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From the Regulators

Published: 01/21/2014

News and Notices
By: Alexis BowieJamie Litchen and Joel McElravy

CSA Staff Notice 31-336 - Guidance on Know-Your-Client (“KYC”), Know-Your-Product (“KYP”) and Suitability Obligations

In order to improve registrants’ understanding of, and compliance with, the KYC, KYP and suitability obligations, the Canada Securities Administrators ("CSA") has provided guidance and “best practice” tips to registrants, including portfolio managers, exempt market dealers and those registrants who are not members of a self-regulatory organization (SRO) on such requirements. The Notice also sets out selected requirements and guidance for KYC, KYP and suitability requirements for dealer members of the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA).

Some highlights of the Notice include:

  • Adequate documentation of the suitability process (including KYC) is critical to ensuring that a registrant is meeting its securities law obligations
  • A meaningful suitability assessment is required - assessing suitability is more than a mechanical fact-finding or “tick the box” exercise
  • Failure to adequately know your client may lead to a distribution of securities by an issuer or dealer in breach of a prospectus exemption which is a serious breach of securities law

The Notice also addresses the KYC obligation when dealing with an Accredited Investor (“AI”). A registrant’s obligation to determine that a prospectus exemption is available is supplemented and informed by the registrant’s obligation to “know” the client or purchaser. While a person may rely on factual representations by a purchaser in determining if they qualify as an AI, the Notice suggests that relying solely on a representation in a subscription agreement that the client is an AI will generally not be sufficient for a registrant to satisfy its KYC obligation. The following are suggested practices for registrants that distribute securities in reliance on a prospectus exemption:

  • Develop a KYC form that collects sufficient information (e.g, minimum income and asset thresholds consistent with NI 45-106);
  • Tailor or develop a separate KYC form for clients that are corporations, partnerships, trusts or other entities, and not individuals, to support reliance on the exemption;
  • Consider a client’s willingness vs. ability to accept risk;
  • Obtain a breakdown of financial assets and net assets of the client;
  • Make further enquiries about the client’s financial circumstances if there is reasonable doubt;
  • Do NOT rely solely on the investor’s representation on the AI certificate without collecting KYC information to assess reliance on the prospectus exemption;
  • Do NOT assume that another person has complied with the KYC obligation or the obligation to determine that the client is eligible to purchase securities on a prospectus-exempt basis; and
  • Do NOT process trades without complete and adequate KYC information to support reliance on the exemption

OSC Staff Reviews Use of Non-GAAP and Additional GAAP Measures

The Ontario Securities Commission ("OSC") has published Staff Notice 52-722, a report on OSC staff’s review of non-GAAP financial measures and additional GAAP measures. The filings of 50 Ontario head office reporting issuers were reviewed. The review focused on the following:

  • The location of non-GAAP financial measures or additional GAAP measures;
  • Calculations of non-GAAP financial measures or additional GAAP measures;
  • The presentation of non-GAAP financial measures or additional GAAP measures; and
  • Disclosure of non-GAAP financial measures or additional GAAP measures.

The OSC concluded that the results of its review were “disappointing,” identifying concerns relating to the use of these measures in 86% of the issuers reviewed.

The terms “non-GAAP financial measure” and “additional GAAP measure” are defined in CSA Staff Notice 52-306, which provides guidance on the use of such measures in public disclosure documents. Examples of these measures include: EBITDA, Adjusted Earnings, Cash Cost/Ounce, Free Cash Flow and Net Operating Income.

The OSC flagged the following areas where improvement is needed in relation to the use of non-GAAP financial/additional GAAP measures:

  • providing explanations relating to the objectives of such measures and why their inclusion in disclosure is useful to investors;
  • providing a clear quantitative reconciliation of the non-GAAP financial measure against the nearest directly comparable GAAP measure;
  • providing meaningful, non-confusing names for additional GAAP measures; and
  • disclosing how additional GAAP measures are calculated in relation to minimum disclosure items required by IFRS.

We published an eLert on the Notice, which can be read here

OSC Provides Update on its Exempt Market Review

The OSC announced that the following new capital raising prospectus exemptions will be published for comment in the first quarter of 2014:

  • offering memorandum exemption;
  • family, friends and business associates exemption;
  • existing security holder exemption (to consider comments on the CSA’s proposed TSX-V existing securityholder exemption – see item below); and
  • crowdfunding exemption, together with a registration framework for online funding portals.

The objective of these exemptions is to facilitate capital raising for start-ups and small and medium-sized enterprises and to modernize Ontario’s exempt market regulatory regime.

We published an eLert on the proposal, which can be read here

CSA Proposes Changes to Registrant Regulation

The CSA is seeking public comment on various proposed changes to the registrant regulatory framework. The comment period ends on March 5, 2014.

The CSA’s proposed changes are centred around NI 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, but also affect NI 33-109, NI 52-107 and their respective companion policies and forms, as well as OSC Rules 33-506 and 33-502.

The proposed changes to NI 31-103 and its companion policy include:

  • restricting the activities that exempt market dealers are permitted to conduct, including prohibiting exempt market dealers from conducting brokerage activities (an area where the CSA had previously expressed concern);
  • clarifying that the exemption for trades made through registered dealers is not available if the person relying on the exemption contacts/solicits a purchaser in relation to the trade; and
  • providing an exemption from the dealer registration requirement for trades in short-term debt.

There are many more changes being proposed. A comprehensive summary is available in the CSA Notice published in relation to these changes. The complete set of proposed changes is available as a supplement to the OSC Bulletin.

New Exemption for Distributions to Existing Security Holders Proposed (but not in Ontario)

On November 21, 2013, regulators in BC, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Yukon, Northwest Territories, Nunavut, and PEI published for comment a proposed prospectus exemption that would, subject to certain conditions, allow issuers listed on the TSX-V to raise money by distributing securities to their existing security holders.

Currently, if a TSX-V issuer wishes to distribute securities to an existing securityholder that is not an accredited investor, the issuer must issue a prospectus or distribute under an exemption to the prospectus rules. As a result, non-accredited investor security holders are forced to acquire additional securities on the secondary market and incur brokerage fees when doing so.

The proposed exemption (not yet applicable to Ontario, but see previous item) considers allowing TSX-V issuers to distribute securities to existing security holders in reliance on their continuous disclosure record.

The proposed exemption would be subject to certain limitations, including the type of security eligible for issue (shares and units) and investment amount ($15,000 per investor within any 12-month period, unless advised otherwise by a registered professional). The offering would need to be announced via press release and would only be available to investors that were securityholders as of the record date. Liability for misrepresentations in any offering document voluntarily provided to such investors would also apply.

The comment period for these proposed changes closes on January 20, 2014.

We published an eLert on the proposal, which can be read here.