Canadian Regulatory Framework PDF

The Canadian Regulatory Framework 3 CHAPTER OVERVIEW In this chapter, we discuss the basic principles of securities regulation. You will learn how provincial securities legislation functions and a...

The Canadian Regulatory Framework 3 CHAPTER OVERVIEW In this chapter, we discuss the basic principles of securities regulation. You will learn how provincial securities legislation functions and about the rules, regulations, and guidelines of self-regulatory organizations. LEARNING OBJECTIVES CONTENT AREAS 1 | Identify the principles of securities regulation. General Principles of Securities Regulation 2 | Identify the key players in Canadian securities Key Government Players Involved in Securities regulation. Regulation 3 | Explain the role of the self-regulatory Self-Regulatory Organization organization, the provincial regulators, and the marketplaces. 4 | Describe the role of the Canadian Investor Investor Protection Funds Protection Fund and the limits of its coverage. 5 | Describe anti-money laundering and anti- Money Laundering and Terrorist Financing in terrorist financing requirements. the Securities Industry © CANADIAN SECURITIES INSTITUTE 3 2 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 KEY TERMS Key terms are defined in the Glossary and appear in bold text when they first occur in the chapter. administrator money laundering Canadian Investor Protection Fund Mutual Fund Dealers Association Canadian Securities Administrators National Instrument dealer member Passport System Designated Stock Exchange primary distribution disclosure registrant Financial Transactions and Reports Analysis regulator Centre of Canada secondary distribution Integrated Market Enforcement Teams secondary trading Investment Industry Regulatory Organization of Canada self-regulatory organization Joint Serious Offences Team Universal Market Integrity Rules © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 3 INTRODUCTION The securities industry is a heavily regulated industry. Its many rules and regulations are designed to promote a fair and efficient securities marketplace and protect investors. The various governmental and industry organizations impose the following rules and restrictions, among others, on market participants: Before selling new securities in the public marketplace, issuers of those securities must provide potential buyers with certain prescribed information in specified formats. Public companies and insiders of those companies must also provide specific information to the public on an ongoing basis. These disclosure rules are in place to help potential buyers and sellers of securities on the secondary market make informed decisions. Distributors of securities, both dealer members and their employees, must abide by rules governing their conduct. For example, securities rules and regulations specify the responsibilities registrants have to their clients when providing information about securities and when making recommendations to buy and sell them. Dealer members must supervise their employees’ conduct and use care when handling clients’ assets. Both registrants and the firms that employ them must meet specific registration requirements in order to be licensed to carry out registrable activities. In this chapter, we discuss the basic principles of securities regulation in broad language. GENERAL PRINCIPLES OF SECURITIES REGULATION 1 | Identify the principles of securities regulation. Securities legislation has been passed by each province to regulate the primary and secondary distribution of securities and to protect buyers and sellers of securities. In most provinces, a securities commission administers the applicable Act. In provinces with no commission, an administrator, registrar, or other official handles securities administration. We use the term administrator to describe the securities regulatory authority of each province, whether it is a commission, registrar, administrator, or other official. The various regulators work together to coordinate and harmonize the regulation of the Canadian capital markets through the Canadian Securities Administrators (CSA). The primary mandate of each securities regulator is to promote the integrity of financial markets and ensure investor protection. An example of this dual mandate is expressed in the British Columbia Securities Commission’s mission statement: The mission of the British Columbia Securities Commission is to protect and promote the public interest by regulating trading in securities 1) to ensure the securities market is fair and efficient and warrants public confidence and 2) to foster a dynamic and competitive securities industry in British Columbia that provides investment opportunities and access to capital. Likewise, the Ontario Securities Commission (OSC) has a similar mandate “to protect investors from unfair, improper or fraudulent practices and to foster fair and efficient capital markets and confidence in their integrity.” The same sentiment is echoed by the Canadian Investment Regulatory Organization (CIRO), which is the investment industry’s self-regulatory organization (SRO): CIRO is committed to the protection of investors, providing efficient and consistent regulation, and building Canadians’ trust in financial regulation and the people managing their investments. This focus on market integrity and investor protection has broad and extensive implications for participants in the securities industry. Securities legislation and SRO rules and regulations are crafted to incorporate these values. © CANADIAN SECURITIES INSTITUTE 3 4 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 The licensing regime dictates the conditions under which individuals and firms are permitted to enter the industry. Therefore, your ability to participate in the industry upon successful licensing is a privilege rather than a right. As with all privileges, the regulator can revoke them in certain circumstances, which we will discuss later in this chapter. The concepts noted above include specific issues, such as insider trading, anti-money laundering, and cybersecurity- related issues. Each of these types of concerns, individually and collectively, can disrupt the capital markets and jeopardize the market’s integrity and investor confidence in it. Although these issues will be discussed further on in this course, it is important for you to appreciate that securities regulators have other matters at play when they seek to regulate the industry. Generally, the securities acts are based on three broad principles of regulation: 1. Disclosure of facts that investors need to make reasoned investment decisions 2. Registration of securities dealers, advisors, and other stated categories of registration 3. Enforcement of securities laws and administrative policies DISCLOSURE The underlying principle of securities regulation in Canada is full, true, and plain disclosure. Every person or corporation that offers for public sale securities that have not yet been publicly distributed must follow specific disclosure rules. They must file with the administrator and deliver a prospectus to the purchaser that contains a full, true, and plain disclosure of all material facts relating to the securities offered for sale. Until disclosure has been made to the satisfaction of the administrator concerned, it is illegal to sell or offer to sell the securities. A prospectus or similar document can be likened to a contract between the issuing company and the person who purchases the security in question. If we consider a prospectus from this perspective, anyone making such a purchase would naturally want to be informed of certain facts so that they can make an informed decision. Bearing this fact in mind, the administrators have determined and specified which facts must be disclosed to potential investors. Disclosure is normally made in a prospectus issued by the company and its underwriter and accepted for filing by the administrator of the province or provinces in which the offering will be made. In most provinces, a sale from a control position is subject to the same disclosure requirement. (A securities holder who exercises significant influence over the issuer of the same securities is in a control position.) When a security moves beyond primary distribution, it may be further bought and sold by investors, often through a stock exchange. This activity is called secondary trading, and the securities traded this way are said to be freely trading. (In other words, they are no longer sold via prospectus, but rather are bought from or sold by the investor directly on the secondary market.) To maintain an exchange listing that allows investors to engage in secondary trading, the issuer must meet the requirements of the applicable act or acts and of any exchange on which the securities are traded. These requirements, often referred to as continuous disclosure requirements, vary in complexity among the different exchanges. Again, similar to prospectus requirements upon initial distribution, continuous disclosure requirements are in place to help investors make informed decisions. The rules require, among other things, the periodic filing of financial statements and the filing of information concerning material changes to the company. Continuous disclosure requirements apply to the following communications: Insider trading reports disclosing trading activities of persons connected to the company (sometimes called insiders or referred to as having a special relationship to the company) The information circular required in a proxy solicitation Regular corporate financial reports, including management’s discussion and analysis Annual information forms © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 5 Timely disclosure of material changes in the affairs of issuers (i.e., changes that are significant in that they may affect an investor’s decision to buy or sell a particular security) Other shareholder communications The purpose of continuous disclosure is to ensure that material information is effectively communicated from issuers to the public and investment professionals. It ensures that such information is readily available to all market participants. This flow of information into the marketplace supports the integrity of the public markets. In contrast, consider a marketplace where critical information was available only to a certain group of people. This imbalance would be unfair to other market participants seeking to make informed investment decisions. REGISTRATION The administrators are responsible for registering persons and companies that engage either in direct selling of securities to the public or in advising others on buying or selling securities. Thus, they are able to impose proficiency, integrity, and financial compliance on those that apply for or hold registration. They also have the power to suspend or cancel an entity’s registration when they consider it to be in the public interest. Every investment dealer that underwrites or sells securities must be registered with the administrator in any province in which the securities are sold. All partners, directors, officers, and salespersons employed by investment dealers must also be registered with the administrator of the appropriate province. Investment dealers must also be members of CIRO and must follow its rules. CIRO determines the customer types a dealer member and its representatives can serve and approves the products they can deal in. DID YOU KNOW? Investment dealer members offer a broad selection of investment products, such as stocks, bonds, and mutual funds. Some dealer member firms offer advice and a full range of services, such as market analysis, securities research, and portfolio management. Others simply sell or buy investment products based on client instructions. INVESTIGATION AND PROSECUTION The administrators are empowered to begin an investigation, prosecute for violation of an Act, and impose sanctions for conduct that is contrary to the public interest. They also have authority to compel the attendance of witnesses at a hearing, take evidence under oath, seize documents for examination, freeze funds or securities on deposit with or under the control of any person, and have many of the powers of a court. Administrators can suspend, cancel, or revoke registration; levy fines; disgorge monies; order trading in a security to cease; and deny a person the right to trade securities in a province. The implementation of an administrator’s powers can have serious consequences. A person or firm whose registration is cancelled can lose the ability to earn a living. If an issuer’s securities cease trading, the issuer is less able to raise capital. In certain provinces, the administrators have broader powers, such as the power to prevent a person from becoming a director or officer of a public company, give public reprimands, and levy fines. In addition, an administrator who finds that any provision of an Act has been violated may recommend that a charge be laid against the offending party. If found guilty, the party may be fined, imprisoned, or both. In all provinces, anyone who disagrees with a ruling of the administrator may appeal to the courts. Moreover, securities legislation prohibits participation in any activity that the participant knows, or reasonably ought to know, is fraudulent. Likewise, acts are prohibited that could result in a misleading appearance of trading in a security or an artificial price for a security. There is also a general prohibition against knowingly making misleading or untrue statements that could significantly affect the market price or value of a security. © CANADIAN SECURITIES INSTITUTE 3 6 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 EXAMPLE The maximum penalties for offences under the Securities Act (Ontario) are a fine of $5,000,000 and imprisonment for a term of not more than five years less a day. The OSC also has the power to order the payment of an administrative penalty of up to $1,000,000 and to order the disgorgement of monies obtained as a result of noncompliance with Ontario securities law. The securities acts all contain secondary market civil liability provisions. Investors are not required to prove they relied on misleading disclosure when buying or selling stock or other securities. The provinces also have the power to order repayment of a financial loss to a member of the public resulting from illegal or improper trading. Even the most determined public officials and the most exhaustive legislation cannot guarantee that persons who purchase or sell securities will not suffer a financial loss. It is almost impossible to restrict the activities of unscrupulous promoters completely without impeding the efforts of legitimate entrepreneurs. The laws are designed to prevent, as far as possible, blatant fraud and deceit, and to protect investors who lack investment expertise. However, no legislation supplants the need for investors and their advisors to evaluate an investment both before its initial purchase and periodically while the investment is held. DID YOU KNOW? Many retail investors assume that protection of their funds from loss is guaranteed. As a Registered Representative (RR), you should make sure your clients understand that they must accept certain risks when investing. During the client discovery process, you should explain—and, more, importantly document—all relevant risks so that the client can make an informed decision. KEY GOVERNMENT PLAYERS INVOLVED IN SECURITIES REGULATION 2 | Identify the key players in Canadian securities regulation. Regulation of the securities industry in Canada occurs at three levels: federal, provincial, and industry. THE FEDERAL GOVERNMENT In the United States, the Securities and Exchange Commission has exerted considerable regulatory authority on a national level since the early 1930s. In contrast, no formal federal securities regulatory body exists in Canada. Canadian officials have proposed that some type of federal authority be established, and work continues in that regard. Nonetheless, certain securities activities are regulated by federal legislation and authorities. For example, the Canada Business Corporations Act regulates proxy solicitations and insider trading for federally incorporated companies. An indirect federal government interest also exists given that banks are federally regulated and own many large securities dealers in Canada. However, any securities activity that takes place in provincially regulated subsidiaries of the banks is subject to provincial securities regulation. Securities dealers are also subject to the federal Proceeds of Crime (Money Laundering) and Terrorism Financing Act (PCMLTFA), which is enforced by the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) and the federal Personal Information Protection and Electronic Documents Act (PIPEDA). INTEGRATED MARKET ENFORCEMENT TEAMS Integrated Market Enforcement Teams (IMETs) were launched in November 2003 with the goal of strengthening the law enforcement community’s ability to detect, investigate, and deter capital markets fraud. IMETs is a joint © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 7 initiative of the Royal Canadian Mounted Police (RCMP) and the federal government. The teams work closely with securities regulators, the SRO, the exchanges, and other federal and provincial authorities. JOINT SERIOUS OFFENCES TEAM The OSC launched its Joint Serious Offences Team (JSOT) in May 2013 to elevate efforts to target fraud and other serious misconduct. JSOT is an enforcement partnership between the OSC, the RCMP Financial Crime program, and the Ontario Provincial Police Anti-Rackets Branch. JSOT investigates and prosecutes serious violations of the law using provisions of the Securities Act (Ontario) and Criminal Code. Staff work with police agencies and the Ministry of the Attorney General to bring more cases before the courts and to send a strong message to those who might harm the public. THE PROVINCES Each province regulates securities activities within its borders through a securities commission or equivalent, and its own securities legislation. As a result of the CSA’s efforts, securities markets are now governed by a number of largely harmonized National Instruments (NI) and Multilateral Instruments (MI). A NI is an instrument that has been adopted by all CSA jurisdictions, whereas an MI has not been adopted by one or more CSA jurisdictions. National Instruments that are of particular relevance to dealer members include NI 31- 103 and NI 81-102. The governing bodies in each of the provinces and territories are listed as follows: Alberta – Alberta Securities Commission (ASC) British Columbia – British Columbia Securities Commission (BCSC) Manitoba – The Manitoba Securities Commission (MSC) New Brunswick – Financial and Consumer Services Commission (FCNB) Newfoundland and Labrador – Office of the Superintendent of Securities Service Northwest Territories – Office of the Superintendent of Securities Nova Scotia – Nova Scotia Securities Commission (NSSC) Nunavut – Nunavut Securities Office Ontario – Ontario Securities Commission (OSC) Prince Edward Island – Office of the Superintendent of Securities Quebec – Autorité des marchés financiers (AMF) Saskatchewan – Financial and Consumer Affairs Authority of Saskatchewan (FCAA) Yukon Territory – Office of the Yukon Superintendent of Securities THE CANADIAN SECURITIES ADMINISTRATORS The CSA is an umbrella organization whose objective is to improve, coordinate, and harmonize the regulation of the Canadian capital markets. It aims to achieve consensus on policy decisions that affect the capital markets and their participants. It also aims to work collaboratively in the delivery of regulatory programs across Canada through such means as the review of continuous disclosure and prospectus filings. The mission of the CSA members is threefold: 1. To protect investors from unfair, improper, or fraudulent practices 2. To foster fair and efficient capital markets 3. To reduce risks to the market’s integrity and to investor confidence in the markets © CANADIAN SECURITIES INSTITUTE 3 8 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 As an informal body, the CSA functions through meetings, conference calls, and day-to-day cooperation among the securities regulatory authorities. While the CSA coordinates initiatives on a cross-Canada basis, provincial or territorial regulators handle all complaints regarding securities violations in their respective jurisdictions. Enforcement of securities regulations is also done on an individual basis by each province or territory. DID YOU KNOW? On October 3, 2019, the CSA released its final amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. This initiative, known as the Client Focused Reforms (CFRs), made changes to the registrant conduct requirements with the following intent: To better align the interests of securities advisers, dealers, and representatives (registrants) with the interests of their clients To improve outcomes for clients To clarify for clients the nature and terms of their relationship with registrants The CFR initiative is based on the concept that the interests of the client must come first in the client- registrant relationship. CSA TOOLS AND PROCESSES The CSA uses three primary tools in delivering its mandate: the Passport System, the Super Memorandum of Understanding (Super MOU), and various electronic databases. PASSPORT SYSTEM The Passport System is designed to reduce unnecessary duplication in the review of filings made in multiple jurisdictions and is based on the principles of mutual reliance. Under this system, the various securities regulatory authorities are prepared to rely primarily on the analysis and review provided by another authority when necessary. For example, they rely on each other to review prospectuses and effect streamlined regulation in contexts such as enforcement and registration. SUPER MOU The Super MOU is a memorandum of understanding about the oversight of the marketplaces. Like the Passport System, it provides for the oversight functions to be based on mutual reliance principles. Each recognized marketplace has a principal regulator responsible for its oversight. DIVE DEEPER The OSC is the principal regulator for the Toronto Stock Exchange (TSX) and CIRO. The ASC and the BCSC are the principal regulators for the TSX Venture Exchange. The AMF is the principal regulator for the Montreal Exchange (MX). More information regarding oversight responsibility can be found on these administrators’ websites. ELECTRONIC DATABASES The CSA maintains electronic databases to streamline regulatory processes and make information more easily available to the market: © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 9 SEDAR+ SEDAR+ is the web-based system used by all market participants to file, disclose and search for information in Canada’s capital markets. In July 2023, it consolidated and replaced the System for Electronic Analysis and Retrieval (SEDAR), the national Cease Trading Order (CTO) database, and the Disciplined List (DL) database. Future phases of SEDAR+ will replace the System for Electronic Disclosure by Insiders (SEDI), the National Registration Database (NRD) and the remaining filings in local systems. SEDI SEDI allows insiders to file insider reports with all CSA regulators through a single submission over the internet. The public can access insider reports soon after they are filed. NRD NRD is a database that allows dealers, underwriters, advisers, and individuals to submit registration applications, changes, renewals, and fees electronically in a single submission to all regulators. In addition, the CSA keeps constituents fully informed of its activities through regular notices, news releases, and publications regarding major initiatives and enforcement activities. DID YOU KNOW? A Cease Trading Order prohibits trading in a company’s securities. They are issued by a provincial or territorial securities commission or similar regulatory body against a company for failing to meet disclosure requirements. A CTO might be issued to a company for failing to file a financial statement on time. It might also be issued as a result of an enforcement action that involves an investigation of wrongdoing. INTERNATIONAL ACTIVITIES As the securities industry became more globalized, the lines of separation faded between international securities markets. The need arose for greater collaboration among regulators in different jurisdictions. As a result, global organizations now exist that enable the securities regulators to work toward the common goal of efficient capital markets. We discuss two of those organizations below. INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS The International Organization of Securities Commissions (IOSCO) regulates more than 95% of the world’s securities markets. The organization has the following objectives: To cooperate in developing, implementing, and promoting adherence to internationally recognized and consistent standards of regulation, oversight, and enforcement in order to protect investors, maintain fair, efficient and transparent markets, and address systemic risks To enhance investor protection and promote investor confidence in the integrity of securities markets, through strengthened information exchange and cooperation in enforcement against misconduct and in supervision of markets and market intermediaries To exchange information at both global and regional levels on their respective experiences in order to assist the development of markets, strengthen market infrastructure, and implement appropriate regulation IOSCO has over 200 members, including the OSC, the AMF, the ASC, the BCSC, and CIRO. © CANADIAN SECURITIES INSTITUTE 3 10 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 FINANCIAL STABILITY BOARD The Financial Stability Board (FSB) was established in April 2009 at the G20 Leaders’ Summit as the successor to the Financial Stability Forum. The Bank of Canada and the Office of the Superintendent of Financial Institutions (OSFI) are members. The FSB’s mandate includes the following objectives: Assess and address vulnerabilities affecting the financial system. Promote information exchange among authorities responsible for financial stability. Monitor and advise on market developments and their implications for regulatory policy. Advise on and monitor best practices in meeting regulatory standards. Undertake joint strategic reviews of the policy development work of the international standard-setting bodies to ensure their work is timely, coordinated, and focused on priorities, and that it addresses gaps. Set guidelines for and support the establishment of supervisory colleges. Manage contingency planning for cross-border crisis management, particularly with respect to systemically important firms. Collaborate with the International Monetary Fund (IMF) to conduct early-warning exercises. SELF-REGULATORY ORGANIZATION 3 | Explain the role of the self-regulatory organization, the provincial regulators, and the marketplaces. SROs are industry organizations that regulate their own members. SROs are officially granted their regulatory powers by the administrators, and authority is typically given in the form of a recognition order. SROs are responsible for enforcing their members’ conformity with securities legislation. They also have the power to prescribe their own rules of conduct and financial requirements for their members. In Canada, the SRO for investment and mutual fund dealers is CIRO. CIRO’s rules and regulations are designed to uphold the principles of securities legislation. The administrators monitor the conduct of the SRO and review their rules to ensure that they do not conflict with provincial securities legislation. The rules of the SRO must be in the public’s best interest and must set a standard equal to or higher than those imposed by the provinces. CIRO has extensive powers to investigate possible violations of its rules and to take disciplinary action against member firms and their employees when appropriate. Sanctions for less serious offences may include fines, strict supervision, and the requirement to rewrite qualifying exams. Serious offences may result in the loss of registration and substantial fines. DID YOU KNOW? Prior to January 1, 2023, there were two SROs in Canada, the Investment Industry Regulatory Organization of Canada (IIROC), and the Mutual Fund Dealers Association of Canada (MFDA). IIROC was the national SRO overseeing all investment dealers and trading activity on equity and debt marketplaces in Canada. IIROC was responsible for enforcing the rules and regulations regarding sales, business conduct, financial practices, and trading activities of its dealer members and their representatives. The MFDA was the SRO responsible for regulating the distribution of mutual funds by its members in Canada. The MFDA did not regulate the mutual funds themselves; this responsibility remained with the securities commissions. © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 11 CANADIAN INVESTMENT REGULATORY ORGANIZATION CIRO is the national self-regulatory organization that oversees all investment dealers, mutual fund dealers and trading activity on Canada’s debt and equity marketplaces. CIRO sets and enforces rules for the business and financial conduct of Canadian investment and mutual fund firms and their individual registrants across Canada. All registrants are subject to high proficiency standards, training and supervision by member firms. IIROC was created by consolidating the Investment Dealers Association of Canada (IDA) and Market Regulation Services Inc. (RS) In June 2008. The IDA was formed in 1916 when a group of Toronto bond dealers created the Bond Dealers Section of the Toronto Board of Trade. Starting in the 1990s, provincial regulators recognized the IDA as an SRO for investment dealers and their registered employees. Securities legislation was introduced to require mandatory membership in an SRO (which had previously been voluntary) for any firm wishing to operate as an investment dealer in Canada. The trade association role was eliminated in 2006 with the creation of a separate and independent trade association known as the Investment Industry Association of Canada (IIAC). IIAC is a member-based advocacy association that advances the growth and development of the Canadian investment industry. It is not a regulatory body. Its member firms range in size from small regional firms to large organizations that employ thousands of individuals across the country. The IIAC’s mandate is fourfold: advocacy, industry profile, member support, and market advancement. Effective January 1, 2023, the CSA approved the merger of IIROC and the MFDA into a new, single SRO. The new SRO, now known as CIRO, assumed the regulatory responsibilities of the MFDA and IIROC. CIRO COMPLIANCE AND SURVEILLANCE CIRO’s compliance teams examine firms for compliance with conduct, trading, prudential and operating rules. They work with firms to ensure they continually meet high standards while providing financial services to their clients. The compliance function includes business conduct regulation, financial compliance, and trade review and analysis. CIRO conducts financial compliance reviews and sets minimum requirements to ensure that firms have enough capital for their business’s specific nature and volume. Capital requirements prevent firms from failing by preventing excessive leverage and risky business practices. CIRO-regulated firms also participate in the Canadian Investor Protection Fund (CIPF) (see below), which protects individual investors in the unlikely event that a firm should go bankrupt. CIRO also carries out business conduct compliance reviews to ensure that their dealer members have proper supervision procedures in place. Supervision should include handling client accounts to ensure that advice and transactions appropriately reflect a client’s needs and instructions. The accounts must be handled by RRs who are familiar with each client’s financial situation, investment needs, objectives, investing experience, and risk tolerance. In other words, the RRs must follow the Know Your Client (KYC) and suitability rules. Furthermore, CIRO carries out trading conduct compliance reviews to check trading firms’ trade desk procedures. The reviews assess whether trade desk procedures comply with the Universal Market Integrity Rules (UMIR) and applicable provincial securities law. Finally, CIRO conducts market surveillance and trading review analysis to ensure that trading is carried out in accordance with UMIR and applicable provincial securities law. Enforcement staff investigate possible breaches of CIRO rules and discipline firms and individuals when regulatory misconduct is identified. Discipline can include fines, suspensions, and permanent bans or termination for both individuals and firms. CIRO is a member of the Intermarket Surveillance Group (ISG), which comprises over 50 members worldwide, including all major stock exchanges. The mandate of the ISG is to promote effective market surveillance among international exchanges. © CANADIAN SECURITIES INSTITUTE 3 12 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 OTHER CIRO INITIATIVES CIRO offers a whistleblower service to evaluate reports of systemic wrongdoing. It takes prompt action on reported first-hand knowledge or tangible evidence of potential securities frauds or other unethical behaviour by individuals or firms in the investment industry. CIRO has a toll-free number and a web page where you can contact the whistleblower team. Team members will immediately assess the situation and ensure that prompt and appropriate follow-up action on reported issues or behaviour is taken. You can learn about other CIRO initiatives on the organization’s website, along with the following information: CIRO firm membership and status The registration status of individuals Disciplinary information about dealer members and individuals A glossary of terms and definitions, which includes registrants’ titles and industry terminology Recent regulatory developments, such as new policies and rule proposals Industry trends that CIRO feels are important for its stakeholders to be aware of (e.g., cybersecurity and business continuity) Links to other regulators, organizations, governments, and investor education sites CIRO AND THE FINANCIAL INDUSTRY REGULATORY AUTHORITY CIRO and its U.S. counterpart, the Financial Industry Regulatory Authority (FINRA) cooperate to enhance both organizations’ effectiveness through exchanging information and other cross-border assistance. In addition to information sharing on compliance- and enforcement-related matters, CIRO and FINRA work together on issues related to firm oversight and examinations. FINRA is the largest independent regulator for all securities firms doing business in the United States. As such, it has the following responsibilities: Protecting investors and market integrity through regulation Registering and educating industry participants and examining securities firms Writing and enforcing rules and the federal securities laws Informing and educating the investing public Providing trade reporting and other industry utilities Administering the largest dispute resolution forum for investors and firms THE EXCHANGES AND MARKETPLACES IN CANADA The Canadian exchanges monitor the compliance of listed companies with the terms of the exchange listing agreements and policies. Where appropriate, an exchange can deny pre-approval of certain transactions, require corrective disclosure, halt or suspend trading, and, in egregious cases, terminate a company’s listing. CIRO regulates the trading activity on a number of marketplaces, including the TSX, the TSXV, and alternative trading systems (ATS). © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 13 DID YOU KNOW? An ATS is registered as an investment dealer and is subject to CIRO’s supervision. Generally speaking, an ATS brings buyers and sellers of securities together and brings together the orders for securities of multiple buyers and sellers. It uses established non-discretionary methods under which the orders interact with each other. For a complete list, visit CIRO’s website. DESIGNATED STOCK EXCHANGES Domestic and foreign-based exchanges must meet the following criteria to be considered a Designated Stock Exchange by Canadian regulatory authorities. Only securities that are listed on a designated exchange are eligible to be held in RRSPs, TFSAs, or other registered accounts. The exchange must carry out the normal business of an exchange in listing securities; facilitating the trading, clearing, and settlement of these securities; monitoring and enforcing trades executed on its system; and offering transparent pricing information to the public. It must have acceptable standards for new company listings (including standards that address the number of shareholders and the dispersion of ownership) and for the maintenance of a listing. It must operate within a regulatory framework that meets acceptable standards in relation to investor protection, disclosure requirements, corporate governance, and market integrity, as may be espoused by IOSCO. It must have an experienced management and governance team, a successful track record of operations, and sufficient financial resources to ensure long-term viability. It must have a range of listings and adequate liquidity for investors to buy and sell securities at reasonable bid- ask spreads. Foreign-based exchanges must meet the following additional criteria: The host country of the exchange must have commercial, legal, and tax relations with Canada, as demonstrated, for example, by having entered into a comprehensive tax treaty or an agreement on the exchange of tax information. The host country must be a member in good standing in the international financial community through membership in such organizations as the World Trade Organization, the IMF, IOSCO, the Financial Action Task Force, or similar bodies. The securities regulatory and juridical framework of the exchange’s host country must provide rights and remedies to Canadian investors, including brokers acting on investors’ behalf, which are comparable to those available to investors in Canada. The exchange must be recognized by the host government and other foreign governments, where applicable, for tax purposes comparable to those for designated exchanges under the Canadian Income Tax Act. The host country of the exchange be at low risk of imposing capital restrictions or other impediments on the liquidation of investments and the repatriation of funds by foreign investors. As an RR, you should be mindful of changes to securities that may make them no longer eligible to be held in registered accounts. You should also know your firm’s policies regarding pink-sheet or over-the-counter listed companies. DIVE DEEPER A complete list of Designated Stock Exchanges can be found on the Department of Finance Canada’s website at https://www.canada.ca/en/department-finance/services/designated-stock-exchanges.html. © CANADIAN SECURITIES INSTITUTE 3 14 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 INVESTOR PROTECTION FUNDS 4 | Describe the role of the Canadian Investor Protection Fund and the limits of its coverage. The securities industry has long recognized the need to offer the investing public protection against losses due to the financial failure of any dealer member. This protection is a vital element in maintaining public confidence in the dealer member-client relationship. Note that investors are not protected from market losses, but rather from losses related to the financial collapse of a dealer member. The funds and programs discussed below were established for this purpose. CANADIAN INVESTOR PROTECTION FUND CIPF maintains two funds to cover a client’s securities and cash balance losses resulting from a member firm’s insolvency but not a client’s losses due to poor investment performance. From the moment an investor becomes a member firm’s client, CIPF covers that client’s accounts. The fund designated as the “investment dealer fund” is available to satisfy potential claims for coverage by customers of CIRO members registered as investment dealers. The fund designated as the “mutual fund dealer fund” is available to satisfy potential claims for coverage by customers of CIRO members registered only in the “mutual fund dealer” category. The CIPF is sponsored solely by CIRO and funded by member firms. Each member firm must meet the following obligations: Promptly pay its regular and special CIPF assessments Provide CIPF or CIRO with all information required to assess its financial condition or risk of loss Acknowledge and consent to the exchange of information between CIRO and CIPF, in accordance with any information-sharing agreements made by them, regarding the following matters: The firm’s operations Its customers’ affairs Its partners, directors, officers, shareholders, employees, agents, or any other persons permitted by law Permit CIPF to conduct reviews of its operations and fully cooperate with CIPF and its staff and advisers in connection with such reviews Comply with any actions CIPF may direct CIRO to take, or with any actions CIRO has authorized CIPF to take on its behalf COMPENSATION FOR CLIENT LOSSES CIRO has systems in place to measure dealer members’ capital profitability and liquidity position to monitor their financial health. All capital deficiencies are referred to CIRO’s enforcement team for possible disciplinary action, including suspension. DID YOU KNOW? CIPF does not cover clients’ losses that result from other causes, such as changing market values of securities, unsuitable investments, or the default of an issuer of securities. Accounts with non-CIPF members are not entitled to CIPF coverage, except accounts of foreign affiliates of a CIPF member firm, which are carried out in accordance with CIRO requirements. © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 15 When a dealer member becomes insolvent, CIPF appoints a trustee in bankruptcy. Each claim is considered according to the policy adopted by CIPF’s board of governors. Under the policy, certain persons and entities are not eligible customers and, therefore, not entitled to CIPF protection. Likewise, certain losses in the accounts of eligible customers are not covered. Visit CPIF’s website to see its coverage policy in full. CIPF has placed a limit on the coverage provided for a client’s general accounts equal to $1,000,000 for losses related to securities and cash balances. Clients’ separate accounts are each entitled to the maximum coverage of $1,000,000 unless they are combined with other separate accounts. GENERAL ACCOUNTS Accounts belonging to a single client, including cash, margin, short sale, options, futures, and foreign currency accounts, are combined and treated as one general account. The combined amount is entitled to the maximum coverage. In addition, a client’s proportionate interest in an account held on a joint or shared ownership basis is combined with the client’s general account. However, if clients share a joint account at an insolvent firm but do not have individual accounts at the same firm, the proportionate interest of each client in the account is treated as a separate account. Each client would therefore be eligible for coverage to the limit of $1,000,000. EXAMPLE Jonas and Darryl each has an account in his own name. Jonas’s account is worth $700,000, and Darryl’s is worth $500,000. The couple also shares a joint account worth $1,200,000. The couple’s accounts are entitled to CIPF coverage in the following amounts: Jonas: $700,000 (individual) + $300,000 (joint) = $1,000,000 Darryl: $500,000 (individual) + $500,000 (joint) = $1,000,000 Because each client has reached his maximum coverage in a general account, the remaining $400,000 in the joint account is not covered by CIPF. SEPARATE ACCOUNTS Accounts categorized as separate accounts are treated as if they belong to separate clients, and each separate account is entitled to the maximum coverage. Separate accounts of a similar type are grouped as a single, separate account that qualifies as a whole for the maximum coverage. The following types of accounts are considered separate accounts: Registered retirement accounts, including: Registered retirement plans such as RRSPs Registered retirement income funds (RRIFs) Life income funds (LIFs) Locked-in retirement accounts or plans (LIRAs or LIRSPs) Locked-in retirement income funds (LRIFs) Registered education savings plans (RESPs) Testamentary trusts Inter vivos trusts and trusts imposed by law Accounts such as those of guardians, custodians, conservators, and committees Personal holding corporations (if beneficial ownership of a majority of the equity capital of the corporation is held by persons other than the client) © CANADIAN SECURITIES INSTITUTE 3 16 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 Partnerships Unincorporated associations or organizations With regard to registered retirement accounts, all such plans or funds belonging to a single client through the same or a different trustee are combined and aggregated as a single separate account. Separate accounts are not combined unless a client holds them in the same capacity. The following examples illustrate the application of this policy. EXAMPLE If one client has two RRIFs, the accounts would be combined and treated as one separate account. If one person has two accounts in trust, one for a daughter and the other for a son, the accounts would be treated as two separate accounts. In other words, they would not be combined with each other, nor would they be combined with either child’s personal accounts. However, the accounts must be genuine trusts, and the beneficiaries must have been disclosed when the accounts were opened. DID YOU KNOW? The MFDA Investor Protection Corporation (MFDA IPC) was to MFDA member firms what CIPF was to IIROC dealer members. With the merger of IIROC and MFDA, the two investor protection funds – the MFDA IPC and the CIPF – merged into a single investor protection fund known as the Canadian Investor Protection Fund (CIPF). DIVE DEEPER The CIPF has a MOU with the Securities Investor Protection Corporation, the U.S. equivalent of CIPF, to work together in the event of the insolvency of a brokerage firm doing business in both the U.S. and Canada. Further details are available on the CIPF’s website: www.cipf.ca CANADA DEPOSIT INSURANCE CORPORATION Created in 1967, the Canada Deposit Insurance Corporation (CDIC) is a federal Crown corporation that provides insurance for deposits in eligible Canadian banks and trust and loan companies. Eligible deposits include Canadian and foreign currencies, guaranteed investment certificates (GICs), and other term deposits. CDIC insures these deposits to a limit of $100,000 per person at each member institution. For example, a depositor with two accounts at two different banks, each worth $100,000, would be fully insured. However, if the two accounts were at the same bank or at different branches of the same bank, they would be insured only to $100,000. Registered Education Savings Plans and Registered Disability Savings Plans are eligible for separate coverage of $100,000. PROVINCIAL INSURANCE FUNDS FOR DEPOSITORS Deposits in provincially regulated credit unions, caisses populaires, and provincially regulated trust and loan companies are covered under provincial deposit insurance plans. Deposit insurance plans vary between provinces. Insurers include the Credit Union Deposit Insurance Corporation of British Columbia, the Deposit Insurance Corporation of Ontario, and the AMF. © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 17 MONEY LAUNDERING AND TERRORIST FINANCING IN THE SECURITIES INDUSTRY 5 | Describe anti-money laundering and anti-terrorist financing requirements. When a criminal activity generates substantial profits, the people involved must find a way to control the funds without attracting attention to themselves or to the crime. Terrorist organizations are different in that profit is not their primary motive. Nevertheless, they must also generate funds to finance their activities in a way that does not attract attention. In many ways, the securities industry provides an ideal mechanism for criminal and terrorist outfits, both to generate funds and to hide their activities. For this reason, the industry is regulated to prevent such abuses (as are other vulnerable sectors). Dealer members are in an ideal position to help curb criminal and terrorist activities by limiting access to the markets. Through compliance with regulation and with robust policies and procedures, they can ensure that suspicious clients and transactions are identified and reported to the appropriate authorities. MONEY LAUNDERING Money laundering is a process in which the proceeds of crime are converted into seemingly legitimate funds through complex transactions. By obscuring the origin of the funds, criminals can use them without raising suspicion about their legitimacy. They do this by disguising the sources of the funds, changing their form, or moving them to a place where the funds are less likely to attract attention. THE THREE STAGES OF MONEY LAUNDERING The three basic stages of money laundering, which can be thought of as the “wash cycle”, “spin cycle”, and “dry cycle”, are placement, layering, and integration: Placement Placement involves the physical disposal or deposit of cash proceeds derived from an illegal activity within the legitimate financial system. One of the following methods might be used for this purpose: Structuring, which involves breaking up large amounts of cash into smaller, less conspicuous sums. The so-called structured deposits are subsequently deposited directly into bank accounts, always in amounts lower than levels at they must report. Mingling criminal proceeds with deposits from legitimate cash businesses, such as stores, bars, and restaurants. Bribing the personnel of a bank or other financial institution to accept deposits without reporting them. Smuggling cash into countries with lax anti-money laundering requirements. Purchasing a series of monetary instruments, such as certified cheques or money orders, that are then collected and deposited into accounts at another location. The investment business is generally not cash-based, so it is less at risk from the initial placement of criminally derived funds than mainstream banking operations. Most payments to brokerage accounts are made by way of cheques or transfers from other financial institutions. By the time the funds reach a dealer member, they have likely already gone through the placement phase. © CANADIAN SECURITIES INSTITUTE 3 18 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 Layering Layering involves separating illicit proceeds from their source by creating complex layers of financial transactions. The transactions are designed to obscure the audit trail and hide the original source, thereby providing anonymity. The securities industry is more at risk at this stage. Funds can easily be converted into entirely different assets and combined in an investment portfolio with lawful assets. The origin of the funds may be concealed by executing numerous buy-and-sell transactions of various investment instruments. Alternatively, the launderer may simply wire the funds through a series of accounts at various banks across the globe. Integration Integration involves placing the laundered proceeds back into the economy in such a way that they appear to be normal business funds. Frequent techniques include the use of corporate entities controlled by the launderers through which they make loans to themselves. Repayment, of course, is unnecessary. They may also use the funds to purchase real estate they can use without charge, either as personal property or as a business to generate additional, seemingly legitimate income. MONEY LAUNDERING MECHANISMS INVOLVING THE SECURITIES INDUSTRY The securities industry is characterized by its diversity and by the ease with which trading can take place, with little regard to national borders. The same characteristics that make the securities markets attractive to ordinary investors also make the industry a potential mechanism for the laundering of funds from criminal sources. Successful money laundering schemes often involve multiple transactions at more than one financial institution, and even in multiple jurisdictions. Borders can help blur the audit trail because law enforcement agencies often face jurisdictional obstacles when investigations extend outside of their home countries. Proceeds of crime laundered through the capital markets can be generated by illegal activities from both outside and within the securities industry. For illegal funds generated outside of the industry, securities transactions are used to conceal the source of funds and obscure an audit trail. Illegal activities carried out within the securities markets also generate illegal funds that must be laundered. Such activities might include insider trading, securities fraud, and market manipulation. In both cases, the industry offers launderers the potential for a double advantage: it provides a mechanism to launder illegal funds and to profit from the related investments. Illicit funds are often laundered through the purchase and sale of liquid securities. The audit trail of the proceeds of crime can be blurred through several buy-and-sell transactions involving numerous entities, accounts, and types of securities. Securities can also be purchased in another name, such as that of a shell company. The company might be located in a jurisdiction where local laws protect the anonymity of the owners. Often in such jurisdictions, many local lawyers, accountants, and “company formation agents” are in the business of setting up and operating such companies. DID YOU KNOW? A shell company is a business without substance or commercial purpose that is incorporated merely to conceal the true beneficial ownership of business accounts and assets owned. Some money launderers open accounts at two different dealer members and enter offsetting transactions with each broker. © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 19 EXAMPLE At ABC Securities, a money laundering outfit takes long positions in Eurodollar futures contracts. At the same time, they short the exact same contracts at another dealer member. One side of the trade reports a capital gain, whereas the other side reports a loss. In other words, the two transactions offset each other, with the cost being primarily the cost of the two commissions. The proceeds of the profitable side have the appearance of legitimacy, whereas the losses on the other side are concealed. Another money laundering method involves establishing a publicly traded company to serve as a front for a money laundering operation. Another advantage of using a publicly traded company is the opportunity to profit twice by creating a successful means of laundering criminal funds and by selling shares in the business to unwitting investors. In such a case, a criminal organization creates a company for an apparently legitimate commercial purpose. It then commingles illegal funds with those generated by the legal commercial activity. This method usually requires the use of fraudulent accounting practices. A variation of this scheme is to invest in a private company first, then take the company public with a share purchase offer on the equities market. The earnings from the sale of the shares creates the illusion that the funds are legitimate earnings on securities investments. TERRORISM AND TERRORIST FINANCING Whereas the motivating factor behind most types of criminal activity is financial gain, acts of terrorism are politically motivated. This difference is significant, but nonetheless, terrorist organizations still need financial support to achieve their goals. As with criminal organizations, a successful terrorist group is one that is able to build and maintain an effective financial infrastructure through various sources of funding. Terrorist financing can be difficult to detect because some terrorist funds are derived from charities and other legitimate sources. In such cases, there can be little evidence to link individual or multiple financial transactions to terrorists. Another difficulty is that terrorist attacks do not always require large sums of money, and the associated transactions are usually not complex. ANTI-MONEY LAUNDERING AND ANTI-TERRORIST FINANCING REGULATIONS Securities firms are subject to various regulatory and statutory requirements with respect to money laundering and terrorist financing. The Proceeds of Crime (Money Laundering) and Terrorist Financing Act and Regulations, also known as the PCMLTFA and PCMLTFR, were implemented with the following goals: To detect and deter money laundering and terrorist financing activity To respond to threats posed by organized crime To assist in fulfilling Canada’s international commitments to fighting transnational crime The PCMLTFA imposes requirements on financial institutions to implement specific measures to detect and deter money laundering and the financing of terrorist activities. Thus, in the securities industry, federal regulation is supplemented by SRO rules, which help facilitate the investigation and prosecution of such activities. To this end, dealer members must have appropriate procedures in place regarding client identification, recordkeeping, and reporting. Specifically, the PCMLTFA and CIRO require that dealer members report suspicious financial transactions and cross-border movements of currency and monetary instruments. © CANADIAN SECURITIES INSTITUTE 3 20 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 FINTRAC is the agency responsible for ensuring compliance with the PCMLTFA and for dealing with reported and other information. FINTRAC collects, analyzes, assesses, and discloses information to assist in the detection, prevention, and deterrence of money laundering and terrorist financing. It is authorized to provide key identifying information on suspicious transactions to law enforcement agencies if there are reasonable grounds to suspect that the information would be relevant to investigating or prosecuting a money laundering offence. This information may also be provided to the Canada Revenue Agency, the Canadian Security Intelligence Service, and Immigration Canada if there is reason to suspect tax evasion or a threat to national security. FINTRAC also has the primary responsibility of monitoring the compliance of financial intermediaries with recordkeeping, KYC requirements, and mandatory suspicious transaction reporting requirements. © CANADIAN SECURITIES INSTITUTE  CHAPTER 3      THE CANADIAN REGULATORY FRAMEWORK 3 21 SUMMARY The securities industry in Canada is regulated by the provincial securities commissions and SROs, and, to a smaller extent, by federal legislation. The securities acts of each province are based on the three basic principles of regulation: disclosure, registration, and enforcement. Each province regulates securities activities within its borders, and attempts to create a formal national regulator have been unsuccessful so far. However, the provinces have managed to harmonize their regulations through meetings of the CSA and through the reformulation and implementation of National Instruments. From an industry point of view, regulation is conducted through SROs that have been given the privilege of regulating their own members. SROs are responsible for enforcing conformity with securities legislation and have the power to prescribe rules of conduct and financial requirements for their members. As well as the securities industry being heavily regulated to protect investors, the CIPF is set up to guard against losses due to the financial failure of SRO member firms. In this section, we reviewed the regulatory landscape in the securities industry and discussed the standards of conduct that underlie ethical decision-making. In the next section, we discuss business conduct and the handling of client accounts, and we examine the critical job functions of the registrant in the context of industry rules. © CANADIAN SECURITIES INSTITUTE