CIRO Publishes Phase 5 of its Rule Consolidation Project

The Canadian Investment Regulatory Organization (“CIRO”) has published for comment Phase 5 of its rule consolidation project (the “Rule Consolidation Project”). Phase 5 involves rules relating to outsourcing and service arrangements, continuing education, reporting and handling of complaints, internal investigations and other reportable matters, recordkeeping and client reporting, financial solvency, client asset use and custody and financing arrangements. Comments are being accepted until June 25, 2025.

Background

The purpose of the Rule Consolidation Project is to combine the rules currently applicable to investment dealers and mutual fund dealers, respectively, into one set of requirements applicable to both categories of CIRO dealer members. The Phase 1 proposals outlined a framework for the development of the consolidated rules. The Phase 2 proposals involved rules relating to margin, debt markets and inter-dealer bond brokers and trading. The Phase 3 proposals involved rules relating to membership and member business activity approval matters, clearing and settlement of trades and trade delivery standards and examination, investigation and enforcement. The Phase 4 proposals involved rules relating to managing significant areas of risk, individual approval, business conduct and client accounts and review procedures for approvals.

Phase 5 Proposals

Phase 5 addresses certain requirements that, while common to the Investment Dealer and Partially Consolidated Rules (“IDPC Rules”) and Mutual Fund Dealer Rules (“MFD Rules”), nevertheless differ in ways that, in CIRO’s assessment, could have material impacts on stakeholders. The Phase 5 proposals include, in part:

Acceptable back-office and service arrangements

• Introducing broker/carrying broker (“IB/CB”) arrangements: IDPC Rule requirements for existing Type 1 to 4 IB/CB arrangements would be adopted, along with the majority of MFD Rule requirements for introducing and carrying arrangements between two mutual fund dealers. A new section would be added to the rules to provide CIRO staff with the ability to grant exemptions from the IB/CB arrangement requirements, given the complexity of various business models and the potential for diverse arrangements between investment dealers and mutual fund dealers;
• Other outsourcing and back-office arrangements: IDPC Rule requirements would be adopted in respect of other permitted outsourcing and back-office arrangements, such as arrangements with foreign affiliates, arrangements with Canadian financial institution affiliates and clearing arrangements with other dealers;
• Service arrangements: MFD Rule requirements would be adopted as there are no equivalent requirements in the IDPC Rules;

Continuing education requirements for “Approved Persons”

• The existing separate continuing education regimes for investment dealers and mutual fund dealers would be maintained as an interim measure while a separate CIRO project considers the harmonization of these requirements;

Reporting and handling of complaints, internal investigations and other reportable matters

• Reporting requirements: CIRO proposes the introduction of the defined term “serious misconduct”, which would contain a non-exhaustive list of reportable matters. In addition, the reporting requirements that previously only applied to Approved Persons would be extended to employees of dealer members;
• Internal investigations and discipline: CIRO proposes to base the trigger for an internal investigation on the concept of “serious misconduct” and extend the rules to the conduct of employees;
• Settlements and confidentiality restrictions: The rules would clarify that a dealer member must not impose confidentiality or similar restrictions on a client pursuant to a release entered into between the dealer member and client, or otherwise. A provision would be introduced to prohibit dealer members from preventing clients, via a release agreement or otherwise, from communicating or sharing information with securities regulatory authorities or other enforcement authorities;
• Client complaints: CIRO proposes to adopt the existing IDPC Rule regime, which sets out different standards for institutional and retail client complaint handling, as current MFD Rules do not distinguish between retail and institutional clients;

Recordkeeping and client reporting

• Recordkeeping requirements: General IDPC Rule requirements would be adopted with certain changes regarding minimum mandatory records and internal controls and access to records to further align and clarify dealer recordkeeping responsibilities in conformity with existing rule expectations and industry practice. For specific records, CIRO proposes to incorporate the more prescriptive requirements from both sets of existing rules;
• Client reporting requirements: CIRO proposes to generally adopt IDPC Rule requirements while incorporating certain elements from MFD Rules;

General dealer member financial standards

• Minimum capital levels: CIRO proposes to maintain both IDPC and MFD Rule requirements;
• Early warning tests: IDPC Rules provide for several early warning tests and two early warning levels, whereas MFD Rules provide for fewer and simpler early warning tests and one early warning level. CIRO proposes to harmonize the early warning tests and requirements for investment dealers and Level 4 mutual fund dealers. Existing MFD Rule early warning tests would be maintained for Level 1 to 3 mutual fund dealers, and an additional profitability test would be introduced;
• Financial report filing requirements: Existing due dates for financial filings for mutual fund dealers and investment dealers would be maintained, except where a mutual fund dealer chooses to offer margin lending. In that case, the filing deadline would be aligned with the deadline imposed on investment dealers;
• Appointment of auditors and audit requirements: CIRO proposes to adopt IDPC Rule requirements and criteria for qualifying as an auditor to perform the audit of a dealer member’s year-end financial report, which are more stringent than existing MFD Rule criteria. In addition, the MFD Rule requirement to inform CIRO of any change in auditor would be adopted, and the audit workpaper record retention requirements would be aligned with the general dealer member record retention requirements;

Financial disclosure to clients

• IDPC Rules require investment dealers to provide a summary statement of their financial position and a list of current executives and directors to a client upon request and to notify clients that the information is available upon request. There are no equivalent requirements in the MFD Rules. CIRO proposes to adopt these requirements for both investment dealers and mutual fund dealers but would provide mutual fund dealers with additional time to prepare the statement to align with the separate financial report filing deadlines;

Pricing internal control requirements

• IDPC Rule requirements would be adopted as there are no corresponding requirements under the MFD Rules. This includes requirements to ensure consistent and accurate pricing of investment products and verification of the dealer member’s pricing against independent sources;

Client asset use and custody

• Segregation and related internal controls: CIRO proposes to adopt a modified version of the IDPC Rule segregation requirements that integrates and maintains the core requirements applicable to the investment dealer margin lending model and the mutual fund dealer full segregation model;
• Custody and related internal controls: CIRO would adopt IDPC Rule requirements for custody agreements;
• Client free credit balances: CIRO proposes to adopt a modified version of IDPC Rule requirements that integrates and maintains the core requirements applicable to the IDPC Rule allowable use model and the MFD Rule full cash segregation model. Level 4 mutual fund dealers would also be allowed to use client free credit balances in their businesses, subject to meeting the same client free credit balance and financial solvency requirements as investment dealers;
• Safekeeping, safeguarding and related internal controls: A modified version of the IDPC Rule safekeeping requirements would be adopted;
• Insurance requirements: CIRO proposes to adopt IDPC Rule requirements;

Financing arrangements

• IDPC Rules relating to repurchase and reverse repurchase market trading practices and cash and securities loan, repurchase and reverse repurchase agreement transactions would be adopted as there are no corresponding provisions in the MFD Rules; and

Regulatory financial report (DC Form 1)

• IDPC and MFD Rules require dealers to file a regulatory financial report on a monthly and annual basis. CIRO proposes to introduce a single form that will: (i) introduce separate schedules for requirements that are unique to investment dealers or mutual fund dealers; (ii) blend and harmonize the financial statements and similar schedules; (iii) customize certain schedules to dealer type; and (iv) adopt IDPC Rule schedules where there is no corresponding MFD Rule schedule. CIRO believes that having one form will create efficiencies while allowing customization of reporting requirements that may be unique to investment dealers or mutual fund dealers.

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