NIN 97/40 - Conditional Exemption From Registration for United States Broker-Dealers and Agents [NIN - Rescinded]

The Commission, together with other members of the Canadian Securities Administrators ("CSA"), is publishing for comment the text of proposed National Instrument 35-101 and Companion Policy 35-101CP, which deal with trading in foreign securities between United States of America ("U.S.A.") broker-dealers and their clients from the U.S.A. who are present in a Canadian jurisdiction. The National Instrument and Companion Policy contain footnotes that are not part of the proposed instrument or policy, but which have been included to provide background and explanation.

The proposed National Instrument and Companion Policy are initiatives of the CSA. The proposed National Instrument is expected to be adopted as a rule in each of British Columbia, Alberta, Ontario and Nova Scotia, and as a blanket order or ruling in all other jurisdictions represented by the CSA. The proposed Companion Policy is expected to be adopted as a policy in all jurisdictions represented by the CSA.

Background

The proposed National Instrument is based on an initiative that was developed by the North American Securities Administrators Association ("NASAA") Cross-Border Trading Committee and that was approved by the members of NASAA (the "NASAA Proposal"). The NASAA Proposal was published in the Ontario Securities Commission Bulletin (1995), 18 OSCB 5252. NASAA is composed of regulators from the Canadian provinces and territories, the American states, the District of Columbia, Mexico and Puerto Rico. NASAA's membership does not include the Securities & Exchange Commission of the U.S.A. (the "SEC").

The proposed National Instrument and Companion Policy implement, in part, the recommendation of the CSA Task Force on Operational Efficiencies that Canadian securities regulatory authorities increase the coordination of regulation, including the standardization of requirements.

Substance and Purpose of Proposed National Instrument and Companion Policy

The proposed National Instrument provides U.S.A. broker-dealers and their agents with a conditional exemption from the applicable registration and prospectus requirements under Canadian securities legislation in order to facilitate certain cross-border trading in foreign securities between U.S.A. broker-dealers and their clients from the U.S.A. who are present in a Canadian jurisdiction .

Terms used in the proposed Companion Policy that are defined or interpreted in the proposed National Instrument or a definition instrument in force in the jurisdiction should be defined or interpreted in accordance with the National Instrument or the definition instrument, unless the context otherwise requires.

Summary of Proposed National Instrument and Companion Policy

The proposed National Instrument provides certain U.S.A. broker-dealers and their agents with an exemption from the applicable registration and prospectus requirements under Canadian securities legislation. Under the exemption, a U.S.A. broker-dealer and its agents may engage in two specific types of cross-border trading activities in foreign securities.

The first category of trading activity provided for under the exemption permits U.S.A. broker-dealers and their agents to trade solely in foreign securities with an individual ordinarily resident in the U.S.A. who is temporarily resident in the local jurisdiction and with whom the broker-dealer had a broker-dealer client relationship before the individual became temporarily resident in the local jurisdiction. The second category of trading activity provided for under the exemption permits U.S.A. broker-dealers and their agents to trade solely in foreign securities with an individual for the individual's tax-advantaged retirement savings plan, and with the individual's tax-advantaged retirement savings plan, if the plan is located in the U.S.A., the individual is the holder or contributor of the plan, and the individual was previously resident in the U.S.A.

The proposed National Instrument also exempts a distribution of foreign securities by U.S.A. broker-dealers and their agents under the registration exemptions provided for in the proposed National Instrument from the prospectus requirement and the underwriter registration requirement. As a result, issuers whose securities are traded only in the manner prescribed under the proposed National Instrument are exempt from the prospectus requirements applicable under Canadian securities legislation. However, the distribution of foreign securities must comply with all applicable U.S.A. federal securities laws and state securities legislation in the U.S.A.

Under the proposed National Instrument, U.S.A. broker-dealers and their agents are, in these circumstances, exempt from the applicable registration and prospectus requirements under Canadian securities legislation subject to certain conditions. This approach is consistent with the proposed National Instrument's underlying policy that investors will be relying primarily upon the regulation by the home jurisdiction's securities regulators and statutory liability imposed under legislation in the U.S.A. for protection. Although the Canadian securities regulatory authorities will retain jurisdiction to investigate activity outside the scope of the proposed National Instrument, as well as activities that violate the proposed National Instrument's general anti-fraud requirement, it is contemplated that the licensing and surveillance of the broker-dealer and agents will be conducted primarily by securities regulators in the U.S.A.

For the purposes of monitoring the trading activities of U.S.A. broker-dealers and their agents in Canada on an ongoing basis, the proposed National Instrument sets forth a number of conditions relating to delivery of documents and other regulatory requirements.

Under the proposed National Instrument, U.S.A. broker-dealers are required to have their principal place of business in the U.S.A. and maintain membership in the National Association of Securities Dealers ("NASD"). In addition, the broker-dealer must deliver the following materials to the securities regulatory authority immediately after the broker-dealer's first trade under the exemption: the most recent copy of the broker-dealer's Form BD; evidence of membership in NASD; evidence that the broker-dealer is registered in the state of the U.S.A. from which the trade took place; and an executed submission to jurisdiction and appointment of agent for service of process.

The broker-dealer is prohibited from advertising or soliciting new accounts in any Canadian jurisdiction. In addition, the broker-dealer must provide books and records upon request and inform the securities regulatory authority immediately of any criminal proceeding brought against the broker-dealer or its agents in any jurisdiction, or of any finding or sanction imposed on the broker-dealer or its agents as a result of any self-regulatory or regulatory action involving fraud, theft, deceit, misrepresentation or similar conduct in any jurisdiction. Lastly, in the course of dealings with its clients, the broker-dealer is under a duty to act fairly, honestly and in good faith and disclose in writing to each client that the broker-dealer and its agents are not subject to the full regulatory requirements applicable under Canadian securities legislation.

Agents who are representing U.S.A. broker-dealers that comply with the above conditions are also subject to a number of requirements under the exemption. An agent is required to deliver to the securities regulatory authority immediately after the agent's first trade under the exemption: the most recent copy of the agent's Form U-4; evidence that the agent is registered in the state in the U.S.A. from which the trade took place; and, an executed submission to jurisdiction and appointment of agent for service of process. Similar to broker-dealers, the agent is required to inform the securities regulatory authority immediately of any criminal proceeding brought against the agent in any jurisdiction, or of any finding or sanction imposed on the agent as a result of any self-regulatory or regulatory action involving fraud, theft, deceit, misrepresentation or similar conduct in any jurisdiction. In addition, the agent must act fairly, honestly and in good faith in the course of his or her dealings with the agent's clients.

Each of the Canadian securities regulatory authorities retains the authority to revoke the exemption, subject to applicable statutory provisions governing hearings and reviews, as it applies to a broker-dealer or agent if it considers the broker-dealer's or agent's conduct to be contrary to the public interest.

The proposed Companion Policy includes a statement that was approved by the NASAA members indicating that the Canadian securities regulatory authorities, in connection with delivery of the required material under the exemption, will not make any inquiries concerning any possible failure to register in relation to past trading activities of the type provided under the exemption up until a date which is 120 days after the effective date of the implementation of the proposed National Instrument. In addition, the Canadian securities regulatory authorities will not make inquiries concerning any possible failure to register in relation to any other trading activities that may have been conducted in any Canadian jurisdiction prior to September 1, 1996. This statement does not preclude the Canadian securities regulatory authorities from making inquiries if it comes to their attention that a U.S.A. broker-dealer or agent may have been engaged in improper trading activities in their jurisdiction beyond failing to register. A number of state securities regulators in the U.S.A. have agreed not to make inquiries of any Canadian dealer or salesperson on a reciprocal basis.

The proposed Companion Policy also provides guidance regarding the scope of trading activities permitted under the proposed National Instrument as well as the conditions of the exemptive relief.

Reciprocity

The NASAA Proposal, which is intended to be reciprocal in nature, provides for certain regulatory accommodations in relation to cross-border trading activities by certain U.S.A. broker-dealers and their agents, as well as certain Canadian dealers and those individuals registered to act on their behalf ("salespersons"). The proposed National Instrument will implement the NASAA Proposal on a uniform basis in all Canadian jurisdictions. Regulatory accommodations of a largely reciprocal nature are to be provided by the state securities authorities in the U.S.A. to Canadian self regulatory organization ("SRO") member dealers and their salespersons on a state-by-state basis. To date, the following state securities authorities in the U.S.A. have implemented the NASAA Proposal in their jurisdiction by establishing a simplified category of registration for Canadian SRO member dealers and their salespersons, or by providing them with an exclusion (from the definition of "broker-dealer" and "agent" under state law) or an exemption from the state registration requirements: Colorado, Florida, Iowa, Kansas, Maine, Michigan, North Dakota, Oregon, Rhode Island, Utah, Washington and Wisconsin. Seventeen other state securities authorities in the U.S.A. are in the process of implementing the NASAA Proposal in their jurisdictions according to information received by the Chair of the NASAA Cross-Border Trading Committee.

The Application of U.S.A. Federal Securities Laws

The NASAA Proposal relates to state requirements and does not affect the application of U.S.A. federal securities laws such as the Securities Act of 1933 (the "1933 Act"), the Exchange Act of 1934 (the "1934 Act"), and the Investment Company Act of 1940 (the "Investment Company Act"). In order for reciprocal relief to be available to Canadian SRO member dealers and their salespersons under the NASAA Proposal, no-action or other relief regarding U.S.A. federal securities laws would be required from the SEC. The CSA, the Investment Dealers Association of Canada (the "IDA") and the Investment Funds Institute of Canada have been discussing these issues with the SEC staff.

SEC Rule 15a-6 under the 1934 Act exempts from the federal broker-dealer registration requirement non-U.S.A. broker-dealers that engage in unsolicited transactions¹

¹ Rule 15a-6(a)(1).

and certain direct/solicited transactions²

² Rule 15a-6(a)(3) and Rule 15a-6(a)(4).

with U.S.A. persons. The IDA has written to SEC staff requesting their concurrence that SRO member dealers will be permitted to offer services of the type contemplated in the NASAA Proposal under Rule 15a-6. At this time, there are some indications that this relief may not be granted.

The cross-border sale of mutual fund units, which constitute an important investment component of registered retirement savings plan or registered retirement income fund accounts in Canada, also raises an issue of reciprocal market access under the NASAA Proposal because of the application of the Investment Company Act to non-U.S.A. investment companies.³

³ In Canada, the equivalent of a U.S.A. investment company is generally referred to as an "investment fund".

These issues are described further below.

Section 7(d) of the Investment Company Act prohibits a foreign fund from making a public offering of its securities in the U.S.A. without obtaining a SEC order permitting it to register under the Investment Company Act. Section 7(d) has operated to significantly limit the entry of foreign funds into the U.S.A. market.⁴

⁴ Section 7(d) authorizes the SEC to issue such an order permitting the foreign investment company only if the SEC finds that it is both legally and practically feasible to enforce the provisions of the Investment Company Act against the foreign investment company, and that the issuance of the order is consistent with the public interest and the protection of investors. Section 7(d) is intended to subject foreign investment companies that access the U.S.A. market to the same type and degree of regulation that applies to U.S.A. investment companies. This standard effectively requires a foreign investment company that is organized in a country with substantially different investment company regulation to structure itself and operate as a United States company. Accordingly it has proven difficult for most foreign investment companies to become registered under Section 7(d). Protecting Investors: A Half Century of Investment Company Regulation. United States Securities and Exchange Commission, 1992, 189-90.

As a result, the application of the Investment Company Act will operate as a bar to the reciprocal operation of the NASAA Proposal with regard to the sale of mutual funds to Canadian investors unless relief from its requirements is obtained.

Section 7(d) of the Investment Company Act does not expressly prohibit private offerings or limit the number of shareholders that a foreign fund may have. Section 3(c)(1) of the Investment Company Act addresses offerings by private investment companies. It excepts from the definition of "investment company" an entity that has no more than 100 beneficial owners of its securities and that does not presently propose to make a public offering of its securities in the U.S.A. The SEC's Division of Investment Management, in interpreting sections 7(d) and 3(c)(1), has stated that an unregistered foreign fund can make a private offering in the U.S.A. concurrently with a public offering abroad and not violate section 7(d), provided that the fund has no more than 100 beneficial owners resident in the U.S.A.

⁵ Touche Remnant & Co. (Aug. 27, 1984). More recently, the SEC clarified that it would not recommend enforcement action if a non-U.S.A. fund that is not registered under the Investment Company Act permitted more than 100 U.S.A. residents to remain beneficial owners of the fund's securities, if, in addition to the satisfaction of a number of other conditions, the 100 U.S.A. investor limit was exceeded solely because non-U.S.A. holders (i.e. beneficial owners who purchased their securities while residing outside the United States) have relocated to the United States. Investment Funds Institute of Canada (Mar. 4, 1996).

In many circumstances, the cross-border sale of mutual funds under the NASAA Proposal to Canadian investors will not qualify for the private offering exemption because the number of investors resident in the U.S.A. will likely exceed the 100 investor limit and will not be sold exclusively to qualified purchasers.⁶

⁶ The National Securities Improvement Act of 1996 has introduced reforms to private company offerings, including the creation of an additional exception for funds sold exclusively to "qualified purchasers". The SEC has proposed rules to implement this exception: SEC Release No. IC-22405 (Dec. 18, 1996). "Qualified purchasers" are defined as (i) any natural person who owns not less than $5 million in investments; (ii) a family-owned company that owns not less than $5 million in investments; (iii) certain trusts; and (iv) any other person that owns and invests on a discretionary basis not less than $25 million in investments.

The securities registration provisions of the 1933 Act may also apply to trades effected by Canadian dealers under the NASAA Proposal if such trades are not restricted to secondary market transactions but include public offerings of securities.

⁷ In addition, the issuer may become subject to the securities registration requirement and periodic reporting obligations under the 1934 Act if, as a result of the increased trading activity permitted under the NASAA Proposal, the issuer has a greater number of shareholders resident in the United States: section 12(g) of the 1934 Act. However, the issuer may still avoid the registration requirement and period reporting requirements if it furnishes to the SEC reports and other information it makes available in its home market: Rule 12(g)3-2(b) under the 1934 Act.

This restriction would apply to cross-border trades in mutual funds by Canadian dealers under the NASAA Proposal.

The SRO Structure in Canada

The regulatory relief contemplated in the NASAA Proposal is restricted to dealers who are members of an SRO in their home jurisdiction. In the U.S.A., a broker-dealer generally may not commence securities activities until it becomes a member of an SRO, namely NASD. Currently, in Canada, not all dealers are required to be a member of an SRO. As such, these dealers will not be eligible to qualify for the relief available under the NASAA Proposal. The CSA believes that the movement towards a new regime that requires all dealers to be a member of an SRO will address any imbalances arising from the structural differences that exist between Canada and the U.S.A. in the area of self-regulation.

The CSA recognizes the importance of providing Canadian dealers and their salespersons with cross-border access of a reciprocal nature contemplated by the NASAA Proposal. Comment is specifically requested on the lack of full reciprocity by the securities regulators in the U.S.A. on the substance of the proposed National Instrument.

Foreign Securities

The NASAA Proposal was not limited to trading in foreign securities. The term "foreign securities" is defined in the proposed National Instrument to include securities of Canadian issuers that are interlisted on an exchange or quoted on a market in the U.S.A. The NASAA Proposal also does not provide relief from the registration of securities distributed under federal law. The proposed National Instrument provides such relief but only for distributions of foreign securities that are otherwise made in compliance with securities law in the U.S.A.

The restriction of the relief provided in the proposed National Instrument is necessary to ensure that there is regulatory oversight over the distribution of securities into Canada to the limited class of persons for which the relief is permitted. Comment is specifically requested on the restriction of the relief under the proposed National Instrument to trades in foreign securities and the definition of foreign securities.

Alternatives Considered

In developing the proposed National Instrument, the Canadian securities regulatory authorities considered whether the NASAA Proposal should be implemented in Canada by way of an exemption or a simplified category of registration. Given the restricted nature of the permitted trading activities afforded to U.S.A. broker-dealers and their agents under the proposed National Instrument, and the underlying policy that investors will be relying primarily upon the regulatory standards of the broker-dealer's or agent's home jurisdiction for protection, it was decided to implement the NASAA Proposal by way of exemptions from the applicable registration and prospectus requirements under Canadian securities legislation. In order to monitor these trading activities in the Canadian jurisdictions on an ongoing basis, and to ensure that investor protection is not compromised, the exemption has been made conditional upon the satisfaction of a number of filing and other regulatory requirements.

Anticipated Costs and Benefits

It is anticipated that Canadian SRO member dealers and their salespersons will benefit from the regulatory accommodations, and the corresponding reduction in costs, provided by the securities authorities in the U.S.A. by permitting them to engage in certain cross-border trading activities with individuals from Canada. It is also anticipated that the proposed National Instrument will provide similar cost benefits to U.S.A. broker-dealers and their agents by permitting them to engage in certain cross-border trading activities with individuals from the U.S.A. under the exemption. The costs of compliance with the requirements of the Proposed National Instrument will not be significant.

Comments

Interested parties are invited to make written submissions with respect to the proposed National Instrument and Companion Policy. Submissions received by January 19, 1998 will be considered.

Submissions should be made to all of the Canadian Securities Administrators listed below in care of the Ontario Commission in duplicate, as indicated below:

British Columbia Securities Commission
Alberta Securities Commission
Saskatchewan Securities Commission
The Manitoba Securities Commission
The Ontario Securities Commission
Office of the Administrator, New Brunswick
Registrar of Securities, Prince Edward Island
Nova Scotia Securities Commission
Securities Commission of Newfoundland
Securities Registry, Government of the Northwest Territories
Registrar of Securities, Government of the Yukon Territory

c/o Daniel P. Iggers, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario M5H 3S8

Submissions should also be addressed to the Commission des valeurs mobilières du Québec as follows

Jacques Labelle
General Secretary
Commission des valeurs mobilières du Québec
Tour de la Bourse
C.P. 246, 17th Floor
Montréal, Québec H4Z 1G3

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

Questions may be referred to any of the following:

Robert Hudson
Special Advisor, Registration
British Columbia Securities Commission
(604) 660-4883
0r 1-800-373-6393 (in B.C.)

David Sheridan
Legal Counsel
Alberta Securities Commission
(403) 297-2630

Marcel de la Gorgendière
Chairman
Saskatchewan Securities Commission
(306) 787-5645

David Cheop
Counsel
Manitoba Securities Commission
(204) 945-2561

Randee Pavalow
Policy Co-ordinator/Advisor
Ontario Securities Commission
(416) 593-8257

Joëlle Saint-Arnault
Legal Advisor
Commission des valeurs mobilières du Québec
(514) 873-5009 ext. 237

Elaine Anne MacGregor
Deputy Director, Capital Markets
Nova Scotia Securities Commission
(902) 424-7768

DATED at Vancouver, British Columbia, on October 16, 1997

Adrienne R. Wanstall
Member