Mutual Funds Industry Regulation PDF

Mutual Funds Industry Regulation 2 CONTENT AREAS Securities Regulation Provincial and Territorial Securities Acts The Canadian Securities Administrators Self-Regula...

Mutual Funds Industry Regulation 2 CONTENT AREAS Securities Regulation Provincial and Territorial Securities Acts The Canadian Securities Administrators Self-Regulatory Organization Purchasers’ Statutory Rights The Standards of Conduct Client Focused Reforms Rules for Telemarketing and the National Do Not Call List LEARNING OBJECTIVES By the end of this chapter, you should be able to: 1 | Provide a general description of the scope of securities law as it applies to mutual funds and how to comply with it. 2 | Describe and implement a program of standards of conduct within the branch of the mutual fund dealer. 3 | Implement a system for enforcing standards of conduct. © CANADIAN SECURITIES INSTITUTE 2 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. annual information form National Instrument assets portfolio bonds power of attorney cold calls prospectus conflict of Interest right of rescission dividends right of withdrawal load simplified prospectus misrepresentation © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 3 INTRODUCTION The securities industry is heavily regulated by various governmental and industry organizations that impose rules and restrictions on participants in the securities marketplace to promote market integrity and protect investors. Mutual fund dealers and their representatives must abide by the rules governing their conduct. For example, securities regulations specify the responsibilities that mutual fund salespersons have to their clients when making recommendations to buy or sell securities and when providing information to clients. Mutual fund dealers must supervise their employees’ conduct and use care when handling client assets. These rules, among others, promote a fair and efficient securities marketplace. In this chapter, we discuss the basic principles of securities regulation, the functioning of provincial securities legislation, and the rules, regulations and guidelines of the self-regulatory organization (SRO) in the industry. SECURITIES REGULATION In the United States, the Securities and Exchange Commission has exerted considerable regulatory authority at the national level since the early 1930s. In contrast, no formal federal securities regulatory body exists in Canada. Thirteen provincial and territorial securities commissions and agencies are the regulatory bodies responsible for the administration of securities legislation in their respective provinces and territories. The establishment and issuance of mutual funds and the activities of mutual fund dealers fall under provincial and territorial jurisdiction. Provincial or territorial securities regulators have the power to create and enforce their own laws and regulations and can delegate some of their powers to the appropriate self-regulatory organization (SRO), as discussed later in this chapter. The securities regulators’ powers and responsibilities as they pertain to mutual funds fall within three main categories: registration, disclosure, and enforcement. REGISTRATION Anyone who sells mutual funds or other securities or who provides investment advice to a client must be registered with the securities regulator in the jurisdiction in which the client resides. Mutual fund dealers must also register with the securities regulator in the jurisdiction in which the clients of its sales representatives reside. In addition, mutual fund dealers and their sales representatives must register with the appropriate SRO. Chapter 3 explains in further detail the registration requirements. DISCLOSURE National Instrument 81-101 and Companion Policy 81-101CP set out the requirements of mutual funds with respect to documentation of initial disclosure. Mutual funds must regularly file disclosure documents, including the fund facts document, simplified prospectus, annual information form (AIF), and financial reports with the securities regulators. Disclosure documents are consistent with the basic principle behind provincial securities regulation, namely, that of “full, true, and plain disclosure.” The better the information and the more disclosure provided, the greater the investor’s opportunity to make informed investment decisions. Disclosure is also an important issue with regard to allowable sales communications practices. ENFORCEMENT Securities regulators enforce the securities legislation in their respective provincial and territorial jurisdictions. The securities regulators have the power to subpoena witnesses, seize documents for examination, act as an © CANADIAN SECURITIES INSTITUTE 2 4 BRANCH COMPLIANCE OFFICER’S COURSE administrative tribunal, and prosecute offenders in the criminal courts. They may also prosecute alleged violators of the law before administrative tribunals. As part of this function, regulators may perform audits of registrants, including mutual fund dealers, to assess their compliance with securities legislation. The SRO can enforce compliance with its rules, but its powers are less extensive than those of the securities regulators. However, the SRO can refer matters to the securities regulators for enforcement if it feels that the offence justifies a harsher penalty than it can impose or if the investigative powers of the securities regulators are required. NATIONAL INSTRUMENT 81-102 AND COMPANION POLICY 81-102CP National Instrument 81-102 is the primary legislation relating to the regulation of mutual funds in Canada. It has been adopted in every jurisdiction in Canada and is enforced by all securities regulators. It deals with many aspects of mutual fund activities, including setting out limitations and prohibitions with respect to the investments that mutual funds can make, outlining settlement procedures for sales and redemptions, establishing restrictions on advertising, and setting custodial requirements. Companion Policy 81-102CP provides interpretative guidance on the language of NI 81-102. A branch compliance officer (BCO) is not expected to be able to interpret in detail the entire contents of NI81-102 and its companion policy. Some legal training is normally required for that purpose. Nevertheless, BCOs should be familiar with several provisions of the instrument and its overall intent. NATIONAL INSTRUMENT 31-103 National Instrument 31-103 establishes registration requirements for all sellers of securities. It has rationalized and codified a number of requirements applicable to all registered dealers and registrants, including mutual fund dealers and their sales representatives. It also addresses registration categories, proficiency qualifications, registration requirements and categories of registration, compliance requirements, disclosure requirements, and dealings with clients. Under NI 31-103, the registration category of a mutual fund dealer representative is called a dealing representative. A dealing representative may any trade securities that the individual’s sponsoring firm is permitted to trade. The individual branch manager category of registration was not retained in NI 31-103. That instrument requires dealers to establish systems of controls and supervision to provide reasonable assurance that the dealer and individuals acting on its behalf comply with securities legislation and manage risks associated with its business. However, the SRO did retain the branch manager category, and BCOs are generally registered with the SRO under this category. Mutual fund dealers that are members of the SRO must report any material change to the BCO directly to the SRO within five business days. PROVINCIAL AND TERRITORIAL SECURITIES ACTS The provincial and territorial securities acts, regulations, and rules provide a comprehensive framework for securities activities, including definitions, rules, and technical details associated with registration requirements, as well as prohibitions and restrictions on certain activities. Each province and territory has its own securities regulator in the form of a securities commission or a superintendent of securities to enforce the securities acts in their jurisdiction. The requirements of securities regulations differ among the provinces and territories. For example, in Manitoba and the Northwest Territories, there is an explicit and absolute ban on unsolicited calls, or cold calls. The legislation specifically prohibits sales representatives from making unsolicited telephone calls or personal visits to non- clients in an effort to sell securities or solicit mutual fund trades. In Quebec, solicitation is permitted, but certain requirements must be met. Given these and other variances, it is important to be familiar with and follow your dealer’s policies and procedures, which should reflect the requirements of its province or territory. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 5 THE CANADIAN SECURITIES ADMINISTRATORS Although there is no formal federal regulatory body in Canada responsible for securities regulation, and each regulator has its own set of rules, the securities regulators from the 10 provinces and three territories have formed a joint panel known as the Canadian Securities Administrators (CSA). The CSA is a voluntary umbrella organization whose objective is to improve, coordinate, and harmonize the regulation of the Canadian capital markets. It aims to achieve consensus on policy decisions that affect the capital markets and their participants. It also works collaboratively to deliver regulatory programs across Canada, such as the review of continuous disclosure and prospectus filings. The mission of the CSA members is threefold: To protect investors from unfair, improper, and fraudulent practices To foster fair and efficient capital markets To reduce risks to the market’s integrity and threats to investor confidence in the markets As an informal body, the CSA functions through meetings, conference calls, and day-to-day cooperation among the regulatory authorities. The CSA Chairs meet quarterly in person and monthly by conference call. Each CSA member carries out the following activities: Formulating policy Making rules Sitting on administrative tribunals in hearings on securities-related matters Hearing appeals from decisions made by staff or the SROs SELF-REGULATORY ORGANIZATIONS The SROs are industry organizations that regulate their own members. In the Canadian securities industry, the SROs have been officially granted their regulatory powers by the administrators. Authority is typically given in the form of a recognition order. The SROs are responsible for enforcing their members’ conformity with securities legislation. They also have the power to prescribe their own rules of conduct and financial requirements for their members. The SRO rules and regulations are designed to uphold the principles of securities legislation. The administrators monitor the conduct of the SROs and review their rules to ensure that they do not conflict with provincial securities legislation. The rules of the SROs must be in the public’s best interest and must set a standard equal to or higher than those imposed by the provinces. The SROs have extensive powers to investigate possible violations of their rules and to take disciplinary action against member firms and their employees when appropriate. Sanctions for less serious offences may include fines, strict supervision, and the requirement to rewrite qualifying exams. Serious offences may result in the loss of registration and substantial fines. Prior to January 1, 2023, there were two SROs in Canada, the Investment Industry Regulatory Organization of Canada (IIROC), and the Mutual Fund Dealers Association of Canada (MFDA). IIROC Until 2023, IIROC was the pan-Canadian self-regulatory organization overseeing all investment dealers and trading activity on the equity and debt marketplaces in Canada. It was responsible for enforcing the regulations regarding sales, business and financial practices, and trading activities of the individuals and dealer members under its jurisdiction. It also established new rules and developed recommendations to interpret and amend existing rules. © CANADIAN SECURITIES INSTITUTE 2 6 BRANCH COMPLIANCE OFFICER’S COURSE THE MFDA The MFDA was the mutual fund industry’s SRO responsible for regulating all sales of mutual funds by its members in all provinces except in Quebec. It did not regulate the mutual funds themselves; this responsibility remains with the securities regulators. All mutual fund dealers outside of Quebec had to be members of the MFDA. In Quebec, the mutual fund industry was regulated by the Autorité des marchés financiers (AMF), the Quebec securities regulator. An agreement had been signed between the AMF and the MFDA to avoid regulatory duplication for mutual fund firms operating both in Quebec and elsewhere in Canada. The Chambre de la sécurité financière (the CHAMBRE) is Quebec’s self-regulatory organization in the mutual fund and insurance industry. The CHAMBRE is responsible for setting and monitoring continuing education requirements and enforcing a code of ethics among the licensed representatives. The policies and regulations of the MFDA set minimum standards for mutual fund dealers. Mutual fund activities must comply with all aspects of applicable securities laws and regulations, including policies and regulations set out by the MFDA. IIROC AND MFDA MERGER As of January 1, 2023, the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) have combined to form New Self-Regulatory Organization of Canada (New SRO). The New SRO is the national self-regulatory organization that oversees all investment dealers, mutual fund dealers, and trading activity on Canada’s debt and equity marketplaces and is carrying on the regulatory functions of IIROC and the MFDA. Any references to IIROC and MFDA on the website and other course materials remain, and refer to the New SRO, until a new name is formed. Along with the merger of IIROC and MFDA, the two investor protection funds - the MFDA Investor Protection Fund (MFDA IPC) and the Canadian Investor Protection Fund (CIPF) - have merged into a single investor protection fund under the CIPF designation. Prior to January 1, 2023, Quebec’s mutual fund dealers were regulated by the AMF. Mutual fund dealers registered in Quebec must become members of the new SRO by January 1, 2023. Dealers registered as mutual funds dealers as of December 31, 2022, automatically become members of the New SRO, with no additional formality. Mutual fund dealers registered in Quebec have been allowed a transitional phase to give them time to integrate their Quebec activities under the new SRO. The new SRO’s regulatory requirements, with the exception of the rules necessary to ensure its smooth functioning, will not apply to the dealers’ activities in Québec during this period. The AMF will continue to supervise the mutual fund dealers registered in Quebec during the transitional phase. Recognition of the new SRO by the AMF will not alter the mandate, functions, or powers of the Chambre de la sécurité financière (CSF), as stated in the Act respecting the distribution of financial products and services. The CSF is Quebec’s SRO of the mutual fund and insurance industry and is responsible for setting and monitoring continuing education requirements and enforcing a code of ethics for licensed representatives. ANTI-MONEY LAUNDERING AND ANTI-TERRORIST FINANCING LAWS Securities firms are subject to various regulatory and statutory requirements with respect to money laundering and terrorist financing. The Proceeds of Crime (Money Laundering) and Terrorist Financing Act and Regulations, also known as the PCMLTFA and PCMLTFR, were implemented primarily to detect and deter money laundering and terrorist financing activity, respond to threats posed by organized crime, and assist in fulfilling Canada’s international commitments to fighting transnational crime. Its requirements are supplemented by IIROC rules. The object of PCMLTFA is to implement measures to detect and deter money laundering and the financing of terrorist activities and to facilitate the investigation and prosecution of those offences. It establishes recordkeeping © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 7 and client identification requirements for persons and entities that engage in activities that are susceptible to offences related to money laundering or terrorist financing. It also requires the reporting of suspicious financial transactions and cross-border movements of currency and monetary instruments. The PCMLTFA established the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), the agency responsible for ensuring compliance with the Act and for dealing with reported and other information. FINTRAC collects, analyzes, assesses, and discloses information to assist in the detection, prevention, and deterrence of money laundering and terrorist financing. It is authorized to provide key identifying information on suspicious transactions to law enforcement agencies if there are reasonable grounds to suspect that the information would be relevant to the investigation or prosecution of a money laundering offence. This information could also be provided to the Canada Revenue Agency (CRA), the Canadian Security Intelligence Service (CSIS), and Immigration Canada if there is reason to suspect tax evasion or a threat to national security. FINTRAC is also primarily responsible for monitoring the compliance of financial intermediaries with recordkeeping requirements, the Know Your Client (KYC) rule, and mandatory suspicious transaction reporting requirements. Some important considerations for the securities industry include the following information: The definition of securities dealing in PCMLTFA includes “other financial instruments”, which makes it clear that dealer members dealing solely in financial instruments that fall outside the definition of securities, and not only those authorized under provincial legislation to deal in securities, are included. In other words, dealers who deal with any type of financial instruments or commodities must also comply with the legislation. PCMLTFA requires the reporting of an attempted transaction where there are reasonable grounds to believe it is related to a real or attempted money laundering or terrorist financing offence. This requirement applies to both completed and attempted transactions. Dealer members are required under the Criminal Code to disclose to the Royal Canadian Mounted Police (RCMP) and CSIS “the existence of property in their possession or control that they know is owned or controlled by or on behalf of a terrorist group” and any transactions or proposed transactions related to such property. Dealer members must also file a report on any such disclosure with FINTRAC and to disclose to the RCMP, CSIS, and FINTRAC the possession of the property of listed persons under the Regulations Implementing the United National Resolutions on the Suppression of Terrorism (UNST Regulations). Dealer members must determine whether they are dealing with a foreign or domestic politically exposed person (PEP) or a head of an international organization (HIO) established by the governments of more than one country. A foreign PEP is a person who “holds or has held an office or position in or on behalf of a foreign state.” A domestic PEP is a person who holds a specific office within or behalf of a Canadian federal, provincial, or municipal government. When a dealer member has determined that a client is a foreign PEP, it must take reasonable measures to establish the source of any funds deposited or expected to be deposited to the client’s account. It must also obtain the approval of senior management to keep the account open within 30 days of its activation. For existing accounts for which the client is found to be a foreign PEP, the approval must be completed within 30 days of that finding. Upon approval to deal or continue dealing with the foreign PEP, the dealer member must conduct enhanced, ongoing monitoring of the activity in the foreign PEP’s accounts. This requirement also applies to the spouse, common-law partner, child, mother, father, sibling, or spouse’s or common- law partner’s mother or father of any such person. It should be noted that the definition of a foreign PEP covers only those holding such positions in a national state, not those holding offices in provinces or municipalities. If a dealer member determines that it is dealing with a domestic PEP, an HIO, or a family member of a domestic PEP or HIO, the firm must perform a risk assessment to determine whether the individual is at high risk of money laundering. If so, the dealer must also take reasonable measures to determine the source of funds in the account and obtain within 30 days senior management’s approval to keep the account open. © CANADIAN SECURITIES INSTITUTE 2 8 BRANCH COMPLIANCE OFFICER’S COURSE Dealer members must assess the risk of a money laundering or terrorist financing offence and take special measures regarding activities that pose a high risk. Anti-money laundering and anti-terrorist financing (AML/ATF) compliance policies and procedures must be written, kept up to date, and approved by a senior officer, and a training program for employees or agents must be put in place. In addition, the AML/TF compliance program must be audited every two years, and the review must cover both the AML/ATF policies and procedures and the risk assessment and training programs. Furthermore, the review must be documented, and its findings must be reported in writing to an officer within 30 days of the assessment. Dealer members must obtain the client’s date of birth in addition to information already required. They are prohibited from opening an account for a client if they cannot establish the client’s identity using the means required by the PCMLTFA regulations. They must ensure that their wholly owned subsidiaries and business locations carrying out activities similar to those of dealer members in countries that are not members of the Financial Action Task Force (FATF) have developed and implemented policies and procedures consistent with the requirements of the PCMLTFA, unless a particular policy or procedure contravenes the laws of the country in which it is located. For recordkeeping purposes, dealer members must record the intended use of every new account opened. They must verify the identity of an individual opening an account before any transactions are conducted other than an initial deposit. Documents viewed must be originals and cannot have expired. The recordkeeping provisions allow the recording of the type, reference number, and place of issuance of the piece of identification to be maintained on or with the new account form or signature card. Until the identify verification process is complete, any transactions except an initial deposit are prohibited. Dealer members must consider several issues regarding the initiation of an account transfer (which is considered an initial deposit) before the identity verification has been completed. Two considerations are the risk that the client will be unable to effect transactions and the possibility that the transfer itself could be part of a layering operation. Dealer members filing a suspicious transaction or attempted transaction report must also keep a copy. Under the suspicious transaction reporting regulations, “suspicious” is defined as “reasonable grounds exist to suspect a money laundering offence”. “Reasonable grounds to suspect” is determined by what is reasonable in the circumstances, such as normal business practices and systems within the industry. These reporting requirements apply not only to regulated financial institutions, securities dealers, and currency exchange businesses, but also to individuals acting as financial intermediaries, such as accountants. Under these provisions, failure of an individual to report a suspicious transaction is an offence punishable by up to five years imprisonment, a maximum fine of $2 million, or both. In addition, FINTRAC has legislative authority to issue an administrative monetary penalty of up to $500,000 to reporting entities that are in non-compliance with PCMLTFA. The transaction (or attempted transaction), and specifically what led to a suspicion, is the significant information in a suspicious transaction report. Once it has been determined that there are reasonable grounds to suspect that a transaction or attempted transaction is related to the commission of a money laundering offence, the dealer member must send a suspicious transaction report to FINTRAC as soon as practicable. To comply with this requirement, the dealer might implement a policy requiring representatives to escalate money laundering concerns immediately. If done in good faith, dealer members and their employees who report suspicious transactions to FINTRAC are protected from criminal and civil legal proceedings for doing so. There is no monetary threshold for making a report on a suspicious transaction, and an employee cannot be convicted of failing to report if a suspicious transaction is reported to his or her superior or supervisor. Representatives are not allowed to inform (or “tip”) anyone, including the client, about the contents of a suspicious transaction report or even that a report has been made because such notification could impair a criminal © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 9 investigation. Failure to comply with the reporting requirements can lead to criminal charges against a dealer member or an individual employee, or both. Depending on the facts surrounding a tip, a sales representative could be liable to a Criminal Code prosecution for potential offences, including counselling an offence, accessory after the fact, breach of trust by a public officer, obstructing a peace officer, obstructing justice, and public mischief. Willful blindness occurs when someone is aware that a situation should be investigated but fails to follow through, usually because they do not want to jeopardize a business deal or business relationship. Failure to report a suspicious transaction through willful blindness is punishable by a fine of up to $2 million, imprisonment for up to five years, or both. Knowing involvement in money laundering carries higher penalties than willful blindness (up to 10 years in prison). However, it is not always easy to tell the difference, which puts anyone ignoring signs of money laundering or terrorist financing activity at higher risk. CROSS-BORDER CURRENCY AND MONETARY INSTRUMENTS REPORTING REGULATIONS Regulations regarding cross-border currency and monetary instruments reporting require all persons and entities to report the importing and exporting of currency and monetary instruments of $10,000 or more, or the equivalent in a foreign currency, to the CRA. There are, however, no restrictions on the amount of currency or monetary instruments that may be imported into or exported from Canada, simply that they must be reported. The law applies to any movement across the border, including by mail, courier, or other conveyance, unless the currency or monetary instruments are transported without leaving controlled areas. IIROC rules clarify the definition of monetary instruments to include those that are in bearer form only, or another form if title to them passes on at delivery. These include stocks, bonds, debentures and treasury bills, negotiable instruments such as bank drafts, cheques, promissory notes, traveler’s cheques, and money orders. Instruments specified as belonging to a named individual or entity, such as cheques made out to a specific person or company and not endorsed, as well as fully registered securities that have not been signed off, do not need to be reported. THE OFFICE OF THE SUPERINTENDENT OF FINANCIAL INSTITUTIONS The Office of the Superintendent of Financial Institutions (OSFI) has no legislated role with respect to PCMLTFA; however, it does subscribe to the core principles of supervision of deposit takers and insurance companies. It requires that it be able to determine whether banks have adequate policies, practices, and procedures in place, including strict KYC rules that prevent banks from being used by criminal elements. OSFI also shares the results of its AML/ATF assessments on all federally regulated financial institutions with FINTRAC. Their assessments focus on three key areas: Whether the institution has implemented the policies and procedures needed to comply with PCMLTFA Whether it has the requisite framework of controls in place to report designated transactions to FINTRAC Whether the quality of those controls and the supporting risk management processes are adequate Canadian securities dealers must report monthly to their principal supervisory or regulatory body concerning the possession or control of any property described above. Securities dealer members report to the new SRO, federally regulated financial institutions report to OSFI, and mutual fund dealers report to the provincial securities administrators. TERRORIST FINANCING REPORTING OBLIGATIONS CSA Staff Notice 31-352 describes the terrorist financing reporting obligations for registrants, exempt international dealers, and exempt international advisors. The Notice introduced a new consolidated reporting form that must be submitted to the principal regulator by email on or before the 14th day of each month. IIROC dealer members continue to report monthly to IIROC using the appropriate reporting forms issued by IIROC. © CANADIAN SECURITIES INSTITUTE 2 10 BRANCH COMPLIANCE OFFICER’S COURSE The consolidated report should be signed by a senior officer of the firm, preferably the chief compliance officer. The Notice imposes the following requirements on registrants, exempt international dealers, and exempt international advisors: They must regularly review their records to determine whether they are in possession or control of property owned or controlled by or on behalf of a designated person, and report these findings monthly. They must take necessary measures to determine whether clients are designated persons. If a client is identified as a designated person, in addition to filing the monthly report with their principal regulator or IIROC, registrants must “freeze” the property and report the details to the RCMP and CSIS. A terrorist property report to FINTRAC may also be required. They must file a “Nil” report with their principal regulator or IIROC once it is determined that, for that month, none of their clients is considered a designated person. Furthermore, these regulations require anyone in Canada, as well as Canadians outside Canada, to disclose to FINTRAC, the RCMP, and CSIS the existence of any property in their possession or control that they believe is owned or controlled by or on behalf of anyone on this list. This includes information about any transaction or proposed transaction relating to that property. In addition, reporting is required under the UN Reporting System. The report must be filed no later than the 15th day of each calendar month unless the 15th falls on a Saturday, Sunday, or statutory holiday (in which case the report is due on the next business day). Reports must be submitted using the UN Reporting System found on IIROC’s website. It is an offence under the United Nations Act to deal in property of a designated person or otherwise contravene the regulations. This includes the debiting of service charges and the crediting of interest, or, if the frozen property is a securities portfolio, the crediting of interest, dividends, or other entitlements and the charging of custody fees, transaction fees, or any other debits or credits to the account. This system is for use by IIROC dealer members only. Canadian financial institutions that are not IIROC members must use the appropriate reporting form issued by the relevant province or SRO. JOINT INITIATIVES OSFI and FINTRAC have a memorandum of understanding (MOU) under the authority of the Public Safety Act for exchanging information about money laundering and terrorist financing. The MOU minimizes the potential overlap of work and reduces the impact of administrative requirements on federally regulated financial institutions. FINTRAC and IIROC also have an MOU to exchange information related to money laundering and terrorist financing. Under the agreement, FINTRAC provides information to IIROC to facilitate its risk assessment of dealer members subject to PCMLTFA. In turn, IIROC provides FINTRAC with information regarding dealer members’ adherence to and compliance with PCMLTFA. In addition, the Financial Institutions Commission of British Columbia (FICOM) and FINTRAC have an MOU to exchange compliance information in their joint fight against money laundering and terrorist financing. FICOM is responsible for the administration of The Financial Institutions Act, The Credit Union Incorporation Act, and The Insurance Act. It provides FINTRAC with the results of its assessments of compliance with AML/ATF measures. In return, FINTRAC provides information to help facilitate FICOM’s risk assessment within its regulated sectors. The agreement facilitates the exchange of compliance information and also minimizes the potential overlap of work. To successfully combat international organized crime and terrorism, those involved must be deprived of the monetary proceeds of their criminal activities. Unfortunately, individual jurisdictional efforts aimed at curtailing money laundering have proven to be insufficient. Coupled with the existence of jurisdictional boundaries, global law enforcement efforts to tackle this threat have become strained. The need for cooperation and coordination © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 11 to deter and detect international money laundering has led to the development of numerous international initiatives. For example, Canada is a member of the Asia/Pacific Group on Money Laundering, a regional body comprising 31 member nations, including the U.S., Japan, Australia, and India. Perhaps the best known of these international initiatives is the Financial Action Task Force on Money Laundering (FATF), which was established by the G-7 countries in 1989. The FATF is an intergovernmental body comprising 37 countries (including Canada) and two regional organizations. Its purpose is to establish international standards, to improve national legal systems and strengthen international cooperation in the fight against money laundering. The FATF has identified certain “choke points” in the money laundering process that are very difficult for launderers to avoid and where they are most vulnerable to detection. The three choke points that have been identified are the entry of cash into the financial system, transfers to and from the financial system, and cross- border flows of cash. It is at the point of entry of cash into the financial system where money laundering is most likely to be detected. The FATF maintains and publishes a list of “high-risk and non-cooperative” jurisdictions that have inadequate AML/ATF financing regimes. PURCHASERS’ STATUTORY RIGHTS The CSA have adopted a statement of withdrawal and rescission rights for purchasers, which is summarized in this section. RIGHT OF WITHDRAWAL Securities legislation in certain of the provinces and territories of Canada provides purchasers with the right to withdraw from an agreement to purchase mutual funds within two business days after receiving the fund facts document. As discussed later in this course, the fund facts must be delivered to clients before any mutual funds are purchased. In addition, securities legislation in certain provinces provides purchasers of mutual funds with a limited right to cancel their purchase within 48 hours of receiving confirmation of their order. The client is entitled to receive the original purchase price back on exercise of this right. Any load commissions are returned, and early redemption penalties do not apply in the case of no-load funds. If units of a mutual fund are purchased under a reinvestment plan, the purchaser has no right of withdrawal with respect to the units purchased (after the initial purchase) unless they asked to receive subsequent fund facts and amendments upon renewal. The right of withdrawal can cause problems if a branch staff member fails to deliver the fund facts to the unitholder when an account is opened (or when the offering documents are amended or renewed) because the right of withdrawal remains intact. In some provinces, this open-ended right is subject to a time limit or does not apply to purchases over a certain amount. Because of this continuing right to obtain the original purchase price back, the BCO should implement a system to ensure that investors receive the fund facts before accepting an instruction to purchase a mutual fund. A checklist form such as the one described in Chapter 10, Supervisory and Control Systems, may be useful. If a client asks to exercise the right of withdrawal, refer the matter to your head office or the legal or compliance department. © CANADIAN SECURITIES INSTITUTE 2 12 BRANCH COMPLIANCE OFFICER’S COURSE RIGHT OF RESCISSION In several provinces and territories, securities legislation provides purchasers with a right of rescission or damages if the offering documents (fund facts, prospectus, or AIF) or any amendment to those documents is shown to contain a misrepresentation. These rights usually must be exercised within certain a time limit. There is little likelihood that this right will be exercised, but if a client makes such a claim, you should immediately contact your head office or the legal or compliance department and follow your dealer’s written procedures. If a client wishes to invoke a right of rescission, you should contact the mutual fund dealer’s legal or compliance department or follow your mutual fund dealer’s procedures. THE STANDARDS OF CONDUCT The clients of your branch are entitled to the highest standards of service and ethical conduct. A breach of those standards may give rise to client complaints, which you will have to address. A fair and even approach to all client disputes is required, including supporting your sales representatives when warranted. Despite the age-old adage, the client is not always right in the investment world. Sometimes the cause of a dispute is an unreasonable request or demand on the part of the client. The key standards of conduct your sales representatives must comply with (and which you must continually reinforce) are as follows: Know your client As emphasized throughout this course, the sales representative must make a diligent effort to learn the client’s essential and current financial and personal circumstances, investment knowledge, risk profile, investment time frame, and investment objectives. This can only be accomplished by completing the KYC form, periodically reviewing and updating it, and maintaining it along with any supplemental notes or records. Know your product In addition to meeting their KYC obligations, mutual fund representatives must fully understand the structure, features, fees, and risks of the products they recommend to clients and how the products can be used to help clients achieve their investment objectives. The approval of an investment product by the firm is not enough in itself to discharge the representative’s obligation to take reasonable steps to understand the product and its suitability for a client. It is important to keep in mind that know-your-product obligation is a distinct obligation of individual representatives, separate from the product due diligence responsibilities of the firm. Suitability and All recommendations must be based on an analysis of the KYC information, the acceptability proposed transactions, and the client’s account. Any client order, whether solicited or unsolicited, should be subject to both the suitability and acceptability requirements. This objective may be achieved by the review of the KYC information and the examination of the impact of a trade on the client’s asset allocation. Trades that would exceed the risk exposure, as indicated in the client’s KYC profile, are generally unreasonable. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 13 Appropriate cautions All trades must be reviewed for suitability. If a trade is found to be unsuitable based on a client’s objectives, risk profile, or other circumstances, the sales representative must take appropriate measures to deal with the unsuitable order. These include advising against proceeding with the order and recommending suitable alternatives. The sales representative must document any actions they take. Sales representatives should only recommend suitable and reasonable mutual fund investments that are consistent with the profile of their clients. Integrity of client The information provided by the client is to be used for the benefit of the client information and assets only. This objective may be accomplished by ensuring that both you and the sales representatives maintain arm’s-length relationships with clients. For example, it is improper for a sales representative to ask a client for a personal loan. Even if the client and the sales representative have a long-standing relationship, by acting in this manner, the sales representative is making personal use of the client’s KYC information. Besides profiting from the knowledge that the client can afford to extend the loan, the representative is also interfering with the client’s investment opportunities by appropriating some of their investing potential. If a sales representative engages in this type of behaviour, you should immediately refer the case to the regional compliance officer (RCO) for disciplinary action. The human resources function at your mutual fund dealer should also be informed promptly. Accuracy and All product and market knowledge passed on to all clients must be complete and completeness of accurate. All sales representatives must be fully familiar with and understand the information relayed to content of the fund facts documents, prospectuses, and annual information forms of the client the mutual funds they offer, and they must be able to demonstrate that they know the product. This objective may be accomplished by ensuring that your sales representatives have a solid understanding of the mutual funds and asset allocation services your dealer offers and can accurately describe their features to clients. For example, if a client wants a product that will hold its value when interest rates rise, the sales representatives should be able to tell him or her that only a money market mutual fund meets this requirement. Confidentiality of client All information concerning the client’s accounts must be considered confidential and Information must not be disclosed to anyone outside the mutual fund dealer without the client’s written permission. Where a client provides permission, it is essential that they understand the nature of this action and its possible consequences. This objective may be accomplished by ensuring that sales representatives refrain from discussing client information with anyone outside the mutual fund dealer and by ensuring that client lists, KYC information, and other client-specific information be maintained in secure locations. © CANADIAN SECURITIES INSTITUTE 2 14 BRANCH COMPLIANCE OFFICER’S COURSE No outside deals Sales representatives must not engage in outside deals that appear to involve the mutual fund dealer (or any affiliated financial institution). This objective may be accomplished by ensuring that sales representatives refrain from trading in any other securities, including private placements and private deals. For example, if a client offers a branch sales representative the opportunity to participate in a business he or she is starting, the sales representative should either decline the offer or obtain head office approval before entering into the deal. The danger is that the branch of the mutual fund dealer or affiliated financial institution might appear to be involved in the financing beyond the institution’s usual manner such as providing a small business loan. It is your job to ensure that sales representatives avoid any action that could compromise the integrity and reputation of the mutual fund dealer or affiliated financial institution. Responsible behaviour Sales representatives must not engage in behaviour that could improperly influence a client. This objective may be accomplished by insisting that sales representatives keep their personal business affairs confidential and that they maintain personal integrity. For example, sales representatives should not discuss their personal investment approach or philosophy or their investment holdings with clients except in the most casual manner. For example, saying to a client “I really like our firm’s Asian Pacific Growth Fund. I bought $20,000 of it myself” is improper behaviour that could unduly influence a client to buy units in the fund. The purchase may not be suitable or reasonable for their financial circumstances, risk profile, personal circumstances, investment knowledge, time horizon, or investment objectives. Avoiding the use of All branch employees must avoid using insider information, such as information about insider information a planned takeover bid or the settlement of a material lawsuit involving a public company (that is, a company whose shares are traded on a stock exchange). This objective may be accomplished by ensuring that the flow of information is secure within the branch. In some cases, some information (possibly a misplaced fax message or confidential memorandum) could reach employees inadvertently. Although the information may be innocently obtained, its use by an employee or any person the employee shares the information with may be illegal. Even if the use of such information will not likely affect mutual fund values and cannot directly harm a client, the indirect effect on the financial institution or the mutual fund dealer’s reputation could be devastating. As BCO, you should emphasize this risk with your sales representatives. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 15 Avoiding material All branch employees must avoid conflict-of-interest situations. conflicts of interest This objective may be accomplished by ensuring that all sales representatives are properly (real or perceived) instructed on the dealer’s policies and procedures with respect to outside business activities and appropriate dealings with clients. Adherence to the following guidelines is required: Obtain approval from the BCO or the RCO (or both) before engaging in any outside business activities, including volunteer activities, or accepting any compensation from any person or organization other than the dealer. Do not act as a personal custodian for the money or property of clients. Do not receive or hold client property or mail addressed to or on behalf of a client. Disclose all outside business relationships with clients. Avoid personal financial dealings with clients, including lending or borrowing money. Discuss any offer of a gratuity or compensation from client with the BCO. Typically, unless the gift is truly nominal, the offer should be graciously declined. Do not agree to share in the profits or losses of a client’s accounts. Do not open a joint account with a client. Do not act as trustee or executor for a client. Exceptions may be permitted for immediate family members and for clients in extremely limited circumstances as long as approval is obtained. Do not accept gifts from clients or offer gifts to them other than dealer-approved gifts of nominal value. To avoid conflicts of interest, or even the appearance of a conflict, BCOs must ensure that sales representatives under their supervision are aware of the approval process for outside business activities and what constitutes acceptable dealing with clients. Sales representatives should be encouraged to seek counsel if they have any questions as to whether a proposed activity is permitted or represents an actual or perceived conflict of interest. No discretionary Do not allow the sales representative to be appointed power of attorney or a trading trading authorization, even if the client requests it. Only limited trading authorizations may be accepted, which would permit you to accept requests electronically. Make sure there are no blank signed forms in the file. They would suggest an intention to trade on a discretionary basis, which is not permitted unless the sales representative is registered as an advising representative for a portfolio manager. ENFORCING STANDARDS OF CONDUCT To ensure proper behaviour, several systems should be implemented. At a minimum, you should review the KYC files periodically to ensure that they remain current and that the clients’ asset allocations remain suitable and reasonable. An effective approach could include a regular, systematic review of a certain proportion of files. Remember that the activities of new sales representatives are subject to enhanced scrutiny. Many mutual fund dealers require their sales representatives to certify, either in writing or electronically, that they are in compliance with all policies and procedures and have reviewed all product and service information updates, including the fund facts, prospectuses, and annual information forms for the funds offered. To ensure compliance with the conflict-of-interest requirements, you should conduct scheduled reviews of all sales representatives’ trading accounts for the first six months. After six months, they are treated the same as established sales representatives. © CANADIAN SECURITIES INSTITUTE 2 16 BRANCH COMPLIANCE OFFICER’S COURSE Cautions about unsuitable trades should be acknowledged and signed by the client, where possible, and the sales representative. Check to make sure that orders processed without a client’s signature were not discretionary trades. Telephone trades, for example, do not have a client signature even though the client authorized them. However, it should be noted in the file that the call was recorded or an email or fax was forwarded as confirmation of the request and evidence of the client’s authorization. Whenever possible, have phone calls directed to the call centre, which is usually able to record all calls. If electronic trade acceptance is permitted by your dealer, you should ensure that the firm’s internal policies and procedures regarding recordkeeping are followed. CYBERSECURITY AND AWARENESS Cyber risks are relevant to every organization given their dependence on information technology and data to operate their businesses. Cyber risk is increasingly one of the greatest risks to the mutual fund industry due to the frequency complexity of cyber breaches and the harmful consequences that can result for both the client and the dealer. The MFDA and IIROC, in addition to the securities regulators in Canada and the Unites States, have identified cybersecurity and privacy as critical issues that mutual fund representatives and supervisors alike must be aware of in their daily operations and practice. Much like the threat that money laundering poses to the industry, cyber risks are serious threats to clients and the securities industry. As the BCO, you are responsible for ensuring that mutual fund representatives under your supervision comply with the dealers’ policies and procedures that relate to cybersecurity and incident prevention and detection, including electronic communication. You are also responsible for ensuring that all required training is completed and understood by the mutual fund representatives under your supervision. CLIENT FOCUSED REFORMS On October 3, 2019, the CSA released its final amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. In an initiative called the Client Focused Reforms (CFR), the CSA proposed changes to the registrant conduct requirements to better align the interests of securities registrants (including advisors, dealers, and representatives) with the those of their clients. The intent of the initiative was to improve outcomes for clients and make clearer to them the nature and terms of their relationship with registrants. The provisions set out in the CFR regarding conflicts of interest, which were the first reforms implemented from the initiative, came into effect on June 30, 2021. As such, the MFDA has harmonized its implementation timelines with those adopted by the CSA in respect to all CFR amendments made to MFDA regulatory instruments. The MFDA has also amended its rules for consistency with the CSA’s CFR conflicts of interest amendments, which became effective on June 30, 2021. The changes align the MFDA’s existing requirements with the enhanced obligations of the CSA CFRs. The CSA CFRs, among other things, introduced a requirement to address material conflicts of interest in the best interests of the client. While the new SRO’s current conflict-of-interest rules already include a best-interest standard, it has aligned its standard with the CSA’s CFRs. The amendments also introduced enhanced standards for the disclosure of conflicts of interest. The disclosure must include a description of the nature and extent of the conflict of interest, the potential impact on and risk the conflict of interest could pose to the client, and how the conflict of interest has been, or will be, addressed. CHANGES TO CONFLICT-OF-INTEREST RULES Effective June 30, 2021, Part 13 of NI 31-103 requires registered firms and individuals to identify, address, and disclose material conflicts of interest. Representatives must address such conflicts in the best interest of the client and provide guidance to explain when a conflict of interest is considered material. To comply with NI 31-103, representatives must avoid material conflicts of interest if there are no adequate or appropriate controls available in the circumstances to address the conflict in the client’s best interest. Similarly, if a © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 17 conflict can be addressed using controls, but the controls used by a registered firm do not sufficiently mitigate the effect of the conflict, the firm must avoid the conflict until it has implemented sufficient controls. The changes to the conflict provisions introduced several requirements to the existing conflict rules, as noted in NI 31-103. They can be summarized as follows: Both firms and individual registrants acting on behalf of their firms must identify material conflicts of interest that currently exist between a client and the firm or an individual acting on behalf of the firm. As part of this process, they must also identify material conflicts that are reasonably foreseeable. The material conflicts so identified must be addressed in the best interests of the client. If the conflicts cannot be addressed in the best interests of the client, they must be avoided. The firm must disclose any material conflict of interest that may impact a client at the time of account opening, or as soon as possible if the conflict is identified later. For each conflict identified, the disclosure provided to clients must be prominent, specific, and written in plain language. It must outline the following matters: The nature and extent of the conflict The impact and risk it may pose to the client The way in which it has been or will be addressed The CFR amendments point out that it is not enough for a registrant to rely solely on disclosure as a means to satisfy its obligations under the conflict provisions. Finally, individual representatives have similar obligations to those of the firm and must report conflicts to their firm promptly. RULES FOR TELEMARKETING AND THE NATIONAL DO NOT CALL LIST The Canadian Radio-television and Telecommunications Commission (CRTC) established the Unsolicited Telecommunications Rules (the Rules) and the National Do Not Call List (National DNCL), which provide a regulatory framework for telemarketing calls and other unsolicited telecommunications received by consumers. The Rules and the National DNCL established requirements for telemarketers relating to allowable times of day to call, required introductions, record maintenance, and penalties. The National DNCL is part of the rules that telemarketers must subscribe to and consult in most cases before making calls. However, in certain circumstances (e.g., where consent to be called has been provided), they do not have to consult the National DNCL, but must still comply with the broader framework of the Rules. Any mutual fund dealer that uses the phone for solicitation is subject to the Rules, and anyone working for a mutual fund dealer is subject to the Rules when engaged in telemarketing. The Rules also apply to organizations that conduct telemarketing on behalf of an organization. However, the National DNCL provisions do not apply to a telemarketing communication made to a business consumer. The CRTC defines “solicitation” as “selling or promoting a product or service, or the soliciting of money or money’s worth, whether directly or indirectly and whether on behalf of another person. This includes solicitation of donations by or on behalf of charitable organizations.” Telemarketing is defined as “the use of telecommunications facilities to make unsolicited telecommunications for the purposes of solicitation”. The Rules and the National DNCL do not apply to calls to existing clients in regard to servicing an account. Neither do they apply to communications within a normal relationship between a sales representative and a client where information is sought or given regarding recommendations for appropriate products and services. © CANADIAN SECURITIES INSTITUTE 2 18 BRANCH COMPLIANCE OFFICER’S COURSE If a potential client has provided the mutual fund dealer with express consent to be contacted, the sales representative may do so. For example, if a client fills out a form that indicates his or her willingness to be contacted at a trade show or other promotional event, the National DNCL provisions would not apply, and the sales representative would be permitted to contact the individual. For mutual fund dealers, the key exemption in the regulation is for existing business relationships under certain circumstances. Such a relationship is defined as a business relationship that has been formed by a voluntary, two- way communication between the person calling and the person being called. However, in situations where there has been prior contact with a prospective client who does not have an account with the firm and has not expressed consent to be called, the Rules apply, but the exemption is available. To clarify, if the mutual fund dealer has received an inquiry from a prospective client in the previous six months, the sales representative may be permitted to call to re-establish contact or inform them of a new development, The dealer must still register under the National DNCL, pay fees, observe the time restrictions for calling, and otherwise comply with the introduction and call display requirements of the Rules, but it does not have to subscribe to the National DNCL list or check the list before the call. The entire Rules framework, including the requirement to subscribe to the National DNCL, applies if any of the dealer’s business is generated through cold calling potential clients or referrals. The enforcement process for the National DNCL is complaint driven. The penalties for each violation range up to $1,500 for individuals and to up to $15,000 for corporations. The following factors are considered when determining whether to issue a notice of a violation and what amount the associated penalty may be: The nature of the violation (minor, serious, very serious, negligent, or intentional) The number and frequency of complaints and violations The relative disincentive of the measure The potential for future violations The CRTC has indicated that, once an account has been opened, the Rules do not apply to dealer-client communication in the ordinary course of business. However, they have also recommended that it may be prudent to include express consent to be contacted by phone in the client’s opening documentation. Express consent includes the following forms of communication: Written consent to be contacted by way of telecommunications, signed by the person giving consent Oral consent verified by an independent third party or an audio recording of the consent retained by the telemarketer or client of the telemarketer Electronic consent through the use of a toll-free number Electronic consent over the internet Consent through other methods as long as a documented record of that consent is created by the consumer or by an independent third party CANADA’S ANTI-SPAM LEGISLATION Canada’s Anti-Spam Legislation (CASL) establishes rules for the sending of commercial electronic messages (CEMs). The legislation requires businesses to obtain either express “opt-in” or implied consent to send CEMs, including emails and certain types of social media messages. In addition, all electronic marketing messages must clearly identify the sender. They must include the sender’s contact information and provide an unsubscribe mechanism, unless fully exempted from the legislation. Organizations that do not comply with CASL risk serious penalties, including criminal charges, civil charges, personal liability for company officers and directors, and penalties up to $10 million. As a BCO, it is your responsibility to ensure that your sales representatives comply with these rules. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2 MUTUAL FUNDS INDUSTRY REGULATION 2 19 SUMMARY Now that you have completed this chapter, you should be able to meet the following objectives: 1. Provide a general description of the scope of securities law as it applies to mutual funds and know how to comply with it. The provincial and territorial securities commissions are the regulatory bodies responsible for the administration of the securities legislation in their respective provinces and territories. The regulatory bodies in all provinces and territories have delegated powers to the new SRO with respect to mutual fund dealers, with a transitioning period for Quebec’s dealers. National Instrument 81-102 is the primary legislation relating to the regulation of mutual funds in Canada. National Instrument 31-103 addresses registration categories and requirements, proficiency qualifications, categories of registration compliance requirements, disclosure, and dealings with clients. 2. Describe and implement a program of standards of conduct within the branch of the mutual fund dealer. Key standards of conduct that sales representatives must comply with are as follows: « The sales representative must make a diligent effort to learn the client’s financial and personal circumstances, investment knowledge, risk profile, investment time frame, and investment objectives. « All recommendations should be based on an analysis of the client’s KYC information. « All products that are being recommended must be fully understood by the sales representatives. « All trades must be reviewed for suitability. « The information provided by the client must be used for the benefit of the client only. « All product and market knowledge passed on to all clients must be complete and accurate. « All information concerning the client’s accounts must be considered confidential. « Sales representatives must not engage in outside deals. « Sales representatives must not engage in behaviour that could improperly influence a client. « All branch employees must avoid using insider information. « All branch employees must avoid conflict-of-interest situations. « Sales representatives should not have power of attorney in client accounts or trading authorization beyond permission to accept client requests, for example, by phone, fax, or email. 3. Implement a system for enforcing standards of conduct. Many mutual fund dealers require their sales representatives to certify, in writing, that they are in compliance with all policies and procedures. Branch compliance officers must periodically review clients’ KYC files to ensure that they remain current. An effective approach could include a systematic review of a certain proportion of files on a periodic basis. They must review all sales representatives’ trading accounts as per the schedule for the first six months of employment. They must make sure that orders are processed with the client’s signature or other evidence that the client’s authorization has been properly recorded for telephone trades. © CANADIAN SECURITIES INSTITUTE 2 20 BRANCH COMPLIANCE OFFICER’S COURSE They must ensure that sales representatives provide the fund facts document before accepting any purchase instruction. They must ensure that sales representatives are aware of and have received the necessary training regarding cyber security. Representatives who use the phone for solicitation are subject to the Unsolicited Telecommunications Rules and the National DNCL. © CANADIAN SECURITIES INSTITUTE