sbg regulatory
SBG Commentaries No. 7 - December 2010


This commentary is of interest to all IIROC members.
IIROC requests comments on proposed plain language rules
Rule 3400: Suitability
Rule 3500: Sales practices
Rule 3600: Communications with the public
Rule 3700: Reporting and handling of complaints, internal investigations and other reportable matters
Rule 3800: Books and records
Rule 3900: Supervision
The On October 8, 2010 IIROC published for comment the second set of rules rewritten as part of its new rulebook project.  Rules Notice 10-0266 describes the rules and several changes included in them.
The notice also contains links to the proposed rules and proposed guidance notes that are also out for comment, the old rules, a table of concordance.  Comments are due by January 6, 2011 and are to be sent to: 
Brendan Hart
Policy Counsel, Member Regulation Policy
Investment Industry Regulatory Organization of Canada
121 King Street West, Suite 1600
Toronto ON M5H 3T9
A second copy should be addressed to the attention of:

Manager of Market Regulation

Ontario Securities Commission
20 Queen Street West
19th Floor, Box 55
Toronto, Ontario
M5H 3S8 


The Project
The project goals are outlined on IIROC's website:
  • Restate the rules in plain language style
  • Streamline rules by focusing on core requirements and moving details to Guidance Notes
  • Improve clarity and understanding of rules
  • Eliminate obsolete, duplicative and unnecessary requirements
  • Reorganize rule structure more logically
  • Clearly state the objective of each rule

Proposed rule changes

Although it is not reflected in the stated goals, in the course of the project IIROC decided that it could not just rewrite the existing rules and eliminate the obsolete or unnecessary, in some cases it would need to make substantive changes.
The number of substantive rule changes in the proposed Rules 3400 to 3900 is not small.  Here is the list, broken down by our reactions.

What we like

·         A change in proposed Rule 3405(1)(iii) eliminating any requirement to obtain a suitability waiver from a regulated entity as defined in Form 1.  However, in making the change the proposed rule eliminates a current exemption that should be retained, as noted below.

·         A change in proposed Rule 3506(3) eliminating for institutional accounts the current requirement to give 60 days prior notice of fee changes

·         Changes to the rules on disclosure of inside information obtained by an Approved Person or Dealer Member making the terminology consistent with securities legislation.  The specific changes are replacing "privileged information" with "material non-public information," using the "special relationship" approach in place of "fiduciary obligation" and replacement of the exception allowing disclosure to those authorized to receive it with "in the necessary course of business."

·         Elimination of the current requirement for policies and procedures on client communications and research analyst conflicts to be filed with and approved by IIROC.

·         Movement of guidelines on research reports, current in Rule 3400, into a guidance note, proposed Guidance Note 3600-3.

·         Extension of the prohibition on gag provisions in settlement agreements as regards provision of information to regulators, currently in place regarding settlements with retail clients, to settlements with institutional clients.

·         Changes to the terminology used in Proposed Rule Section 3800 regarding books and records to make the extent of the rules clear and eliminate unnecessary duplication for similar products.  The specific substitutions are:

o    "Investment products" in place of securities;

o    "Derivatives" in place of commodity futures contracts and futures contract options.  However, we note that the notice does not include options among the derivatives covered by the term, while they appear to be included as derivates in Proposed Rule 3832 regarding confirmation requirements.

o    "Marketplace" in place of "exchange."

·         Removal in Proposed Rule 3805(4) of a requirement in current Rule 17.13 that requests for statistical information from Dealer Members be approved by the IIROC Board before being issued.

·         A requirement in Proposed Rule 3812 to record the time an order is modified, which is the standard practice and expectation already in place.

·         Clarification of client statement content requirements.

·         Inclusion in a new proposed Rule 3842 of the requirements for consolidated statements (i.e. those consolidating transactions and/or positions within and outside the Dealer Member) which are currently included only in IDA Member Regulation Notice MR-0087.  We agree that these are rules.

·         Movement of supervisory review criteria and thresholds into guidance notes.  These were left over from IDA Policy 2 and were included in the Registration Reform Project revisions only to make it clear that the old criteria and thresholds continued to be acceptable.

·         A requirement for alternate designated supervisors to be in place for all options and futures business, not just retail options and futures.

We also applaud the decision to have rules refer only to Dealer Members and add a general statement that relevant rules are equally applicable to Approved Persons

What we don't like.

Retention of current rule 1300.1(p) in its current formulation

Proposed rule 3402(1) requires that a Dealer Member ensure that any order accepted is suitable for the client.  This retains the formulation of current rule 1300.1(p), which we think was a mistake that should be corrected.

As currently written, the rule requires a dealer member to refuse to accept an order if the dealer member thinks it is unsuitable. Previously, the suitability rule covered only recommendations, although established interpretations and practices required dealers to warn a client if they thought an unsolicited trade was unsuitable.  If the client persisted, the dealer was permitted to proceed with the trade.

We think that the prior approach was the right one, although the obligation to warn should have been written into the rules.  That's what was done in section 13.3(2) of National Instrument 31-103:

If a client instructs a registrant to buy, sell or hold a security and in the registrant's reasonable opinion following the instruction would not be suitable for the client, the registrant must inform the client of the registrant's opinion and must not buy or sell the security unless the client instructs the registrant to proceed nonetheless.


Under the current formulation, a dealer member is obligated to refuse an unsuitable order, even one that the client wishes to conduct on his or her own it.  It essentially forces the client to go to a suitability-exempt discount broker to execute such an order.  The current formulation is therefore paternalistic and unfair to clients.  A client might, for example, be encouraged to move all his or her business to a discount broker, where he or she would not even have the benefit of the dealer's opinion of future trades.

The dealer could also offer order-execution services in advisory accounts under proposed Rule 3406(2), a revision of current Rules 1300.1(r), 1300.1(t) and 3200.  However, the record keeping to required to offer such a service has proven too onerous for it to be taken up.

Changes to the suitability rule

Additions to the suitability rule in section 3402(2) require that the Dealer Member consider the suitability of the account type, the trading strategy, the order type and the method of financing the trade, whether or not the financing is provided by the Dealer Member.  While we have no difficulty with the proposition that the trading strategy and method of financing are considerations, we disagree with the idea that there can be an inherently unsuitable type of account, and what an unsuitable order type might be is a mystery left unexplained in the covering notice.

We think that suggesting that an account type might be unsuitable is an open invitation to confusion. Moreover, we wonder why including the concept in the rule is necessary.  Surely unsuitable trading or recommendations can be dealt with without reference to the "suitability" of the type of account in which the activity occurred.  An account type is meaningless by itself; an account of any type can just lie there harmless until activity occurs in it.  It is the activity that might be unsuitable, not the account type.

For example, some firms currently open only margin accounts.  That doesn't make trading on margin suitable for all of their clients, nor are they suggesting anything of the sort.  It is administratively more simple, and often of assistance to the clients, to have a margin account.  If, for instance, the client wants an upcoming dividend or the proceeds of an upcoming redemption paid out early, it can be done simply in a margin account.  The firm and RRs have an obligation to ensure that any margin trading is suitable, but that doesn't mean that clients who should not trade on margin should only have cash accounts.

Nor do we think that this change is simply harmless.  We see it as a virtual certainty that regulatory staff will find that margin accounts are unsuitable for some clients at some firms, irrespective of what happens in them, making the dealer fight it out up the chain and wasting everyone's time.

As to order type, when is an order type unsuitable?  We can't think of a situation in which the order type is in and of itself unsuitable.  The resulting trade can certainly be unsuitable, but that it already well covered by proposed Rule 3402.

Finally, Proposed Rule 3403(2) is a new addition stating: "Compliance with the know-your-client and suitability requirements is primarily the responsibility of the Registered Representative." While we agree that the registered representative has the front-line responsibility for compliance, we don't really think the rule is true or that it offers much reassurance to the supervisors who no doubt thought it a good idea.

The proposed section seems to us to be more guidance than rule, so if there is any good reason for including it (and right now we can't think of one) it should be moved into a Guidance Note, and we note that in fact there is a general statement in Guidance Note 3900-1 that compliance with relevant business conduct requirements is primarily the registered representative's responsibility.

Elimination of suitability waivers for some institutional customers

Current rule 2700 exempts a Dealer Member from making a suitability determination with respect to an account of an institutional client (as defined in IIROC Rule 1)  that is also a  "permitted client" as defined in National Instrument 31-103 if the Dealer Member obtains a written suitability waiver from the client.

The proposed rule eliminates this exemption.  The covering notice refers to the addition of regulated entities to those to whom the Dealer Member owes no suitability obligation, without a waiver being necessary.  However, the "permitted client" definition includes types of institutions that are neither regulated entities as defined in IIROC rules nor the types of institutions exempted in proposed rule 3405(1)(ii): Dealer Members, portfolio managers, exempt market dealers, banks, trust companies and insurers.

Some of those left out of the new rule that can waive a suitability determination under the current rule are:

·         A pension fund that is regulated by either the federal Office of the Superintendent of Financial Institutions or a pension commission or similar regulatory authority of a jurisdiction of Canada or a wholly-owned subsidiary of such a pension fund;

·         An entity organized in a foreign jurisdiction that is analogous to the above

·         The Government of Canada or a jurisdiction of Canada, or any Crown corporation, agency or wholly-owned entity of the Government of Canada or a jurisdiction of Canada;

·         Any national, federal, state, provincial, territorial or municipal government of or in any foreign jurisdiction, or any agency of that government;

·         A municipality, public board or commission in Canada and a metropolitan community, school board, the Comité de gestion de la taxe scolaire de l'île de Montréal or an intermunicipal management board in Québec;

·         A person or company acting on behalf of a managed account managed by the person or company, if the person or company is registered or authorized to carry on business as an adviser or the equivalent under the securities legislation of a jurisdiction of Canada or a foreign jurisdiction (it is unclear  whether the term "Portfolio Manager" in proposed Rule 3405(1)(ii) is used generically so as to cover foreign registered advisers)

·         An investment fund if...

o     The fund is advised by a person or company authorized to act as an adviser under the securities legislation of a jurisdiction of Canada (see comment above re "Portfolio Manager" in proposed rule 3504(i)(ii);

·         A registered charity under the Income Tax Act (Canada) that obtains advice on the securities to be traded from an eligibility adviser, as defined in section 1.1 of NI 45-106, or an adviser registered under the securities legislation of the jurisdiction of the registered charity;

·         Aperson or company, other than an individual or an investment fund, that has net assets of at least $25 million as shown on its most recently prepared financial statements

Given the lack of discussion of this change, we hope that it was a drafting error that will be amended before the rule is finalized.

Prior disclosure and waiting period for changes in account management fees and commissions

A new requirement to provide advisory fee and commission schedules at the time of account opening and 60 days prior to any changes.  The requirement for commission schedule disclosure covers only "a fixed dollar or percentage commission fee." 

Some dealers with managed accounts charge a fee that is negotiated initially and renegotiated periodically.  This rule will require that the renegotiation occur 60 days before the new fee applies.  We see no reason for that waiting period when the fee is negotiated directly between the parties involved.

As far as the commission disclosure is concerned, given the wide variety of factors that may go into a commission calculation, including the ability of an RR to override it in specific instances, we fail to see how this will benefit clients.  There is already confirmation disclosure of commission charges, enabling them to challenge any commission they think inappropriate. 

The argument in the notice is simply that the new rule will make the treatment of advisory fees and commissions consistent with the treatment of service fees.  We suggest that adding a whole new class of disclosure requires more than just analogy to an existing rule.  The first thing to ask is whether the current rule of service fees really accomplishes anything useful.  Maybe it should be eliminated instead of changing the rules on something analogous.  Even if the service fee requirement is justifiable, and we think it is, extending it to commissions and advisory fees still needs a separate justification, which is not made in the notice, and which we think will be difficult to make.

Change in the record retention period for advertising and sales literature

Proposed rule 3602(7) extends the retention period for all advertising and sales literature material from two to seven years and for correspondence from five to seven hears.  The notice refers only to adoption of the Rule 3800, which makes the general retention period for records consistent with the retention period under National Instrument 31-103.  However, proposed rule 3802 states that Dealer Members can conform to specific rules or legislation that gives other retention periods. 

 The rationale given in the notice is that proposed rule 3802 ensures consistency with other dealer member rules and securities legislation. While we are all for consistency where it is useful, we shouldn't forget Ralph Waldo Emerson: "A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines."  We therefore think that more justification is needed.

The current retention period for advertising and sales literature was, as best we can recall, chosen because it is by and large retained so that IIROC and review it to ensure it is consistent with the rules.  So far as we have ever seen, the material is very seldom of interest in disciplinary matters, a use which drives the longer retention for many other kinds of records.

Type size of research report disclosures

Proposed Rule 3609 (1) requires that research report disclosures be made in a clear, comprehensive and prominent manner.  This is all well and good, although we think plain language rules dictate something like: "A Dealer Member's research report disclosures required in section 3607 and 3608 must be clear, comprehensive and prominently displayed."

Be that as it may, the section on disclosure prominence in Guidance Note 3600-3 says "research report disclosures should be in the same type size and legibility as that in the body of the report."  Leaving aside some further quibbling we could do about the writing, we wonder at this obsession with type size that bedevils regulators.  Do the regulators really have time to sit there with calipers measuring type sizes?  There are a host of ways to make written material prominent, even if the size is not exactly the same.  Once again, this guidance is written in a way that virtually makes it a rule; we suggest that the proposed rule as written (or perhaps rewritten) is enough.

Delivery of confirmations to approved persons

Proposed Rule 3830 requires delivery of trade confirmations to the client "or, if the client consents, to an approved person acting for the client."  We admit that "approved person" is not capitalized, so it may be intended to mean a third party authorized by the client, rather than an "Approved Person" of the dealer.  Even if that is the case, however, and we sincerely hope it is, we think it dangerous to permit confirmations to be delivered to third parties, other of course than under proposed Rule 3833 regarding managed accounts.

There is no discussion of the change from current Rule 200.1(h) in the covering notice.

We're confused

Separation of Comset reporting deadlines from the reporting regulation

Proposed Rule 3700 contains the complaint handing, internal investigation and reporting requirements currently in Rules 2500B regarding retail clients, 2700 regarding institutional clients and 3100 regarding record keeping and Comset reporting.

While the rules are little changed in the proposed plain language rules, the Comset reporting timelines and requirement to report through Comset have been moved to Guidance No. 3700-1.

The timelines and reporting method are rules, not guidelines.  They establish specific times and a specific reporting method, not approximate or best efforts times or alternative methods depending on the Dealer Member's facilities, size or location.  They should therefore be included in the rules.

Furthermore, separating them from the reporting rules will make the rules more cumbersome to use, because the information necessary for compliance appears into two places.

Inclusion in records of whether derivatives transactions are opening or closing

Proposed Rules 3806(xi); 3812(2)(viii); and 3832(1)(i)(h) and 3831(1)(ii)Ib) requires Dealer Members to show on, respectively, blotters, ledgers and confirmations whether derivatives transactions are opening or closing.  However, the requirement exists only where recording opening or closing transactions is required by the marketplace.

The notice explains that keeping this information is helpful to a Dealer Member's risk controls and improve market efficiency by letting the clearing corporation know whether a specific transaction is opening or closing.  While we agree with the whole idea, we wonder why it is subject to the provision that maintenance of the information be required by the marketplace.

To the extent that the provision will assist dealers in risk control, we think it should not be limited by marketplace requirements.  Removing the provision would make the requirement apply to, for example, over-the-counter derivatives such as contracts for difference and foreign exchange contracts where there is no formal marketplace.

Specific requirements for blotter information

Requirements for specific elements of trade information to be maintained in blotters have been put in Proposed Guidance Note 3800-2.  Once again, these are hard rules, not guidance.  Similar requirements for ledgers, confirmations and statements remain in the proposed rules.

We fail to see the reason for separating some prescriptive elements into a guidance note that is not really guidance.  The covering notice provides no rationale for the decision.

What's Missing?

Guidance on supervisory policies and procedures

We think there should be general guidance on policies and procedures.  After a brief introduction, Proposed Guidance Note 3900-1 jumps right into supervision of retail accounts.  We would like to see guidance on topics like:

·         Whether having policies and procedures in writing means that they also have to be collected into a consolidated manual, as some regulators seem to think. (We don't think that its really necessary);

·         Accessibility to those needing to use them;

·         How to determine a "reasonable time" within which changes should be made after a rule change, which may vary depending on how much notice there is and how extensive the changes are.

We're sure a group of compliance officers could think of other topics.

A final proofreading

The proposed rules continue to be littered with grammatical errors and syntactical infelicities.  We have already pointed out one or two.  There are more.


If these issues are of concern to you, Sutton Boyce Gilkes Regulatory Consulting Group can help you draft a comment letter.


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