Sales Representative Supervision PDF

Sales Representative Supervision 9 CONTENT AREAS Supervising the Relationship Between the Client and the Sales Representative Confidentiality Mutual Fund Performance Communications...

Sales Representative Supervision 9 CONTENT AREAS Supervising the Relationship Between the Client and the Sales Representative Confidentiality Mutual Fund Performance Communications Describing Fees and Loads Supervising the Rates of Return Communications to Clients Client Account Performance Reporting Unacceptable Sales Practices Non-Registered Sales Staff Prohibited Activities Registered Sales Staff Prohibited Activities Orders Supervision Sales Practices Supervision Disclosure of Conflicts of Interest LEARNING OBJECTIVES 1 | Describe the relationship between mutual fund sales representatives and clients, and discuss the obligations and responsibilities that arise from this relationship. 2 | Explain why standard performance data must always be used when any performance data is provided or displayed. 3 | Identify the mutual fund-related activities that non-registered sales staff may perform and those they are prohibited from performing. 4 | Discuss the order activities registered sales staff are prohibited from performing. 5 | Supervise the order-execution process, including the processing of client orders. © CANADIAN SECURITIES INSTITUTE 9 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. current yield no-load fund distributor soft-dollar arrangements fiduciary responsibility trailer fee management expense ratio © CANADIAN SECURITIES INSTITUTE  CHAPTER 9 SALES REPRESENTATIVE SUPERVISION 9 3 INTRODUCTION The supervision of sales representatives is a key responsibility of a branch compliance officer (BCO). Failure to properly supervise the activities of your staff, both registered and non-registered, may result in serious consequences for you, your staff, and your firm. In this chapter, we address the many procedures that sales representatives must follow to comply with regulations. We discuss the importance of confidentiality, and we explain how to communicate mutual fund performance and the related fees and loads. Next, we describe acceptable and unacceptable sales practices and identify the activities that are prohibited by registered and non-registered staff. Finally, we address your role as a BCO in the supervision of orders and sales practices, and we end the chapter by explaining why conflicts of interest must be disclosed to clients. SUPERVISING THE RELATIONSHIP BETWEEN THE CLIENT AND THE SALES REPRESENTATIVE The ethical and legal responsibilities of sales representatives toward their clients and the appropriate handling of conflicts of interest are important considerations in the mutual fund sales and advisory process. The single most important relationship on the dealer side of the mutual fund industry is the one between the sales representative and the client. The moment that contact is made regarding mutual funds, a relationship is established. Sales representatives often have a fiduciary responsibility to investors, that is, an obligation to act in the best interests of investors and not solely in the mutual fund dealer’s interest. When acting in the client’s best interest, the sales representative is not permitted to realize any personal gain that might instead have been obtained for or by the client. This responsibility extends beyond the notion of private gain to include the need to exercise reasonable care and professional judgment in providing advice and services to clients. Conflicts of interest are embedded in the financial system. For example, sales representatives who are compensated on the volume of mutual fund sales might be motivated to sell mutual funds rather than more suitable investments such as guaranteed investment certificates (GICs). Or they might extend loans to clients to buy mutual funds, regardless of whether the funds are suitable, simply to increase sales of both mutual funds and loans. In these situations, the sales representative’s personal interests (and those of their employer) are in conflict with the client’s interests. The sales representative must either avoid the conflict or disclose it, either implicitly or explicitly, to the client. The structure and operation of mutual funds create numerous conflicts of interest that are typically outside your control as BCO. Two examples of transactions with inherent conflicts of interest that could affect the value of mutual funds held by your clients are discussed below. THE USE OF AFFILIATED BROKERS Mutual fund managers must use brokers to purchase and sell securities for a mutual fund’s portfolio. The fees and commissions charged by brokers are paid by the fund. If the fund manager chooses to use an affiliated broker (i.e., another subsidiary of the same bank), it raises the concern as to whether the choice of broker is in the best interest of the fund or is intended to increase commissions paid to the broker. There is nothing inherently wrong with this practice, particularly if it results in cost savings for the fund; however, there is the danger of abuse. This issue is addressed through the disclosure of brokerage arrangements and commissions paid by the mutual fund in the annual information form provided to investors. © CANADIAN SECURITIES INSTITUTE 9 4 BRANCH COMPLIANCE OFFICER’S COURSE SOFT-DOLLAR TRANSACTIONS A broker or dealer can provide non-monetary benefits to the mutual fund company or the fund’s portfolio manager in return for receiving a specified number of commissions, order flows, or other benefits (collectively known as soft-dollar benefits). For example, a fund manager might receive research reports and statistical data in return for guaranteeing a specific amount of commission income to the broker. This raises the question of whether the mutual fund is paying too much for the services provided by the broker and whether the mutual fund is receiving any value from the soft-dollar arrangement in return. If the benefits of the arrangement are of assistance or value only to the portfolio manager or the company, then the fund is paying for something from which it derives no benefit. National Instrument 23-102 and related Companion Policy 23-102CP seek to clarify when portfolio managers can exchange client brokerage commissions as payment for soft-dollar arrangements. The Instrument dictates that portfolio managers cannot direct brokerage commissions to a dealer under formal or informal arrangements in return for goods or services unless the commissions are related to order-execution goods or services or research goods or services. Order-execution goods and services are those that are directly related to an order management system, and research goods and services include research, reports, databases, and software to support the investment. Ethical and moral questions in the securities industry are not limited to mutual funds and their managers; sales representatives could have similar ethical lapses while fulfilling their duties. Internal policies and procedures at the mutual fund dealer should generally include guidance on acceptable practices regarding ethics and conflicts of interest. CONFIDENTIALITY In the mutual fund industry, confidentiality is a fundamental aspect of the client relationship. Clients must trust that their private information is kept secure. To preserve and protect that trust, and to meet legal and regulatory requirements, sales representatives have a duty to preserve and protect the confidential information clients are required to share with them. GUIDELINES FOR PROTECTING CONFIDENTIAL INFORMATION As BCO, you must make sure that sales representatives take all reasonable steps to protect their clients’ confidential information. The following guidelines should be in place for this purpose: Control access to confidential information. Exercise care when discussing confidential information with dealer employees, clients, and other third parties (including family members and friends). Refrain from discussing confidential information in public places such as public transit, elevators, and restaurants. Keep documents in the workplace safe and away from areas where they can be lost, stolen, or viewed by bystanders or other dealing representatives with no need to know. Take steps to secure sensitive information when an employee’s desk or computer is unattended. Safeguard documents that are physically or electronically removed from the office. Act with the knowledge that conversations on phones and communications over the internet may not be confidential. Verify that the correct fax number or email address of a recipient is used when sending confidential information. Use a secure fax or dealer client portal where appropriate, and obtain authorization from the client to communicate electronically. © CANADIAN SECURITIES INSTITUTE  CHAPTER 9 SALES REPRESENTATIVE SUPERVISION 9 5 Determine whether confidential information should be shredded or otherwise made inaccessible before disposal. Do not leave computers unattended and accessible to outsiders or dealer personnel with no need to know. Log off computers at the end of the day and when away from the workplace. Regarding acceptable electronic communication with clients, sales representatives under your supervision must know and comply with the dealer’s policies and procedures. Most dealers will deliver confidential client information and statements through a secure web portal with encryption and password protocols in place. When in doubt about how to handle confidential information, sales representatives should seek guidance from their BCO. If you, as the BCO, have questions, seek counsel from your regional compliance officer (RCO) or legal department before using or disclosing any client information. MUTUAL FUND PERFORMANCE COMMUNICATIONS As BCO, you are responsible for ensuring that your sales representatives’ discussions with clients conform to ethical and legal standards and that they follow the rules pertaining to discussions of past performance of mutual funds. NEED FOR STANDARD PERFORMANCE DATA When discussing mutual fund performance, sales representatives are allowed to describe a mutual fund in terms of rate of return, volatility or yield, rating, and rankings, as long as a discussion of standard performance data is (SPD) also provided. In other words, if any performance data is mentioned, the sales representative must also disclose the SPD. The SPD differs for different types of funds, as follows: For money When discussing mutual fund performance with a client, the SPD used must be the market funds current yield or the current and effective yield. In other words, it must reflect a seven- day period ending not more than 45 days before the date of use. For all other The total return* including one, three, five- and 10-year numbers, must be calculated mutual funds not more than 45 days before the date of appearance or use of the advertisement in which it is included, or not more than three months before the date of publication of any other sales communication. * Total return reflects the change in net asset value plus distributions. A sales representative can only discuss rankings prepared by an independent organization and accompanied by the SPD for the mutual fund that is being discussed. With all mutual fund-related disclosures, footnotes and the SPD must be shown using a minimum 10-point font size. FUNDS WITH RECORDS OF LESS THAN ONE YEAR If the mutual fund is less than one year old, the sales representative should provide full information about the fund, including goals and objectives, risks of the fund, type of income generated by the fund, and types of investments in the fund. Do not volunteer any performance data since there is no SPD available. If specifically asked by the client, you may give only the total rate of return to date. For a money market fund less than a year old, only the current yield should be given. © CANADIAN SECURITIES INSTITUTE 9 6 BRANCH COMPLIANCE OFFICER’S COURSE PAST PERFORMANCE DISCLOSURE The client must be reminded that past performance is not necessarily indicative of future performance. This is a standard and required form of disclosure that should be repeated several times during a sales presentation. As an example of the pitfall of using past performance, consider the following case in which you are given the annual returns for the past ten years: Year 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Return (%) 23.5 33.6 −18.8 14.4 −14.9 −1.0 3.0 96.2 3.4 0.0 The descriptive statistics here are interesting. The simple average or mean return over the 10-year period is 13.9%, and the geometric or compound average is 10.4%. However, in only one of the 10 years (2016) was the return even close to either of those numbers. The fund was a big winner one year, a winner three years, a loser four years (if you consider a minimal return a loss given the opportunity cost), and a big loser twice. In fact, the fund had six bad years and four good years. An investor who held for 10 years earned a respectable 10.4% over the period. What does this tell us for the future? Looking at possible short-term results, the 10.4% number is meaningless. What you can expect is a reasonable chance of a reasonable return, the possibility of some fairly severe losses, and a fair chance that you will only break even. In other words, the past supplies no clue as to future performance in the short run. With a long holding period, the 10.4% return takes on greater relevance and becomes the best, albeit problematic estimate. The less volatile the fund, the more reliable the estimate. FUTURE PRICE OR VALUE Sales representatives may not predict the future prices or values of specific mutual funds; representations as to future value are strictly prohibited. Even statements about probability, such as, “there is a good chance that this fund will double in the next two years”, are not permitted. As BCO, you must make sure that sales representatives do not engage in this kind of forecasting. Even with respect to money market funds, the current yield for the past seven-day period is historical. Sales representatives must not imply to clients that this is the yield they will get next week or what the fund is “currently earning.” PERFORMANCE GRAPHS AND CHARTS Sales representatives may use performance charts and graphs to illustrate the variability of mutual fund investments, but these should be supplied by head office. They must not prepare their own charts and graphs. Furthermore, the rules of the Mutual Fund Dealers Association (MFDA) require all advertisements and sales communications be approved by a director, officer, compliance officer, or branch manager who has been designated responsibility by the mutual fund dealer for advertisements and sales communications prior to use or distribution to the public. USE OF COMPARISONS Performance comparisons between funds, benchmarks, and indexes are allowed, but they must conform to the following rules: All data must pertain to the same period. If two funds are compared, they must be compared using the same time frame, (e.g., one-year, three-year, or five-year comparisons). If different types of investments are compared, the relevant investment characteristics should be clearly distinguished in terms of different credit ratings and relevant differences in guarantees, potential fluctuations © CANADIAN SECURITIES INSTITUTE  CHAPTER 9 SALES REPRESENTATIVE SUPERVISION 9 7 in yields, income, total return, insurance, tax features, and all other factors necessary to make fair, transparent comparisons. For example, if you compare a GIC and a money market fund or other income fund, you must emphasize the differences in CDIC insurance, financial institution guarantees, and fluctuations in the principal. If a fund’s performance is compared to a benchmark such as an index or an average, the index or average should be clearly described. Any material differences between the way the performances of the index or average and the mutual fund itself are calculated should be clearly drawn. DESCRIBING FEES AND LOADS There are three main costs that may be borne by fund holders, depending on the fund: Loads or sales charges payable at purchase Management fees charged directly to the fund Management expenses charged directly to the fund, such as operating and legal costs The total management fee plus management expenses make up the management expense ratio (MER). The MER is calculated annually and shows the cost of running that particular mutual fund. Therefore, when determining how efficiently a fund has operated on an annual basis, the MER is a good indicator. Sales charges are levied by so-called load funds. Loads are often negotiable, and some dealers sell load funds at zero commission. However, load funds sold this way are not considered no-load funds. No-load funds are funds that charge no sales fees. All funds charge management fees and expenses. Performance data are calculated after deducting these costs, which accrue daily and are taken into account each time the net asset value per unit is calculated. Performance data does not consider sales charges paid to purchase load funds. Load funds are widely sold. The commissions are paid by the investor to the mutual fund dealer at the time of purchase and are calculated on the total investment. For example, an investor who invests $10,000 in a mutual fund and pays a 5% load pays $500 in commissions, and that amount is deducted from the total to be invested. This represents a load of 5.26% as a percentage of the $9,500 that goes to the purchase of units ($500/$9,500 = 5.26%). Although loads as high as 9% (or 9/91 × 100 = 9.9% effective) may be published, they are negotiable and can normally be reduced depending on the size of the order and the client’s bargaining skills. Over 40% of Canadian mutual funds charge no loads at all. The no-load group, consisting primarily, but not exclusively, of funds offered by mutual fund dealer subsidiaries of banks and trust companies, charges no sales commissions. Instead, they are sold through sales representatives within their branches or through arrangements with brokers. A portion of the management fee, called a trailer fee, may be paid as a commission to the sales representative or the selling broker. Many funds are now offering choices. In some cases, as many as four different classes of shares or units may be offered by the same fund, each with a different combination of sales commissions and management fees. Your sales representatives should be able to explain the differences to their clients. The managers of many mutual funds pay trailer fees or service fees to mutual fund dealers and their sales representatives. The fees are generally paid each quarter and are based on the value of mutual funds held in the client’s account with the dealer. The typical fee is between 1.00% and 0.50% per year. It is said to be paid as compensation by the dealer for providing services to unitholders of the fund, thereby minimizing the services the manager would have to provide directly. Many believe that trailer fees are simply retention commissions designed to act as a disincentive for sales representatives to generate another sales commission by recommending that their clients sell units of one fund to purchase units of another. © CANADIAN SECURITIES INSTITUTE 9 8 BRANCH COMPLIANCE OFFICER’S COURSE Some no-load funds charge a fee of up to 2% on redemptions within 90 days of purchase to deter frequent traders who otherwise could purchase and sell mutual funds without any cost. This fee is a penalty fee and not a commission, as it is paid to the mutual fund, not the sales representative or the mutual fund dealer. SUPERVISING THE RATES OF RETURN COMMUNICATIONS TO CLIENTS As with any communication delivered to the client, the expectation is that the client will be provided with “full, true, and plain disclosure”. This obligation extends to any communication provided to the client where an annualized rate of return is given regarding a specific account or group of accounts. A client communication that includes an annualized rate of return must include an explanation of the method of calculating the rate of return and must be in accordance with standard industry practices. NI 31-103 prescribes requirements regarding performance reporting, including the need to explain how the annualized rate of return and percentage return were calculated, as well as the need to provide a money-weighted return. A time-weighted return such as the Dietz or Modified Dietz method, and any method approved under the Global Investment Performance Standards as endorsed by the CFA institute, may be provided in conjunction or as a separate statement. Regardless, the money-weighted return must be provided at least once every 12 months to clients. For client accounts that have been opened for less than 12 months, the rate of return shown must be the total rate of return beginning from the time the account was opened at the mutual fund dealer. It is also expected that any client communication that contains or refers to a rate of return has been reviewed and approved by head office or by the designated individual who is responsible for performance reporting at the dealer. CLIENT ACCOUNT PERFORMANCE REPORTING In addition to communicating rates of return, clients must be provided with information about the performance of their investments. As described under NI 31-103 and MFDA rule 5.3.5, the sales representative and BCO must ensure that clients are provided annually with a performance report that covers at least a 12-month period. Performance reporting provided to clients must include the following information: The market value of the assets held in the client account at the start and end of the period covered by the report If the market value of the investment is not readily attainable, the performance report should include a statement explaining why the information was not included. Total assets deposited and withdrawn during the period covered by the performance report For example, money that has been deposited and withdrawn during the 12-month period or any funds or investments transferred from another mutual fund dealer should be reflected in the performance report. The gain or loss in the account as of the end of the period covered by the report This should include any fees and charges to the account and any accruals for investments that earn interest income. The annualized total percentage returns These should be calculated using a money-weighted rate-of-return method for one-, three-, five-, and 10-year periods and “since inception”; periods of less than one year cannot be annualized. Your dealer may also choose to send performance reports more frequently than every 12 months, but the minimum threshold for account performance reporting should be no less than annually and should cover at least a 12-month period. © CANADIAN SECURITIES INSTITUTE  CHAPTER 9 SALES REPRESENTATIVE SUPERVISION 9 9 UNACCEPTABLE SALES PRACTICES The rules regarding verbal and written sales communications with clients are set out in Section 15 of National Instrument 81-102. It is your responsibility as BCO to ensure that the sales representatives follow these rules. Section 15 of NI 81-102 specifically sets out what is considered misleading information. The following sales communications are automatically considered unacceptable or misleading, which you may decide to stress at periodic sales meetings: Saying anything that is in conflict with the mutual fund offering documents (fund facts, prospectus, and annual information form) Presenting information in a way that could distort the information in the offering documents Over-emphasizing tax savings Including a visual image or chart that gives a misleading impression Using exaggerated projections that do not reflect market conditions Using excessive switching tactics such as convincing a client to switch into mutual funds when it is clearly not suitable Guaranteeing the ability to repurchase units at a particular price in the future Suggesting that the net asset value of the fund is likely to remain stable when such a statement cannot be justified Prospecting a client by phone or personal call (in some provinces), unless the client is a current client or has requested the call MFDA Rule 2.7 also deals with verbal and written sales communications. In addition to repeating many of the prohibitions above, this rule prohibits any advertisement or sales communication that is detrimental to the interests of the public, the MFDA, or any member of the MFDA. The broad language of this rule gives the MFDA considerable leeway in initiating disciplinary actions. NON-REGISTERED SALES STAFF PROHIBITED ACTIVITIES With the introduction of National Instrument 31-103 Registration Requirements (NI 31-103), a principal change was made in the registration trigger. Previously, a non-registered individual could not participate in any activity that would be seen to be “acting in furtherance of a trade” or “trading in securities.” However, under NI 31-103 the registration trigger was changed from a “trade trigger” to a “business trigger”, meaning that any person who is in the business of trading in securities or advising in securities requires registration. When assessing whether a non-registered individual’s activities trigger the registration requirement under NI 31-103, consider whether they engage in any of the following activities: Directly or indirectly holding oneself out as being in the business of the activity Responding to questions about mutual funds in a way that is not permitted Claiming to be registered under securities legislation without being registered Intermediating a trade between a buyer and seller of securities Being or expecting to be remunerated or otherwise compensated for undertaking the activity Soliciting others in connection with the activity, either directly or indirectly © CANADIAN SECURITIES INSTITUTE 9 10 BRANCH COMPLIANCE OFFICER’S COURSE ALLOWABLE ACTIVITIES FOR NON-REGISTERED SALES STAFF Despite the general and specific prohibitions, non-registered staff may perform some limited functions with respect to mutual fund activities. The important, albeit ancillary, mutual fund-related activities that your non-registered employees are allowed to perform are as follows: Advise clients that the financial institution has a mutual fund dealer subsidiary that sells mutual funds. Refer clients to the sales representatives, the mutual fund dealer branch investment, sales centre, or telephone communications systems. Receive redemption requests to forward to a registered sales representative for processing. Distribute brochures, fund performance updates, and other promotional material, including current fund prices. Define the general characteristics of mutual funds if asked by a client, including diversification, professional money management, and recordkeeping. However, non-registered staff must limit their response to defining these characteristics. They may not provide specific information nor discuss specific mutual funds. Provide current account information. Receive a completed order form to forward to the sales representative. As BCO, you must ensure that activities are organized in such a way that non-registered staff are not perceived as being in the business of mutual fund sales. REGISTERED SALES STAFF PROHIBITED ACTIVITIES All advice regarding a trade in a mutual fund must be based on client-specific information, and investment suitability must be maintained at all times. To provide acceptable advice, the sales representative is expected to obtain information that will typically result in the client being invested in the dealer-approved model portfolio or portfolio mixes. Neither you nor your sales representatives should independently design your own model portfolios or portfolio mixes. These are typically prepared at head office, and instructions are provided for amending the model portfolios to meet the demands or needs of clients. These instructions should be followed. DISCRETIONARY TRADING Sales representatives should never trade on a discretionary basis. Discretionary trading occurs when the sales representative determines the timing or price of a purchase or sale without specific instructions from the client. For example, if a client asks the sales representative to exercise their judgment on when to place an order, the sales representative must refuse the request. Make sure your sales representatives understand that discretionary orders should not be accepted or placed. A sales representative who places a discretionary order may be reprimanded or even terminated by the dealer. The securities regulatory authorities will also impose disciplinary action on sales representatives who engage in unauthorized trading. Make sure you and your sales representatives do not process any transactions for clients without their prior consent and instruction. SELLING MUTUAL FUNDS TO NON-RESIDENTS Canadian mutual funds are not registered for sale outside of Canada. Most countries have legislation requiring domestic registration of mutual fund dealers and sales representatives. Accordingly, your mutual fund dealer would probably be in violation of foreign legislation if Canadian mutual funds were sold to non-residents without a current and local legal opinion to support the investment. Requests from non-residents who telephone or write specifically requesting information on mutual funds should be directed to head office. © CANADIAN SECURITIES INSTITUTE  CHAPTER 9 SALES REPRESENTATIVE SUPERVISION 9 11 The U.S. Securities and Exchange Commission has adopted a rule that, in certain circumstances, allows Canadian mutual fund dealers to deal with Canadians who are residents of the U.S. for transactions in registered accounts, including RRSPs, RRIFs, LIFs, and LIRAs. Most U.S. states have now adopted similar regulatory relief for Canadian mutual fund dealers dealing with holders in their jurisdictions of Canadian, self-directed, tax-advantaged retirement plans. Before accepting an order from a non-resident, you should consult with head office or your RCO to make sure the order is acceptable. SHORT-TERM TRADING Short-term trading is the redemption of mutual fund securities within 90 days of purchasing them. This activity can be potentially abusive to the long-term unitholders in that it can add transaction costs to the mutual funds. Sales representatives must be satisfied that the transaction is suitable for the client considering the client’s investment objectives and risk profile. In general, mutual funds are designed to be held over the long term. While short-term trading of some securities may be suitable for certain clients, mutual funds other than money market funds are not appropriate vehicles for this purpose. MARKET TIMING Market timing involves short-term trading of mutual fund securities to take advantage of short-term price discrepancies between the net asset value of a mutual fund and the stale value of the securities within the mutual fund’s portfolio. The practice of conducting frequent trades to benefit from short-term changes in a mutual fund’s net asset value can also negatively impact performance. Many mutual fund companies monitor trading activities daily to identify any market timing or short-term trading, and they may issue letters of warning, levy short- term trading fees, or reject some trade requests. You and your sales representatives should be aware of these potential penalties when considering the suitability of purchases and redemptions of mutual fund units by clients. Sales representatives under your supervision should be familiar with important information about the mutual fund, including practices to address short-term trading and market timing. This information may be found in the simplified prospectus or verified by contacting the mutual fund company directly. Sales representatives are prohibited from facilitating any market timing activities and from engaging in or assisting a client in engaging in any transaction designed to avoid detection. LATE TRADING Late trading is an illegal activity that occurs when purchase or redemption orders are received by the mutual fund company after the close of business (typically 4:00 p.m. Eastern Time) but are filled at that day’s closing unit price rather than the next day’s closing unit price. IMPROPER ORDERS You should watch for signs of improper sales techniques and closely monitor the activities of any sales representative you suspect of this breach of professionalism. Previous client issues, poor recordkeeping, and non- adherence to the firm’s policies and procedures may be examples of improper sales activities. History has shown that offenders often tend to follow a habitual and recognizable pattern. © CANADIAN SECURITIES INSTITUTE 9 12 BRANCH COMPLIANCE OFFICER’S COURSE ORDERS SUPERVISION Clients who want to buy mutual funds must provide an order. It is your responsibility as BCO to make sure all orders are valid and suitable, as outlined in the most current Know Your Client (KYC) information. Orders may be received during a face-to-face interview, by telephone, electronically (by internet or fax), or in written form. Regardless of the method, there are several requirements to ensure that a client’s order is valid, as follows: Identification Confirm that the person accessing the account is the owner of the account. Unless the validation sales representative knows the client, proper personal identification should be obtained from the client, and identity verification requirements under the Financial Transactions and Reports Analysis Centre of Canada must be satisfied. Suitability Confirm that the transaction is suitable and reasonable given the client’s KYC confirmation information by verifying the client’s financial situation, investment knowledge, investment objectives, and risk profile. Permissibility Confirm that the transaction is permitted in the client’s account. To be permissible, the validation order should not be restricted by specific account conditions* (such as a third-party signature or verification). If required, a power of attorney or trading authorization should be obtained. The MFDA has approved the use of the Limited Trading Authorization Form, which was developed by the Investment Funds Institute of Canada to facilitate trade execution. Sales representative Confirm that the processing and implementation of the order were conducted through confirmation a registered sales representative. Disclosure Confirm that the appropriate disclosure documents have been provided to the client. confirmation * Certain accounts may have restrictions or limitations placed on transactions that can be undertaken or the withdrawal of redemption proceeds. For example, the account may be pledged to a creditor who has prohibited the purchase of equity funds. PERMITTED ORDERS In most jurisdictions, your sales representatives can accept orders for and provide advice on proprietary mutual funds (and third-party funds where permitted) and on exempt investment products such as Treasury bills, bank term deposits, Government of Canada Savings Bonds, and GICs. Clients who wish to buy financial products such as stocks or derivatives should be directed to the affiliated securities dealer of your financial institution. TRANSMITTING THE ORDER Purchase and redemption orders must be forwarded to the fund administration office on the day of receipt by the branch. In most cases, orders received by the fund before 4:00 p.m. ET on a given trading day are executed at the closing unit price for the day. Orders received after that time on a given day are generally executed at the closing price the next trading day, but they cannot be executed at the same day’s price. For orders received after normal business hours (or on a day that is not a business day), the order is executed on the next business day if it cannot be executed that day. For example, if a branch receives an order at 2:00 p.m. on Monday, it should forward the order for processing by the end of that business day. If the fund manager receives the order after 4:00 p.m., it will usually be processed the next day at Tuesday’s closing net asset value. It cannot be processed at the 4:00 p.m. price. © CANADIAN SECURITIES INSTITUTE  CHAPTER 9 SALES REPRESENTATIVE SUPERVISION 9 13 Make sure the sales representative explains the forward pricing aspect of mutual funds to the client, that is, that the trade is executed at the first available opportunity at the closing price for the day. When a client asks the price of the units, the sales representative should explain that the price is not known at this time. Backdating or late-trading an order in an attempt to buy units at a previous day’s price is illegal. The lag between the time an order is taken and the time it is executed creates risk for your dealer. For example, suppose a client places an order to buy an equity mutual fund at 5:30 p.m. at your branch. The next day, the stock market plunges, and the client withdraws the order. The only defences to these sharp and potentially unfair trading tactics are as follows: Make sure the two-business day withdrawal period starts as soon as possible. Refuse to do business with clients who exhibit this type of behaviour. As BCO, you are not required to accept a client’s order to purchase mutual fund units, although you should advise your RCO of any refusal to accept an order. TELEPHONE ORDERS Although most mutual fund orders are placed in branches, clients occasionally may want to place orders over the telephone. There are no legal prohibitions on this activity except for calls originating out of province if the salesperson is not registered in the province where the caller is located. For example, if a resident of British Columbia is vacationing in Manitoba and calls his sales representative in Vancouver to place a trade, the sales representative cannot take the order unless he or she is registered in Manitoba. Policies on phone orders vary among mutual fund dealers that are subsidiaries of financial institutions. Most banks and trust companies have toll-free phone lines that allow clients to trade wherever they are in Canada. Conversations on these toll-free lines are usually recorded. Accordingly, most bank- and trust company-affiliated dealers encourage clients who wish to place orders by telephone to call the mutual fund dealer’s toll-free phone line directly. Sales representatives who are registered in a single province or territory cannot take phone calls from another province or territory to purchase mutual funds. They can only accept orders originating from the province or territory in which they are registered. (However, they may be registered in more than one province or territory. For example, in the Ottawa/Gatineau area, representatives are often registered in both Ontario and Quebec.) Calls originating from another province or territory must be directed to personnel registered to sell mutual funds within that province. Often, the sales representatives who manage toll-free lines have been registered in numerous, if not all, jurisdictions so that they can take orders across Canada. Because phone orders can give rise to disputes, you should implement programs to reduce potential conflicts. First, only accept phone orders from clients you know well and trust. Make sure that sales representatives follow these practices: Take detailed notes of their conversations with clients, and read the order back to them while on the phone to verify its accuracy. Date the notes and place them in the client file. Try to get the client to follow up a phone order with a letter, fax, or telex confirming the order the same day if possible. The objective should be to create a complete paper trail for audit purposes. Ideally, clients should be encouraged to use the toll-free phone lines where conversations are typically recorded. A digital recording of a conversation with a client is enormously helpful in dealing with a dispute about what was said or not said. © CANADIAN SECURITIES INSTITUTE 9 14 BRANCH COMPLIANCE OFFICER’S COURSE ELECTRONIC TRANSMITTAL OF ORDERS At present, rules around the sale and redemption of mutual funds securities by mutual fund distributors through certain electronic means are in a state of transition. For example, order transmittal over the internet is becoming more common, primarily among discount brokers (i.e., the no-advice channel), which have obtained exemptions from the suitability rule. In such cases, clients sign an acknowledgement that the dealer will not be responsible for determining suitability when accepting orders. WRITTEN ORDERS National Instrument 31-103 introduced the business trigger, which imposes registration requirements if a person engages in, or holds themselves out as engaging in, the business of advising others with respect to investments. As BCO, you should structure your office to ensure that a sales representative is available if a client wishes to place an order. If there is no registered sales representative at the branch, non-registered employees can receive, but not assist in the completion of, written instructions from clients. This activity should be isolated and incidental to the non-registered employee’s activities to ensure that receipt of a such a written order is not misconstrued as “acting in the business of mutual funds.” These instructions are then forwarded to the RCO or the compliance department at head office for execution and compliance. Such orders are still subject to KYC and suitability requirements and must be reviewed by a registered sales representative before acceptance. Note that receipt of an order differs from acceptance of that order. All mutual fund orders, regardless of the method of receipt, must be transmitted to the mutual fund company on the same day the order is received. As previously discussed, where a purchase order is received after normal business hours or on a non-business day, the sales representative must inform the client that the trade will be executed at the first available opportunity at the closing price for the day. TRADING ERROR CORRECTIONS An error correction is a request to change the particulars of a trade or trades as the result of an error either by the sales representative or the dealer. It is essential that any erroneous trades made in a client’s account be corrected immediately. Neither you nor the sales representative must assume responsibility for covering a trading error. Under no circumstances should a sales representative attempt to “trade a client out” of a mutual fund error. As the BCO, you should have policies and procedures in place at the branch to ensure that you are informed of all errors and that they are escalated to head office for approval of the corrective actions. Corrections must be handled through head office to ensure proper handling of the transactions. The use of backdating or backward-price tactics to correct errors is strictly prohibited, and sales representatives who “correct” errors in this manner should be reported to the RCO and the compliance department at head office (or both) for disciplinary measures. CLIENT ORDERS AND INSTRUCTIONS As the BCO you are responsible for ensuring that your branch retains records of all orders and instructions given or received for the purchase, sale, or exchange of mutual funds in accordance with the dealer’s record retention policy. SALES PRACTICES SUPERVISION As BCO, you can enforce several practices and procedures at the branch level to ensure that your sales representatives comply with acceptable sales practices. First, you should discuss this topic at your regular sales and compliance meetings with sales representatives. © CANADIAN SECURITIES INSTITUTE  CHAPTER 9 SALES REPRESENTATIVE SUPERVISION 9 15 Second, for new sales representatives, for the first 90 days of their employment, you must approve all new accounts before any trading takes place. Subsequent trades are to be approved within one business day, but if leveraging was recommended, they must be approved before any transaction takes place. After 90 days, you must approve all new accounts within one business day. For subsequent trades, you must review the greater of five trades or 10% of the trades each day. However, if leveraging was recommended, the trade must be checked before being processed. In addition, you must check the greater of five trades or 10% of the previous month’s trades at the end of each month. This practice must continue until the end of the sixth month. Third, we recommend a regular practice of periodically and randomly sitting in on sales sessions between your sales representatives and their clients to monitor and evaluate the interaction. It is imperative that you maintain evidence of your supervision. A documented and accessible record of supervision will assist you immeasurably during regulatory and internal reviews. DISCLOSURE OF CONFLICTS OF INTEREST All sales representatives should be reminded that any outside business activities they take part in may pose a perceived or actual conflict of interest. Appropriate disclosure and approval of any such activities are therefore required before they engage in them. Outside business activities should be reviewed and attested to at least annually, with copies placed in the sales representative’s file. © CANADIAN SECURITIES INSTITUTE 9 16 BRANCH COMPLIANCE OFFICER’S COURSE SUMMARY Now that you have completed this chapter, you should be able to complete the following objectives: 1. Describe the relationship between mutual fund sales representatives and clients, and discuss the obligations and responsibilities that arise from this relationship. Sales representatives often have fiduciary responsibilities to investors, meaning that sales representatives have an obligation to act in the best interests of investors, and not solely in the mutual fund dealer’s interest. A sales representative is expected to act in the best interest of the client and not realize any private gains that might instead have been obtained for or by the client. 2. Explain why standard performance data must always be used when any performance data is provided or displayed. Sales representatives’ discussions with clients must conform to ethical business and legal standards. There are specific rules pertaining to the discussion of the past performance of mutual funds. If any performance data is mentioned, the sales representative must also disclose the SPD. 3. Identify the mutual fund-related activities that non-registered sales staff may perform and those they are prohibited from performing. Prohibited activities include: « Directly or indirectly holding oneself out as being in the business of the activity. « Responding to questions about mutual funds in a manner that is not specifically permitted. « Claiming to be registered under securities legislation without actually being registered. « Intermediating a trade between a buyer and seller of securities. « Being, or expecting to be, remunerated or otherwise compensated for undertaking the activity. « Soliciting, directly or indirectly, others in connection with the activity. Permitted activities include: « Advising clients that the financial institution has a mutual fund dealer subsidiary that sells mutual funds. « Referring clients to the sales representatives, the mutual fund dealer branch investment or sales centre, or the telephone communications systems. « Receiving redemption requests to forward to a registered sales representative for processing. « Distributing brochures, fund performance updates and other promotional material, including current fund prices. « Defining the general characteristics of mutual funds if asked by a client. These characteristics include diversification, professional money management, and recordkeeping. « Providing current account information. « Receiving a completed order form to forward to the sales representative. 4. Discuss the order activities registered sales staff are prohibited from performing. Discretionary trading is prohibited. Selling mutual funds to non-residents is prohibited. Short-term trading is not appropriate for mutual funds. Sales representatives are prohibited from facilitating any market timing activities. Late trading is illegal. © CANADIAN SECURITIES INSTITUTE  CHAPTER 9 SALES REPRESENTATIVE SUPERVISION 9 17 5. Supervise the order-execution process, including the processing of client orders. BCOs are required to supervise the order-execution process, which includes: « How client orders are processed. « Who reviews the orders for proper documentation. « How it is determined, regardless of whether the client was fully informed when placing the order. © CANADIAN SECURITIES INSTITUTE