Registering as an EMD for Mortgage Investment Entities
By: Susan Han
The project known as ‘Registration Reform’ was supposed to make the rules surrounding regulation of people and entities engaged in the trading of securities consistent and harmonized across Canada. The idea was that a uniform set of rules would result in less confusion for members of the investing public, as well as efficiency and cost reduction for the members of the industry.
For the larger full service broker-dealers, much of this has been achieved. In general, if you want to work as a securities dealer for a major wirehouse, the rules will be more or less consistent whether you work in Calgary, Vancouver, or Toronto. On the other hand, there has been a singular lack of regulatory consistency and harmonization when it comes to the rules applicable to mortgage investment entities and the distribution of these products. Different rules will apply depending on where you are in Canada. The term Mortgage Investment Entity (MIE) is the one favoured by securities regulators and it refers to Mortgage Investment Corporations (MICs), as well as to other pooled vehicles for mortgage investment, such as mortgage income funds set up as unit trusts.
The starting point is CSA Staff Notice 31-323, Guidance Relating to the Registration Obligations of Mortgage Investment Entities, released February 25, 2011. (It is to be noted that this Staff Notice came about only after a series of temporary measures and interim relief orders, indicating that policymakers had not canvassed the issues and developed positions beforehand). Staff Notice 31-323 confirmed that there were at least two regulatory regimes for MIEs: one for Alberta, and one for all other jurisdictions in Canada.
This article is a discussion of the securities registration requirements around the sale and distribution of securities of MIEs, so we will set aside considerations relating to the requirement to register as an investment fund manager or a portfolio manager. The effect of the coming into force of National Instrument 31-103, Registration Requirements, Exemptions and Ongoing Registrant Obligations, was that securities of MIEs could no longer be distributed, even on a private placement basis, except through firms and individuals registered as dealers under the applicable securities legislation.
This presented a problem for MICs, who had traditionally sold their securities under prospectus and registration exemptions. Following a series of interim orders, the Canadian Securities Administrators in Staff Notice 31-323 advised that in all jurisdictions other than British Columbia, an MIE or other person or company trading in securities of an MIE would be subject to the dealer registration requirement based on the view that they were in the business of trading. In British Columbia, the Commission granted an exemption from the registration requirement for trades in MIE securities. The most current exemption expires June 30, 2014.
However, west of the Ontario-Manitoba border, MICs could continue to rely on the various Blanket Orders issued by regulators in those jurisdictions which continue to permit trade-based exemptions to persons who would otherwise have to register as dealers. These are collectively known as the Northwestern Exemption, and Staff Notice 31-323 confirmed the CSA’s view that persons trading in securities of MICs were subject to the registration requirement, not that they could not rely on available exemptions. The end result was that in Alberta, for example, it continued to be possible for MIEs to distribute their securities in reliance on the Northwestern Exemption, provided that they were able to meet the conditions of such Exemptions. British Columbia has proposed revocation of the Northwestern Exemption, which together with the expiry of the exemption order for MIEs, will have the effect of imposing the dealer registration requirement on the distribution of securities MIEs and MICs in that province.
So, in order to comply with securities rules, MICs and other MIEs will have to engage dealers, most likely EMDs, to distribute their securities, or they will have to themselves register as EMDs. A MIC or other MIEs may decide to do this because, for example, they already have the relationships with their investors, and it makes little sense to pay a third party to intermediate those pre-existing relationships.
A MIC, or its management company, can apply for registration as an EMD. The application needs to be directed to the securities regulator in the province where the head office is located, and that regulator is called the principal regulator. Under the ‘passport’ system, registrants can be registered with multiple regulators while dealing only with its principal regulator. The passport system in theory allows a firm to be registered in all Canadian jurisdictions, even if it deals directly only with the regulator in its home or principal jurisdiction. However, there are a few additional rules and considerations. Ontario is not a party to the passport system, so although Ontario can be a principal regulator, if the firm’s principal regulator is not Ontario, then the firm must in effect apply separately in Ontario. Note that fees are payable to each jurisdiction in which a firm is registered.
The key to a smooth registration process is to have all of the pieces in place before the application is submitted. Often, a challenge for MICs registering as EMDs is to identify an individual who is qualified to act as the firm’s Chief Compliance Officer (CCO). That individual must meet certain proficiency requirements, which will generally involve passing the requisite exam. All individuals who deal directly with clients on the sale of securities of the MIC will have to be registered as Dealing Representatives, and they too will have to pass proficiency exams. It is permissible in small organizations for the Ultimate Designated Person (most likely the President or Chief Executive Officer), the CCO and the dealing representative to be one and the same individual.
In addition to proficiency requirements applicable to individuals, an applicant for registration will need the prescribed insurance, working capital, audited financial statements prepared in accordance with GAAP and comprehensive and detailed compliance policies and procedures. Applicants are required to have written business plans and business continuity plans.
It’s a new day for MIEs and MICs – particularly in western Canada. Ontario MICs have been adjusting to the securities registration rules for a few years now, and can attest that life as a securities registrant can be a little bumpy, particularly at the beginning. So in one sense, recent developments will bring us just a little bit closer to a harmonized set of rules, although perhaps not in the way certain industry participants would have favoured. But the likelihood of returning to a world before MIEs needed to concern themselves with securities registration is slim, vanishingly so