NIN 97/12 - Joint Securities Industry Committee on Conflicts of Interest - Interim Report [NIN - Rescinded]

Published Date:	1997-03-14
Effective Date:	1997-03-12

The five Canadian self-regulatory organizations established a Joint Securities Industry Committee on Conflicts of Interest in the fall of 1996 in response to several controversial incidents that occurred in emerging company markets. The self-regulatory organizations asked the Committee to examine the potential conflicts of interest that occur when brokers and member firms participate in emerging company investments and to ascertain if the existing self-regulatory rules and provincial regulations adequately protect investors. The Committee was not charged with responsibility for investigating or reporting on specific incidents or transactions.

The Committee released its Interim Report on February 27, 1997 to solicit reaction from securities regulators, the investing public, corporate issuers, member firms and other participants in the financial community on the appropriateness of its proposed recommendations. The Commission is publishing the Summary of Recommendations set out in the Interim Report, as well as a definition of "Pro Group" that is necessary to make sense of the recommendations.

The issues raised in the Interim Report are important and the Commission encourages market participants to respond to the request for comments. Written comments should be submitted on or before April 11, 1997 to the Secretary of the Committee:

Ian C.W. Russell
Senior Vice-President
Investment Dealers Association of Canada
Suite 1600, Standard Life Centre
121 King Street West
Toronto ON M5H 3T9

Participants interested in obtaining a copy of the full Interim Report should direct their requests to the Investment Dealers Association of Canada at the following address:

Investment Dealers Association of Canada
Suite 1325
P.O. Box 11614
650 West Georgia Street
Vancouver BC V6B 4N9

Telephone: (604) 683-6222
Fax: (604) 683-3491

DATED at Vancouver, British Columbia, on March 12, 1997.

Douglas M. Hyndman
Chair

Attachments

Summary

The Joint Industry Committee on Conflicts of Interest concluded from its deliberations that the existing regulations governing the conduct of member firms within the self-regulatory systems, together with the provincial securities legislation and policies, have for the most part protected the clients of member firms when investing in the securities of companies. The Committee recognized, however, that investors have not always been treated fairly in emerging company markets, contributing to the widespread perception among market participants that unfairness exists in venture markets. This unfairness and the perception of unfairness have been exacerbated by the bull market conditions which have prevailed in recent years. The temptation becomes great in such markets for brokers and other employees in member firms, and those associated with brokers to participate in early stage financings, and sometimes sell out quickly at profits which are significant in relation to the underlying economic risks.

Practices which have resulted in unfair treatment to some investors will in the long run damage confidence in the integrity of capital markets, and the efficiency and liquidity of markets will suffer accordingly. Unfair treatment has occurred in some instances because existing securities regulations and rules in the self-regulatory system have not gone far enough to address potential conflicts of interest in the capital-raising process. The Committee also has the view that some of the unfair practices which have taken place have been without regard to the fiduciary obligations which, in many cases, exist between the broker and his client. The Committee believes that participants in the industry should become more conscious of their fiduciary obligations.

The Committee concluded that Canada has one of the most efficient emerging company markets in the world and that every effort should be taken to encourage the growth and expansion of the marketplace to promote capital formation by new, small and mid-sized businesses in the country. Recommendations for regulatory reform must strike the right balance between providing adequate protection to the investing public to create a climate of improved investor confidence, and preserving the liquidity and efficiency of the marketplace to promote capital formation by small business. The Committee recommends the adoption of several new rules and modifications to existing rules in the self-regulatory system. Client preference rules, particularly as they apply to distributions of securities by way of private placements and initial public offerings, need to be tightened. Further, disclosure rules relating to the holdings of member firms and their employees are not sufficiently comprehensive, and must address both the circumstance where these entities act in concert, and the perception that those holdings represent common interests. Finally, the existing statutory conflict of interest rules requiring disclosure of significant holdings, and the requirement for an independent member firm in an underwriting, should be triggered once the combined investments of a member firm and its brokers are meaningful, even if their holdings, independent of one another, are not.

The specific recommendations of the Committee are summarized below. The report which elaborates on the Committee's observations and reasoning in reaching the policy recommendations follows.

Recommendations

1. The self-regulatory organizations should require that member firms solicit client interest in all securities, including private placements, offered or to be sold by reporting issuers if the firm or employees of the firm intend to purchase, and give priority to client orders above all other orders.

2. The self-regulatory organizations should require member firms to disclose the aggregate holdings of the member firm and certain employees (the "Pro Group") in any class of a reporting issuer's voting or equity securities if those holdings which in aggregate exceed 10% of the outstanding securities of that class.

3. Brokers employed by member firms should inform clients of the Pro Group's disclosed holdings at the time their clients receive advice or give trading instructions relating to the securities of those reporting issuers. These holdings should be disclosed in the bulletins of stock exchanges where the securities are listed, on trade contract confirmations and in research reports.

4. The statutory hold periods which apply to private placement securities held by members of the Pro Group should not be permitted to be abridged, including on reverse take-overs or major transactions between private companies and junior capital pool companies, when the holdings of any class of a reporting issuer's voting or equity securities by the Pro Group exceed 20% of the outstanding securities of that class, or the Pro Group is acting as underwriter or agent in the transaction. Notwithstanding the foregoing, the abridgement of the hold period would be permitted for privately placed shares qualified through the prospectus of a subsequent public offering if the price paid for the privately placed shares is at least 85% of the prospectus offering price, or in the event of an arms-length merger or take-over bid for the shares of the reporting issuer.

5. The provincial regulations and the stock exchanges impose different special hold periods or escrow requirements on 'seed' or 'founders' shares apart from the normal statutory hold periods. Provincial regulators and stock exchanges should endeavour to create uniformity in these special hold periods and escrow provisions for emerging companies by implementing policies based upon the principles contained in the model currently in place in British Columbia for VSE listed issuers.

6. The self-regulatory organizations and securities commissions, as appropriate, should impose the current statutory conflicts of interest rules, such as the involvement of an independent firm in an underwriting and disclosure of the conflict of interest relationship, when the Pro Group holdings exceed 20% of any class of the voting or equity securities of a reporting issuer.

7. The self-regulatory organizations should rigorously enforce the existing and proposed rules and impose significant penalties for infractions to prevent harm to investors arising from conflicts of interest of member firms and brokers participating in the capital-raising process for emerging companies. The provincial securities commissions also have an obligation to monitor compliance with the existing provincial statutes and mete out stiff penalties for any infractions.

8. The provincial securities commissions should consider regulatory changes to improve public access to investments in emerging companies in non-public or "exempt" markets without jeopardizing the protection of the investing public. The provincial securities commissions should work together to achieve greater harmonization of provincial securities regulations, particularly with respect to prospectus exemption requirements and hold periods for private placements.

9. The provincial securities commissions should implement appropriate rules which govern conflicts of interest, particularly personal investing, by the investment managers of mutual fund companies.



The Pro Group will be defined as:

(i) the member firm (ii) registrants of the firm (includes directors, officers, registered representatives and investment advisors) (iii) employee shareholders of the firm (iv) if applicable, partners of the firm (v) the controlling shareholder of the firm (vi) any subsidiary of the firm (vii) associates of persons referred to in clauses (b), (c) and (d) above

For the purposes of the definition, "associates" will have the meaning set out in several provincial Securities Acts, in particular, (i) a trust or estate in which that person has a substantial beneficial interest, but not including the discretionary accounts held with the member firm;

(ii) an issuer in respect of which that person beneficially owns or controls, directly or indirectly, voting securities carrying more than 10% of the voting rights attached to all outstanding voting securities of the issuer, or

(iii) a relative, including the spouse of that person or a relative of that persons' spouse, where the relative has the same home as that person.