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Compliance with the Accredited Investor Exemption - A Nine-Point Plan for EMDs
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By:
Brian Koscak, EMDA Chairman and Partner, Cassels Brock & Blackwell LLP
David Gilkes, EMDA Director and President of North Star Compliance & Regulatory Solutions Inc.

On May 13, 2011, the Ontario Securities Commission (OSC) published OSC Staff Notice 33-735 – Sale of Exempt Securities to Non-Accredited Investors (OSC Staff Notice 33-735), which has two primary objectives:

  • provides guidance on the financial assets versus the net assets tests of the definition of an Accredited Investor (principal residence and ‘other real estate’ excluded from the financial assets test); and
  • sets out the OSC’s expectations for issuers and dealers selling securities to Accredited Investors.

Although OSC Staff Notice 33-735 is issued by the OSC and not the Canadian Securities Administrators, it provides helpful guidance in this area, especially its list of steps that issuers dealers and their dealing representatives should take in order to meet their obligations when selling exempt securities to an Accredited Investor.

It is not sufficient for issuers/dealers to simply rely on a client initialling or checking off a box in an Accredited Investor certificate (or a schedule to a subscription agreement) stating that the investor is purchasing the security as an Accredited Investor. More action is required as set out in this chart:

OSC Staff
Notice 33-735
EMD Firm Responsibilities
(UDP/CCO)
EMD Dealing Representative
Responsibilities
Read and understand the definition of Accredited Investor- part 11 of NI 31-103 requires firms to provide adequate training to ensure that Dealing Representatives understand the Accredited Investor definition, especially the difference between financial assets and net assets
- ensure firms provide training on the Accredited
Investor definition and evidence of completed training programs in the course of a compliance field review
- understand the definition of Accredited Investor and be able to explain it to their investor clients
- attend firm training seminars on this topic
Develop an accurate
form for collecting Know Your Client
information
- develop a Know Your Client form
- the KYC form must include information about client’s financial circumstances, investment objective and risk tolerance
- Chief Compliance Officer (CCO) must review completed Know Your Client forms to ensure they are fully and accurately completed and confirm an individual is an Accredited Investor under the appropriate definition
- must ensure Know Your Client form is fully and accurately completed
- should be able to determine whether an investor is an Accredited Investor
Explain the Accredited Investor definition to clients and ensure that their Know Your Client forms are properly completed- firms must ensure Know Your Client forms are properly completed before any trade is completed- explain the Accredited Investor definition to clients before they complete their Know Your Client form
- should prepare and retain notes in connection with any matters that arise in the completion of a Know Your Client form
- notes should be made on Know Your Client form or kept with the form
- ensure the client excludes real estate from the financial assets test
Do not sell an exempt security if you do not have sufficient information to determine whether the client qualifies as an Accredited Investor- EMD firms must verify that an investors’ KYC
information satisfies the appropriate Accredited Investor definition
- some EMD firms may ask to see tax returns for the last two years for income test requirements for individuals under the Accredited Investor definition
- cannot simply rely on signed subscription agreement
- must ensure that an investors’ Know Your Client information satisfies the appropriate Accredited Investor definition
Ensure the exempt security is suitable for the client- Section 13.3 of NI 31-103 sets out the suitability requirement
- Even if an investor satisfies the appropriate
Accredited Investor definition, the investment must be suitable for an investor. This must be confirmed by the CCO
As per CSA Staff Notice 33-315 Suitability Obligation and Know Your Product, a Dealing Representatives must understand:
- the general investment needs and objectives of a client and any other factors necessary for them to be able to determine whether a
proposed trade is suitable [Know Your Client information including risk tolerance]
- the attributes and associated risks of the securities a Dealing Representatives is recommending to the client
Review the KYC form- CCO must review the KYC form to ensure that the information collected is complete and consistent with the appropriate Accredited Investor definition relied upon by investor and that the trade is suitable
- if there is conflicting information, the EMD firm must take appropriate action and document follow-up procedures to confirm compliance and reliance
- CCO is in effect the ‘second set of eyes’ to ensure compliance in his/her gatekeeper role
- Dealing Representatives must review the KYC form to ensure that the information collected is complete and consistent with the appropriate Accredited Investor definition relied upon by investor and that the trade is suitable.
Retain documentation- EMDS firms should retain records that support reliance on the Accredited Investor definition
- Securities regulatory authorities will want to view such documentation in connection with a compliance field review
- Dealing Representatives should retain
records that support reliance on the Accredited Investor definition
- Good practice for a Dealing Representatives to have duplicate set of records
Establish policies and procedures- EMD firm Policy and Procedures Manual (PPM) should establish policies and procedures to ensure securities sold under the Accredited Investor exemption are only sold to investors who satisfy the appropriate Accredited Investor definition
- CCO must ensure policies and procedures are in fact followed otherwise they could be used against an EMD firm and/or a Dealing Representatives in establishing non-compliance with one’s own policies and procedures
- Dealing Representatives should have knowledge and comply with the EMD firm’s PPM requirements involving sales to investors who satisfy the appropriate Accredited Investor definition
Report the sale of exempt securities to the OSC- CCO to make sure that the issuer has filed Form 45-106F1 (as required by NI 45-106) with the applicable securities regulatory authority for sales made in reliance on Accredited Investor exemption
- a copy of a signed Form 45-106F1 should be included in a closing book to a transaction in connection with a private placement offering
 N/A

For more information contact:
Brian Koscak - bkoscak@casselsbrock.com
David Gilkes - davidgilkes@northstarcompliance.com

For more articles, please download the Exempt Market Update - the national magazine of the EMDA

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