BCO Chapter 5.pdf

Disclosure Requirements 5 CONTENT AREAS Disclosure Requirements at Branch Level Fund Facts and Other Documents to Deliver Additional Disclosure Requirements The Required Form of Disclos...

Disclosure Requirements 5 CONTENT AREAS Disclosure Requirements at Branch Level Fund Facts and Other Documents to Deliver Additional Disclosure Requirements The Required Form of Disclosure Maintaining Evidence That Disclosures Have Been Provided LEARNING OBJECTIVES 1 | Describe the four disclosure items that must be acknowledged by clients when a mutual fund account with a dealer is opened within a branch of an affiliated financial institution. 2 | Identify the information the sales representative must disclose to the client. 3 | Ensure that the sales representative provides full disclosure to clients, including all required disclosure documents. 4 | Identify the required documentation, and ensure that all documentation is provided. © CANADIAN SECURITIES INSTITUTE 5 2 BRANCH COMPLIANCE OFFICER’S COURSE KEY TERMS Key terms are defined in the glossary and appear in bold text when they first occur in the chapter. fund facts referral arrangement management fee © CANADIAN SECURITIES INSTITUTE  CHAPTER 5 DISCLOSURE REQUIREMENTS 5 3 INTRODUCTION In this chapter, we examine the disclosure obligations imposed on employees of a branch or sub-branch of a mutual fund dealer operating within the premises of a related or affiliated financial institution. We will also explain what constitutes satisfactory disclosure to the client and how the sales representative may carry it out. As a branch compliance officer (BCO), you should be able to identify and perform the key responsibilities and duties associated with setting up appropriate branch systems. You must also comply with all legal requirements that relate specifically to the activities of a mutual fund dealer when such activities take place within a branch of a financial institution. As the BCO, you are accountable for your sales representatives’ understanding of their disclosure obligations. You must make sure the sales representatives know how disclosures should be made and the documentation required. They must also understand the contractual obligations both they and their dealer have to their clients. The rules regarding verbal and written sales communications are set out in Section 15 of National Instrument 81-102, National Instrument 31-103, the rules of the new SRO, and other statutes. Your obligation in this regard is to ensure compliance with the rules and with head office guidelines prohibiting untrue or extravagant claims, misleading statements, and statements that conflict with information in the offering documentation. The major disclosure requirements and prohibitions are set out in NI81-102, new SRO’s rules, and NI31-103. However, the securities regulators in some provinces and territories have further disclosure requirements that registrants must also comply with. DID YOU KNOW? The offering documentation for mutual funds includes the fund facts document for each class or series, the simplified prospectus (“the prospectus”), and the annual information form (AIF). DISCLOSURE REQUIREMENTS AT BRANCH LEVEL Section 14.4 of NI31-103 applies only to registrants (both dealers and registered sales representatives) who conduct securities-related activities within a branch or office of a Canadian financial institution. A registered securities or mutual fund dealer is not considered a financial institution. When opening an account for a retail client, the registrant must deliver a written statement containing four disclosures: Disclosure of separate entity Disclosure of no deposit insurance coverage Disclosure of no financial institution guarantee Disclosure of fluctuating net asset values and yields A retail client is an individual with a net worth of less than $5,000,000 or an individual or company with total assets or annual revenues of less than $10,000,000 that is not a registrant or a financial institution. The registrant must obtain confirmation from the retail client that he or she has read the written disclosure statement and acknowledges the four disclosures. Your head office prepares the required disclosure and client acknowledgement forms, but it is your responsibility as BCO to ensure compliance with these requirements. The four required disclosures are described in detail below, and additional disclosure requirements are discussed in a later chapter. © CANADIAN SECURITIES INSTITUTE 5 4 BRANCH COMPLIANCE OFFICER’S COURSE DISCLOSURE OF SEPARATE ENTITY Every client who buys a mutual fund from a securities or mutual fund dealer must be made aware that the dealer is a separate legal entity from the underlying financial institution and that the financial institution does not guarantee the value of the mutual fund. This critical distinction must be emphasized. The client must understand and acknowledge that the transaction is with the mutual fund subsidiary, and not with the financial institution in which the subsidiary is operating. Even though the financial institution and the mutual fund dealer are operating within the same physical branch or location, they are not the same entity. DISCLOSURE OF NO DEPOSIT INSURANCE COVERAGE The Canada Deposit Insurance Corporation (CDIC), the Autorité des marchés financiers (AMF), and the Credit Union Deposit Insurance Corporation (CUDIC) provide insurance or protection against the loss of money resulting from the default of one of their members. The guarantees provided by these entities apply to certain types of deposits issued by member financial institutions of up to $100,000 of combined principal and accrued interest per client at each financial institution. Coverage from CDIC and AMF applies only to deposits with a principal of fixed, non-fluctuating value. Deposits covered include chequing and savings accounts, term deposits, and guaranteed investment certificates. Since April 30, 2020, term deposits with maturities of more than five years are eligible for CDIC and AMF protection. Mutual funds do not qualify for CDIC, AMF, or CUDIC, and the disclosure required under Section 14.4 of National Instrument 31-103 must clearly indicate this fact. In discussions with clients, sales representatives must not in any way imply that CDIC, AMF, or CUDIC guarantees apply to mutual funds. The disclosure document provided to clients when they open an account includes the statement, “no deposit insurance coverage,” and this disclosure also appears in the prospectus. However, the statement alone does not suffice; your sales representatives must reinforce the point with a verbal discussion during the sales interview. DISCLOSURE OF NO FINANCIAL INSTITUTION GUARANTEE The disclosure document must clearly indicate that the affiliated financial institution (of which the mutual fund dealer is a subsidiary) does not guarantee in any way, unless otherwise stated, the mutual fund securities sold by the mutual fund dealer. This disclosure is intended to ensure that clients do not believe that the financial institution is backing the securities sold by its mutual fund dealer subsidiary, even though there is some similarity in their names. Although the lack of a financial institution guarantee is disclosed and acknowledged in writing, your sales representatives should also communicate this fact during the sales interview. Oral disclosure is particularly important for clients with a history of investing only in bank deposit products such as certificates of deposit (CDs) and guaranteed investment certificates (GICs) and who are buying mutual funds for the first time. The fact that an investment in a mutual fund is not guaranteed is also disclosed in the offering documents. However, some mutual fund managers offer guaranteed mutual funds (but not segregated funds, which are not mutual funds). The simplified prospectus for those funds does not contain the disclosure statement, and the sales representative can say that such funds are guaranteed as long as the description of the guarantee is fair and truthful. Investors who have only ever purchased CDs or GICs are often confused by mortgage mutual funds. They are happy when interest rates rise because their investments will yield more if they are renewed on maturity. However, the net asset value of a mortgage mutual fund decreases when interest rates rise, which may come as an unpleasant surprise if the client has not been properly informed. © CANADIAN SECURITIES INSTITUTE  CHAPTER 5 DISCLOSURE REQUIREMENTS 5 5 To add to the confusion, the underlying mortgages may be guaranteed against default by the financial institution. The client should understand, however, that this guarantee is not a guarantee of the mutual fund itself. Instead, it guarantees the right to purchase the mortgages owned by the fund at market value (not face value) if they go into default. The net asset value of the fund will fluctuate as interest rates change. DISCLOSURE OF FLUCTUATING NET ASSET VALUES AND YIELDS Another fact that must be stated in the disclosure document is that the value of mutual funds units fluctuates. DID YOU KNOW? Mutual funds can be established as corporations or trusts. Mutual fund corporations issue shares, whereas a mutual fund trust issues units. Because mutual fund trusts are more common, we refer to units in this course. All mutual fund securities are subject to fluctuating net asset values, with the exception of most Canadian money market funds. For those, the fund managers attempt to fix the net asset value per unit (normally at $10.00 per unit). Generally, however, the net asset values of mutual funds fluctuate daily as their values reflect the changing values of their underlying assets. Potential clients must be informed that mutual funds, including money market funds, are subject to fluctuating yields. One reason for this warning is to differentiate mutual funds from fixed-value and fixed-return deposits such as term deposits and GICs issued by financial institutions. Also, unlike fixed-rate financial institution deposits, the return on an investment in mutual funds is never known in advance. Even for money market funds, the quoted current and effective yields are historical. These points should be reinforced during the sales discussion with the clients, especially new or unsophisticated clients, and particularly clients with a history of investing in bank deposit products who are buying mutual funds for the first time. These clients are used to fixed values and may not fully understand the implications of fluctuating market values. Many investors were upset when the market values of fixed-income funds such as bond and mortgage funds fell in 1999 as interest rates increased. Their idea of fixed interest rates paid on mortgages conflicted with the reality that a portfolio of mortgages fluctuates in value as interest rates change. Make sure your sales representatives are able to explain that rising interest rates will drive the prices of interest-bearing securities down and depress the value of fixed-income mutual funds. Table 5.1 | Fixed Value of Money Market Funds There is no guarantee that the fixed value of money market funds can be maintained. However, money market mutual fund managers can maintain the fixed net asset value per unit (NAVPU) except in highly unusual situations. They do this in through three means: Investing in high-quality money market securities Using accounting conventions that smooth out the effect of interest fluctuations Keeping a relatively short average maturity for the portfolio When interest rates are very low, the management expense ratio (MER) of a money market fund may exceed the interest earned by the fund. As a result, the NAVPU drops (unless the manager does not charge the fund the full amount of its management fee or otherwise absorbs the fund’s expenses). © CANADIAN SECURITIES INSTITUTE 5 6 BRANCH COMPLIANCE OFFICER’S COURSE FUND FACTS AND OTHER DOCUMENTS TO DELIVER Mutual fund dealers must deliver the fund facts document to investors before accepting their instructions to purchase a mutual fund. This document provides key information about a mutual fund in plain language. It does not need to be provided if the client has already been given the current version of the fund facts for the mutual fund they intend to buy. However, if the facts have been amended or renewed, clients should receive a copy of the current renewed or amended version the next time they buy the mutual fund. Offering documents for mutual funds are generally renewed at least annually. If a client requests the prospectus, the annual or semi-annual financial statements, the annual or semi-annual management report of fund performance, or the AIF, these must also be provided. The prospectus and AIF are available to investors upon request. Before any instructions to buy or sell a mutual fund are accepted, clients must be given the following information: The management fee amount The cost of selling the mutual fund in the future Any trailing commissions or other embedded fees Any load options Any switch or change fees Much of this information is included in the fund facts document. If there is a significant change in how a fund is operated or managed, an amendment must be made to the offering documents. The current fund fact must be provided to all purchasers of the fund until the next renewal, even those who have previously received the current fund facts. The exhibit that follows is a sample fund facts template provided by the Canadian Securities Administrators and adopted by issuers. Exhibit 5.1 | XYZ Canadian Equity Fund – Series B FUND FACTS June 30, 20XX Before you invest in any fund, consider how the fund would work with your other investments and your risk profile. QUICK FACTS Fund code XYZ123 Fund manager XYZ Mutual Funds Date series started March 31, 2000 Portfolio manager Capital Asset Management Ltd. Total value of fund on June 1, 20XX $1 billion Distributions Annually, on December 15 Management expense ratio (MER) 2.25% Minimum Investment $500 initial, $50 additional © CANADIAN SECURITIES INSTITUTE  CHAPTER 5 DISCLOSURE REQUIREMENTS 5 7 Exhibit 5.1 | XYZ Canadian Equity Fund – Series B WHAT DOES THE FUND INVEST IN? The fund invests in a broad range of stocks of Canadian companies. They can be of any size and from any industry. The charts below give you a snapshot of the fund’s investments on June 1, 20XX. The fund’s investments will change. Top 10 investments (June 1, 20XX) Investment mix (June 1, 20XX) 1. Royal Bank of Canada 7.5% Financial services 34.0% Energy 26.6% 2. Toronto-Dominion Bank 7.1% Industrial goods 16.5% 3. Canadian Natural Resources 5.8% Business services 6.4% Telecommunication 5.9% 4. The Bank of Nova Scotia 4.1% Hardware 3.7% 5. Cenovus Energy Inc. 3.7% Healthcare services 2.3% Consumer services 2.1% 6. Suncor Energy Inc. 3.2% Media 1.9% 7. Enbridge Inc. 3.1% Consumer goods 0.6% 8. Canadian Imperial Bank of Commerce 2.9% 9. Manulife Financial Corporation 2.7% 10. Canadian National Railway Company 1.9% Total percentage of top 10 investments 42.0% Total number of investments 93 HOW RISKY IS IT? Risk Rating The value of the fund can go down as well as up. You XYZ Mutual Funds has rated the volatility of this fund could lose money. as medium. One way to gauge risk is to look at how much a fund’s This rating is based on how much the fund’s returns returns change over time. This is called volatility. have changed from year to year. It doesn’t tell you how volatile the fund will be in the future. The rating can In general, fund with higher volatility will have returns change over time. A fund with a low risk rating can still that change more over time. They typically have a lose money. greater chance of losing money and may have a greater chance of higher returns. Funds with lower volatility Low Low to Medium Medium High tend to have returns that change less over time. They medium to High typically have lower returns and may have a lower chance of losing money. For more information about the risk rating and specific risks that can affect the fund’s returns, see the Risk section of the fund’s simplified prospectus. No guarantees Like most mutual funds, this fund doesn’t have any guarantees. You may not get back the amount of money you invest. © CANADIAN SECURITIES INSTITUTE 5 8 BRANCH COMPLIANCE OFFICER’S COURSE Exhibit 5.1 | XYZ Canadian Equity Fund – Series B HOW HAS THE FUND PERFORMED? This section tells you how Series B units of the fund have performed over the past 10 years. Returns are after expenses have been deducted. These expenses reduce the fund’s returns. Year-by-year returns This chart shows how Series B units of the fund performed in each of the past 10 years. The fund dropped in value in 3 of the 10 years. The range of returns and change from year to year can help you assess how risky the fund has been in the past. It does not tell you how the fund will perform in the future. 30 26.7 24.1 20 16.2 15.7 12.9 15.1 10 5.3 0 % -10 -6.9 -7.0 -20 -22.9 -30 Year Best and worst 3-month returns This table shows the best and worst returns for Series B units of the fund in a 3-month period over the past 10 years. The best and worst 3-month returns could be higher or lower in the future. Consider how much of a loss you could afford to take in a short period of time. Return 3 months ending If you invested $1,000 at the beginning of the period Best return 32.6% April 30, 20X1 Your investment would rise to $1,326. Worst return −24.7% November 30, 20X8 Your investment would drop to $753. Average return The annual compounded return of Series B units of the fund was 6.8% over the past 10 years. If you had invested $1,000 in the fund 10 years ago, your investment would now be worth $1,930. WHO IS THIS FUND FOR? A WORD ABOUT TAX Investors who: In general, you’ll have to pay income tax on any money you make on a fund. How much you pay depends on are looking for a long-term investment; the tax laws where you live and whether or not you want to invest in a broad range of stocks of hold the fund in a registered plan, such as a Registered Canadian companies; Retirement Savings Plan or a Tax-Savings Account. can handle the ups and downs of the stock market. Keep in mind that if you hold your fund in a non- Don’t buy this fund if you need a steady source of income registered account, fund distributions are included in from your investment. your taxable income, whether you get them in cash or have them reinvested. © CANADIAN SECURITIES INSTITUTE  CHAPTER 5 DISCLOSURE REQUIREMENTS 5 9 Exhibit 5.1 | XYZ Canadian Equity Fund – Series B HOW MUCH DOES IT COST? The following tables show the fees and expenses you could pay to buy, own and sell Series B units of the fund. The fees and expenses – including any commissions – can vary among series of a fund and among funds. Higher commissions can influence representatives to recommend one investment over another. Ask about other funds and investments that may be suitable for you at a lower cost. 1. Sales charges You have to choose a sales charge option when you buy the fund. Ask about the pros and cons of each option. Sales charge What you pay How it works in per cent (%) in dollars ($) Sales charge 0% to 4% of the $0 to $40 on You and your representative decide on the amount you buy every $1,000 rate. you buy The initial sales charge is deducted from the amount you buy. It goes to your representative’s firm as a commission. 2. Fund expenses You don’t pay these expenses directly. They affect you because they reduce the fund’s returns. As of March 31, 20XX, the fund’s expenses were 2.30% of its value. This equals $23 for every $1,000 invested. Annual rate (as a % of the fund’s value) Management expense ratio (MER) This is the total of the fund’s management fee (which includes the trailing commission) and operating expenses. XYZ Mutual Funds waived some of the fund’s expenses. If it had not done so, the MER would have been higher. 2.25% Trading expense ratio (TER) These are the fund’s trading costs. 0.05% Fund expenses 2.30% More about the trailing commission The trailing commission is an ongoing commission. It is paid for as long as you own the fund. It is for the services and advice that your representative and their firm provide to you. XYZ Mutual Funds pays the trailing commission to your representative’s firm. It is paid from the fund’s management fee and is based on the value of your investment. The rate depends on the sales charge option you choose. Sales charge option Amount of trailing commission in per cent (%) in dollars ($) Sales charge 0% to 1% of the value of your 0$ to $10 each year on every $1,000 invested investment each year © CANADIAN SECURITIES INSTITUTE 5 10 BRANCH COMPLIANCE OFFICER’S COURSE Exhibit 5.1 | XYZ Canadian Equity Fund – Series B HOW MUCH DOES IT COST? (cont’d) 3. Other fees You may have to pay other fees when you buy, hold, sell or switch units of the fund. Fee What you pay Short-term trading fee 1% of the value of units you sell or switch within 90 days of buying them. This fee goes to the fund. Switch fee Your representative’s firm may charge you up to 2% of the value of units you switch to another XYZ Mutual Fund. Change fee Your representative’s firm may charge you up to 2% of the value of units you switch to another series of the fund. WHAT IF I CHANGE MY MIND? FOR MORE INFORMATION Under securities law in some provinces and territories, Contact XYZ Mutual Funds or your representative for you have the right to: a copy of the fund’s simplified prospectus and other disclosure documents. These documents and the withdraw from an agreement to buy mutual fund Fund Facts make up the fund’s legal documents. units within two business days after you receive a simplified prospectus or Fund Facts document, or XYZ Mutual Funds 123 Asset Allocation St. cancel your purchase within 48 hours after you Toronto, ON M1A 2B3 receive confirmation of the purchase. In some provinces and territories, you also have the Phone: (416) 555-5555 right to cancel a purchase, or in some jurisdictions, Toll-free: 1-800-555-5556 claim damages, if the simplified prospectus, annual Email: [email protected] information form, Fund Facts document or financial www.xyzfunds.com statements contain a misrepresentation. You must act To learn more about investing in mutual funds, within the time limit set by the securities law in your see the brochure Understanding mutual funds, province or territory. which is available on the website of the For more information, see the securities law of your Canadian Securities Administrators at province or territory or ask a lawyer. https://www.securities-administrators.ca/ ®Registered trademark of XYZ Mutual Funds. Source: www.securities-administrators.ca DIVE DEEPER Find the complete Fund Facts: interactive sample at https://www.securities-administrators.ca/fundfacts.aspx?id=1275 ADDITIONAL DISCLOSURE REQUIREMENTS When discussing mutual funds with clients, the sales representative must understand and comply with fundamental disclosure requirements. As mentioned in this chapter, under section 14.4 of NI 31-103, registrants who open a client account to trade securities in an office or branch of a Canadian financial institution must disclose four facts to the client. Those disclosures include written notice that the client is dealing with a separate entity (namely, © CANADIAN SECURITIES INSTITUTE  CHAPTER 5 DISCLOSURE REQUIREMENTS 5 11 the mutual fund dealer affiliate of your financial institution), that the securities purchased are not insured by a government deposit insurer, that the securities are not guaranteed by a Canadian financial institution, and that the securities purchased may fluctuate in value. Clients must in turn acknowledge that they have read the disclosure statement. Sales representatives must also adhere to the following additional fundamental disclosure requirements: Disclosure of the CIPF coverage policy Leverage disclosure Past performance disclosure Relationship disclosure Referral arrangement disclosure Pre-trade disclosure Client Relationship Model disclosure (including cost disclosure, performance reporting, and client statements) Dispute resolution disclosure DISCLOSURE OF CIPF COVERAGE POLICY The Canadian Investor Protection Fund (CIPF) provides discretionary coverage to clients of members of the new SRO for losses of property in client accounts through insolvency of the dealer. The maximum amount of coverage for eligible client accounts is $1,000,000. Upon request, a sales representative must provide clients with a copy of the CIPF brochure, which describes the policy in detail. LEVERAGE DISCLOSURE In a leveraged transaction (i.e., the purchase of securities using borrowed funds), the sales representative must have written evidence that the client was given and understood the following disclosures: A leveraged purchase of a mutual fund involves greater risk than a cash purchase. The entire loan plus interest must be paid regardless of the performance of the investment. These disclosures are required when a sales representative recommends that a client purchase a mutual fund or other security using leverage or even becomes aware of the client’s intention to do so. The sales representative must provide the disclosure before the client makes the purchase. The form of the disclosure statement is mandated in MFDA Member Regulation MR-0074. In Quebec, this requirement is set out in the Regulation respecting practice in the securities field. Two additional disclosure statements may be useful for added clarification: The entire investment is at risk, not just the client’s equity portion. Interest paid on the loan reduces the return on the investment. Upon receipt of the written disclosure statement, the client must confirm that they have read it. There is no need to provide the leverage disclosure and receive acknowledgement if you have done so within the six-month period before the leveraged purchase. Mutual fund units and other securities may be purchased using available cash or a combination of cash and borrowed money. If cash is used to pay for the purchase in full, the percentage gain or loss will equal the percentage increase or decrease in the value of the securities. The purchase of securities using borrowed money magnifies the gain or loss on the cash invested. This effect is called leveraging. For example, suppose $100,000 of mutual fund units are purchased and paid for with $25,000 from available cash and $75,000 from borrowings. If the value of the fund units declines by 10% to $90,000, then the equity interest © CANADIAN SECURITIES INSTITUTE 5 12 BRANCH COMPLIANCE OFFICER’S COURSE will have declined by 40%, that is, from $25,000 to $15,000. (The equity interest is the difference between the value of the securities and the amount borrowed.) Investors proposing to buy securities with borrowed funds must be made aware that the purchase involves greater risk than one made with cash only. To what extent such a purchase involves undue risk is to be determined by each purchaser and will vary depending on the circumstances of the purchaser and the securities purchased. The decision to use leverage is up to the client. As BCO, your responsibility is to ensure that the client’s decision is an informed one based on full disclosure. PAST PERFORMANCE DISCLOSURE Another standard disclosure is the statement to clients that historical results do not guarantee future performance. Normally, this is presented as a phrase such as “past performance is no indication of future performance.” RELATIONSHIP DISCLOSURE Regulations require mutual fund dealers to provide written relationship disclosure information (RDI) to clients for each new account opened. This disclosure must include all the information that a reasonable client would consider important about their relationship with the mutual fund dealer and the sales representative. The RDI may be provided in a standalone document or included in the account opening documentation. Regardless of the manner in which the RDI is provided, it must describe the following facts: The nature of the advisory relationship This may include a statement that the client is ultimately responsible for investment decisions made in the account but that the client may rely on the investment advice provided by the sales representative. The products and services offered by the mutual fund dealer and the sales representative For example, it should disclose whether only proprietary (in-house) mutual funds are available or whether third- party mutual funds may be held in the client account. The procedures at the dealer regarding the handling of cash and cheques The dealer’s obligation to ensure that every order accepted or recommendation made to the client is suitable for that client It must also indicate that, even if the purchase was made at the client’s direction, the sales representative remains responsible for ensuring that it is suitable. A statement that a suitability review will be conducted in the following situations: When the client transfers asset to the dealer When there has been a material change in the know-your-client (KYC) information previously provided When a different dealing representative becomes responsible for the client account An explanation of the various terms as they relate to the KYC information collected by the dealer It must also describe how this information will be used when assessing investments in the client account. The content and frequency of client reporting for the account How investment performance benchmarks can be used to assess the performance of the client’s investments It should also describe the options available to clients in terms of benchmarks. The type of transaction charges the client may be required to pay The nature of the compensation that may be paid to the dealer It may include a general statement explaining how the dealer is compensated while referring to more specific fee information found in the account documentation or a similar agreement. © CANADIAN SECURITIES INSTITUTE  CHAPTER 5 DISCLOSURE REQUIREMENTS 5 13 Relationship disclosure provided in a standardized document should be approved by head office. Mutual fund dealers must also maintain evidence that the relationship disclosure has been provided to the client. If the RDI is incorporated into the account documentation and has been signed by the client, maintaining a copy of the signed account documentation is sufficient evidence. If the dealer chooses to provide relationship disclosure as a standalone document, it may request signed acknowledgement from the client as evidence, or it may maintain copies of the delivered documents in the client’s file. Where the relationship disclosure documents are not signed by the client, the sales representative should maintain detailed notes of client meetings and discussions as evidence that the information was provided. As with any client account documentation, it is expected that the dealer will take reasonable steps to notify the client promptly whenever there is a significant change in the RDI previously provided. As the BCO, it is your responsibility to ensure that the RDI is given to the client before the account is accepted and that any material change in the information is communicated to the client. REFERRAL ARRANGEMENT DISCLOSURE The new SRO defines a referral arrangement as an arrangement in which a mutual fund dealer that is a member of the new SRO pays a fee for the referral of a client or receives a fee for referring a client. The referral fee could be any form of compensation paid directly or indirectly. The arrangement does not include payment to a third-party service provider where the service provider has no direct contact with clients and where the services are not securities related. Referral arrangements are permitted on the following terms: There must be a written agreement governing the referral arrangement before it is implemented between the mutual fund dealer and the other party. All fees or other forms of compensation paid as part of the referral arrangement must be recorded on the mutual fund dealer’s books and records. Written disclosure of the referral arrangement must be made to the client before any transactions take place. The referral arrangement disclosure document must include the following information: An explanation or an example of how the referral fee is calculated The name of the parties receiving and paying the fee Any conflicts of interest resulting from the referral arrangement The category of each registrant that is party to the agreement, with a description of the activities the registrant is authorized to engage in under that category If a referral is made to a registrant, a notice that all activities requiring registration will be provided by the registrant receiving the referral A description of the activities that either party is not permitted to engage in Any information a reasonable client would consider important in evaluating the referral arrangement Furthermore, there is an ongoing requirement that the client be notified in writing of any change in the referral arrangement disclosure information as soon as is practical and no later than 30th day before the date on which a referral fee is next paid or received. PRE-TRADE DISCLOSURE Before accepting a mutual fund trade or instruction to buy or sell, the sales representative must provide the client with the following information: The actual charges the client must pay on the trade, or a reasonable estimate Whether the mutual fund dealer will receive a trailing commission on the mutual fund being purchased © CANADIAN SECURITIES INSTITUTE 5 14 BRANCH COMPLIANCE OFFICER’S COURSE As BCO, you must ensure that your sales representatives document the fact that pre-trade disclosure was provided and that they file notes as evidence. The RDI and fund facts documents address many of the pre-trade disclosure requirements. CLIENT RELATIONSHIP MODEL DISCLOSURE The Client Relationship Model Phase 2 (CRM2) is a regulatory initiative focused on providing clients with greater transparency regarding mutual fund fees, the services paid for, and investment performance. Clients must receive the following documents: The Account Statement, which provides details on the market value of their account Charges and Other Compensation, which discloses the fees clients pay for services along with any administration charges The Performance Report, which illustrates the performance of their investments The CRM2 disclosure document A fuller description of the reports and client statements is included below: Table 5.2 CRM2 Disclosure Document Required Information Account Statement For each security position reported in the account statement, the statement must include the book cost and total cost of all mutual This statement shows the market value funds since the inception of the client’s account. of the mutual fund holdings and the transaction details during the statement Position cost information must include the market value of the period. mutual fund together with, at the option of the mutual fund dealer, either the mutual fund’s original cost or book cost. When a security It is usually sent quarterly but may be sent is transferred from another firm, if position cost is unavailable, the monthly if there is activity in the account or mutual fund dealer can use market value. if the client requests it. Dealers can choose between original cost and book cost for this disclosure: Original cost is the total amount paid to purchase a security, including any transaction charges related to the purchase. Book cost is the total amount paid for a security, including any transaction charges related to its purchase, adjusted for reinvested distributions, returns of capital, and corporate reorganizations. The account statement can be integrated into the existing client account statement or provided in a separate document sent within 10 days of the account statement. © CANADIAN SECURITIES INSTITUTE  CHAPTER 5 DISCLOSURE REQUIREMENTS 5 15 Table 5.2 CRM2 Disclosure Document Required Information Charges and Other Compensation To help clients understand the costs associated with their account and the compensation received by the mutual fund dealer, the This report can be included as part of the dealer must provide clients with an annual summary of all charges account statement, but it must be provided incurred by the client and all other compensation received by the at least annually. dealer that relates to the client account, including any trailing commissions. Referral fees received can be included in this report or disclosed in a separate document. Performance Report The dealer member must provide a performance report to help clients understand how investments held in their accounts are This report is to clients on annually. Mutual performing. The report includes the following information: fund dealers may use charts and graphs to make the information easier for clients to Market value of cash and securities as at beginning and understand. end of period Market value of all deposits/transfers and all withdrawals/ transfers for the reporting period and since account was opened The change in the market value of the account since inception Annualized total percentage returns using a money-weighted return for years 1, 3, 5, and 10 and since the account’s inception DISPUTE RESOLUTION DISCLOSURE The Ombudsman for Banking Services and Investments (OBSI) provides a free, independent service for resolving investment disputes between mutual fund dealers and their clients. To avail themselves of OBSI’s dispute resolution services, clients must first attempt to resolve their dispute directly with the mutual fund dealer. If a client disagrees with the resolution proposed by the dealer, they may escalate the matter to OBSI. Mutual fund dealers must provide disclosure of OBSI’s dispute resolution services when they receive a client complaint. When a complaint is escalated, OBSI investigates it and recommends a course of action. For example, it can make a non-binding recommendation that the mutual fund dealer compensate the client for up to $350,000 if it determines that the client has not been treated fairly. In making a decision, it considers the criteria of good financial services and business practices, relevant codes of practice or conduct, industry regulation, and the law. In Quebec, the AMF provides mediation services to clients residing in Quebec. Mutual fund dealers with clients in Quebec must disclose the availability of these services. THE REQUIRED FORM OF DISCLOSURE All disclosure materials are normally prepared at head office and must be presented without alteration by your sales representatives. The disclosures of separate entity, no deposit insurance coverage, no financial institution guarantee, and fluctuating net asset values should be included with the fund facts. Other disclosure requirements that apply to all sales communications include prospecting letters that discuss mutual funds. Your dealer may also have internal marketing guidelines with which you should be conversant and which you should communicate to the sales representatives under your supervision. © CANADIAN SECURITIES INSTITUTE 5 16 BRANCH COMPLIANCE OFFICER’S COURSE Beyond the documentation stated above, as BCO, you are responsible for ensuring adherence to disclosure requirements regarding fees, compensation, sales incentives, performance data, and disclaimers. If you wish to prepare your own branch materials, you must obtain head office approval. Accordingly, all sales materials, including prospecting letters, should be sent to head office or other designated supervisory office for review and approval before they are used. MAINTAINING EVIDENCE THAT DISCLOSURES HAVE BEEN PROVIDED Dealers must maintain evidence that the required disclosures have been provided to clients, including evidence of delivery by mail. Required disclosures must be provided to clients in writing, and mutual fund dealers and sales representatives must maintain evidence that the disclosures were received in either of two forms: Signed client acknowledgements that they received the required disclosures Copies of the disclosure documents in client files, along with detailed notes of client meetings and discussions This recordkeeping is an important internal control that provides an audit trail for mutual fund dealers to assess compliance on an ongoing basis and in the event of a complaint or dispute. The new SRO requires that evidence that the required disclosures were provided must be maintained for seven years from the date the record was created. © CANADIAN SECURITIES INSTITUTE  CHAPTER 5 DISCLOSURE REQUIREMENTS 5 17 SUMMARY Now that you have completed this chapter, you should be able to meet the following learning objectives: 1. Describe the four disclosure items that must be acknowledged by clients when a mutual fund account with a dealer is opened within a branch of an affiliated financial institution. Disclosure that the mutual fund dealer selling the mutual fund is a separate legal entity from the financial institution. Disclosure that mutual funds do not qualify for the CDIC, AMF, or CUDIC guarantee. Disclosure that the financial institution does not guarantee in any way, unless otherwise advised, the mutual fund securities sold by the mutual fund dealer that operates within a branch of the financial institution. Disclosure that the value of mutual fund units fluctuates. 2. Identify the information the sales representative must disclose to the client. In addition to the fund facts upon purchase of mutual funds, the sales representative must provide the following disclosures: « Written notice that the client is dealing with a separate entity (namely the mutual fund dealer affiliate of the financial institution) « A statement that the securities purchased are not insured by a government deposit insurer « A statement that the securities are not guaranteed by a Canadian financial institution « A statement that the securities purchased may fluctuate in value Additional fundamental disclosures must include: « The CIPF coverage policy « Leverage disclosure « Past performance disclosure « Relationship disclosure « Referral arrangement disclosure « Pre-trade disclosure « Cost disclosure, performance reports, and client statements (CRM 2 & new SRO Rules) « Dispute resolution disclosure 3. Ensure that the sales representative provides full disclosure to clients, including all required disclosure documents. Disclosure materials are normally prepared at head office and presented without alteration by sales representatives. 4. Identify the required documentation, and ensure that all documentation is provided. Beyond the documentation stated above, BCOs are responsible for ensuring adherence to disclosure requirements regarding fees, compensation, sales incentives, performance data, and disclaimers. © CANADIAN SECURITIES INSTITUTE