A significant number of positive developments have come out of the Canadian Securities Administrators’ far-reaching registration reform project. Its core initiative is the proposed National Instrument 31-103, which seeks to modernize and harmonize regulation requirements — a proposal whose time has come and one that the industry heartily endorses.

Many of the developments that have emerged since the previous version of the reform proposal are products of the thorough consultation process the CSA has conducted with all interested parties. The result is a reduction in the number of industry concerns. But, given the sheer breadth of issues covered by the proposal, there are some unintended consequences.

To ensure that more securities dealers are registered, the proposal seeks to introduce a category of dealers that can sell mutual funds to investors without being subject to the same regulatory oversight as other dealers. Although this is an important issue of investor protection, a major matter appears to have been overlooked.

The proposed regulation would not require these exempt market dealers (EMD) to be members of a self-regulatory organization and thus be subject to its regulations and investor protections. Currently, an investor buying a mutual fund through a member of the Investment Industry Regulatory Organization of Canada or the Mutual Fund Dealers Association of Canada receives the benefit of detailed SRO business conduct and prudential rules that apply to the dealer. The investor, as well, is covered by an indemnity fund. Under the reform proposal, an EMD would be able to sell mutual funds and other securities to “accredited investors,” a class of investors meeting certain high income or net-worth criteria. These investors might expect to — but would not — receive the same protections as are available to them through an SRO dealer.

The EMD category would replace the “limited market dealer” category that exists now in Ontario and in Newfoundland and Labrador. However, the LMD is not widely used as a distribution channel for mutual funds. As the name implies, this category is a “limited” category of registration — primarily for underwriting and selling prospectus-exempt products.

Generally, mutual fund companies do not distribute their products through LMDs. This may have been a result of the LMDs not meeting the review standards of fund providers in the two jurisdictions in which registration is currently required.

The replacement of the LMD by the EMD could legitimize these firms as distributors of mutual funds in the eyes of both mutual fund companies and investors. Fewer rules mean cost advantages for these dealers.

An unintended consequence of this policy change would be rapid growth of the EMDs for the distribution of investment funds and other products, as these structures are chosen in preference to IIROC or MFDA platforms. This would result in an erosion of the SRO framework and the investor protections it provides. Regardless of whether investors have a lot of money or a little, they should all be protected by the same oversight.

We have recommended to regulators that EMDs that choose to deal in NI 81-102 mutual fund products must be members of the MFDA. (In the case of Quebec, the company must comply with the regulations on mutual fund dealer requirements in that province.) Or if they carry on business in a securities-related business, they should be registered with IIROC. The handful of EMDs that currently distribute conventional mutual funds could be grandfathered from this SRO membership proposal.

It cannot be repeated enough times that investors want — and should have — a consistent experience with their advisors when purchasing investment funds. Continuing to offer a patchwork of well-meaning but different initiatives is contrary to the spirit of openness that investors are rightfully demanding. IE

Joanne De Laurentiis is president and CEO of the Investment Funds Institute of Canada.