered when the stock drops to the specified level
  • It reduces the amount of loss or protects paper profit
  • Example: "Sell my XYZ stock if the price drops to $20.”
  • These must be entered with a limit attached
• On stop buy order:
  • The opposite of the on-stop sell order
  • It's to buy a stock at or above a certain price
  • Protect a short position when the stock's price is rising, or to ensure that a stock is purchased while its price is rising
  • Example: "Buy 100 XYZ Inc. only if it moves up from $30 to $35.'
  • These must be entered with a limit attached

Orders Categorized by Special Instructions

• Special terms orders are executed on a best-efforts basis
• All-or-none order (AON order):
  • The entire amount of stock must be bought or sold, or no part of the order will be executed
  • The client will not accept partial fills; such orders are filled on a best-efforts basis only
  • Example: "Buy 2,500 shares of XYZ at $20 on an all-or-none basis."
• Fill-or-kill order (FOK order):
  • It is an order in which as much as possible must be filled immediately, after which the balance of the order is cancelled
  • It makes no difference how much of the order remains unfilled
  • Example: "Buy 2,500 XYZ at $20 on a fill-or-kill basis."
• Switch order:
  • It is for the sequential sale of one security and the use of the proceeds to purchase another
  • The second order cannot be activated until the first order is filled
  • Example: "Sell 100 XYZ and use the proceeds from this sale to buy shares of CDE."
• Contingent order:
  • It is an order that takes second place to a primary order
  • A primary order and one or more contingent orders are entered into the trading system simultaneously; however, a contingent order becomes effective only after the primary order is filled
  • Example: "Buy 1,000 shares of XYZ at market and sell 10 calls at the current offer price."
• Delayed delivery order:
  • It is one where the buying and selling parties agree to delay the delivery of the securities beyond the usual settlement period to a date specified in the order
  • This is mostly used with institutional accounts
  • Example: On August 31, a client enters an order to sell 100 shares of ABC at $23 on a 30-day delayed delivery basis. If the order were filled on August 31, delivery and settlement would be made 30 days later, on September 30.
• Short sale order:
  • It's to sell stock that the seller doesn't own; short sellers borrow the stock from a dealer member and sell it with the expectation that the price will go down
  • You must clearly indicate on the order that it is a short order
  • Example: "Sell short 100 XYZ at $20."

Other Types of Orders

• Cancel or change former order (CFO):
  • It is a cancellation and amendment to another order
  • You must use care when dealing with clients who wish to change orders and the client should know if an order may have been already filled
• Professional order, also called employee order and non-client order:
  • It's for the account of a partner, director, officer, shareholder, investment advisor or other employee of a dealer member
  • It must be marked as employee (EMP), PRO, or non-client (N-C)
  • Client orders must be given priority

Fixed Income Trading

• In Canada, bonds trade primarily on over-the-counter (OTC) markets
• Most trading occurs on quote-driven systems over the phone

Standard Trading Units of Debt Securities and Unlisted Securities

• GOC T-bills and other GOC direct and guarantees maturing in less than one year is $250,000 par value
• GOC direct and guarantees with terms of one to three years is $100,000 par value
• GOC direct and guarantees with terms of over three years is $100,000 par value
• Provincial bonds and guarantees is $25,000 par value
• All other bonds (municipal and corporate) is $25,000 par value
• Bonds, convertible debentures, and debentures issued at a $5,000 par value with attached stock warrants, rights, or other appendages is $5,000 par value irrespective of value of appendages
• Common and preferred stocks not listed on a recognized stock exchange:
  • It's 500 shares if market price is below $1/share
  • It's 100 shares if market price is at $1 and below $100
  • It's 50 shares if market is $100 or over
• CIRO rules and guidance require you to deal fairly with customers and provide fair pricing and valuation

Sales and Trading Conduct

• As an RR, you must study and conform to the rules of your province, and keep informed of regulatory changes
• Industry rules include basic requirements to: Know Your Client (KYC), Know Your Product (KYP), and make suitable recommendations

Client Priority

• PRO, EMP, or N-C orders—rank after any client order of the same dealer member for the same security, at the same time, at the same price
• Under UMIR Rule 5.3, participants can't enter a principal or N-C order on a marketplace if the participant knows it will likely execute in priority over a client order that is the same
• Subject to certain exceptions, a trader can never intentionally trade ahead of a client order or tradeable limit order received prior to the entry of the principal order or non-client order without the specific consent of the client

Best Execution

• Best execution requirements are set out in CIRO's IDPC rules, and takes all aspects of the trade into account
• Dealer members must pursue execution of each client order on the most advantageous terms for the client and as quickly as possible
• Factors used to decide best execution:
  • Price
  • Speed of execution
  • Certainty of execution
  • Total transaction cost
• Best execution also refers to the period of time during which the order is handled; members must also consider: - Prices and volumes of the last sale and previous trades - Direction of the market for the security - Posted size on the bid and offer - Size of the spread - Liquidity of the security

Gatekeeper Obligations

• RRs and Investment Representatives (IRs) have a gatekeeper role and must not facilitate breaches of securities laws or regulations
• They may be responsible for breaches by colleagues
• Report to supervisory or compliance personnel activity that appears to violate the rules
• This includes:
  • Specific unacceptable activities
  • Manipulative and deceptive activities
  • Improper orders and trades
  • Frontrunning
  • Best Execution of Client Orders
  • Client priority
  • Market trades
• Supervisors must review any report in accordance with firm policies

Examples of Trading Activity that that May Cause Concern

• A group of clients is trading in a security that is not normally followed
• A client opens an account and immediately purchases large amounts of one stock
• A client or group of clients regularly sells a particular security late in the trading session
• A client wishes to place a buy order and instructs the RR to contact a particular person at another dealer member to take the other side of the trade

Anti-Money Laundering and Suspicious Transaction Reporting

• Under AML/ATF regulations, suspicious transactions must be reported to FINTRAC
• "Suspicious" means if reasonable grounds exist to suspect a money laundering offence or terrorist activity
• Reporting is an offence punishable by up to five years' imprisonment and/or a maximum fine of $2 million
• FINTRAC can issue an administrative monetary penalty (AMP) of up to $500,000 for noncompliance with proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA)

Report Suspicious Transactions

• Dealer members and employees, being required to report suspicious transactions to FINTRAC, are protected from criminal and civil legal proceedings
• A report on a suspicious transaction has no monetary threshold

Prohibited Activities

• It's to identify acceptable and unacceptable sales and trading practices
• RRs must be competent and honest to earn a respectable income, curbing unethical and dishonest practices

Frontrunning

• It’s taking advantage of a client’s order by trading ahead of it, which is a serious offence
• Trading on non-specific information such as rumors does not constitute frontrunning
• Trading based on material non-public information is insider trading, which is illegal
• An RR with knowledge of a pending client order that could reasonably be expected to affect the market price of a security must refrain from:
  • Entering a principal or a non-client order on any marketplace for the security or any related security
  • Soliciting an order from any person for a security or any related security
  • Informing anyone about the client order, other than when necessary
• It is legal to trade ahead of a client order for the client's benefit when the participant/client have agreed on a client-principle cross

Churning

• It is the act of carrying out multiple transactions in a client's account solely to increase the RR's remuneration
• It may be failure to deal fairly, in good faith, and honestly with a client
• You should discuss your recommendations with your clients and get their approval before acting
• Supervisors must oversee trading activity and question any trading that appears excessive

Sales Made Outside of a Jurisdiction

• Filling an order for a client living in another province constitutes trading in that province, and you could be subject to action by the relevant administrator if not registered there

Sale of Unqualified Securities

• It is illegal to trade in most securities that have not been qualified for sale

Illegal Representations to Effect a Trade

• Registered Representatives are subject to penalties for deliberately false statements and prohibitions in Criminal Code

Illegal Representations

• Prohibitions:
  • Representing that someone will resell/repurchase a security, or that the purchase price will be refunded unless if the security is retractable
  • Promising a specific future value for a security (there are rare exceptions)
  • Representing a security will be listed on exchange without administrator consent

General Prohibitions

• Using the name of another RR in advertising without the RR’s written autorization
• Displaying registration certificates at their business location unless course completion certificates is permitted
• Representing Administrator approved the investment merits of any security, the financial standing/fitness/conduct of any registered person
• Improper practices that lead to violations: - Using high-pressure sales tactics - Taking advantage of a person’s inability or incapacity - Making any objectively false/misleading statement - Violating KYC Requirements - Reducing/retracting sales commission - Securities by an undisclosed person - Non-existent transactions

Manipulative Trading Practices

• CIRO defines trading practices that are not acceptable due to principles of a transparent/fair market, including: - Deceiving the purchaser/vendor as to the nature/value of a transaction - Creating a false/misleading appearance of trading - Manipulating the market (entering an agreement to sell/repurchase an instrument; last sales) - Fictitious transactions - Taking the market side opposite clients - Misleading CIRO on any material point - Any “fixed-income trading” practice that is deceptive, fraudulent, manipulative

  -Executing trades that are intended to affect trading volumes/prices

  • Spreading false issuer rumors
    • Disseminating information that government approves trading/institutions Colluding/conspiring against unfairness Acting for unfair advantage, such as:
    • With specific knowledge of new issues _ Executing trades out of client orders before client is disclosed
    • Utilizing any proprietary information

• Abusing market procedures, or Consummating trades outside the context of market price

Unauthorized Discretionary Trading

• Registered Representatives are prohibited from using unauthorized discretion
• Temporary discretionary accounts, they must have valid reasons

Illegal Insider Trading and Tipping

• Insiders are persons in a position to obtain information before the public, so the Acts & CBCA prohibits it or providing use as information

Who Qualifies as Insiders

Directors/Senior Officers of the Issuer

- People/Companies that (excluding Underwriters), beneficially own more than 10%
- Subsidiary that the issuer uses, Senior officer/director
- People who learns something from these

Inside Information Qualifiers

• It is any nonpublic/material fact about the securities of an issuer
• The Securities Act (Ontario) defines material facts as:
  • Information about a material change
  • A change in Issuer's capital, or business that could shift market price

Penalties for Insider Trading & Tipping

Those found complicit can be financially liable to the seller/purchaser

 - Fines/Imprisonment to companies that profit
 - Securities Act fines or imprionment
 - Criminal Code offenses with prison

Firewalls

• These are information barriers to seclude privy individuals; procedures should be developed to safeguard any inside information
• Recommended Safeguards:
  • Employee Education
  • Containment, Transaction Restrictions, Surveillance Physical Seperation

Settlements, Transfers, and Corrections

• RRs must understand trade settlement, securities transfer, and error handling

The Clearing System

• The Canadian Depository for Securities (CDS) Clearing and Depository Services Inc. operate for many, to provide delivery when settling
• As a participant in the exchange, both buying & and selling are done

Advantage with Securities Sold

• Unless declared before hand, security advantages (dividends/etc), or responsibilities, are passed to new owner

Accrued Interest to Seller

• Seller retains all accrued interest on debentures & bonds until sale completed
• Paying the seller then is important to ensure the coupon goes to purchaser

Trading Ex-Dividends/Rights

• Trades are ex-privileges if:
  • They happen on a record date
  • If the date happens mid holiday, you can move it down a business day

Cash Trades

• Settle before usual settlement, they dont have privileges or rights otherwise granted on normal trades

Rights on Stock

• Different exchanges regulate settlement & trading rules

Reducing Outstanding Orders When Shares Trade Ex

Orders must be reduced by payment, if they are: - Open for Purchasing - Open: Stop-Loss for shorts

• Orders not reduced:
  • Open to increase, or to sell

Transfer of Securities

• Transfer follows the agent authority by the company

Simple Transfer

• Individual Transfer
• Signature follows legal name

Transfer with Legal Documentation

• Transfer to entity needs legal papers

Delivery and Payments

• RRs must ensure instructions, payments, delivery are prompt/executed
• Clients should make payments before failing financially
• Be ready for forgeries regarding certificates

Errors

• Can be costly, so members must have process
• (2) Errors: - Pre execution : A change is normally created - Poste xecution: If amount/security isn’t correct, it can be switched with correct number, If mistake is other than those-procedures

Key Responsibilities and Requirements

• RRs are gatekeepers and must not facilitate breaches of securities laws or regulations by clients, but must adhere to CIRO and security administrator rules on salesperson conduct
• The final goal for the RR, is professional conduct