Securities Law

BCN 2003/20 - Publication for Comment of Proposal to Exempt - NASD Affiliates of BC Dealers from Registration Requirements [BCN - Rescinded]

Published Date: 2003-06-20
Effective Date: 2003-06-20

The Commission is publishing for comment a proposal to give BC-based affiliates of BC dealers improved access to the trading facilities of The NASDAQ Stock Market, Inc. (NASDAQ US). This includes its NASDAQ Stock Market (NMS) and SmallCap markets and Over-the-Counter Bulletin Board (OTCBB) quotation service. Appendix ‘A’ to this notice is a submission from NASDAQ Canada Inc.

How to provide your comments
We are seeking comments on all aspects of the proposal, including the submission. We have also raised specific issues that we would like you to comment on. These are set out in text boxes throughout this notice. Please feel free to respond to these issues specifically, or to comment generally on the proposal or submission.

Due date
We will consider all comment letters received by August 19, 2003.

Where to send your comments
You can send us your comment letters in paper, by fax or by e-mail. Please address your submission to:
Denise Duifhuis
Senior Legal Counsel
Legal and Market Initiatives
British Columbia Securities Commission
P.O. Box 10142, Pacific Centre
701 West Georgia Street
Vancouver, BC Canada V7Y 1L2
Phone: (604) 899-6792 or (800) 373-6393 (in B.C. and Alberta)
Fax: (604) 899-6814
e-mail: dduifhuis@bcsc.bc.ca

Comments are public
Comment letters will be placed in a public file and form part of the public record, unless you request confidentiality. Although we will not place comment letters requesting confidentiality in the public file, freedom of information legislation may require us to make comment letters available to the press and the public.

Background and Purpose of the Proposal
Currently, many Canadian dealers transmit orders to NASDAQ US indirectly through intermediaries - electronic communications networks, U.S. broker-dealer affiliates or other U.S. broker-dealers - which in turn transmit them directly to NASDAQ US. Through these arrangements, Canadian dealers have indirect access to NASDAQ US’s execution facilities. Indirect arrangements are administratively cumbersome. More direct access by Canadian registered dealers to NASDAQ US’s facilities could reduce costs, enhance market visibility and transparency for Canadian dealers, improve competition and reduce customer risk.
NASDAQ Canada asked the Commission to consider letting registered BC dealers have more direct access to NASDAQ US’s trading facilities, in particular its NMS and SmallCap markets and OTCBB quotation service.

NASDAQ Canada is also engaged in similar discussions with the Ontario Securities Commission, and anticipates approaching other Canadian securities regulators.

Background on the NASD group of companies
NASDAQ US is a registered securities information processor under US securities law. It is a subsidiary of NASD, a registered self regulatory organization (SRO) in the US. NASDAQ Canada is a wholly-owned subsidiary of NASDAQ US. The US Securities and Exchange Commission (SEC) oversees NASDAQ US. NASDAQ US has applied to become a national securities exchange in the US. If this application is granted, the NASD will continue to be required to operate a quotation and transaction reporting facility for other securities.

In Canada, NASDAQ Canada and NASDAQ US are recognized self regulatory organizations under Quebec law for purposes of carrying on business in Quebec.  NASDAQ Canada has a number of participants in Quebec, most of whom are affiliates of other Canadian registered dealers. These participants, who are members of the NASD, currently transmit orders to NASDAQ US on behalf of their affiliates in Canada on an omnibus basis and, in some cases, directly enter orders received from Quebec customers.

The Proposal
Proposed exemption for NASD affiliates of B.C. dealers

To trade directly via NASDAQ, participants must be members of the NASD. Most Canadian dealers set up an affiliate that joins the NASD. Under current practice, the affiliate is located in the U.S.

Generally, the US affiliate has an “omnibus” relationship with its Canadian affiliate. This means that the US affiliate has an account for its Canadian affiliate in which the transactions of two or more individual accounts are combined and carried in the name of the Canadian affiliate. The identities of the individual account holders and their trades are generally not disclosed to the US affiliate. The US affiliate performs U.S. trades on behalf of the Canadian affiliate. The US affiliate is not registered in Canada. To avoid Canadian registration requirements, it must have a U.S. location and the associated infrastructure and employees. This structure fragments the trading process, and its costs are often enough to dissuade many Canadian dealers, especially small and mid-sized Canadian dealers, from trading on NASDAQ US in this way.

Canadian dealers that do not have US affiliates arrange trades indirectly through “jitneys”, where a non-affiliated US broker who has direct access to NASD performs trades for the Canadian broker. This structure requires the Canadian dealer to pay a fee to the US broker, increasing costs for the Canadian client. It also makes it difficult for market and regulatory authorities in both Canada and the US to monitor trading irregularities.

The costs and complexities of having a US affiliate to access NASDAQ US could be reduced for Canadian dealers if the affiliate could be located in Canada. Under current requirements in British Columbia, the US affiliate would have to be registered as a dealer with the Commission and would have to join the Investment Dealers Association of Canada. However, it is not practical (and may not be possible) for a dealer to be a member of both the IDA and the NASD.

The proposal would overcome this problem by allowing a dealer that is registered in British Columbia and is a member of the IDA (a B.C. dealer) to have an NASD affiliate co-located with a B.C. office of the dealer, and to use dually-engaged employees, and exempting the affiliate from the requirement to register in B.C. This would reduce costs and provide better compliance and regulatory controls.

If adopted, the proposal would be implemented through a BC Instrument, which would exempt an NASD member affiliate of a B.C. dealer from registration, subject to conditions necessary to protect the integrity of regulation and the market in B.C., such as:

  • the NASD affiliate must remain affiliated with a B.C. dealer that is an IDA member;
  • all trading officers and trading employees in B.C. of the NASD affiliate must be dually employed by both the B.C. dealer and its NASD affiliate;
  • the NASD affiliate must comply with relevant NASD requirements;
  • the NASD affiliate must not have any clients in B.C. other than its B.C. dealer affiliate and accredited investors acting as principal or other clients in respect of which registration is not required, and must only engage in transactions in the U.S.; and
  • the NASD affiliate must consent to jurisdiction in any action or proceeding before any court or securities regulatory authority in B.C., agree to provide access to its books and records and give inspection rights to the Commission. 

Issues for comment:
1. Would the proposal help Canadian dealers reduce execution and other costs?
2. Is it appropriate for the NASD affiliate to trade securities in the U.S. on behalf of accredited investors acting as principal or other clients in respect of which registration is not required? Should it be restricted to trading on behalf of its B.C. dealer affiliate or its B.C. dealer affiliate and other dealers?
3. Would the proposal adversely affect or benefit Canadian investors and, if so, how?
4. Would the proposal lead to improved execution of US trades?
5. Would the proposal improve Canadian regulatory oversight?
6. Does the proposal improve access to the U.S. market in a transparent manner?
7. Would the proposal likely or potentially improve competition in the execution of trades?

Recognition as an exchange
Under section 25 of the Securities Act, a person must not carry on business as an exchange in British Columbia unless it is recognized as an exchange. In the past, the Toronto Stock Exchange and other Canadian stock exchanges located outside B.C. were not considered to be carrying on business as an exchange in B.C., despite the fact that dealers in B.C. had trading terminals for the exchanges. NASDAQ Canada submits that neither it nor NASDAQ US will be “carrying on business as an exchange” in B.C., as they will not have any physical presence in B.C.

The Commission’s draft legislative proposal published on April 15, 2003, which sets out a streamlined and simplified regulatory regime to support a new way to regulate securities, proposes a new authorization process for all marketplaces and market services providers to replace the existing regimes for exchanges, alternative trading systems and quotation and trade reporting systems. The proposal reflects the fact that, even today, the recognition process is essentially a negotiation and the circumstances of each application are different. It allows the Commission and the applicant to tailor the conditions and restrictions of the authorization to match the applicant’s business or function and to protect the public interest. Once settled, these conditions and restrictions will form the applicant’s regulatory regime. Because NASDAQ Canada and NASDAQ US will not be carrying on business in British Columbia, their situation would not change under the draft legislation.
 
Issue for comment:
8. The Commission considers that NASDAQ Canada and NASDAQ US are not “carrying on business as an exchange” in B.C. What concerns, if any, does this approach raise?

Clearing and Settling Transactions
NASD members are responsible for clearing and settling all transactions. The NASD affiliates may establish clearing or carrying relationships with U.S. broker-dealers. NASDAQ Canada submits that these arrangements occur outside Canada and are purely administrative in nature; therefore these clearing or carrying brokers should not require registration in B.C or, alternatively, they should be exempt from registration.

Issue for comment:
9. The Commission does not consider that clearing and settlement related to transactions outside Canada require registration in British Columbia.  What concerns, if any, does this approach raise?

Questions
If you have questions about the proposal, please contact:
L.E. Evans, C.A., Director
Capital Markets Regulation
British Columbia Securities Commission
(604) 899-6620 or (800) 373-6393 (in B.C. and Alberta)
e-mail: levans@bcsc.bc.ca

or

Denise Duifhuis
Senior Legal Counsel
Legal and Market Initiatives
British Columbia Securities Commission
(604) 899-6792 or (800) 373-6393 (in B.C. and Alberta)
e-mail: dduifhuis@bcsc.bc.ca

June 20, 2003

 


Douglas M. Hyndman
Chair


This Notice may refer to other documents. These documents can be found at the B.C. Securities Commission public website at www.bcsc.bc.ca in the Commission Documents database or the Historical Documents database.


Appendix A

NASDAQ Canada Submission on the Potential Benefits of the Proposal

Reduced Costs and Better Control Over Orders
If a Canadian dealer can set up a U.S. NASD member affiliate on its own premises in Canada, staff it with Canadian employees, use existing infrastructure, and supervise the employees through its existing Canadian compliance operations, the dealer can reduce the costs of accessing NASDAQ US from those that apply to either foreign affiliate operations or third party jitney operations. In addition, the dealer will likely have better internal controls, as it is more difficult to exercise effective controls over fragmented trading processes and remote locations.

Direct trading costs may also be reduced. The costs of trades on NASDAQ US are less than the prices currently charged by the TSX, and could enhance competition and lower execution costs for Canadians. The cost of crossed trades is of particular importance in the Canadian market, where the “upstairs market” (i.e. large block transactions) represents approximately 70 percent of all trading.

Better Canadian Regulatory Oversight
Canadian regulators and SROs have expressed concern about their inability to regulate foreign transactions originated by Canadian dealers but sent through foreign jitneys. Today, the Commission has no control over foreign jitney brokers. The Commission will be better able to influence and investigate the conduct of co-located NASD affiliates. The NASD and the SEC would also regulate the NASD affiliates.

Greater Transparency of Process
Currently, the protections available to clients accessing US marketplaces are not at all clear. The jitney model may reduce these protections (e.g. know your client and other rules may not apply and direct client remedies against the jitney dealer may be impractical or non-existent) while imposing an additional layer of costs.

Canada’s capital markets would benefit from a clear and transparent process. The Commission and other Canadian securities regulatory authorities have adopted National Instrument 21-101 Marketplace Operation and National Instrument 23-101 Trading Rules (know as the ATS rules) to facilitate both competition and marketplace access for Canadian investors under appropriate conditions.

Attribution of Order Flow for Smaller Canadian Dealers
The Proposal will enable smaller and mid-sized dealers who do not currently have NASD affiliates to access NASDAQ US’s trading facilities (i.e. the NMS and SmallCap markets and the OTCBB quotation service) directly. Volume on NASDAQ US originating from Canadian-based dealers can be substantial.  Much of this trading activity is not attributed to the Canadian originating dealer, as the dealer uses an unaffiliated U.S. NASD firm under a jitney arrangement. This makes it difficult for smaller and mid-sized Canadian dealers to build their reputation in the U.S.

Attribution (i.e. credit for originating order flow) will better enable these dealers to specialize in certain companies, develop expertise, and participate in underwriting activity. The Proposal will allow the dealers to increase their visibility both domestically and in the U.S., assisting them with their brand development and business generally.

Encourages Competition
Competitive markets can over time be expected to lead to a more robust domestic market (for both dealers and trading facilities) and to improve services and reduce costs to investors of all types.

Improved Client Execution and Accountability
If a Canadian dealer, who has direct client contact, uses its own co-located affiliate to execute NASDAQ US trades, it will have more control over the order than if the order is sent for execution to a third party jitney, a U.S. electronic communications network or alternative trading system or even a foreign affiliate. This will likely lead to improved executions for clients and more accountability.