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Overview of common EMD regulatory filing deficiencies

July 26, 2013  
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Source: Originally published in Exempt Market Update, Issue 3 - the leading national magazine for the exempt market professionals.

Overview of common EMD regulatory filing deficiencies

By Stephen Warden, CA, CMC, EMDA Director and Partner, MNP LLP

EMDs are now four full years into the implementation of National Instrument 31-103 (NI 31-103) which introduced a new national regulatory regime for EMDs. Under Part 12 of NI 31-103, EMDs are required to comply with regulatory capital requirements, books and records requirements and
monthly and yearend reporting and audit requirements.

Since implementation, provincial securities regulators have been conducting on-site compliance reviews and desk reviews to assess capital adequacy. The focus of this article is to outline common filing deficiencies so that we can learn and avoid repeating mistakes in our future filings.

There, but for the grace of God, go I!

In the most recent OSC Annual Report for the year ended March 31, 2011, the OSC notes that it oversees approximately 1,250 firms that trade or advise in securities or commodity futures, or act as investment fund managers. The OSC also oversees firms registered with the self regulatory
organizations, the Mutual Fund Dealers Association (MFDA) and the Investment Industry Regulatory Organization of Canada (IIROC) although significant elements of that oversight are delegated to the SRO’s. In its report, the OSC noted that it would take a strong regulatory response to findings of registrant misconduct. The OSC noted that about 10% of its on-site compliance reviews of registered firms in each of the last two fiscal years resulted in referrals to the OSC’s Enforcement Branch for investigation.

Furthermore, its registrant risk model now takes into account whether registrants evidence the three fundamental criteria for determining suitability for registration, which are integrity,
proficiency and solvency. It also considers the sponsoring firm’s track record of submitting error-free submissions and sponsoring suitable candidates for registration. The OSC indicated that it plans to refine its approach further to take into account firms with rigorous hiring practices
and effective supervisory structures. For EMDs registered in Ontario, this suggests that it is vitally important to learn from past deficiencies in financial regulatory reporting.

Compliance Reviews – Who Gets Them and Why?

The OSC conducts compliance reviews of selected firms on a continuous basis. Generally, they use a riskbased approach to select registrants for review; however, occasionally firms are selected for review on a random basis which helps the OSC evaluate the effectiveness of its risk based approach. Compliance reviews of registered firms generally focus on their conduct, practices, operations and capital adequacy. The risk-based approach is intended to identify those firms that are most likely to have material issues. The majority of reviews are proactive in nature, but reviews may be performed on a for-cause basis where the regulators are aware of a potential compliance issue, for example, as a result of a complaint, internal OSC concern or from an SRO or another regulator. The OSC also conduct sweeps, which are compliance reviews of a sample of firms on a specific topic or in an industry sector over a short period of time. Sweeps allow the regulator to respond on a timely basis to industry-wide concerns or issues. In its report, the OSC indicated that its reviews, 31% resulted in "Enhanced Compliance” findings, 57% resulted in "Significant Enhanced Compliance” findings; 3% resulted in "Terms and Conditions” being placed on registration and 9% resulted in referrals to the Enforcement Branch.

In addition, one firm was suspended immediately under new powers available to the Compliance and Registrant Regulation Branch of the OSC. Based on my experience with other regulators in Canada and the US, firms should pay close attention to their regulatory compliance reports
and remediate each finding as soon as practicable. On the  next compliance review, you can expect your regulator will perform follow up audits on the status of remediation and expect that findings are corrected.

In June 2011, the OSC issued an updated and integrated Risk Assessment Questionnaire (RAQ) to firms which included questions relating to different areas of a firm’s operations such as registration, business activities, financial condition, custody, fee arrangements, and compliance.
The completed questionnaires were risk-ranked, and each firm was assigned a risk ranking. Similar to other regulators such as IIROC, the OSC will use the risk ranking as a tool to allocate their staff resources effectively by focusing compliance activities on higher risk firms. The OSC
indicated that in 2012 it has started conducting on-site compliance reviews of firms that are higher risk based on their responses to the RAQ.

The OSC has also indicated that it will no longer provide reminders with respect to the deadline for filings, believe that it is the responsibility of the firm to have a sufficient compliance structure in place that enables it to comply with all regulatory requirements. If a filing deadline is not met,
it may affect a firm’s continued suitability for registration and may result in terms and conditions being imposed on the firm’s registration or even suspension of registration.

In addition, firms will incur late filing fees of $100 for each business day that the filing is late, to a maximum of $5,000 annually. Ouch.

IFRS and Financial Reporting

Part 12, Division 4 of NI 31-103 sets out the financial reporting obligations for registered firms. It requires Ontario-based registrants to deliver their annual audited financial statements (and related calculation of excess working capital- the NI31-103F1) to the OSC within 90 days after their financial year end. For financial years beginning on or after January 1, 2011, Ontario-based registrants are required to deliver to the OSC their annual audited financial statements that are prepared using IFRS. IFRS also applies to certain Ontario-based registrants that are required to prepare and deliver interim financial information to the OSC. An exemption is available to registrants from the requirement to provide comparative information in financial statements and interim financial information for the financial year beginning in 2011; however, in my experience, for many EMDs the cure is worse than the disease. It is oftentimes more work to address the reasons for not providing comparative information than just getting it done.

Calculating Excess Working Capital

The OSC noted that some firms are not accurately calculating their excess working capital on Form 31-103F1 Calculation of Excess Working Capital (Form 31-103F1). When calculating excess working capital, registered firms should exclude any current assets that are not readily
convertible into cash, such as prepaid expenses and security deposits with service providers. The OSC also have concerns with firms that include accounts receivables, especially from related parties, that are not readily convertible to cash. Any receivables that are not able to be converted to cash in a prompt and timely manner should be excluded from the excess working capital calculation.

Insurance Coverage

The OSC noted some instances of inadequate insurance coverage where the amount of insurance required is based on calculations which include the firm’s total assets as well
as clients’ assets under management. Registered firms should account for the expected growth in their business in determining the amount of insurance coverage to ensure that their coverage is adequate.

Registered firms should also ensure that their bonding or insurance provides for a "double aggregate limit” or "full reinstatement” of coverage. To ensure adequate insurance coverage, registered firms should: (1) factor in any expected increase in the firm’s assets or their clients’ assets under management for the next year when determining the amount of their insurance coverage, and, (2) regularly review the adequacy of their insurance coverage, especially when there is a material change in their business or circumstances

A Reminder for Chief Compliance Officers

The OSC notes that there is often no evidence that a registered firm’s Chief Compliance Officer (CCO) has submitted an annual report to the firm’s board of directors (or its equivalent) that assesses the firm’s, and its registered individuals’, compliance with securities law. Section 5.2
of NO 31-103 outlines the responsibilities of the firm’s CCO and thus firms and CCO’s are reminded to prepare a written annual report. In my experience, the report should be appended to the director minutes.

In summary, I always find it useful to learn from the experiences of others. I recommend you review the OSC‘s comments to see what may be applicable to your firm. The EMDA provides an in-depth forum to look at financial regulatory requirements at the EMDA’s CFO Education Series: Regulatory Financial Reporting Certificate Program that was held in Calgary, Vancouver and Toronto in November this year. In future articles, I will continue to discuss other emerging developments of interest to EMDs.

For more information contact:
Stephen Warden -

For more articles, please download the Exempt Market Update, Issue 3 - the leading national magazine for the exempt market professionals