protecting the investor in real time 2003 annual report:: financial statements 13-24 market...

2003 Annua l Repor t

Pro tec t ing the Inves to r in Rea l Time

Market Regulation Services Inc.

Annual Report 2003

: : Tab le o f Conten ts

:: Message from Chair of the Board and President & CEO 1

:: About Market Regulation Services Inc. (RS) 2-4

:: Our Mandate

:: History/Ownership

:: Marketplaces We Regulate

:: Real-Time Surveillance

:: Working with Other Regulators

:: Cost Efficiency

:: International Participation

:: Policy Development

:: Future of RS

:: Market Surveillance Statistics 5

:: Organizational Chart 6

:: Organizational Structure 7

:: Operations, General Counsel & Corporate Secretary

:: Market Surveillance

:: Investigations and Enforcement

:: Western Region

:: Board of Directors 8

:: Board and Advisory Committee Membership 9

:: Management Discussion & Analysis 10-11

:: Auditors' Report 12

:: Financial Statements 13-24

Market Regulation Services Inc. (RS) is the independent regulation services provider for Canadian equity markets. RS monitors each and every market trade in real time every day to protect investor confidence and enhance market integrity.

1

: : Message f rom Cha i r o f the Board and

: : Our First Year's Activities

Market Regulation Services Inc. (RS) opened its doors for business March 1, 2002, as the independent regulation services provider for Canadian equity markets, including the Toronto Stock Exchange (TSX) and the TSX Venture Exchange (TSX VN). Five of the provincial Securities Commissions - Alberta, British Columbia, Manitoba, Ontario and Quebec - recognize RS as a self-regulatory organization (SRO). To this end, RS monitors real-time trading operations and market-related activities of participants on the markets RS regulates to ensure market integrity in the trading of equity securities on those markets.

RS's first year of operations was a busy one. It introduced the Universal Market Integrity Rules (UMIR) as a common set of equity trading rules designed to ensure fairness and maintain investor confidence. These rules essentially create the framework for the integrity of the marketplace and allow for the competitive operation of the exchanges, quotation and trade reporting systems (QTRSs) and alternative trading systems (ATSs) in Canada. In September of 2002, RS initiated the regulation of its first ATS - Bloomberg Tradebook Canada Company (Bloomberg) - and, once the Canadian Trading and Quotation System (CNQ) gets up and running in 2003, RS will regulate its first QTRS. To ensure the rules remain neutral and do not preference one marketplace over another, RS set up an industry-led committee - the Rules Advisory Committee - to regularly review the rules and advise management on future changes. RS then announced tough new Sanction Principles and Guidelines for breaches of these rules.

RS's job is to protect the investor in real time. On the marketplaces for which RS acts as the regulation services provider, RS monitors each and every trade every day for compliance with the trading rules. In 2002, 220 million shares, worth approximately $2.55 billion, traded through an average of 111,000 individual trades every trading day. In addition to providing statistical and rule-based alerts, RS's sophisticated surveillance systems provide valuable data used to review trade desk procedures - to raise standards and improve governance, to prevent violations from occurring in the first place. Indeed, RS places emphasis on deterrence and believes that such a proactive approach will ensure better protection for investors at the end of the day.

This report marks a beginning - it is RS's first annual report, and we look forward to a second year of productive activity. RS will continue to be cost-efficient, ensuring that the benefits of any new initiative outweigh the costs. RS will maintain its commitment to setting high standards in trading regulation at the fairest price to market participants. RS expects to review aspects of UMIR in light of changes that Canada's Securities Commissions may make during the year in the rules governing the integration of marketplaces and the consolidation of order and trade data. As part of a national task force, RS and the country's other senior regulators expect to release their findings on illegal insider trading in the Canadian marketplace. This last initiative is illustrative of RS's cooperative relationships with provincial Securities Commissions, the exchanges and other SROs to make securities regulation in Canada more effective. Finally, the continuing dedication of RS's employees will most certainly play an important part in our future success.

P res iden t & CEO

Tom AtkinsonPresident & CEO

William W. MoriartyChair of the Board


Annual Report 2003

: :

2

: : About Marke t Regu la t ion Serv ices Inc . (RS)

: : Our MandateMarket Regulation Services Inc. (RS) is the independent regulation services provider for Canadian equity markets, including the TSX and TSX VN, Bloomberg and CNQ*. RS is recognized as an SRO by the provincial Securities Commissions in Alberta, British Columbia, Manitoba, Ontario and Quebec, which co-operate in and co-ordinate oversight of RS's regulatory activities. RS's mandate is to foster investor confidence and market integrity through the administration, interpretation and enforcement of a common set of market integrity principles applied to all regulated persons, including dealers, in all markets it regulates.

:: History / OwnershipRS is a not-for-profit SRO funded through a transparent, user-pay fee structure. Created as a joint initiative of the TSX and Investment Dealers Association of Canada (IDA), RS amalgamated the previous in-house surveillance, trade desk compliance, investigation and enforcement functions of the TSX and TSX VN. The birth of RS came about after two big changes in the securities industry. The first change occurred when the TSX demutualized and became a for-profit company. This, together with the Canadian Securities Administrators' (CSA) approval of ATSs entering the Canadian market to compete with the exchanges, demonstrated the need for an independent and impartial market regulation services provider for Canadian equity markets.

RS's ownership is a 50-50 split between the TSX and the IDA, but its corporate governance structure ensures that the decision-making power on the Board resides with the Independent Directors. Fifty per cent of RS's Board is made up of Independent Directors and there is a clear intent to include representation from our marketplaces, buy-side institutions and the regions where RS regulates.

:: Marketplaces We RegulateRS regulates securities trading on two stock exchanges trading in Canada - the TSX and the TSX VN. In 2002, RS initiated the regulation of its first ATS, Bloomberg. By mid-2003, RS expects to be regulating its first QTRS, CNQ. The trading rules -UMIR- seek to foster the trading of securities within a competitive environment in a fair and transparent manner. UMIR creates the framework to ensure market integrity in a competitive trading environment comprised of exchanges, QTRSs and ATSs. :: Real-Time SurveillanceRS's job is to monitor each and every trade in real time every day to ensure it complies with UMIR and the provincial Securities Acts. If a rule is breached, RS investigates immediately and, if necessary, has the power to reverse the trade and to take disciplinary action.

* by mid-2003

MissionRS will foster market

integrity and investor

confidence by regulating

equities securities trading

in Canada in a neutral,

cost-effective and

responsive manner.

VisionTo become the global

benchmark for effective

and efficient market

regulation.

ValuesRS promotes the following

values for its employees:

4Integrity

4Fairness

4Professionalism

4Customer focus


Annual Report 2003

3


RS is the only regulator in Canada that protects investors in real time - and real-time regulation requires sophisticated technology and market expertise to effectively monitor the markets without slowing them down. RS's staff of 80 in Toronto and Vancouver is made up of industry experts, including former traders, compliance officers, securities lawyers and prosecutors. RS regularly reviews trade desk procedures to raise standards and practices and prevent violations from occurring in the first place. As a market regulator, RS can impose fines of up to $1 million depending on the severity of the violation and can suspend or ban individuals from access to the markets.

:: Working With Other RegulatorsIn addition to regulating day-to-day securities trading, RS also plays an active role in a number of co-operative efforts with other securities regulators in Canada, including a task force to address illegal insider trading and the creation of a new national Cease Trade Order (CTO) database.

The CTO database and real-time dissemination system, operated and maintained by RS, contains the names of all companies whose shares are currently cease-traded by a Securities Commission in Canada. This database was created by RS in collaboration with the investment dealer community and provincial Securities Commissions to make it easier for investment dealers to comply with issuer CTOs and help solve the problem of timely CTO notification.

:: Cost EfficiencyWhile RS looks for cost-sharing opportunities with fellow regulators, it also searches for ways to implement new but cost-efficient initiatives within its own walls. RS recently introduced an early warning system - called potential violation alerts - to inform compliance officers of potential violations by their traders, allowing these officers to ensure timely and appropriate action is taken to protect investors. The alerts - delivered same day when possible - fit into the RS regulatory philosophy that instant and preventative near-time intervention by compliance personnel is the most cost-effective regulatory tool.

:: International ParticipationRS is a member of the Intermarket Surveillance Group (ISG), an international committee comprised of members from 31 exchanges around the world, including every major stock exchange. ISG promotes effective market surveillance among international exchanges and RS's involvement helps ensure that it is continually in touch with other regulators and keeps on top of international best practices. RS leads a committee of the ISG to compile international best practices for market regulation.

TSXToronto Stock Exchange

(TSX) is Canada's senior

equities market, consisting

of a broad cross-section of

Canadian issuers.

TSX Venture ExchangeThe TSX Venture

Exchange (TSX VN)

serves Canada's public

venture equity market.

Bloomberg TradebookBloomberg Tradebook

Canada Company is an

alternative trading system

that offers trading in

securities around the

world to Canadian

institutional investors.

CNQOnce operational by mid-

2003, Canadian Trading

and Quotation System will

provide for quotation and

trading of securities

issued by small

capitalized companies.

MarketplacesWe Regulate


Annual Report 2003

: :

4


: : Policy Development

In September of 2002, the Board of Directors of RS formed an advisory committee of experts known as the Rules Advisory Committee (RAC) with a mandate to review proposed amendments to UMIR and related Policies prior to their presentation to the Board. The composition of RAC was designed to reflect the interests of all of the constituencies dealing with or subject to UMIR. RAC was established primarily to assist the President & CEO of RS to ensure that any proposed rule or policy changes adequately address market integrity concerns, are in the public interest, and are also practicable and cost-efficient from the perspective of marketplaces and marketplace participants.

In addition to reviewing each proposed rule and policy amendment and making recommendations to the Board of Directors through the President & CEO, RAC may also review and make recommendations regarding:

4 any application for an exemption from UMIR;4 the position to be taken by RS in response to a request for comments issued by a securities regulatory

authority or SRO;4 the position to be taken by RS in submissions to a securities regulatory authority in respect of any

marketplace proposal; and4 any other matter where RAC's review or comment is, in the opinion of the President of RS, desirable.

To date, RAC has considered a number of proposed amendments to UMIR, responses by RS to requests for comments issued by a securities regulatory authority, and responses by RS in connection with a number of marketplace proposals to change their rules or to introduce new trading facilities.

:: Future of RS

As RS continues to evolve, its focus will remain on contributing to the effectiveness of the Canadian regulatory system and establishing itself as the global standard for market regulation. RS will continue to work with the investment community and other securities regulators and look for opportunities to provide innovative solutions to make regulatory structures in Canada more effective and efficient. RS also benchmarks its operations to ensure that it incorporates international best practices.

In 2003, RAC will be reviewing proposed amendments to the rules regarding manipulative and deceptive trading. In particular, RAC will be reviewing a proposed gatekeeper obligation for investment dealers, requiring traders to report potential violations of specific UMIR rules by clients to their firm's compliance department. It is expected that the CSA will be making a number of amendments to the electronic audit trail requirements and the data consolidation and market integration provisions of the National Instruments 21-101 and 23-101 and these may require some amendments to UMIR.


Annual Report 2003

RS's Complaints Officer can be reached at 416.646.7299 or [email protected].

:: Market Surveillance Statistics for FY 2003

< 300,000 Statistical and Rule-Based Alerts generated Market Supervision uses sophisticated, leading-edge surveillance systems to detect violations of the Securities Act, as well as UMIR and TSX and TSX VN rules and policies. A majority of the alerts are generated, researched and closed by Surveillance Officers in real time.

< More than 600 Technical Violations detected and resolved in FY 2003

Market Supervision detected and resolved a total of 639 confirmed violations of technical trading rules in real time during FY 2003. Technical trading rules include rules governing client principal trading, short sales, market balancing and market stabilization, jitney trading, order exposure and confidential, regulatory markers. Although the primary source of detection is via specialized market monitoring software, Market Surveillance also reviews complaints and deals with self-reported violations as well. In addition, 151, or 23%, of the rule violations resulted in real-time intervention, resulting either in trade cancellations and/or price adjustments. A number of other trades were either adjusted or cancelled outright because the price was deemed unreasonable at the time.

< 40,000 Press Releases vettedMarket Surveillance received and vetted about 40,000 listed company press releases as part of the administration of the TSX and TSX VN timely disclosure policies.

< 1,500 Rule Interpretations givenMarket Policy made more than 1,500 rule interpretations this year, one third of which were related to the transition from marketplace rules to UMIR; another 250 related to interplay between the marketplace rules and UMIR; and the rest related to the general provisions of UMIR or the applications of UMIR to specific fact situations (e.g., questions on market balancing, market stabilization, best execution, client priority, frontrunning etc.).

< 555 Stock Halts and ResumptionsMarket Surveillance can halt trading in a particular company listed on the TSX and TSX VN in anticipation of a material news announcement by the company. The halt in trading allows the company time to release its announcement and for the market to absorb the information.

< More than 85% of Market Share reviewed by Trade Desk Compliance GroupTrade Desk Compliance Officers reviewed trading activities by Participants responsible for more than 85% of the trading on the TSX and TSX VN.

5

: : Marke t Surve i l lance S ta t i s t i cs

:: Trading Activity During 2002 on the Markets We Regulate< Average Daily Transactions 111,000 trades per day = 26.7 million trades per year< Average Daily Volume 220 million shares traded per day = 47.6 billion shares traded per year< Average Daily Value $ 2.5 billion traded per day = $ 638 billion traded per year

30%

ÚÚÚ


Annual Report 2003

: :

6

: : Organ iza t iona l Char t

*Board of Directors

MarketSurveillance

Investigations& Enforcement

WesternRegion

Operations,General Counsel &

Corporate Secretary

Communications &Public Affairs

*Finance and Audit CommitteeReviews annual financial & risk management plans, pricing formula,quarterly & year-end financial statements

*Corporate Governance CommitteeDevelops Board guidelines, including size and composition, recommends candidates as Independent Directors and Representatives of ATSs, and evaluates performance of Directors

*Human Resources CommitteeEnsures executives in place with a total compensation plan that is competitive, motivating and rewarding

Market Supervision

Trade Desk Review

Trading Analysis

Market Policy

4

4

4

4

Market Supervision

Trade Desk Review

Trading Analysis


4

4

4

4

4

4


InvestigativeResearch

*See pages 8 -9 fo r names o f D i rec to rs , Commi t tee members

*Rules Advisory CommitteeReviews and recommends proposedamendments to market integrity rules

3

Finance &Treasury

4

4

4

President & CEO

4

4

Human Resources

Information Technology


Annual Report 2003

7

: : Organ iza t iona l S t ruc tu re o f RS

: : Operations, General Counsel & Corporate Secretary

Operations, General Counsel & Corporate Secretary co-ordinates RS's operational activities, including the Human Resources and Information Technology functions. The General Counsel is responsible for legal services, including advice, opinions, review, as well as the facilitation of all external legal service providers. The Corporate Secretary is responsible for the preparation of materials and the administration relating to RS's Board of Directors and its Standing Committees. The department also co-ordinates general planning and organizational matters between RS Board of Directors and RS Senior Management. Finally, the department acts as a liaison with the provincial Securities Commissions and SROs.

: : Market Surveillance

Market Surveillance monitors all trading activity in real time on the TSX to ensure compliance with UMIR. It ensures timely disclosure of information by publicly traded companies and is responsible for conducting trading analysis and preliminary investigations to assess potential violations, as well as trade desk compliance by market participants based in Ontario and Quebec. Market Surveillance is also responsible for the development and implementation of UMIR and for providing interpretations of, or exemptions from, UMIR with the goal of promoting market integrity. Using sophisticated and leading-edge surveillance systems and programs, surveillance experts monitor trading, company news, stock charts, chat room activity and other sources to identify potential trading violations, such as insider trading, manipulative or deceptive methods of trading, illegal short selling and frontrunning. If necessary, RS can temporarily halt the trading in a company's securities pending a material news announcement to allow the market to properly absorb the information.

: : Investigations & Enforcement

Investigations and Enforcement is responsible for conducting investigations and prosecutions of violations of UMIR and other market specific rules by market participants. Investigations focus on activities that may be in breach of UMIR and/or applicable rules of any marketplace that has retained RS. Requests for investigations come primarily from Market Surveillance but also from the provincial Securities Commissions, marketplaces and, in some instances, the general public. RS investigators also work co-operatively with provincial Securities Commissions and the IDA on investigations of mutual interest. The enforcement process is intended to ensure both general and specific deterrence from rule violations by ensuring that regulated persons are appropriately sanctioned for any violations of UMIR. In addition, if any investigation reveals evidence of a potential violation of securities legislation, the matter is referred to the appropriate Securities Commission. This preserves investor confidence in the marketplace and improves overall standards in the securities industry.

: : Western Region

The Western Region monitors all trading activity in real time and timely disclosure of information on Canada's junior market, the TSX VN, to ensure compliance with UMIR and the TSX VN's timely disclosure requirements. The Region is responsible for conducting trading analysis and preliminary investigations to assess potential violations of the Securities Act and UMIR. The Western Region is also responsible for trade desk compliance and for conducting investigations and prosecutions of violations of UMIR and other market specific rules by market participants based in western Canada.

Vice PresidentMaureen Jensen

Vice PresidentGerry Halischuk

Vice PresidentMarie Oswald

Vice PresidentAlexander Daschko


Annual Report 2003

: :

8

: : Board o f D i rec to rs

: : William W. Moriarty, ChairManaging DirectorRBC Dominion Securities Inc.IDA Representative

:: J. Charles Caty, Vice-ChairRetired Investment ExecutiveIndependent Director

:: Tom AtkinsonPresident & CEOMarket Regulation Services Inc. (RS)RS Representative

:: Luc BertrandPresident & CEOBourse de Montréal Inc.Independent Director

:: Ian BrownSenior Managing DirectorRaymond James Ltd.Junior Markets Representative

:: Eric KirznerProfessorRotman School of BusinessUniversity of TorontoIndependent Director

:: Mark MadoffCo-Director of TradingBernard L. Madoff Investment Securities LLCIndependent Director / ATS Representative

:: Jean MartelSenior PartnerLavery, de BillyTSX Representative

:: Joseph J. OliverPresident & CEOInvestment Dealers Association of CanadaIDA Representative

:: Kathryn PerryFinancial ConsultantIndependent Director

:: Barbara StymiestCEOTSX Group Inc.TSX Representative

The Board of Directors is responsible for the overall governance and strategic direction of RS.

The Board is comprised of 11 members:

4 Two representatives from the TSX4 Two representatives from the IDA4 One representative jointly appointed by the TSX and IDA to represent the junior markets4 Five independent members, including an ATS representative4 RS's President & CEO

The Board is required to look continually at its own composition to ensure it reflects the current market situation and that no one organization or interest has control. The underlying objective at all times is to ensure the markets are regulated in a fair and efficient manner.

: : Board of Directors Membership (as at April 2003)


Annual Report 2003

9

: : Board and Adv isory Commi t tee Membersh ip

Finance & Audit Committee

Eric Kirzner, ChairJ. Charles CatyWilliam W. MoriartyKathryn PerryBarbara Stymiest

Corporate Governance Committee

J. Charles Caty, ChairLuc BertrandEric KirznerMark MadoffWilliam W. Moriarty (ex-officio)

Kathryn Perry

: : M. Cecilia Williams, ChairVice President, Business ControlsGlobal Private Banking and TrustCanadian Imperial Bank of CommerceLegal/Compliance Representative

: : Jean-Guy Brunelle, Vice-ChairManaging Director, Proprietary TradingNational Bank FinancialParticipant Representative

: : Tom Atkinson (ex-officio)President & CEOMarket Regulation Services Inc. (RS)

: : David M.R. CheopVice President, Corporate ComplianceInvestors GroupInstitutional Investor/Subscriber Representative

: : Bruce S. GarlandChief Operating OfficerBloomberg Tradebook Canada CompanyBloomberg Tradebook Representative

: : Andrew JappyHead, International TradingCanaccord Capital Participant Representative

: : David LangManaging Director, Global Institutional ComplianceRBC Dominion Securities Inc.Legal/Compliance Representative

: : Jean MartelLavery, deBillyBarristers and SolicitorsLegal/Compliance Representativeand member of RS Board

: : William W. Moriarty (ex-officio)Managing DirectorRBC Dominion Securities Inc.Chair of RS Board

: : Phillip (Ted) NorrisExecutive Managing DirectorBMO Nesbitt Burns Inc.Participant Representative

: : Rik ParkhillSenior Vice President Trading, TSX MarketsTSX Group Inc.TSX Representative

: : Gerry RocchiManaging Director/PresidentBarclays Global Investors Canada Ltd.Institutional Investor/Subscriber Representative

: : Ray TuckerManaging Director, Institutional Equities TD Securities Inc.Participant Representative

: : John WashburnDirector, TSX Market Services, TSX MarketsTSX Group Inc.TSX VN Representative

: : Rules Advisory Committee

Human Resources Committee

Eric Kirzner, Chair Tom Atkinson (ex-officio)

J. Charles CatyWilliam W. Moriarty (ex-officio)

Kathryn Perry

: : Standing Committees of the Board


Annual Report 2003

: :

10

: : Management D iscuss ion & Ana lys is

The following discussion and analysis provides a summary review of the operations and results of RS for the period ended February 28, 2003. This review should be read in conjunction with the financial statements and accompanying notes as it is intended to assist shareholders and readers in understanding the dynamics of the operations of RS and the key factors underlying the financial results.

: : HighlightsFY 2003 marked the beginning of RS operations as a not-for-profit regulator of equity securities trading in Canada. Financial highlights for FY 2003 include the following:

4 RS introduced a new pricing formula to recover costs related to UMIR regulation of participants. The pricing formula includes a cap on all trades over 30,000 shares in order to ensure a fair assessment for large volume trades. UMIR fees are collected on a monthly basis where participants pay a share of the total fee based on the participant's percentage of overall marketplace volume.

4 The TSX and TSX VN are charged on a cost recovery basis for additional regulation services, including timely disclosure monitoring and investigative research.

4 RS worked to jointly fund strategic regulatory initiatives with other securities regulators in order to reduce the financial impact on participants. Jointly funded initiatives include the Insider Trading Task Force and the Cease Trade Order database initiated by RS during the fiscal year.

4 RS established a reserve of two months' operating expenses to be used to finance operations and capital purchases and to serve as an operating contingency.

:: Excess of Revenue over ExpensesRS accumulated an excess of revenue over expenses for the period ended February 28, 2003 of $4.3 million. This excess translates into an operating surplus of approximately two months' operating expenses, used primarily to finance start-up capital expenditures with the balance held in cash for operating requirements.

:: RevenueOverall revenue was $26.3 million for FY 2003. RS's revenue is primarily generated from two sources: UMIR regulation fees paid by participants and revenue for additional services provided to the TSX and TSX VN. RS generates other revenue from marketplace application fees, interest income and other sources.

UMIR regulation fees were $22.0 million in FY 2003 and accounted for 84% of overall revenues. The formula for the calculation of UMIR regulation fees was amended during the fiscal year and, as a result, fees were reduced. Service agreement revenue for TSX and TSX VN was $4.0 million and accounted for 15% of overall revenues in FY 2003. RS received revenue for timely disclosure monitoring ($2.2 million), investigative research ($1.6 million) and market quality monitoring ($0.2 million) services provided directly to the TSX and TSX VN. Other revenue totalled $0.3 million in FY 2003, accounting for 1% of overall revenues.

:: ExpensesOverall expenses for FY 2003 totalled $22 million. RS has the following expense categories:

4 Compensation and benefits expenses $8.0 million, 36% of overall costs 4 Communications expenses $1.2 million, 5% of overall costs4 Information technology expenses $9.5 million, 43% of overall costs 4 General and administrative expenses $2.8 million, 13% of overall costs4 Interest and amortization expenses $0.5 million, 2% of overall costs


Annual Report 2003

11

: : Management D iscuss ion & Ana lys is

: : Auditor's Report

To the shareholders of Market Regulation Services Inc.

We have audited the statement of financial position of Market Regulation Services Inc. as at February 28, 2003 and the statements of changes in fund balances, operations and cash flows for the 18-month period then ended. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these financial statements present fairly, in all material respects, the financial position of the company as at February 28, 2003 and the results of its operations and its cash flows for the 18-month period then ended in accordance with Canadian generally accepted accounting principles.

PriceWaterhouseCoopers LLPChartered AccountantsToronto, CanadaApril 11, 2003

: : Liquidity and Capital ResourcesTotal cash flow from operations was $4.2 million, with cash used to purchase $3.0 million in capital assets. Capital expenditures were related to start-up requirements, including construction and furnishing of offices and initial IT capital purchases. These activities drove a $1.2 million increase in cash that was used to finance normal operating expense requirements.

: : FY 2004 OutlookRS forecasts revenue of $21.1 million in FY 2004, which is 19% lower than the $26.3 million collected in FY 2003 and represents cost recovery. RS forecasts expenses to be $21.1 million, decreasing 4.1% versus FY 2003 expenses of $22 million. RS forecasts FY 2004 capital spending of $0.3 million, which is 92% lower than FY 2003 capital spending of $3.0 million.

: : Management's Responsibility

Management is responsible for the integrity of the financial statements and other information presented in the annual report. The financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles.

Market Regulation Services Inc. (RS) is committed to full and open disclosure of its operations and maintains a system of internal controls designed to provide reasonable assurance that reliable financial information is available on a timely basis. The preparation of financial statements involves the use of estimates based on management's judgment on transactions that will conclude in future periods.

The Board of Directors of RS has approved the information contained in the financial statements. The Board of Directors fulfills its responsibility regarding the financial statements mainly through its Finance & Audit Committee, which has a process in place to review and make recommendations to the Board.

As the external auditors appointed by the shareholders of RS, PricewaterhouseCoopers LLP is responsible for reporting to the shareholders on the fairness of the presentation of the annual financial statements.


William W. Moriarty Chair of the Board of Directors


Annual Report 2003

: :

12

: : Aud i to rs ' Repor t

:: Auditors' Report

April 11, 2003(except for note 12, which is as of May 14, 2003)

Auditors' Report

To the Shareholders ofMarket Regulation Services Inc.

We have audited the statement of financial position of Market Regulation Services Inc. as at February 28, 2003 and the statements of changes in fund balances, operations and cash flows for the period from September 21, 2001, date of incorporation, to February 28, 2003. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these financial statements present fairly, in all material respects, the financial position of the company as at February 28, 2003 and the results of its operations and its cash flows for the period from September 21, 2001, date of incorporation, to February 28, 2003 in accordance with Canadian generally accepted accounting principles.

PricewaterhouseCoopers LLPChartered AccountantsToronto, CanadaApril 11, 2003


Annual Report 2003

13

: : Financ ia l S ta tements

: : Market Regulation Services Inc.Statement of Financial Posi t ion As at February 28, 2003

Approved by the Board of Directors

Director DirectorWil l iam W. MoriartyChair of the Board


$

Assets Current assets Cash and cash equivalents 1,059,848 Restricted cash (note 3) 119,000 Accounts receivable (note 11) 1,971,816 Due from related party (notes 8 and 11) 467,442 Prepaid expenses 139,187 3,757,293 Property and equipment (note 4) 2,609,404 6,366,697 Liabilities Current liabilities Accounts payable 45,464 Accrued liabilities 1,296,072 Due to related party (note 8) 16,601 Deferred contribution (note 3) 30,000 1,388,137 Lease inducement 462,354 Deferred pension liability 245,000 2,095,491 4,271,206 Fund balances Invested in property and equipment 2,609,404 Unrestricted 1,571,802 Internally restricted (notes 3 and 6) 89,000 Share capital 1,000 4,271,206

$

Assets Current assets Cash and cash equivalents 1,059,848 Restricted cash (note 3) 119,000 Accounts receivable (note 11) 1,971,816 Due from related party (notes 8 and 11) 467,442 Prepaid expenses 139,187 3,757,293 Property and equipment (note 4) 2,609,404 6,366,697 Liabilities Current liabilities Accounts payable 45,464 Accrued liabilities 1,296,072 Due to related party (note 8) 16,601 Deferred contribution (note 3) 30,000 1,388,137 Lease inducement 462,354 Deferred pension liability 245,000 2,095,491 4,271,206 Fund balances Invested in property and equipment 2,609,404 Unrestricted 1,571,802 Internally restricted (notes 3 and 6) 89,000 Share capital (note 10) 1,000 4,271,206


Annual Report 2003

: :

14


: : Market Regulation Services Inc.Statement of Changes in Fund BalancesFor the period from September 21, 2001 to February 28, 2003

Share capital

$

Unrestricted $

Invested in property and

equipment $

Internally restricted

$ Total

$ (note 10) (note 3)

Balance - Beginning of period - - - - - Excess (deficiency) of revenues over

expenses for the period -

4,708,809 (438,603) - 4,270,206 Issuance of common shares (note 10) 1,000 - - - 1,000 Transfers to (from) - (3,137,007) 3,048,007 89,000 - Balance - End of period 1,000 1,571,802 2,609,404 89,000 4,271,206


Annual Report 2003

15


: : Market Regulation Services Inc.Statement of Operat ionsFor the per iod from September 21, 2001 to February 28, 2003

$

Revenues UMIR regulation 21,967,725 Exchange service agreement

Timely disclosure 2,156,196 Investigative research 1,593,553 Market quality 223,554

Fines (note 6) 105,000 Interest 43,503 Other 135,045 Contributed pension asset 40,000 26,264,576 Expenses Compensation and benefits 8,019,414 Communications 1,182,792 Information technology services (note 8) 9,453,008 General and administrative 2,835,580 Amortization of property and equipment 438,603 Interest (note 8) 64,973 21,994,370 Excess of revenues over expenses for the period 4,270,206


Annual Report 2003

: :

16


: : Market Regulation Services Inc.Statement of Cash FlowsFor the period from September 21, 2001 to February 28, 2003

$

Cash provided by (used in) Operating activities Excess of revenues over expenses for the period 4,270,206 Items not affecting cash

Amortization of property and equipment 438,603 Employee future benefits 285,000 Lease inducement 462,354

Changes in non-cash working capital items Increase in accounts receivable (1,971,816) Increase in due from related party (467,442) Increase in prepaid expenses (139,187) Increase in accounts payable 45,464 Increase in accrued liabilities 1,296,072 Increase in due to related party 16,601 Increase in deferred contribution 30,000

Contributed pension asset (40,000)

4,225,855

Investing activities Purchase of property and equipment (3,048,007) Financing activities Issuance of common shares 1,000 Net change in cash during the period 1,178,848 Cash and cash equivalents - Beginning of period - Cash and cash equivalents - End of period 1,178,848 Cash and cash equivalents include restricted cash. Supplementary information Interest paid 53,379


Annual Report 2003

17

: : Notes to F inanc ia l S ta tements

: : Market Regulation Services Inc.Notes to Financial StatementsFebruary 28, 2003

1 Nature of operations

The company was incorporated on September 21, 2001 under the Canada Business Corporations Act. As a not-for-profit organization, the company is exempt from income taxes under Section 149(1)(l) of the Income Tax Act (Canada). The company commenced operations on March 1, 2002. The company is jointly owned by the Toronto Stock Exchange (TSX) and the Investment Dealers Association (IDA).

The company is the independent regulation services provider for Canadian equity markets, including the TSX and TSX Venture Exchange. Recognized by the provincial securities commissions in Alberta, British Columbia, Manitoba, Ontario and Quebec, the company's mandate is to foster investor confidence and market integrity through the administration, interpretation and enforcement of a common set of market integrity principles applied to all regulated persons, including dealers, in all markets it regulates. In addition, if any investigation reveals evidence of a potential violation of securities legislation, the matter is referred to the appropriate securities commission.

The financial statements cover the period from September 21, 2001, date of incorporation, to February 28, 2003.

2 Summary of significant accounting policies

Basis of accounting and presentation

The company follows accounting principles appropriate for not-for-profit organizations in accordance with Canadian generally accepted accounting principles.

Use of estimates

The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and cash equivalents

Cash and cash equivalents consist of cash and liquid investments with terms of maturity at the date of acquisition of 90 days or less and are recorded at cost.

Financial instruments

Financial instruments recognized in the statement of financial position include cash and cash equivalents, accounts receivable, restricted cash, accounts payable and accrued liabilities. Cash and restricted cash are on deposit with Canadian chartered banks.


Annual Report 2003

: :

18



Operating leases and lease inducement

The company rents its premises under an operating lease agreement. The negotiation of the lease agreement resulted in a period of free rent which has been treated as a lease inducement for accounting purposes. The benefit has been allocated over the term of the lease and the difference between the rent expensed and actual cash paid has been accrued as a lease inducement liability.

Revenue

The company follows the deferral method of accounting for revenue. Unrestricted contributions are recognized as revenue when received or receivable if the amount to be received can be reasonably estimated and collection is reasonably assured.

The costs for Universal Market Integrity Rules (UMIR) regulation are recovered from broker/dealers through an allocation model based on the volume of trading activity on both the TSX and TSX Venture Exchange.

Exchange service agreement revenue is earned through services provided by the company for the TSX and TSX Venture Exchange under the regulation services contracts.

Fines are levied on members of the marketplace who are found to be in non-compliance with the UMIR.

Interest is earned on funds held on deposit with Canadian chartered banks.

Property and equipment

Property and equipment are initially recorded at cost and are then amortized on a straight-line basis over their estimated useful lives as follows:

The company has capitalized costs directly attributable to the development of software for its internal use. Once the software is substantially complete and ready for use it will be amortized on a straight-line basis over its estimated useful life.

Computers 3 years Network and communications equipment 5 years Furniture and equipment 5 years Leasehold improvements Term of lease


Annual Report 2003

19

: :

:: Market Regulation Services Inc.Notes to Financial StatementsFebruary 28, 2003

Employee future benefits

The company accrues its obligation under employee benefit plans and the related costs, net of plan assets, as follows:

4 The cost of pensions and other retirement benefits earned by employees is actuarially determined using the projected unit credit method pro-rated on service and management's best estimate of expected plan investment performance for funded plans, salary escalation, retirement ages of employees and expected health care costs.

4 For the purpose of calculating the expected return on plan assets of the defined benefit pension plan, those assets are valued at fair value, which is equivalent to the fair market value as at December 31, 2002. The plan assets of the post-retirement non-pension plan are valued at fair value, which is equivalent to the fair market value as at February 28, 2003.

4 Past service costs for plan amendments are amortized on a straight-line basis over the average remaining service period of active employees at the date of amendment.

4 The excess of net actuarial gain (loss) over the benefit obligation and fair value of plan assets is amortized over the average remaining service period of active employees.

3 Restricted cash and deferred contribution

Restricted cash consists of $30,000 contributed by one of the provincial securities commissions to cover the cost of investigative services performed by the company on its behalf. The amount will be drawn down as the services are performed. In addition, an amount of $89,000 has been internally restricted (note 6).

4 Property and equipment

Notes to F inanc ia l S ta tements

Cost

$

Accumulated amortization

$ Net

$

Computers 268,696 80,594 188,102 Network and communications equipment 835,486 143,100 692,386 Furniture and equipment 696,775 125,889 570,886 Leasehold improvements 1,077,050 89,020 988,030 Development projects 170,000 - 170,000

3,048,007 438,603 2,609,404


Annual Report 2003

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20



5 Employee future benefits

The company provides retirement and post-employment benefits for its employees under both a defined contribution and a defined benefit pension plan. The company is a participating employer in the pension plan administered by the TSX. The pension plan surplus relating to the employees of the company was transferred from the TSX to the company on March 1, 2002. The plans provide benefits that are based on a combination of years of service and a percentage of the participants' plan earnings. The cumulative difference between the provision for pension costs and funding contributions is shown as a deferred pension liability on the statement of financial position.

The company has also established a supplementary income plan (SIP). This plan will not be registered under the Income Tax Act (Canada).

Information about the company's defined benefit pension plan, SIP and post-retirement non-pension plan is follows:

December 31,

2002 February 28,

2003

Registered defined benefit

pension plan $

Supplementary income plan

$

Post-retirement non-pension

plan $

Accrued benefit obligation

Benefit obligation - Beginning of period - - - Current service cost - employer 179,000 17,000 91,000 Interest cost 150,000 9,000 6,000 Employee contributions 79,000 - - Net transfer in 1,930,000 115,000 - Actuarial gain - - (16,000) Benefit obligation - End of period 2,338,000 141,000 81,000 Plan assets

Market value of plan assets - Beginning of

period - - - Actual return on plan assets (114,000) (2,000) - Employee contributions 79,000 - - Net transfer in 2,029,000 56,000 -

Market value of plan assets - End of period 1,994,000 54,000 -


Annual Report 2003

21

: :


The pension expense incurred under the defined contribution pension plan was $212,200 in 2003.

6 Internally restricted fund balance

The company enforces UMIR on behalf of the marketplaces that retain the company to provide regulation services. The company investigates alleged rule violations and administers any settlements and hearings that may arise as a result of such violations. Violations may result in fines levied and collected by the company. The fines collected, net of the costs associated with the investigation, are segregated as an internally restricted fund.

When the internally restricted fund balance exceeds $100,000, and at the board of directors' direction, the company shall pay to a non-profit, income tax-exempt organization organized for the purposes of investor education, all fines levied and collected pursuant to regulation services provided by the company. The internally restricted fund balance is $89,000 as at February 28, 2003.

(...continued from previous page)


Annual Report 2003

December 31,

2002 February 28,

2003

Registered defined benefit

pension plan $

Supplementary income plan

$

Post-retirement non-pension

plan $


Reconciliation of funded status

Funded status - deficit (344,000) (87,000) (81,000) Unamortized net actuarial loss (gain) 279,000 4,000 (16,000)

Accrued benefit liability, net of valuation

allowance (65,000) (83,000) (97,000)

Components of expense

Current service cost - employer, including provision for plan expenses 179,000 17,000 91,000

Interest cost 150,000 9,000 6,000 Expected return on plan assets (165,000) (2,000) -

Net expense 164,000 24,000 97,000 Assumptions

Discount rate 7.00% 7.00% 6.75% Rate of compensation increase 4.50% 4.50% n/a Health care inflation - Select - - 10.00% Health care inflation - Ultimate - - 4.50%

: :

22



7 Commitments

The company is committed to minimum office lease payments for its two offices for each of the next five years and thereafter as follows:

During the year, the company's Toronto office received a free rent and operating expense period of five months. Accordingly, the company is amortizing the benefit over the life of the lease.

8 Related party transactions

During the period, the company entered into the following transactions with the TSX. All transactions entered into with the TSX were in the normal course of operations and measured at the exchange amount, which was the amount of consideration agreed to by the two companies.

Until the company's operations commenced March 1, 2002, the TSX paid all of the company's initial start-up costs on the agreement that the company would reimburse the TSX once operations began. The TSX charged interest on the balances outstanding at the prime rate.

Interest charged by TSX amounted to $57,424.

The company has entered into a services agreement with the TSX for the provision of information technology services. The expense relating to this service is $9,226,634.

Under the services agreement, the TSX also provides general and administrative services. Included in general and administrative expense is $290,516.

Included in communications expense is $19,843 paid to the TSX for on-line information.

Sales to the TSX under the services agreement totalled $4,023,303.

Toronto

$ Vancouver

$

2004 340,000 85,000 2005 340,000 85,000 2006 340,000 87,000 2007 340,000 98,000 2008 550,000 98,000 Thereafter 2,320,000 260,000 4,230,000 713,000


Annual Report 2003

23

: :


9 Credit facility

During the period, the company obtained a demand operating credit facility, with a maximum borrowing limit of $6,500,000, with a Canadian chartered bank. The credit facility bears interest at the prime rate. As at period-end, the company had not drawn on this credit facility.

10 Share capital

The authorized share capital of the company consists of an unlimited number of common shares.

11 Accounts receivable and due from related party

12 Subsequent event

The company is finalizing an amended regulation services contract with the TSX and TSX Venture Exchange to be their exclusive regulation services provider. Under the terms of this contract, the company will continue to charge the exchanges' market participants directly for UMIR regulation. The company will also continue to charge the exchanges directly for additional regulation services, including timely disclosure monitoring and investigative research.

Concurrently, the company is finalizing an amended corporate services agreement with the TSX, whereby the TSX will continue to provide information technology and other administrative services to the company. Amendments to the contracts are effective March 1, 2003 and both contracts will cover an additional four-year term with successive renewal terms of one year each. The contracts are linked; each contract has an option to terminate upon the termination of the other contract.


$

Issued 1,000 common shares 1,000

$

Accounts receivable UMIR regulation revenue receivable 1,911,989 Other receivable 59,827

1,971,816 Due from related party

Exchange service agreement revenue receivable 467,442


Annual Report 2003

: :

24



Year of contract

Minimum payment -base cost

$

2004 7,898,028 2005 7,173,024 2006 6,598,032 2007 6,598,032 Each renewal thereafter 6,598,032


Annual Report 2003


Annual Report 2003

Contact Information:

Market Regulat ion Services Inc. (RS)

Toronto Off ice145 King St. WestSui te 900, P.O. Box 939Toronto, ONM5H 1J8

Tel: 416. 646. 7200Fax: 416. 646. 7265

Vancouver Off iceSuite 2600P.O. Box 11580650 West Georgia St.Vancouver, B.C.V6B 4N8

Tel: 604. 602. 6962Fax: 604. 682. 8514

www.regulat ionservices.com


Annual Report 2003

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