Should an EMD use a Lawyer or a Compliance Consultant?

Nick Wright, BA JD MBA LLM (Tax)
Wright Business Law

An exempt market dealer may rely on lawyers, compliance consultants, accountants and other external advisers in establishing and operating its compliance program. The important starting point, however, is that responsibility for compliance remains with the registered firm.

National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”) requires a registered firm to establish, maintain and apply policies and procedures establishing a system of controls and supervision sufficient to provide reasonable assurance that the firm and individuals acting on its behalf comply with securities legislation and to manage the risks associated with its business in accordance with prudent business practices.

Within that framework, securities counsel and compliance consultants perform different, and frequently complementary, functions.

Regulatory Framework

In Ontario, the dealer registration requirement is principally established by subsection 25(1) of the Securities Act (Ontario). NI 31-103 establishes the national registration framework and prescribes the activities that may be conducted by firms registered in the exempt market dealer category.

Paragraph 7.1(2)(d) of NI 31-103 sets out the EMD category and the securities-related activities that an EMD may conduct, subject to the restrictions and other requirements of securities legislation.

Registration also carries continuing compliance obligations. Section 11.1 of NI 31-103 requires every registered firm to establish, maintain and apply policies and procedures establishing a system of controls and supervision sufficient to:

1. provide reasonable assurance that the firm and each individual acting on its behalf complies with securities legislation; and
2. manage the risks associated with the firm’s business in accordance with prudent business practices.

The compliance system must therefore reflect the firm’s actual business. A firm’s policies, procedures and controls should address its products, clients, distribution model, conflicts, personnel, jurisdictions of operation and other material risks.

External advisers can assist in designing, reviewing and implementing that system. Their involvement does not transfer the registrant’s regulatory responsibility to the adviser. The firm’s ultimate designated person (“UDP”), CCO and other responsible personnel continue to perform the functions assigned to them under securities legislation.

The practical question is consequently less whether an EMD should use a lawyer or a consultant generally, and more which is appropriate for a particular issue.

The Different Roles of Securities Counsel and Compliance Consultants

There is substantial overlap between the work performed by experienced securities lawyers and experienced compliance consultants. A rigid division is neither necessary nor particularly useful.

The distinction becomes clearer when the nature of the question is considered.

Securities counsel is generally appropriate where the engagement requires legal interpretation or advice. Examples include determining whether a proposed business activity requires registration, whether the EMD category permits a proposed activity, how securities legislation applies to a particular distribution model, the legal implications of a material compliance deficiency, or how the firm should respond to a significant regulatory issue.

Compliance consultants frequently provide greater value where the principal task is implementation. Examples include developing compliance calendars, documenting workflows, preparing monitoring procedures, conducting testing, assisting with training, developing operational checklists and helping management implement policies within the firm’s day-to-day operations.

The distinction is therefore functional rather than simply documentary. Drafting a document does not necessarily determine which professional should prepare it. A policies and procedures manual, for example, contains both legal and operational components. Counsel may be required to address the applicable legal requirements and unusual aspects of the firm’s business, while an experienced consultant or internal compliance team may contribute substantially to the procedures through which those requirements are implemented.

Phase 1: Business Model and Registration Analysis

Before applying for registration, a prospective EMD should determine whether its proposed business model can appropriately be conducted within the EMD category and identify the regulatory requirements applicable to that model.

This stage is particularly likely to require securities counsel where questions arise concerning:

• whether the proposed activities constitute trading or advising requiring registration;
• whether EMD registration is the appropriate registration category;
• the scope of activities permitted to an EMD;
• relationships among an EMD, issuer, investment fund manager, portfolio manager or other registrant;
• referral arrangements or compensation structures;
• conflicts of interest;
• proprietary or related-party products;
• activities conducted in multiple provinces or territories;
• cross-border activities;
• novel distribution models; or
• exemptions from registration requirements.

A compliance consultant can assist concurrently with operational readiness. This may include mapping proposed processes, identifying required controls, developing compliance calendars, establishing books and records procedures, preparing training materials and assisting management in translating the regulatory framework into repeatable internal processes.

Financial and capital compliance may also involve several professional disciplines. Preparation and monitoring of Form 31-103F1 Calculation of Excess Working Capital can involve management, compliance personnel, accountants and consultants. Securities counsel becomes particularly relevant where a legal or interpretive issue arises concerning the application of the capital requirements or the characterization of particular arrangements.

Phase 2: Registration Application and Regulatory Review

Registration applications require both substantive analysis and administrative execution.

Experienced consultants may assist applicants in organizing application materials, developing operational documentation, preparing readiness materials and coordinating the information required from management and proposed registered individuals.

Securities counsel is particularly useful where the application presents substantive regulatory issues. These can include unusual ownership structures, novel business models, related-party arrangements, potential conflicts, questions about permitted activities, cross-jurisdictional operations or issues raised by regulatory staff during the application process.

Counsel may also assist in preparing substantive responses to regulatory comments and determining whether proposed changes to the business model or compliance structure have broader legal consequences.

Phase 3: Ongoing Compliance

Once an EMD is registered, much of its compliance function becomes recurring and operational.

Depending on the firm’s size and business model, internal compliance personnel or an external consultant may assist with:

• compliance calendars and filing schedules;
• employee training;
• KYC and KYP processes;
• suitability procedures;
• conflicts monitoring;
• complaint-handling processes;
• books and records;
• testing of internal controls;
• policy updates;
• regulatory filing administration;
• capital monitoring;
• compliance reviews and readiness assessments; and
• documentation of supervisory activities.

These functions can often be performed efficiently without continuous involvement of external securities counsel.

Legal advice becomes more important when an issue moves beyond routine implementation. Examples include a material change to the firm’s business, uncertainty about the interpretation of securities legislation, a significant compliance deficiency, a novel product or distribution arrangement, a proposed transaction creating conflicts or registration issues, significant regulatory correspondence, or an investigation or enforcement matter.

An effective compliance structure therefore includes an escalation process. Internal compliance personnel and consultants should be able to identify matters that require legal analysis and escalate them appropriately.

Policies and Procedures Manuals

An EMD’s policies and procedures manual (“PPM”) illustrates the overlap between legal and operational compliance work.

A generic manual is unlikely to provide an effective compliance framework unless it reflects the firm’s actual business, organizational structure, products, clients, conflicts, processes and risks.

An experienced consultant can provide considerable assistance in developing and maintaining a PPM, particularly with respect to operational procedures, controls, testing and implementation.

Legal review may be appropriate where the PPM addresses substantive interpretations of securities legislation, unusual aspects of the firm’s business, material conflicts, novel products or distribution arrangements, or other issues involving significant legal judgment.

The objective should be a PPM that accurately describes how the firm complies with its obligations and that corresponds to the controls actually used by the firm. The existence of a professionally prepared manual does not itself establish an adequate compliance system if the procedures described in it are not implemented in practice.

Regulatory Reviews and Compliance Deficiencies

The appropriate role of external advisers can change substantially when an EMD becomes subject to a regulatory compliance review or identifies a material deficiency.

A consultant may be particularly effective in conducting readiness assessments, testing controls, reviewing documentation, identifying operational weaknesses and implementing remediation measures.

Securities counsel should generally become more closely involved where the matter raises questions concerning the interpretation of securities legislation, potential breaches, material exposure, privilege, regulatory representations, proposed terms and conditions, enforcement risk or the legal consequences of a remediation strategy.

The distinction can be especially important when an issue discovered during an operational review may constitute a breach of securities legislation. The firm should have an escalation process that allows a potentially significant compliance issue to receive appropriate legal analysis before decisions are made concerning regulatory reporting, remediation or communications with securities regulators.

Interaction with Private Placements and Investment Funds

For many EMDs, registration compliance cannot be considered independently from the securities being distributed.

An EMD distributing securities under National Instrument 45-106 Prospectus Exemptions may need to address matters including:

• availability and conditions of the applicable prospectus exemption;
• accredited investor qualification;
• offering memorandum requirements;
• risk acknowledgement forms;
• reports of exempt distribution;
• selling restrictions;
• conflicts arising from related or connected issuers;
• compensation and referral arrangements; and
• differences among provincial and territorial requirements.

Where an EMD distributes investment fund securities, additional questions may arise concerning the relationship between the dealer and the fund manager, portfolio manager, general partner, trustee or other entities involved with the fund.

These matters can combine legal analysis with operational compliance. Counsel can advise on the applicable securities-law requirements and the structure of the offering or distribution arrangement. Compliance personnel and consultants can then help incorporate those requirements into onboarding, KYC, KYP, suitability, documentation, supervision and record-keeping processes.

A Practical Allocation Framework

An EMD deciding whether to involve securities counsel should consider the nature of the issue rather than the title of the document or filing involved.

Securities counsel should generally be considered where the matter involves:

• interpretation of securities legislation;
• uncertainty regarding registration requirements or permitted activities;
• a novel or materially changed business model;
• significant conflicts of interest;
• complex offering or distribution structures;
• substantive responses to securities regulators;
• potential breaches of securities legislation;
• regulatory investigations or enforcement;
• significant liability exposure; or
• circumstances where legal privilege may be important.

Compliance consultants or internal compliance personnel may generally be appropriate for:

• operational implementation;
• routine compliance administration;
• compliance calendars;
• workflow development;
• training;
• testing and monitoring;
• readiness assessments;
• routine policy maintenance;
• documentation processes; and
• implementation of remediation measures.

Some matters will appropriately involve both.

The firm’s CCO and management should also determine who is responsible for each function, how issues are escalated and how the firm verifies that outsourced work has been properly completed. Retaining an external professional does not eliminate the registered firm’s own obligations under securities legislation.

Choosing a Compliance Model

There is no single lawyer-consultant allocation that is appropriate for every EMD.

A smaller EMD with limited internal compliance resources may rely substantially on external consultants for recurring compliance support while retaining securities counsel for legal and regulatory issues. A larger dealer may perform most functions internally and involve external advisers only when specialized expertise is required. A new or unusually structured firm may require significant legal and consulting assistance during registration and substantially less external support once its compliance infrastructure is established.

This allocation can also control professional costs. Routine operational work does not necessarily require legal rates, while attempting to resolve a significant securities-law issue without appropriate legal advice can create substantially greater costs if the issue later results in a registration delay, compliance deficiency or regulatory proceeding.

Conclusion

Exempt market dealers can use both compliance consultants and securities counsel effectively. Consultants can provide substantial value in implementing compliance processes, testing controls, maintaining documentation and supporting recurring compliance activities. Securities counsel is particularly appropriate where an issue requires legal interpretation, affects the firm’s registration or business model, creates material regulatory exposure, or involves significant interaction with securities regulators.

The EMD remains responsible for its compliance system. Management, the UDP and the CCO should maintain appropriate oversight of outsourced functions and a clear process for escalating matters requiring specialized legal or compliance expertise.

Book a Consultation

If you are applying for registration as an Exempt Market Dealer, Investment Fund Manager or Portfolio Manager, or require securities-law advice concerning an existing registered firm’s business or compliance obligations, contact us to schedule an initial consultation with Nick Wright.