MEMBER REGULATION. notice

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1 MEMBER REGULATION INVESTMENT DEALERS ASSOCIATION OF CANADA notice ASSOCIATION CANADIENNE DES COURTIERS EN VALEURS MOBILIÈRES Contact: R. Corner: (416) rcorner@ida.ca MR 033 Update of and replacement to Compliance Interpretation Bulletin C-117 June 6, 2000 ATTENTION: Ultimate Designated Persons Chief Financial Officers Panel Auditors Distribute internally to: Corporate Finance Credit Institutional Internal Audit Legal & Compliance Operations Registration Regulatory Accounting Research Retail Senior Management Trading desk Training Other Foreign Acceptable Securities Locations On December 29, 1997 IDA Bulletin #2432 and IDA Compliance Interpretation Bulletin C-116 were issued announcing changes to IDA Form 1, the Joint Regulatory Financial Questionnaire and Report. Among the changes announced were amendments made to the definition of acceptable securities locations to codify the framework to be used by Member firms in determining which locations would qualify as other foreign acceptable securities locations. On this same date IDA Compliance Interpretation Bulletin C-117 was also issued to provide Member firms detailed guidance in following this new framework. The remainder of this regulatory notice serves to provide an update to this interpretation bulletin. This bulletin serves as an update to that framework. All changes from previous IDA Compliance Interpretation Bulletin C-117 have been black-lined to alert Member firms. 1. What are the criteria established for other foreign acceptable securities locations? The following is a summary of the rules contained in the General Notes and Definitions to the JRFQ&R for other foreign acceptable securities locations. The rules set out criteria which must be met in order for such foreign securities locations to be considered approved locations. In all circumstances there must be a written custodial agreement in place with the foreign custodian satisfying the minimum provisions set out in IDA Regulation Foreign depositories In the case of foreign securities depositories, they must be incorporated or organized under the laws of the foreign country and operate the central system for handling securities or equivalent book-based entries in that country. The foreign depository must have enabling legislation by a central government authority in the country of operation which provides for compliance and powers of enforcement over its members. The IDA has determined the foreign depositories listed in Appendix B meet this criteria and are considered other foreign acceptable securities locations. TORONTO Suite 1600, 121 King Street West, Toronto, Ontario, M5H 3T9 Telephone (416) Fax: (416) MONTRÉAL Suite 2802, 1 Place Ville Marie, Montréal, Québec, H3B 4R4 Téléphone: (514) Télécopieur: (514) HALIFAX Suite 1620, TD Centre, 1791 Barrington Street, Halifax, Nova Scotia, B3J 3K9 Telephone (902) Fax: (902) CALGARY Suite 2300, 355 Fourth Avenue S.W., Calgary, Alberta, T2P 0J1 Telephone: (403) Fax: (403) VANCOUVER Suite 1325, P.O. Box 11614, 650 West Georgia Street, Vancouver, B.C., V6B 4N9 Telephone: (604) Fax: (604)

2 June 6, 2000 MR-033 Foreign Institutions and dealers In the case of all other foreign financial institutions and securities dealers that do not meet the prescribed requirements set out elsewhere in the definition of an acceptable securities location and that are in the business of providing securities custodial services, there is a net worth criteria in the amount of CAN $150 million to be met, as evidenced by the last audited financial statements of the company. In addition, a Certificate evidencing approval of a foreign institution or dealer as an acceptable securities location by the Board of Directors or committee thereof of a Member firm, must be submitted to the IDA for approval in the form of Appendix C. 2. What is the purpose of a written custodial agreement? In order for any location (i.e., including acceptable institutions) to be considered an other foreign acceptable securities location, there must be a written custody agreement outlining the terms upon which the securities are deposited. As a minimum, the written terms must include provisions to the effect that: (a) no use or disposition of the securities shall be made without the prior written consent of the Member firm; (b) certificates representing the securities can be delivered to the Member firm promptly on demand or, where certificates are not available and the securities are represented by book entry at the location, the securities can be transferred either from the location or to another person at the location promptly on demand; and (c) the securities are held in segregation for the Member firm or its customers free and clear of any charge, lien or encumbrance of any kind in favour of the depository or institution holding such securities Refer to Appendix D for a sample custodial agreement. 3. What must be submitted to the SROs to approve an other foreign securities location? As part of the due diligence process that must be performed by a Member firm in selecting a foreign custodian that is not, an acceptable institution, listed as a member of an acceptable regulatory organization, or, recognized as an acceptable foreign depository, the Member firm must complete a prescribed Certificate questionnaire and submit it to the IDA as part of an application to approve the location (see Appendix C for Certificate questionnaire). The Certificate requires that the Board of Directors or a committee thereof of a Member firm, approve the custodian as a foreign location for holding securities on behalf of the Member firm and its customers. In addition, for each such securities location there must be a copy of the last audited financial statements of the custodian evidencing that it meets the minimum net worth criterion of CAN $150 million. The IDA will review and approve all such submissions by Member firms. Each Member firm must approve the continued use of any such location by its Board of Directors or committee thereof at least annually. This approval must be documented in the minutes of the meetings and be available for review by examiners during a field examination of the Member firm. 4. Is there an alternative method which allows a Member firm to hold customer securities at a location that does not meet the definition of an acceptable securities location? In the event that conditions exist pursuant to governing laws of a country that restrict the movement of security investments out of that country, and it is not possible to arrange a custodial arrangement for the safekeeping of such securities at a location that complies with the criteria set out in the revised definition of an acceptable securities location, a client waiver may be obtained on a transaction by transaction basis

3 June 6, 2000 MR-033 The customer shall acknowledge the risks associated with holding such securities at a specified foreign custodian on behalf of the Member firm in that country, and provide a written waiver holding the Member firm harmless in the event of loss of such securities by the foreign custodian. A written custodial agreement between the Member firm and the custodian must also be in place in order for no capital penalty to apply. Appendix E contains a copy of a sample client consent and waiver. 5. What year-end audit procedures are required for "other" foreign acceptable securities locations? As prescribed by IDA Regulation 300.2(vi), the external auditors must evidence on an annual basis the continued approval of such previously IDA approved "other" foreign securities locations as documented in the minutes of the Board of Directors and/or other duly constituted board committee meetings of the Member firm. As prescribed by IDA Regulation 300.2(vii)(2), the external auditors must obtain during the course of the annual audit 100% positive confirmation for all security positions of the Member firm as at year-end. This includes securities held at other foreign locations approved by the SROs, or locations for which customers have provided a waiver for security positions held. For confirmation requests for which a positive audit confirmation has not been received or otherwise verified by the filing date of the JRFQ&R, the security positions are considered unresolved and a capital charge equal to the market value plus margin of such securities held at the location must be provided by the Member firm. For securities held pursuant to a client waiver and unconfirmed, the Member firm has a responsibility to advise its customers of the situation. For year-end JRFQ&R audit filings, a list of approved "other" acceptable foreign security locations and the market value of securities held at such locations shall be provided as supplementary disclosure to the IDA. The member shall also indicate "other" foreign locations in which a positive confirmation request was not obtained by the auditors at the time of filing and the amount of capital provided. 6. What are the capital implications of holding securities at a non-acceptable securities location? The IDA rules require that for Member firm s inventory or customer securities held at securities locations not otherwise specified in the regulations, a capital charge must be provided equivalent to the market value of securities held at such locations. The capital charge also applies if a proper written custodial agreement is not in place with an institution that otherwise qualifies as an "acceptable securities location". 7. How do the rules apply to global custodial arrangements and subcustodians? For custodial arrangements where the Member firm enters into a master global custodial agreement with an acceptable institution in which securities are also held in subcustodian locations, the agreement must contain either: a legally enforceable indemnity of the acceptable institution in favour of the Member firm for all losses, claims, damages, costs and liabilities in respect of securities and other property held for the Member and its customers at all subcustodial locations. In this instance, all subcustodial locations covered by and indemnified under the global custodial arrangement would be considered acceptable securities locations ; or a legally enforceable indemnity of the acceptable institution in favour of the Member firm for all losses, claims, damages, costs and liabilities in respect of securities and other property held for the Member and its customers at specifically listed subcustodial locations. In this instance, only those subcustodial locations that are specifically listed and indemnified under the global custodial arrangement would be considered acceptable securities locations - 3 -

4 June 6, 2000 MR-033 To ensure that global custodial arrangements entered into are in compliance with the requirements noted above, it is recommended that Member firms consult with their SRO before finalizing any global custodial agreement

5 APPENDIX A ACCEPTABLE SECURITIES LOCATION - DECISION TREE DIAGRAM Is a custodial agreement between the Member firm and custodian in place? If No - Capital charge Yes Does the custodian meet the prescribed criteria as an Acceptable Securities Location per Instructions to Form 1 (JRFQ&R)? If Yes - No capital charge No No No Foreign Institution or Dealer Is the net worth of the custodian greater than $150 million (CAN) and Board of Director Certificate filed with an SRO? Foreign Depository Is the custodian a Recognized Foreign Depository approved by an SRO? Client Waiver Is there a written client waiver obtained subject to the condition where movement of securities held in a country are restricted? If Yes - No capital charge If YES - No capital charge If Yes - No capital charge If No - Capital charge If No - Capital charge If No - Capital charge - 5 -

6 APPENDIX B "OTHER" ACCEPTABLE FOREIGN DEPOSITORIES S.A. Caja de Valores (Stock Clearing Corporation - Argentina) SEGA (Swiss Securities Clearing Corporation) Hong Kong Securities Clearing Company - 6 -

7 APPENDIX C FOREIGN CUSTODIAN CERTIFICATE (Firm Name) On behalf of the Board of Directors or duly constituted committee thereof, we certify that the following information is true and correct and after giving due consideration to criteria noted in this certificate have approved ("custodian") located in ("country") as the custodian of our firm and client security holdings. Please answer the following questionnaire: 1. The holding of firm and client assets in the country is consistent with the best interests of our shareholders and clients after giving due regard to the following considerations: ANSWERS (YES/NO) whether applicable law would restrict the access by our firm's external auditors to books and records kept by a custodian in that country; whether applicable foreign law would restrict our firm's ability to recover assets in the event of the failure of the custodian in that country; whether applicable foreign law would restrict the firm's ability to recover assets that are lost while under the control of the custodian in that country; the likelihood of expropriation, nationalization, freezes, or confiscation of the firm's assets in that country; whether difficulties exist in converting the firm's assets to CAN dollars are reasonably foreseeable. 2. The holding of firm and client assets by this custodian is consistent with the best interests of our shareholders and clients after giving due regard to the following considerations: the financial strength of the "custodian", its general reputation and standing in the country in which it is located, its ability to provide efficiently the custodial services required and the relative costs for those services; whether the "custodian" would provide a level of safeguards for maintaining the firm's assets not materially different from that provided by the firm's Canadian custodians in maintaining the firm's securities in Canada; whether the "custodian" has branch offices in Canada in order to facilitate the assertion of jurisdiction over and enforcement of judgements against such custodians; - 7 -

8 3. The firm has executed a written custody agreement with the custodian and is in compliance with the provisions set out in IDA Regulation The firm has established a system of monitoring the foreign custody arrangement to ensure that securities held at this custodian are limited to an amount reasonably necessary to effect the firm s foreign securities transactions. 6. The Board of Directors, or committee thereof, at least annually will review and approve the continuance of this custodial arrangement to ensure that it is consistent with the best interests of the company and its shareholders and clients? 7. If at any time it is determined that the continuance of the arrangement with the custodian is not consistent with the best interests of the firm and its shareholders and clients, or if the custodian is no longer approved by a Canadian SRO having jurisdiction over the firm, the firm undertakes to withdraw its assets from the care of that particular custodian as soon as reasonably practical, and in any event no longer than 180 days of the date of determination. ANSWERS (YES/NO) Chief Executive Officer Chief Financial Officer - 8 -

9 APPENDIX D CUSTODIAL AGREEMENT AGREEMENT made the day of, 199. B E T W E E N: Name: Address: ("Member") OF THE FIRST PART - and - Name: Address: ("Custodian") OF THE SECOND PART [Note to Members: This draft Custodial Agreement contains the minimum terms that are required by your Canadian SRO (as defined) for foreign custodial location arrangements. Additional terms may be necessary or desirable to protect your interests and you should consult your own advisors in that regard. The SROs and their employees and representatives are not responsible to the Members or their customers or any other person who relies on the provisions of this draft Agreement.] - 9 -

10 WHEREAS: A. the Member is a member of a self-regulatory organization (the "SRO") which is a participating institution in the Canadian Investor Protection Fund; B. the Custodian provides custodial and depository services and meets the criteria as an acceptable securities location set out in the by-laws, rules and regulations of the SRO; C. the Custodian provides services, including custodial and/or depository services, to the Member in connection with the segregation obligations of members of the SRO; D. the by-laws, rules and regulations of the SRO require that the terms upon which any securities are deposited with the Custodian for the Member or its customers include certain written provisions to the effect of subparagraphs 1(a), (b) and (c) hereof; E. the parties hereto desire to comply with the by-laws, rules and regulations of the SRO; IN CONSIDERATION of these premises and other good and valuable consideration received and acknowledged by each of the parties hereto, the parties agree as follows: 1. Terms of Segregation The Custodian shall ensure, in respect of any securities deposited with and held by it for the Member or customers of the Member in accordance with the by-laws, rules and regulations of the SRO that, subject to securing the payment of the reasonable and agreed administration fees and charges in respect of the custodial and depositary services provided: (a) (b) (c) 2. Records no use or disposition of such securities shall be made without the prior written consent of the Member; certificates representing such securities shall be delivered to the Member promptly on demand or, when certificates are not available and the securities are represented by book entry by the Custodian, the securities shall be able to be transferred either from the Custodian or to the account of any other person maintaining an account at the Custodian promptly on demand; and securities shall be held in segregation for the Member or its customers free and clear of any charge, lien, claim or encumbrance of any kind in favour of the Custodian including, without limitation, such of the same as may otherwise arise in respect of margin account dealings. The Custodian shall maintain records in readily accessible form sufficient to identify the securities and other property held by it for the Member and its customers pursuant to this agreement separate and distinct from any other securities or property held by the Custodian. Accounts for securities and property held hereunder shall be in the name of the Member. The Custodian shall permit access to such records or provide confirmation of their contents to the auditors of the Member within seven business days of written request. The Member shall be entitled to receive a report from the Custodian not less frequently than monthly disclosing the state of any account of the Member held by the Custodian including the amount, value and identification of securities by issue held for such account, any deficiencies, and accrued and unpaid fees or charges

11 3. Indemnity The Custodian shall indemnify and save harmless the Member against and from any and all losses of the Member as a result of the failure of the Custodian to return to the Member any securities or property held by it in accordance with this agreement, provided that the liability of the Custodian under this paragraph shall be limited to the market value of the securities and property as at the time which it was required to deliver to the Member the securities and property. 4. Terms This agreement shall remain in full force and effect as long as the Custodian holds any securities on behalf of the Member or its customers. 5. Binding Effect This agreement shall extend to and enure to the benefit of and be binding upon the successors and assigns of the parties hereto but shall not be assigned by the Custodian without the prior written consent of the Member. 6. English Language This agreement has been drawn up in the English language at the request of the parties. Les parties ont requis que la présente convention soir rédigée en anglais. The parties have executed this agreement under the hands of their authorized officers as of the date set out above. [CUSTODIAN] Per: Position: [MEMBER] Per: June 21, 1994 Position:

12 APPENDIX E Account Name Number [Dealer Name] Gentlemen: Consent and Waiver The undersigned hereby expressly authorize(s) you to deposit the following securities [insert type or category of securities] (collectively the "Foreign Securities" held for accounts of the undersigned by you with [insert name of foreign custodian] (the "Foreign Custodian") in [insert address of Foreign Custodian]. The undersigned acknowledges that conditions exist pursuant to governing laws of [country] that restrict the movement of securities investments in [country] out of that country and that prevent compliance by the Foreign Custodian with criteria for custodial and client securities segregation arrangements otherwise required pursuant to Canadian Regulatory standards. Therefore, the safety and recovery of securities held for the undersigned by you with the Foreign Custodian cannot be assured. The undersigned hereby accept(s) all risks relating to the fact that the Foreign Custodian is the depository of the Foreign Securities and hereby waives any claim it may have against you and relieves you of any liability with respect to any loss of the Foreign Securities held for accounts of the undersigned with you by the Foreign Custodian. For greater certainty the undersigned acknowledges that no capital or margin is required to be maintained by you in respect of the Foreign Securities held by the Foreign Custodian and that no claim may be made by the undersigned in respect of protection by the Canadian Investor Protection Fund in the event of a loss in accounts of the undersigned from the inability to recover or deliver the Foreign Securities. The Consent and Waiver shall remain valid until the Foreign Securities are returned by the Foreign Custodian to you to be held in my accounts with you in accordance with Canadian securities segregation requirements. this Signature(s): [Dealer Signature]