Notice and Proposed Changes to Proposed Rule: OSC Rule - 31-506 - SRO Membership - Mutual Funds Dealers

Notice and Proposed Changes to Proposed Rule: OSC Rule - 31-506 - SRO Membership - Mutual Funds Dealers

Request for Comment OSC Rule

 


NOTICE OF PROPOSED CHANGES TO

PROPOSED RULE 31-506

SRO MEMBERSHIP - MUTUAL FUND DEALERS

 

Substance and Purpose of Proposed Rule

The purpose of the proposed Rule is to address certain regulatory issues that arise in connection with oversight of mutual fund dealers. The proposed Rulerequires all mutual fund dealers to be members of a self-regulatory organization, self-regulatory body or stock exchange recognized by the Commission (a"SRO"). The proposed Rule conforms to the fundamental principle in paragraph 4 of section 2.1 of the Securities Act (Ontario) (the "Act") under which theCommission should, subject to an appropriate system of supervision, use the enforcement capability and regulatory expertise of recognized self-regulatoryorganizations.

The proposed Rule is substantially similar in effect on mutual fund dealers as National Policy Statement No. 49 ("NP 49") was on "national dealers".

The proposed changes to the proposed Rule change the effective date to permit the Commission to assist the newly established SRO for mutual funds to meet therequirements of the Commission for recognition. The proposed changes also change the effective date for current registrants to link it to the next date theregistrant is required to file financial statements under the Act rather than the renewal date.

Recent Regulatory History of Mutual Fund Regulation Review

In February 1994, Commissioner Glorianne Stromberg was asked by the Commission to undertake a review of the Canadian investment funds industry for thepurpose of considering whether changes were needed in how investment funds and the offering and sale of their securities are regulated. The CSA supported thisreview. This review culminated in the January 1995 release of Commissioner Stromberg's report "Regulatory Strategies for the Mid-90's - Recommendations forRegulating Investment Funds in Canada" (the "Stromberg Report")(1).

Commissioner Stromberg recommended in her report that there be a national self-regulatory body for all dealers and that the regulatory structure for investmentfunds be simplified by combining provincial resources into a single centralized regulatory body.

The CSA constituted the Investment Funds Steering Group to consider the recommendations contained in the Stromberg Report in June 1995(2). The InvestmentFunds Steering Group urged the CSA and the industry to move toward development of a single SRO to regulate the activities of distributors of mutual funds.(3)

The CSA then established the CSA Investment Funds Implementation Group, a high level CSA committee, to consider how the CSA should implement therecommendations contained in the Stromberg Report and the subsequent report of the Investment Funds Steering Group. The CSA Investment FundsImplementation Group in its report released in May of 1997,(4) placed a high priority on an initiative for a national SRO to regulate the activities of all dealers insecurities, including mutual fund dealers.

The Commission believes that optimally, the mutual fund industry should be regulated by a single national SRO having jurisdiction over all distributors ofsecurities, including mutual fund securities.

Mutual fund dealers who prefer to join the IDA, the only SRO currently recognized by the Commission, will need to change their registration category to meetthe regulatory standards imposed on IDA members.

IFIC and the IDA have established an entity to act as the national SRO for mutual fund dealers. The Commission is continuing to work with IFIC and the IDA toassist the newly formed SRO for mutual fund dealers to meet the requirements of the Commission necessary for recognition by the Commission as a SRO. It isanticipated that the Commission will recognize for the purposes of this proposed Rule a SRO that requires its members to contribute to a member fundedcontingency fund. Therefore all members of recognized SROs will participate in a contingency fund, which is an insurance fund for investor protection withrespect to failed securities firms in Canada. Any such contingency fund is intended to cover losses of securities and cash balances, within prescribed limits,suffered by clients of a participating firm in the event of that firm's insolvency. Levies for the contingency fund may be based on the firm's level of activity in thecapital markets, i.e. gross revenues.

Summary of Proposed Rule

The proposed Rule requires membership in a SRO recognized by the Commission. The anticipated effect of this membership is to require mutual fund dealers tomake contributions to a contingency fund. The proposed Rule does not specify the organization that will be recognized by the Commission for this purpose.However the Commission is working with IFIC and the IDA to assist the SRO that has been formed by them to meet the regulatory standards for recognition bythe Commission.

The proposed changes to the proposed Rule change the effective date to permit the Commission to assist the newly established SRO for mutual funds to meet therequirements of the Commission for recognition. The proposed changes also change the effective date for current registrants to link it to the next date theregistrant is required to file financial statements under the Act rather than the renewal date.

Authority for Proposed Rule

The following sections of the Act provide the Commission with authority to adopt the proposed Rule. Paragraph 143(1)1 of the Act authorizes the Commissionto make rules prescribing requirements in respect of applications for registration and the renewal, amendment, expiration or surrender of registration. Paragraph143(1)2 of the Act authorizes the Commission to make rules prescribing conditions of registration or other requirements for registrants or any category orsubcategory of registrant.

Summary of Comments Received by the Commission on the Proposed Rule

The Commission did not receive any comments on the proposed Rule.

Alternatives Considered

The Commission considers increased reliance on the self-regulatory system to be consistent with the purposes of provincial securities legislation. SROs can bringindustry expertise to bear on members and can apply uniform standards on a consistent basis across provincial boundaries. They can react faster than agovernment agency to changes in market conditions and to activities of concern. As the system under NP 49 has worked well since its adoption in June 1993, theproposed Rule extends the system to mutual fund dealers. Under proposed Rule 31-507 SRO Membership - Securities Dealers and Brokers, Ontario is, in effect,also extending NP 49 to all securities dealers and brokers. Some CSA jurisdictions are considering taking the same approach as Ontario with respect to bothmutual fund dealers and securities dealers.

Unpublished Materials

In proposing the Rule, the Commission has not relied on any significant unpublished study, report or other material.

Anticipated Costs and Benefits

There are substantial benefits involved in a SRO system of regulation. A SRO system helps to ensure compliance with regulatory requirements and also helps toprovide consistent application and interpretation of the regulatory requirements.

Clients of affected mutual fund dealers will benefit from the protections afforded by a SRO system and the availability of a dealer funded contingency fund asmutual fund dealers are not currently required to be members of a SRO and do not currently contribute to a dealer funded contingency fund.

The proposed Rule will impose costs on mutual fund dealers as they are not currently members of a SRO and do not currently contribute to a dealer fundedinvestor compensation fund. These costs will include fees for membership in the SRO as well as the levies of a compensation fund which are expected to bebased on the level of activity in the capital markets, i.e. gross revenues of the participant.

Based on experience to date under NP 49, the Commission believes that the benefits of the proposed Rule justify the costs.

Comments

Interested parties are invited to make written submissions with respect to the proposed Rule. Submissions received by July 17, 1998 will be considered.

Submissions should be sent to the Ontario Securities Commission in duplicate, as indicated below:

c/o Daniel P. Iggers, Secretary

Ontario Securities Commission

20 Queen Street West

Suite 800, Box 55

Toronto, Ontario M5H 3S8

A diskette containing the submissions (in DOS or Windows format, preferably WordPerfect) should also be submitted. As the Act requires that a summary ofwritten comments received during the comment period be published, confidentiality of submission cannot be maintained.

Questions may be referred to any of:

Tanis MacLaren

Associate General Counsel

Ontario Securities Commission

(416) 593-8259

Randee Pavalow

Policy Co-ordinator

Ontario Securities Commission

(416) 593-8257

Proposed Rule

The text of the proposed Rule including the proposed changes follows, together with footnotes that are not part of the Rule but have been included to providebackground and explanation.

Dated: June 19, 1998.

ONTARIO SECURITIES COMMISSION RULE 31-506

SRO MEMBERSHIP - MUTUAL FUND DEALERS(5),(6)

PART 1 MEMBERSHIP REQUIRED

1.1 Membership Required - A mutual fund dealer(7) shall be a member of a SRO(8) for mutual fund dealers recognized by the Commission under section 21.1 ofthe Act.

PART 2 EFFECTIVE DATE

2.1 This rule shall be effective for an applicant for registration as a mutual fund dealer on the later of

(a) , 1998(9); and

(b) on the day that is sixty days after the date the Commission recognizes a SRO for mutual fund dealers under section 21.1 of the Act.

2.2 This rule shall be effective for a mutual fund dealer on the first date on which its annual financial statements must be filed under the Act that occurs after thelater of:

(a) , 1999(10); and

(b) the day that is sixty days after the date the Commission recognizes a SRO for mutual fund dealers under section 21.1 of the Act.

PART 3 EXEMPTION

3.1 Exemption - The Director may grant an exemption to this Rule, in whole or in part, subject to such conditions or restrictions as may be imposed in theexemption.

Footnotes

 

1. "Regulatory Strategies for the Mid-90's - Recommendations for Regulating Investment Funds in Canada" prepared by Glorianne Stromberg for theCanadian Securities Administrators, January 1995.

2. News Release of the Ontario Securities Commission dated June 23, 1995 (1995), 18 OSCB 2992. The mandate of the Investment Funds Steering Groupwas released on September 7, 1995 (1995), 18 OSCB 4018.

3. The final report of the Investment Funds Steering Group - "The Stromberg Report, An Industry Perspective" - was released in November, 1996.

4. The "Report of the CSA Investment Funds Implementation Group" was published in Ontario on May 16, 1997 (1997), 20 OSCB 2512.

5. This Rule is new.

6. A general local definition rule has been adopted as Rule 14-501 - Definitions. It contains definitions of certain terms used in more than one rule. Rule 14-501also provides, among other things, that terms used in a rule and defined in Section 1 of the Securities Act or subsection 1(2) of the Regulation will have therespective meaning given to them in the Securities Act or Regulation, as appropriate. In addition a national definition rule has been adopted as NationalInstrument 14-101 Definitions. It contains definitions of certain terms used in more than one national instrument. National Instrument 14-101 also provides that aterm used in a national instrument and defined in the statute relating to securities of the applicable jurisdiction, the definition o which is not restricted to a specificportion of the statute, will have the meaning given to it in that statute, unless the context otherwise requires. National Instrument 14-101 also provides that aprovision or a reference within a provision of a national instrument that specifically refers by name to a jurisdiction, other than the local jurisdiction, shall nothave any effect in the local jurisdiction, unless otherwise stated in the provision.

7. The term "mutual fund dealer" is defined in Rule 14-501 as "a person or company registered under the Act in the category of mutual fund dealer".

8. The term "SRO" is defined in National Instrument 14-101 Definitions as "a self-regulatory organization, a self-regulatory body or an exchange". TheCommission has recognized the Investment Dealers Association of Canada under section 21.1 of the Act.

9. The Commission expects this date to be approximately six months after the later of the date the Rule is adopted by the Commission in final form or the datethe Rule becomes effective under the Act.

10. The Commission expects this date to be approximately eighteen months after the later of the date the Rule is adopted by the Commission in final form andthe date the Rule is effective under the Act.