Investment funds and asset management - Regulatory update 

publication 

July 2012

Securities and Public Markets Bulletin

Several regulatory developments have recently occurred which will have an impact on investment funds, investment fund managers and advisers operating in Canada. This regulatory update will summarize these developments, for further details as to how these regulatory changes may affect you, or your business please contact your legal professional at McMillan LLP.

I.    final rules for registration of non-resident investment fund managers announced

In recent McMillan regulatory updates dated February 2012 and March 2012, we noted that securities regulatory authorities across Canada had published for comment draft Multilateral Instrument 32-102 – Registration Exemptions for Non-Resident Investment Fund Managers (the "Instrument") and Multilateral Policy 31-202 – Registration Requirement for Investment Fund Managers (the "Policy"). The Instrument and the Policy represent two different registration regimes in Canada for non-resident investment fund managers.

Generally speaking, an "investment fund manager" is an entity which manages the business, operations or affairs of one or more investment funds. For the purposes of this bulletin, the term "non-resident investment fund manager" includes both investment fund managers who do not have their head office or principal place of business in a province or territory of Canada (an "international investment fund manager") and investment fund managers who do not have a place of business in the local province or territory ("domestic non-resident investment fund managers").

On July 5, 2012, securities regulatory authorities across Canada published the final versions of the Instrument and the Policy which will each become effective on September 28, 2012. Any managers that are required to register as an investment fund manager in one or more Canadian jurisdictions as a result of the new Instrument or Policy must submit their application for registration by no later than December 31, 2012.

summary of final instrument

The Instrument will be effective in the Provinces of Ontario, Québec and Newfoundland and Labrador (collectively, the "Instrument Jurisdictions"). Implementation of the Instrument is subject to Ministerial consent in each of Ontario and Québec. Notice of the Instrument, including the Instrument itself, the relevant annexes and Companion Policy 32-102CP, is available here.

In general, and subject to certain exemptions, the Instrument provides that a non-resident investment fund manager must register as an investment fund manager in an Instrument Jurisdiction if the fund they manage is marketed and distributed to investors in the Instrument Jurisdiction.

available exemptions from the investment fund manager registration requirement

The Instrument provides certain exemptions from the requirement to register as an investment fund manager in the Instrument Jurisdictions for international investment fund managers and domestic non-resident investment fund managers. More specifically, the Instrument exempts both international investment fund managers and domestic non-resident investment fund managers from registration in an Instrument Jurisdiction:

  1. if there are no security holders of any of the investment funds managed by the investment fund manager in the Instrument Jurisdiction;

  2. if there is no "active solicitation" after September 27, 2012 of residents in the Instrument Jurisdiction by either the investment fund manager or any of the investment funds it manages; or

  3. solely in the case of international investment fund managers, if all securities of the investment funds distributed in the Instrument Jurisdiction were distributed under an exemption from the prospectus requirement to investors who qualify as "permitted clients" for the purposes of National Instrument 31-103 - Registration Requirements, Exemptions and Ongoing Registrant Obligations ("NI 31-103"). Examples of "permitted clients" include individuals with financial assets of $5 million or more, a person or company (other than an individual or investment fund) with net assets of $25 million or more, pension funds regulated either federally or provincially or subsidiaries of such funds, and certain investment funds.

Effective September 28, 2012, an international investment fund manager who intends to rely on the permitted client exemption referenced in item 3 above will be required to provide:

(a)    to the securities regulatory authority in the applicable Instrument Jurisdiction(s):
(i) a notice advising of the reliance by the international investment fund manager on the exemption, including disclosure of assets under management attributable to investors resident in the applicable Instrument Jurisdiction; (ii) Notice of Regulatory Action regarding disciplinary history, settlement agreements and ongoing investigations of the international investment fund manager; and (iii) a completed Form 32-102F1 - Submission to Jurisdiction and Appointment of Agent for Service whereby the International Investment Fund Manager submits to the jurisdiction of the applicable Instrument Jurisdiction and appoints an agent for service in that Instrument Jurisdiction; and

(b)    to the permitted clients who purchase securities of the investment funds managed by the international investment fund manager in each applicable Instrument Jurisdiction a notice: (i) indicating that the international investment fund manager is not registered in the Instrument Jurisdiction; (ii) identifying the foreign jurisdiction in which the head office or principal place of business of the international investment fund manager is located;
(iii) including a statement that all or substantially all of the assets of the international investment fund manager may be situated outside of Canada; (iv) noting that, as a result of (iii), there may be difficulty in enforcing legal rights against the investment fund manager; and (iv) listing the name and address of the agent for service of process of the international investment fund manager in the Instrument Jurisdiction.

We note that, beginning March 31, 2013, registered international investment fund managers will be required to provide notice to investors including substantially similar disclosure to that required to be provided by unregistered international investment fund managers relying on the permitted client exemption.

meaning of "active solicitation"

The Companion Policy to the Instrument provides that intentional actions taken by the investment fund or the investment fund manager to encourage a purchase of the fund's securities, such as pro-active, targeted actions or communications that are initiated by an investment fund manager for the purposes of soliciting an investment would be considered to be "active solicitation". Examples of "active solicitation" provided in the Companion Policy include:  

(a)    direct communication with residents of the Instrument Jurisdiction to encourage their purchase of the investment fund's securities;

(b)    advertising in Canadian or international publications or media (including the Internet), if the advertising is intended to encourage the purchase of the investment fund's securities by residents of the Instrument Jurisdiction (either directly from the fund or in the secondary resale market); and

(c)    purchase recommendations being made by a third party to residents of an Instrument Jurisdiction if that party is entitled to be compensated by the investment fund or the investment fund manager for the recommendation itself or for a subsequent purchase of fund securities by residents of the local jurisdiction in response to the recommendation.

The Companion Policy to the Instrument indicates that the following activities would not be considered to be "active solicitation" in an Instrument Jurisdiction:

(a)    advertising in Canadian or international publications or media (including the Internet) only to promote the image or general perception of an investment fund;

(b)    responding to unsolicited enquiries from existing or prospective investors in an Instrument Jurisdiction; and

(c)    solicitation of a prospective investor that is only in the Instrument Jurisdiction on a temporary basis (e.g. where a resident of another jurisdiction is on vacation in the Instrument Jurisdiction).

changes between draft and final versions of instrument

Very few changes were made between the final Instrument and the earlier draft Instrument with the principal changes being: (a) the inclusion of a clarification that where an investment fund manager manages more than one investment fund, the exemption from registration will only apply if all of the investment funds managed meet the criteria for exemption; (b) the "grandfathering" of any active solicitation which took place prior to September 28, 2012 for the purposes of determining if a registration requirement has been triggered; and (c) the withdrawal of New Brunswick as one of the Instrument Jurisdictions.

summary of final policy

The Policy will be adopted in British Columbia, Alberta, Saskatchewan, Manitoba, Prince Edward Island, Nova Scotia, New Brunswick, Northwest Territories, Nunavut and Yukon (collectively, the "Policy Jurisdictions"). Notice of the Policy, including the Policy itself and relevant annexes, is available here.

Unlike the Instrument Jurisdictions, a manager will only be required to register as an investment fund manager in a Policy Jurisdiction if it: (a) carries on the functions and activities of an investment fund manager in that Policy Jurisdiction; or (b) has a head office in the Policy Jurisdiction or directs or manages the business, operations or affairs of an investment fund from a physical place of business in the Policy Jurisdiction.

In determining whether an investment fund manager "carries on the activities of an investment fund manager", the Policy lists a number of functions and activities that are indicative of a positive answer, though no single function or activity is determinative of the matter.

The principal difference between the final Policy and the earlier draft Policy is a clarification that functions or activities carried out by an investment manager in a Policy Jurisdiction due to the presence of security holders in the Policy Jurisdiction, solicitation of investors in a Policy Jurisdiction, or the distribution of securities in a Policy Jurisdiction will not give rise to a requirement to register as an investment fund manager unless these functions or activities are directed from within the Policy Jurisdiction and result in the investment manager directing or managing the business of the investment fund in the Policy Jurisdiction.

important points to bear in mind

In general terms:

  1. a Policy Jurisdiction will only require registration of a non-resident investment fund manager if the manager carries on certain significant investment manager activities in that Policy Jurisdiction; whereas

  2. the Instrument Jurisdictions take a broader view of their jurisdiction over non-resident investment fund managers and will generally require a non-resident manager to register as an investment fund manager if the investment fund they manage is marketed to investors in the Instrument Jurisdiction (subject to certain limited exemptions).

NI 31-103 is the governing instrument as it relates to the registration requirements and ongoing obligations of investment fund managers. Generally speaking, registration as an investment fund manager pursuant to NI 31-103 requires a manager to meet certain minimum capital and insurance requirements at the time the application for registration is submitted. Registered investment fund managers must appoint a chief compliance officer who meets certain prescribed minimum proficiency requirements set out in NI 31-103. In addition, registered investment fund managers must file annual (audited) and interim (unaudited) financial statements with the applicable securities regulatory authorities and comply with certain other reporting requirements applicable to investment fund managers in NI 31-103. Finally, registered investment fund managers may be subject to regulatory compliance audits from time to time by the applicable securities regulatory authorities.

Investment fund managers seeking registration in an additional jurisdiction for 2013, or international investment fund managers making an initial registration application for 2013, are reminded that, if a registration is approved prior to December 31 2012, a full registration fee will be payable for each of 2012 and 2013.

All managers of investment funds are encouraged to consult with legal counsel as soon as possible to discuss the implications of the Instrument and the Policy on their business operations, to determine if they will be required to register as an investment fund manager in any Instrument Jurisdiction or Policy Jurisdiction and to take the necessary steps to apply for registration (if required) prior to the December 31, 2012 deadline.

II.    delay in requirement for portfolio managers to implement alternative dispute resolution services

The Canadian Securities Administrators announced on July 5, 2012 that they are reviewing the dispute resolution provisions contained in NI 31-103, and that they may publish proposed amendments to these provisions for comment. In the meantime, the current exemption from the requirement to provide dispute resolution services has been extended to the earlier of September 28, 2014, or the coming into effect of any proposed amendments to the dispute resolution provisions.

III.    OSC to contact clients of certain registrants in the course of compliance reviews

On June 4, 2012, the Ontario Securities Commission (the "Commission") advised all registered exempt market dealers, scholarship plan dealers and portfolio managers (collectively, the "Affected Registrants") that it will be changing its compliance review process under section 20 of the Securities Act (Ontario) (the "Ontario Act") beginning with the next scheduled set of reviews.

Section 20 of the Act permits the Commission to appoint representatives to review the books, records and documents which are required to be maintained by registrants under section 19 of the Act. Section 20 also permits these representatives to enter the premises of registrants and inquire into, examine and make copies of such books, records and documents.

Under the new policy, Commission staff may contact clients of the Affected Registrants directly as part of the compliance review process. While direct client contact has not been a regular part of the Commission's compliance review process to date, it has been utilized from time to time.

Clients of Affected Registrants contacted by the Commission can expect to be asked a number of questions about their experience with the registrant, including questions relating to collection and updates of "know-your-client" information, investment recommendations made to the client and advice provided. While the focus of the Commission's efforts will be on clients of Affected Registrants located in Ontario, the Commission may also contact clients located in other jurisdictions.

As a general matter, unless Commission staff have reason to believe that regulatory action against an Affected Registrant may be warranted, clients contacted by Commission staff will be informed that they are being contacted in the ordinary course of a regular compliance review and that the contact should not be interpreted as a sign of misconduct on the part of the Affected Registrant. Clients will also be advised that their participation in the compliance review process is voluntary and that they are not required to speak with Commission staff or respond to their questions. Affected Registrants will receive a written report describing the Commission's findings, together with any deficiencies uncovered as a result of the review. The report will list the names of clients contacted by the Commission and particulars of any deficiencies noted in respect of such clients.

Determinations about the Affected Registrants whose clients are to be contacted during the course of a compliance review will be random, although the Commission has advised that it will increase its reviews of Affected Registrants for which it has received complaints or referrals from another regulator or Commission branch and that it will also use the risk rankings produced from Commission risk assessments in order to prioritize its reviews.

Affected Registrants may wish to pro-actively advise their clients that they may be contacted by the Commission in the context of routine compliance reviews and that any such contact is not necessarily indicative of any regulatory issues or concerns relating to the Affected Registrant. 

by Michael Burns and Hartley Lefton

a cautionary note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2012