Waverley Corporate Financial Services Ltd. – s. 31
An application for a hearing and review of this decision was made to the Commission pursuant to section 8 of the Securities Act (Ontario), and all notices, orders, and decisions relating to that application can be found in "OSC Proceedings": The Commission’s final decision imposing revised terms and conditions can be accessed by clicking here.
IN THE MATTER OF
STAFF’S RECOMMENDATION TO IMPOSE TERMS AND CONDITIONS ON
THE REGISTRATION OF WAVERLEY CORPORATE FINANCIAL SERVICES LTD.
OPPORTUNITY TO BE HEARD BY THE DIRECTOR
UNDER SECTION 31 OF THE SECURITIES ACT (ONTARIO)
1. For the reasons outlined below, my decision is to set aside all but one of the terms and conditions recommended by staff (Staff) of the Compliance and Registrant Registration Branch (CRR) of the Ontario Securities Commission (OSC) and impose the following terms and conditions on Waverley Corporate Financial Services Ltd. (Waverley) and Donald McDonald (McDonald), registered as ultimate designated person (UDP) and chief compliance officer (CCO).
- Waverly shall cease all activity conducted under the Issuer-Connected DR Model (as defined below) and shall not sponsor a dealing representative, except in accordance with Ontario securities law, effective 30 days from the date of this decision to allow for an orderly transition; and
- McDonald is required to successfully complete, and provide proof thereof for, the Osgoode Certificate in Regulatory Compliance and Legal Risk Management for Financial Institutions, by no later than July 15, 2017.
2. Waverley is registered under the Ontario Securities Act (the Act) in the category of exempt market dealer (EMD). Waverley is operating two types of business models within the firm; one is a traditional exempt market dealer business model and the other is novel. The traditional model is where Waverley is engaged by issuers to assist with raising money on their behalf through marketing and selling of exempt securities. The dealing representatives in this model are solely employed and compensated by Waverley and hold themselves out to clients as representatives of Waverley. This business model is not at issue in this opportunity to be heard (OTBH).
3. The novel business model consists of Waverley providing registration and compliance services to independent issuers by sponsoring an employee, principal or person connected to an independent issuer as a dealing representative, referred to herein as an Issuer-Connected DR Model (the Issuer-Connected DR Model).
4. Staff commenced a compliance review of Waverley in September 2014, soon after registration was granted. A number of foundational legal issues regarding registration and compliance deficiencies were identified during the review. Staff and Waverley have been in discussions regarding the foundational legal issues for a significant period of time. The expansion of the exempt market in Ontario and the accompanying regulatory reforms played a part in the length of time that this matter has been under review.
5. By letter dated February 8, 2016, Staff advised Waverley that it was recommending to the Director that terms and conditions be placed on its registration.
6. Pursuant to section 31 of the Act, Waverley is entitled to an OTBH before the Director decides whether to accept Staff's recommendations. The OTBH procedures provide that an opportunity to be heard will normally be conducted as an exchange of written submission, and either applicant or Staff may request an appearance.
7. This OTBH was conducted through written submissions and correspondence provided by Michael Denyszyn, Senior Legal Counsel, CRR and Melissa MacKewn, Crawley MacKewn Brush LLP representing Waverley and McDonald.
8. The written submissions were supplemented with one in-person meeting on May 25, 2016. At the in-person meeting, after reviewing and considering the written submissions of both parties, I provided preliminary views on the foundational legal principles of registration that were raised in this OTBH and outlined the regulatory basis on which to conclude that regulatory deficiencies were present and that action was required. Having provided this preliminary view, Waverley was presented with an opportunity to work with Staff to present a joint agreement, to the Director, on specific terms and conditions to address the regulatory deficiencies identified, including those deficiencies relating to the Issuer-Connected Dealing Model. The parties were given two weeks to present a joint agreement to the Director.
9. Through an iterative process that concluded on June 26, 2015, Staff and Waverley took action to remediate certain of the issues identified in the February 8, 2016 letter, which are not covered in this decision. However, no joint agreement was presented to the Director on the issues relating to the Issuer-Connected DR Model and the recommendation for the Osgoode Certificate program. Therefore, this decision is limited to these two issues.
Law and Reasons
A. Are the Issuer-Connected DRs acting on behalf of Waverley?
10. The registration requirements in section 25 of the Act specify that a person engaging in the business of trading in securities must be registered as a dealer or a registered representative of a dealer and that the registered representatives of a registered dealer are required to be acting on behalf of the registered dealer.
11. Subsection 32(2) of the Act requires each registered dealer to establish and maintain systems of control and supervision, including the supervision of its registered representatives.
12. In order to comply with the regulatory requirements of sections 25 and 32 of the Act, a firm must have the ability to supervise the representatives who are acting on behalf of the firm. The plain meaning of the word “supervise” is to observe and direct the work of a person. In order to supervise, the firm requires a means to direct the representatives to take action or prohibit a course of action and to actively monitor the actions.
13. Under the structure of Waverley’s Issuer-Connected DR Model, the representatives (Issuer-Connected DR) are:
- employees, principals or connected to an independent issuer and they exclusively market the securities of that issuer to clients through their registration with Waverley (i.e. they do not market or sell any other exempt security that is offered by Waverley);
- primarily compensated by the issuer, but receive a commission from the sale of the securities that is split 90 to 95% to the Issuer-Connected DR and 5 to 10% to Waverley;
- located in the offices of the issuer and conduct all registerable activity from that office;
- required to pay a “desk fee”, which is a flat fee to Waverley for use of technology and supervision and compliance oversight provided by Waverley; and
- execute a Dealing Representative and Branch Services agreement, which is a business services agreement with Waverley.
14. In my view, the first four elements above tip the balance of power in the relationship in favour of the Issuer-Connected DR and not the sponsoring firm, which limits Waverley’s ability to enforce compliance with Ontario securities law. The structure of the Issuer-Connected DR Model creates inherent and serious conflicts of interest between Waverley and its sponsored dealing representatives that negatively impacts Waverley’s ability to effectively supervise the Issuer-Connected DRs.
15. The Issuer-Connected DRs are financially independent of Waverley because they are primarily compensated by the issuer; whereas, Waverley is financially dependent on the Issuer-Connected DRs through the payment of a flat rate “desk fee” and a small percentage of commission from each sale of securities. In this instance, Waverley is being compensated by its sponsored representative for supervision and compliance oversight, which are obligations required of Waverley as a registrant under Ontario securities law.
16. Further, in its marketing materials Waverley provides that its business model will provide a “turn-key platform for the EMD business” and that “Dealer Representatives may keep their own brand and client relationships (subject to some sub-branding with Waverley for compliance purposes). By characterizing the relationship between Waverley and its Issuer-Connected DRs as “sub-branding for compliance purposes”, it de-emphasizes the importance of the supervisory relationship required of a sponsoring firm. Essentially, it solidifies a structure whereby the Issuer-Connected DRs have a primary relationship with the independent issuer and a secondary relationship with Waverley.
17. Through the extensive discussions with Staff, Waverley has implemented changes to the the Issuer-Connected DR Model. The Issuer-Connected DRs now have Waverley business cards and signage, use Waverley branded know your client (KYC) forms and relationship disclosure documents are used to inform clients that the Issuer-Connected DR is connected to the issuer. However, in my view, these practices are not sufficient to mitigate the inherent imbalance that exists between Waverley and the Issuer-Connected DRs.
18. In my opinion, these factors considered in the context of the entire Issuer-Connected DR Model demonstrate that Waverley lacks any substantial means to supervise, observe or otherwise direct the Issuer-Connected DRs. If Waverley is not able to adequately supervise the Issuer-Connected DRs then it would follow that they are not acting on behalf of Waverley. Therefore, Waverley has not complied with subsections 25(1)(b) and 32(2) of the Act.
B. Has Waverley Adequately Responded to Conflicts of Interest?
19. Even if it could be said that the Issuer-Connected DRs were acting on behalf of Waverley, I am not satisfied that Waverley has adequately responded to the actual and/or potential conflicts of interest that result from the Issuer-Connected DR Model.
20. Subsection 32(1) of the Act imposes a duty on every registered person or company to comply with Ontario securities law, including expressly the regulations that apply to conflicts of interest. Also, subsection 13.4(2) of NI 31-103 requires a registered firm to respond to an existing or potential conflict of interest identified by the firm in its reasonable opinion. The Companion Policy to NI 31-103 provides guidance on the options firms have to respond to conflicts of interest:
In general, three methods are used to respond to conflicts of interest:
- control, and
If a registrant allows a serious conflict of interest to continue, there is a high risk of harm to clients or to the market. If the risk of harming a client or the integrity of the markets is too high, the conflict needs to be avoided.
21. As discussed above, the structure of the Issuer-Connected DR Model creates serious conflicts of interest between Waverley and the Issuer-Connected DRs, which in turn creates a high risk of harm to clients. Also, the Issuer-Connected DR Model creates conflicts of interest between the Issuer-Connected DR and the client. The Issuer-Connected DRs have an inherent incentive to market and sell the securities of his/her related issuer to keep the issuer operating and maintain their primary means of compensation. The Issuer-Connected DR’s financial dependency on the issuer increases the risk of unsuitable products being sold to clients.
22. Even though the Issuer-Connected DRs provide copies of disclosure statements to clients and use Waverley branded paperwork there is client confusion as to which entity and in what capacity the Issuer-Connected DR is acting throughout the client relationship. In my view disclosure is not sufficient to respond to these serious conflicts of interest. Furthermore, Waverley documents are provided after the decision to invest had been made.
23. In my opinion, the serious conflicts of interest inherent in the Issuer-Connected DR Model create a high risk of harm to investors and avoidance is the appropriate response. Therefore, Waverley has not complied with subsection 32(1) of the Act or section 13.4 of NI 31-103.
C. Has Waverley’s Conduct Rendered its Registration Otherwise Objectionable?
24. Finally, Waverley is facilitating and promoting the ability for certain issuers to engage in registerable activity without themselves being registered. In its marketing material, Waverley states that it provides a platform for regulatory capital, registration, accounting, audit, insurance and compliance (CCO, KYC, Know Your Product and Suitability) to issuers by offering to register a dealing representative with Waverley as a low cost alternative to registration as an EMD firm. Waverley’s “turn-key” platform allows an issuer to shelter under Waverley’s registration without itself being registered.
25. Subparagraph 2.1(2) (iii) of the Act states that, in pursuing the purposes of the Act, the Commission shall have regard to fundamental principles including the primary means for achieving the purposes of the Act, which includes requirements for the maintenance of high standards of fitness and business conduct to ensure honest and responsible conduct of the market participants.
26. Waverley is providing issuers with a means of circumventing regulatory requirements, which then frustrates the regulator’s ability to enforce the purposes of the Act, including providing protection to investors from unfair, improper or fraudulent practices and fostering fair and efficient capital markets.
27. This practice of sheltering an Issuer-Connected DR’s registration is counter to the primary means for achieving the purposes of the Act since it does not meet the requirements for the maintenance of high standards of fitness and business conduct to ensure honest and responsible conduct of the market participants. In my view, such conduct by a registrant renders Waverley’s registration otherwise objectionable and warrants the imposition of terms and conditions.
D. Terms and Conditions
28. Section 28 of the Act provides the director, in his or her discretion, with the power to impose terms and conditions on the registration of any person or company when that company has failed to comply with Ontario securities law or that the registration is otherwise objectionable.
29. Staff recommended a number of terms and conditions, including that McDonald be required to successfully complete, and provide proof thereof, the Osgoode Certificate in Regulatory Compliance and Legal Risk Management for Financial Institutions, on the basis of alleged proficiency concerns.
30. With respect to that recommendation, McDonald represented in written submissions that he is prepared to take the recommended Osgoode Certificate course in the spirit of cooperation and given his interest in continuing education and best compliance practices. Since Waverley continues to be registered and operate as an EMD, an increased knowledge regarding compliance practices will benefit McDonald and Waverley.
31. I have no reason to doubt that McDonald is an experienced and qualified corporate finance professional as represented in the submissions, but as the UDP and CCO of the firm, he is required to fulfill the responsibilities that are provided in Part 5 of NI 31-103. These responsibilities include supervision to ensure compliance with securities legislation, promoting compliance, and establishing and maintaining policies and procedures for assessing compliance by the firm and the individuals acting on its behalf. Based on the findings in this decision, I am not confident that McDonald fully appreciates the responsibilities that are placed on the UDP and CCO. Therefore, I accept Staff’s recommendation for this term and condition.
32. My rationale for setting aside all but one of Staff’s recommended terms and conditions is the fact that they did not adequately address the inherent serious conflicts of interest that exist in the Issuer-Connected DR Model and Waverley did not satisfy me that terms and conditions were not necessary in the circumstances.
33. My decision is that as currently structured, the Issuer-Connected DR Model does not comply with subsections 25 (1)(b) and 32 of the Act, and it has inherent, serious conflicts of interest that create a high degree of harm to clients which need to be avoided. Also, this business model facilitates and promotes the ability for certain issuers to conduct registerable activity without being registered, which I find to be objectionable. Avoidance through the cessation of the activity is the response that addresses the serious conflicts of interest and remedies the non-compliance with Ontario securities law. Therefore, my decision is to impose the first term and condition as provided above.
“Debra Foubert” J.D.
Compliance and Registrant Regulation Branch
Ontario Securities Commission
July 15, 2016