use of the general "conduct unbecoming" section of the IIROC rules as a basis for
initiating enforcement action, the specificity of the requirements together
with the statement that non-compliance with the notice on its own can result in
enforcement action makes this a rule, regardless of what IIROC chooses to call it.
IIROC has a
constitution and an elaborate rule-making process. New rules must be approved
by the Board, published for comment by the CSA and then approved by the CSA. Establishing
rules by issuing staff notices circumvents that process, taking away the authority
of the Board to pass new rules and of the CSA to approve them.
requirements of the notice give IIROC staff the right to approve or disapprove
of a new non-arm's length product. There
is no identification of the IIROC staff who will make the decisions, the
grounds on which they might disapprove of a product or what changes in the
product, disclosures or advertising they can demand before granting approval.
does do not state the basis on which IIROC might approve a product for
distribution without notice, or whether the provision simply provides the basis
for the general exemption for products issued by federally regulated financial
requirements in the notice do not establish an appeal process in the event a
dealer member disagrees with the dictates or decision of IIROC staff. Is there
an appeal to a district council or hearing panel? Can a decision be appealed to
the Board? Decisions by district counsels, hearing panels and the Board can generally
be appealed beyond IIROC to the securities commission, but without an
established process for formal hearings, decisions and appeals there will be no
formal decision or no formal record on which to appeal.
period and documents required will already add to the time between completion
of the offering materials and the ability of the dealer to sell the
product. That will cause pressure on the
dealer to simply accede to IIROC staff decisions or dictates rather than face disallowance
of the distribution or changes in materials that it does not believe to be
requirements constitute a step by IIROC staff into product approval that goes
beyond anything in the current IIROC rules.
IIROC has very limited authority over what a dealer member can or cannot
sell. Most of the current rules simply
set conditions - proficiency, supervision, margin, etc. - for categories of
Even when a
dealer sells its own shares or the shares of its holding company in a private
placement, the only requirement is that the district council be satisfied that
there are resale restrictions to prevent the development of a public market
until certain conditions are met. It
does not require any form of pre-approval of the issue itself.
There are of
course general conflicts of interest provisions, including the disclosure
requirements in National Instrument 31-103 regarding related issuers.
None of these,
however, gives IIROC the authority to look at a particular distribution of a
particular security and decide whether it can happen.
This kind of
extension of authority is clearly one that should go through careful
consideration and be subject to reasonable checks and balances, rather than
being implemented through a notice.
discussion, the regulators have recently adopted a more principles-based
approach to regulation. Even in terms of
conflicts of interest, the prescriptive rules have been reduced in favour or
principles and guidelines. There
continue to be prescriptive rules relating to self-dealing, but they take the
form of disclosure requirements, client's consent requirements or outright
prohibitions, for example prohibiting discretionary trades for clients in the
securities of related issuers.
notice is completely prescriptive, requiring approval by IIROC staff of the
distribution of specific issues. Merit
review is not something IIROC has ever done before, and not something that has
been a part of securities regulation at the commission level for many years.
Such a radical
departure from current practice is again something that requires careful
consideration through the full rule-making process, including a sustainable
rationale for differentiating the situation it deals with from all those others
that are dealt with in a totally different way.
The notice grants a
total exemption for "securities issued by a federally regulated or provincially
regulated financial institution distributed pursuant to an exemption under
the broad variety of instruments issued by financial institutions and the
recurrent concerns about any interference by securities regulators in the
affairs of federally-regulated financial institutions, it is hardly surprising
that IIROC should grant such a broad exemption.
there is no explanation and of why this is a reasonable measure and why the
requirements should end up with what is in essence one law for one set of
dealer members (affiliates of federally-regulated financial institutions who
sell their products) and another for everybody else.
initial overview explains that "in
recent years there have specific instances where clients of IIROC Dealer
Members have suffered losses as a result of investing in such products," not
only products sold by IIROC dealers but also mutual fund dealers and others in
Canada, the United States and elsewhere.
is undoubtedly true that "clients have suffered losses by investing in such
products" but not true that none of those losses have come through bank-issued
products. There are certainly those who
have lost income for various periods of time, and probably in some cases at
least part of their principal, on principal-protected notes or
partially-protected notes issued by banks, not to mention index-linked GIC's
that have paid no return. Furthermore, both federally and provincially
regulated financial institutions have been known to fail, taking client assets
with them and wiping out the value of securities not covered by deposit
March 23, 2009 IIROC issued the final version of its Notice 09-0087: "Best
practices for product due diligence."
Given that notice, which does not exempt bank-issued products, what is
the need for an additional regime for non-arm's length products?
answer is quite clearly the final point in the overview: "in some cases,
including those involving IIROC Dealer Members, the client losses have resulted
in compensation being paid by industry protection plans such as Canadian
Investor Protection Fund ("CIPF")."
notice results from a couple of cases in which IIROC members have sold worthless
securities of affiliated companies to their customers. These sales were fraudulent in one way or
another, needed to prop up the affiliates. That does not mean government-regulated
financial institutions won't or don't commit fraud or sell fraudulent
new rule adds a significant burden to one set of dealer members but not another,
apparently based on a risk determination made by IIROC staff. Nowhere is there any explanation of that risk
analysis. Nowhere is there any analysis of how many non-prospectus,
unmarginable, non-arm's length issues IIROC dealer members have been involved
in, the types of securities issued, their nominal value, the level of risk they
impose either to clients or CIPF or why something more is needed than the
product due diligence and suitability requirements already in place.
On the other
side there is no assessment of the likely costs of going through the process
the notice seeks to establish.
demand for cost-benefit analysis is something of a knee-jerk reaction for
dealers anxious to delay or avoid regulatory changes, even when such changes
are justifiable. It is often very
difficult to quantify costs that are spread unevenly across different types of
dealers, and impossible to quantify the benefits from unknown problems avoided.