Effective Date: December 31, 2021
This Rules Notice provides guidance (Guidance) to Dealer Members (Dealers) on the supervision of order execution only (OEO) account1 activity given the additional risks associated with third-party electronic access to marketplaces when orders may not be directly handled by staff of the Dealer. This Guidance provides instruction on:
- the manner in which to apply client identifiers (IDs),
- the types of activities that may be considered manipulative and deceptive, and
- what a Dealer needs to consider when developing its policies and procedures and systems of supervision and control.
- 1The term “order execution only account” is defined in IIROC Rule 1200 – Definitions to mean: “an account which is not subject to a suitability obligation where:
(i) the client is solely responsible for making all investment decisions, and
(ii) the Dealer Member provides no recommendation to purchase, sell, hold or exchange any security, including any class of security or security of a class of issuer”.
On November 13, 2014, IIROC published notice of the approval of amendments to UMIR and the Dealer Member Rules (Amendments) respecting OEO accounts as a form of third-party electronic access to marketplaces.2 These Amendments introduced a more comprehensive regulatory framework for OEO accounts, including:
- a requirement to assign on each order client IDs to:
- certain “active” clients
- clients that are not individuals and registered as a dealer or adviser under applicable securities legislation
- clients who are not individuals and in the business of trading securities in a foreign jurisdiction in a manner analogous to a dealer or adviser (dealer or adviser equivalent)
- a requirement to advise IIROC of the client IDs and the clients associated with them
- a requirement that the policies and procedures and systems of control of a Dealer offering OEO accounts (OEO Dealer) consider the added risk of order entry with limited order handling by staff of the OEO Dealer
- a definition of Manipulative and Deceptive Activities.
Supervision of order execution only accounts
An OEO Dealer, while not responsible for making suitability determinations for clients, must comply with all other applicable provisions of the IIROC Rules3 , including, but not limited to: sections 3240, 3926, 3927 and 3955.
An OEO Dealer is required to have written policies and procedures and systems of supervision and control in place to review client trading for all aspects of sections 3240 and 3955. The standards set out in section 3927 are the minimum requirements to supervise account activity and a Dealer is not precluded from establishing policies, procedures and systems of supervision and control that exceed the minimum standard where warranted by the business activities or offerings of the Dealer.
Dealers that maintain accounts for clients who meet the definition of “institutional client”4 must comply with the requirements set out in sections 3950 and 3951.
IIROC believes that orders entered by OEO account clients may pose additional risks to the integrity of the market and to the Dealer itself as a result of the direct nature of order entry by the client. In an OEO account, the limited ability for staff of the Dealer to directly handle orders eliminates a significant opportunity to identify potentially problematic orders or patterns prior to the entry of the order to a marketplace. Section 3955 requires an OEO Dealer to take into account the additional risks associated with the method of order entry and the absence of order handling by employees of the OEO Dealer. IIROC expects that an OEO Dealer’s policies and procedures and systems of supervision and control address these added risks.
The policies and procedures developed and implemented by the Dealer must be reasonably designed to ensure that the Dealer’s regulatory obligations are continually being met, including its client obligations and its obligations to the market generally.5
In terms of a Dealer’s obligations to the market, its policies and procedures must address its gatekeeping obligations, such as monitoring client account activity for orders and trades that may be harmful to the integrity of the market. This includes activity that is or may be considered manipulative and deceptive. Effective gatekeeping also includes reviewing for problematic account activities that cannot be easily detected by a single order or trade, but through the identification of patterns that may emerge over a period of time.
A Dealer’s policies, procedures and systems of supervision and control should be appropriate to the size and scope of the Dealer and the types of business conducted.
Manipulative and Deceptive Activities
As part of its supervision obligation, a Dealer is expected to have policies and procedures in place that are reasonably designed to identify account activity that is or may be considered manipulative and deceptive. “Manipulative and Deceptive Activities” is defined in the IIROC Rules to mean:
“Any manipulative or deceptive methods, act or practice in connection with any order or trade on a marketplace, and includes the entry of an order or the execution of a trade that would create or could reasonably be expected to create:
- a false or misleading appearance of trading activity in or interest in the purchase or sale of a security, or
- an artificial ask price, bid price or sale price for the security or a related security.”.6
IIROC is of the view that the policies and procedures developed by the Dealer should take into account higher risk activities and consider orders and trades that may pose heightened risks to market integrity. For example, an OEO Dealer must consider the heightened risks associated with the entry of orders that are not directly handled by staff of the Dealer. UMIR Policy 2.2 sets out a list of activities that may be considered manipulative and deceptive. These activities would similarly be considered Manipulative and Deceptive Activities under the IIROC Rules definition. These activities include:
- effecting a trade in a security that involves no change in beneficial or economic ownership,
- making purchases of, or offers to purchase a security at successively higher prices or in a pattern generally of successively higher prices,
- making sales of, or offers to sell a security at successively lower prices or in a pattern generally of successively lower prices,
- entering an order or a series of orders for a security that are not intended to be executed,
- entering an order or orders for the purchase or sale of a security to:
- establish a predetermined sale price, ask price or bid price,
- effect a high or low closing sale price, ask price or bid price, or
- maintain the sale price, ask price, or bid price within a predetermined range,
- entering an order for the purchase of a security without, at the time of entering the order, having the ability or the reasonable expectation to make the payment that would be required to settle any trade that would result from the execution of the order,
- entering an order for the sale of a security without, at the time of entering the order, having the reasonable expectation of settling any trade that would result from the execution of the order,
- effecting a trade in a security between accounts under the direction or control of the same person,
- entering an order or orders for the purchase of a security with the knowledge that an order of substantially the same size, at substantially the same time and at substantially the same price for the sale of that security, has been or will be entered by or for the same or different persons, and
- entering an order or orders for the sale of a security with the knowledge that an order or orders of substantially the same size, at substantially the same time at substantially the same price for the purchase of that security, has been or will be entered by the same or different persons.
IIROC previously issued guidance confirming IIROC’s position that certain trading strategies may be considered manipulative and deceptive for the purposes of UMIR7 . These strategies, which may similarly be considered manipulative and deceptive under the definition of Manipulative and Deceptive Activities in the IIROC Rules, include:
- “Quote Stuffing”
- “Quote Manipulation”
- “Abusive Liquidity Detection”.
To assist IIROC in providing a consistent level of market surveillance of trading activity that may pose similar risks to market integrity as other forms of third-party electronic access to marketplaces, subsection 3241(6) requires that each order entered on a marketplace that retains IIROC as its regulation services provider (applicable marketplace) by or on behalf of: an “active” OEO account client, or an OEO account client that is not an individual and is registered as a dealer or adviser under applicable securities legislation or a dealer or adviser equivalent, contain the client ID that has been assigned to the client.
An “active” client is any OEO account client whose trading activity on applicable marketplaces exceeds a daily average of 500 orders per trading day in any calendar month. IIROC expects that an OEO Dealer will, on a monthly basis, review orders from the prior month to identify any clients that met the prescribed threshold in that month. Once a client has been identified, the OEO Dealer is expected to advise IIROC of the client ID and the name of the client associated with it. This information is required to be provided to IIROC under subsection 3241(5).
IIROC requires that a client ID also be applied to orders for any OEO account client that trades on an applicable marketplace that is not an individual and: (i) is registered as a dealer or adviser under applicable securities legislation; or (ii) is a dealer or adviser equivalent, regardless of the level of account activity. IIROC expects that OEO dealers will identify any such current clients and will advise IIROC of the client ID and the name of the client associated with it. IIROC must be advised of the client ID and name of each new client that is a non-individual and is registered as a dealer or adviser under applicable securities legislation or is a dealer or adviser equivalent upon the account being opened.
Questions and Answers
The following is a list of questions regarding OEO accounts as a form of third-party electronic access to marketplaces:
How often does a Dealer need to confirm whether a client ID is required for any of its clients?
A Dealer should, on a monthly basis, review order activity from the previous month for client activity that meets the threshold at which the use of a client ID is required.
Once a client account has been identified that meets the threshold where the use of a client ID is required, the requirement to include the client ID on all subsequent orders sent to an applicable marketplace will continue to apply regardless of the future activity of that particular client account.
How does a Dealer calculate order activity to determine whether a client is “Active”?
The calculation of order activity is based on the average number of orders sent to an applicable marketplace per trading day during the previous calendar month. For the purposes of calculation, the OEO Dealer must consider both original orders and any subsequent “CFOs”. For example, a client order to buy 100 shares of a security on an applicable marketplace would count as one order. If the client were to subsequently amend that order to a different limit price, the amendment to the order would be counted as a separate order. In this example, the original order and the amended order with the new limit price would be counted as two orders.
Order cancellations should be excluded from the calculation of order activity. Orders generated directly by an OEO Dealer's systems, such as by an OEO Dealer’s VWAP algorithm, should also be excluded from the calculation of order activity.
For the purpose of determining whether the use of a client ID is required, do orders that are handled directly by registered staff of the OEO Dealer need to be considered?
No. The principle underlying the use of client IDs for particular accounts is to address the potential heightened risks associated with the entry of orders where there is no intermediation by staff of the OEO Dealer. If an OEO Dealer’s practice includes the intermediation of client orders by registered staff of the OEO Dealer, those orders may be excluded from the “active client” calculation. IIROC would consider orders that are received either electronically or non-electronically by the OEO Dealer but are subject to review by registered staff of the OEO Dealer prior to routing to an applicable marketplace to be “directly handled by registered staff of the Dealer”.
Where an OEO Dealer’s practice includes the handling of orders on both an intermediated and non-intermediated basis and splitting the client’s order flow is not operationally practical, IIROC does not object to the OEO Dealer including all orders for purposes of determining client ID requirements.
In the case of a client with multiple accounts at an OEO Dealer, does the OEO Dealer need to take all the accounts into consideration when determining whether the client has met the threshold where a client ID is required?
No. If a client has more than one account with the same OEO Dealer, the OEO Dealer should consider the client’s activity at the account level only for the purposes of determining whether the active trading threshold has been met. The use of a client ID is only required for each account that on its own meets the threshold of an “active client”. All accounts of non-individuals registered as a dealer or an adviser under applicable securities legislation or a dealer or adviser equivalent are required to use a client ID, regardless of account activity.
Does trading authorization granted on an account impact the client ID requirement?
No. The requirement to use a client identifier is based on the account itself and not based on trading authorization. An account opened in the name of a non-individual registered as a dealer or advisor registered under applicable securities legislation or dealer or advisor equivalent must always use a client ID regardless of client activity. All other accounts, including accounts that have granted trading authorization, would only require the use of a client ID when the average daily number of orders sent to an applicable marketplace for that particular account exceeds 500 in any one month.
Is there an obligation to monitor on a “real-time” basis orders entered by an OEO client?
Each Dealer’s supervision policies and procedures and systems of control should be appropriate for its size and business and be reasonably designed to prevent and detect violations of any requirement applicable to the Dealer’s business. An OEO Dealer should consider employing supervisory controls that have the ability to detect an offending order prior to such order being entered to a marketplace. To the extent that this is not possible, the OEO Dealer should, at a minimum, have sufficient pre- and post-trade compliance testing to address the added risks associated with orders entered by OEO account clients.
The ability to monitor trading on a “real-time” basis would be particularly helpful if additional monitoring of a specific client’s activity becomes necessary as a result of a regulatory request, or if the OEO Dealer itself determines that trading by a particular client requires additional monitoring.
- IIROC published provisions respecting electronic trading which became effective March 1, 2013 that are applicable to all Dealers that are also Participants for the purposes of UMIR.8
These provisions outline certain elements of the risk management and supervisory controls, policies and procedures which must be employed by Participants. These include: automated controls to examine each order before entry on a marketplace to prevent the entry of an order which would result in:
- the Participant exceeding pre-determined credit or capital thresholds,
- a client of the Participant exceeding pre-determined credit or other limits assigned by the Participant to that client, or
- the Participant or client of the Participant exceeding pre-determined limits on the value or volume of unexecuted order for a particular security or class of securities, and
- provisions to prevent the entry of an order that is not in compliance with applicable Requirements.9
Can a Dealer use the same compliance testing and review standards to monitor trading activity by OEO account clients as it does for full service brokerage?
Under IIROC Rule 3926 and IIROC Rule 3955, Dealer’s policies and procedures and systems of control should be designed to address the risks relevant to its business. Orders entered through OEO accounts may introduce additional risks to the Dealer and to the marketplace generally given the limited involvement of staff in the handling of client orders. To the extent that a Dealer does not have separate compliance testing and review standards for its OEO account business, it must ensure that its overall standards of compliance and supervision sufficiently address the heightened risks associated with OEO account order entry.
Are there any particular risks that need to be addressed in compliance procedures for trading by OEO account clients?
IIROC Rule 3955 requires that policies and procedures and systems of supervision and control take into account the risks associated with the method of OEO account order entry and the absence of intermediation by employees of the Dealer. Therefore compliance procedures for OEO accounts, at a minimum, should address:
- orders that have been entered which are not intended to be executed, such as orders entered for the purpose of determining the depth of the market, affecting a calculated opening price, checking for the presence of hidden liquidity or other similar improper purpose;
- orders that have been entered on a marketplace and trades that have executed for the purpose of creating a high or low closing price in the case of a trade, or a high or low bid or offer in the case of an order;
- orders that have been entered at unreasonable prices; and
- trades that involve no beneficial change in ownership (i.e. wash trading) particularly where a client has multiple accounts.
This Rules Notice relates to the following UMIR and IIROC Rules:
- Rule 1200 of IIROC Rules,
- section 3240 of IIROC Rules,
- section 3241 of IIROC Rules,
- section 3926 of IIROC Rules,
- section 3927 of IIROC Rules,
- section 3950 of IIROC Rules,
- section 3951 of IIROC Rules,
- section 3955 of IIROC Rules, and
- UMIR Policy 2.2.
Previous Guidance Note
This Rules Notice repeals and replaces the guidance set out in IIROC Notice 14-0264 – Guidance Respecting Order Execution Services as a Form of Third-Party Electronic Access to Marketplaces (November 13, 2014).
This Guidance Note was published under Notice 21-0190 - IIROC Rules, Form 1 and Guidance.
- 2See Notice 14-0264 – IIROC Notice – Guidance – Guidance Respecting Order Execution Only Account Services as a Form of Third Part Electronic Access to Marketplaces (November 13, 2014).
- 3In this Guidance, all rule references are to the IIROC Rules unless otherwise specified.
- 4As defined in subsection 1201(2) of the IIROC Rules.
- 5See section 1404 of the IIROC Rules.
- 6See subsection 1201(2) of the IIROC Rules.
- 7See IIROC Notice 13-0053 - Rules Notice – Guidance – UMIR – Guidance on Certain Manipulative and Deceptive Trading Practices (February 14, 2013).
- 8See IIROC Notice 12-0363 - Rules Notice – Notice of Approval – UMIR – Provisions Respecting Electronic Trading (December 7, 2012).
- 9“Requirements” include UMIR, applicable securities regulation, requirements of any self-regulatory organization applicable to the activity of the account and the rules and policies of any marketplace on which the account activity takes place.