Canadian Investment Funds Course PDF

Canadian Investment Funds Course Printed Text IFSE Institute Tel: 1-888-865-2437 Fax: 905-803-0944 www.ifse.ca © 2022, IFSE Institute All rights reserved. No part of this publication may be reproduced in any form without written permission from the IFSE Institute. C205V4PT 06/22 Contents How to Study for the Canadian Investment Funds Course...................................................................... v Unit 1: Regulatory Environment........................................................................................................... 7 Lesson 1: Regulatory Bodies....................................................................................................................... 8 Lesson 2: Legislation and Regulations...................................................................................................... 16 Unit 2: Registrant Responsibilities...................................................................................................... 27 Lesson 1: Ethics......................................................................................................................................... 28 Lesson 2: Compliance............................................................................................................................... 32 Lesson 3: Conflicts of Interest.................................................................................................................. 44 Lesson 4: Compliance Issues..................................................................................................................... 55 Lesson 5: Registration Requirements....................................................................................................... 71 Unit 3: Know Your Client, Know Your Product, and Suitability............................................................ 79 Lesson 1: Overview of the Suitability Process.......................................................................................... 80 Lesson 2: Know Your Client (KYC)............................................................................................................. 83 Lesson 3: Know Your Product (KYP)........................................................................................................ 103 Lesson 4: Suitability................................................................................................................................ 108 Lesson 5: Strategic Investment Planning................................................................................................ 124 Lesson 6: Dealing with Older and Vulnerable Clients............................................................................ 129 Unit 4: Economic Factors and Financial Markets............................................................................... 137 Lesson 1: Economic Factors.................................................................................................................... 138 Lesson 2: Financial Markets.................................................................................................................... 144 Lesson 3: Canada's Financial System...................................................................................................... 150 Unit 5: Types of Investments........................................................................................................... 157 Lesson 1: Building Blocks of Mutual Funds............................................................................................ 158 Lesson 2: Fixed Income Securities.......................................................................................................... 162 Lesson 3: Bonds...................................................................................................................................... 168 Lesson 4: Equities................................................................................................................................... 183 Lesson 5: Derivatives.............................................................................................................................. 190 Unit 6: Types of Mutual Funds......................................................................................................... 197 Lesson 1: Introduction to Mutual Funds................................................................................................ 198 Lesson 2: Mutual Fund Categories......................................................................................................... 202 Lesson 3: Conservative Mutual Funds.................................................................................................... 206 ©2022 IFSE Institute iii Lesson 4: Growth-oriented Mutual Funds............................................................................................. 214 Lesson 5: Other Investment Products and Investment Funds............................................................... 225 Unit 7: Portfolio Management......................................................................................................... 231 Lesson 1: The Portfolio Manager............................................................................................................ 232 Lesson 2: Financial Analysis.................................................................................................................... 241 Lesson 3: Mutual Fund Performance and Risk....................................................................................... 247 Unit 8: Mutual Funds Administration............................................................................................... 261 Lesson 1: Mutual Fund Organization...................................................................................................... 262 Lesson 2: Purchasing Mutual Funds....................................................................................................... 268 Lesson 3: Redeeming Mutual Funds....................................................................................................... 274 Lesson 4: Fee Structure.......................................................................................................................... 282 Lesson 5: Disclosure................................................................................................................................ 293 Lesson 6: Account Types......................................................................................................................... 299 Unit 9: Retirement........................................................................................................................... 309 Lesson 1: Government and Employer Plans........................................................................................... 310 Lesson 2: Registered Retirement Savings Plans..................................................................................... 328 Lesson 3: Withdrawing from RRSPs........................................................................................................ 339 Lesson 4: Locked-In Accounts................................................................................................................. 350 Unit 10: Taxation............................................................................................................................. 355 Lesson 1: Canadian Tax System.............................................................................................................. 356 Lesson 2: Taxation of Investment Income.............................................................................................. 366 Lesson 3: Taxation of Mutual Funds....................................................................................................... 374 Unit 11: Making Recommendations................................................................................................. 383 Lesson 1: Evaluating the Client............................................................................................................... 384 Lesson 2: Selecting Mutual Funds.......................................................................................................... 398 Lesson 3: Asset Allocation...................................................................................................................... 402 Lesson 4: Tax Efficient Strategies........................................................................................................... 408 iv © 2022 IFSE Institute How to Study for the Canadian Investment Funds Course The Canadian Investment Funds Course (CIFC) Printed Text is intended to act as a supplement to the online course. It is to be used in conjunction with the online course. How Much Time Should You Spend Preparing? We recommend that you spend at least 90 hours preparing to write the exam. Suggested Approach for Each Unit For each unit, you should: 1. Read the unit carefully. Make sure that you understand the terms and concepts. 2. Try the Online Exercises. To reinforce the concepts, try the suggested online exercises located within each unit. 3. Complete the Quizzes found online. The quizzes can be found online on the course landing page. 4. Complete the Sample Exam found online. The sample exam can be found online on the course landing page. Things to know for the Final Exam: The final exam is a formal proctored exam consisting of 100 multiple choice questions. The exam is worth 100% of your grade. You will have 3 hours to complete it. You will be required to obtain a mark of 60% to pass. ©2021 IFSE Institute v Launching the Online CIFC Course 1. Go to the website www.ifse.ca 2. In the Login box in the top right-hand corner, enter your User Name and Password, then click LOGIN. 3. Under My IFSE > Courses > Canadian Investment Funds Course, click Launch this course. vi © 2022 IFSE Institute Canadian Investment Funds Course Unit 1: Regulatory Environment Introduction In Canada, there are a number of regulatory bodies and regulations that govern the sale of mutual funds. As a Dealing Representative, you need to be aware of these bodies and the regulations. Once you are licensed, your mutual fund dealer will provide further training about your responsibilities. This unit takes approximately 35 minutes to complete. Lessons in this unit: Lesson 1: Regulatory Bodies Lesson 2: Legislation and Regulations © 2022 IFSE Institute 7 Unit 1: Regulatory Environment Lesson 1: Regulatory Bodies Introduction The sale of mutual funds in Canada is regulated and monitored by a number of provincial and federal organizations. As a Dealing Representative, you need to be aware of the organizations and regulations that affect you in the province in which you are selling mutual funds. This lesson provides an introduction to the regulatory bodies. Your Compliance Department will provide more detailed training in your responsibilities. This lesson takes approximately 15 minutes to complete. At the end of this lesson, you will be able to: explain how the securities regulation is structured in Canada explain the role of each regulatory body: Provincial securities commissions Canadian Securities Administrators (CSA) Mutual Fund Dealers Association of Canada (MFDA) Autorité de marchés financiers (AMF) Chambre de la sécurité financière (CSF) Investment Industry Regulatory Organization of Canada (IIROC) Ombudsman for Banking Services and Investments (OBSI) Office of the Superintendent of Financial Institutions Canada (OSFI) list the legislation that regulates the securities industry 8 © 2022 IFSE Institute Canadian Investment Funds Course Financial Services Regulatory Bodies When you become a Dealing Representative, you will be part of a group of professionals that needs to adhere to regulations designed to protect the interests of both the investing public and industry participants. In Canada, there are several monitoring bodies in the mutual funds industry at the provincial and national level. Provincial and Territorial Level Each province and territory has a regulatory body, usually referred to as a securities commission. National Level The following organizations all play a role in the regulation of the Mutual Funds industry: Canadian Securities Administrators (CSA) Mutual Fund Dealers Association of Canada (MFDA) Ombudsman for Banking Services and Investments (OBSI) Investment Industry Regulatory Organization of Canada (IIROC) Office of the Superintendent of Financial Institutions Canada (OSFI) Securities Regulators Mandate All provinces and territories have a regulatory body (Securities Regulator), often referred to as a securities commission, which administers that jurisdiction's Securities Act or equivalent legislation. Each Securities Regulator sets its own standards for registration and has the power to grant or revoke registrations. Securities Regulators generally have a mandate to: protect investors from unfair, improper and fraudulent practices promote fair and efficient capital markets promote confidence in capital markets reduce systemic risk For registered firms and individuals that are directly regulated by the provincial and territorial securities regulators, the rules, regulations, and legislation apply specifically to securities, and are not extended to © 2022 IFSE Institute 9 Unit 1: Regulatory Environment related investment products. This differs from the regulatory requirements for registered firms who are regulated by the self-regulatory organizations (SROs). SRO-regulated firms include investment dealers, who are members of the Investment Industry Regulatory Organization of Canada (IIROC), and mutual fund dealers, who are members of the Mutual Fund Dealers Association of Canada (MFDA). SRO member firms and their Dealing Representatives are subject to rules and regulations that apply to securities and related investment products, including structured products. For the purposes of this course, the terms “securities” and “investment products” are used interchangeably, though both apply to mutual fund dealers and their Dealing Representatives. Securities Regulator/Securities Commission Role Each Securities Regulator is responsible for the following: establishing strict standards for disclosure of information before new securities can be offered to the public reviewing and approving mutual funds and new issue prospectuses before they are offered for sale in their province or territory registering the companies and individuals who sell securities in their province or territory registering the companies and individuals that manage mutual fund portfolios established in their province or territory enforcing securities regulations governing the buying and selling of securities investigating investor complaints against companies and their employees disciplining companies or individuals found to contravene the regulations Your role as a Dealing Representative is to: register with your Securities Regulator adhere to the Securities Regulator's rules, regulations and standards Canadian Securities Administrators (CSA) The CSA is a policy-making body composed of members from each Securities Regulator. It is a forum for Canada's Securities Regulators to improve, coordinate, and harmonize regulation of the Canadian capital markets. 10 © 2022 IFSE Institute Canadian Investment Funds Course The CSA’s mandate consists of three goals: to protect investors from unfair, improper, or fraudulent practices to foster fair and efficient capital markets to reduce risks to the market’s integrity, and to investor confidence in the markets CSA pursues these goals through a national system of harmonized securities regulations, policies, and practices. Securities Regulators enforce these regulations, policies and practices. Mutual Fund Dealers Association of Canada (MFDA) The Mutual Fund Dealers Association of Canada (MFDA) is the self-regulatory organization for the distribution side of the Canadian mutual funds industry. The MFDA is structured as a not-for-profit corporation and its members are mutual fund dealers that are licensed with Securities Regulators. All mutual fund dealers outside the province of Québec are required to be members of the MFDA. As a self-regulatory organization, the MFDA is responsible for regulating the operations, standards of practice and business conduct of its members and their Dealing Representatives, with a view to enhancing investor protection and strengthening public confidence in the Canadian mutual fund industry. The MFDA is empowered by securities regulators in each of the enumerated jurisdictions (provinces and territories) to: admit members perform compliance reviews enforce rules through a transparent disciplinary process that can result in fines, suspension, or termination of membership The MFDA also administers a separate legal entity called the MFDA Investor Protection Corporation (IPC) that provides protection for eligible customer losses as a result of a MFDA Member's insolvency. The IPC is funded by contributions from MFDA Members and provides customers with coverage to a maximum of $1 million in their general accounts and a maximum of $1 million for their retirement accounts. This coverage only extends to accounts held by MFDA Members in nominee name, and the coverage does not apply to funds held in client name at fund companies. Ombudsman for Banking Services and Investments (OBSI) The Ombudsman for Banking Services and Investments (OBSI) is not a regulator but an independent and impartial organization whose objective is to attempt to resolve disputes between participating banking services and investment firms and their clients. As of August 1, 2014, all dealers and advisors must also be © 2022 IFSE Institute 11 Unit 1: Regulatory Environment OBSI members, except in Quebec where the mediation regime administered by the AMF will continue to apply. OBSI can provide recommendation to settle claims up to $350,000. As an alternative to the legal system, OBSI provides a mechanism to ensure members deal fairly with their customers. Securities Regulatory Bodies in Quebec In Quebec, there are two monitoring bodies. Autorité de marchés financiers (AMF) Mutual fund dealers operating in the province of Québec are required to be registered under the Autorité de marchés financiers (AMF), the securities regulator in Québec. The AMF has further delegated the responsibility of ongoing regulatory compliance and continuing education requirements to the Chambre de la sécurité financière (CSF). Chambre de la sécurité financière (CSF) The Chambre de la sécurité financière (CSF) is the recognized self-regulatory organization (SRO) for Québec representatives dealing in investment funds that are not under IIROC supervision. (In Québec, IIROC is the recognized SRO for investment dealers.) CSF's mission is to protect consumers by maintaining discipline and overseeing the training and ethics of its members, which include Dealing Representatives and financial planners. Note: Quebec is the only province where registration for financial planning activities is required. The CSF is empowered by the AMF in Québec to: admit members investigate complaints enforce rules through a disciplinary process that can result in fines, suspension or termination of membership Investment Industry Regulatory Organization of Canada (IIROC) The Investment Industry Regulatory Organization of Canada (IIROC) is the national self-regulatory organization for investment dealers. IIROC’s principal activities include: protection of the investing public self-regulation 12 © 2022 IFSE Institute Canadian Investment Funds Course liaison with provincial securities commissions public policy representation maintenance of orderly marketing and trading education publication of statistical information liaison with other financial institutions IIROC’s main objective is to create a favourable environment for the investing public by encouraging high practice standards and enforcing regulatory compliance in its membership. Office of the Superintendent of Financial Institutions (OSFI) The Office of the Superintendent of Financial Institutions Canada (OSFI) is the primary supervisor and regulator of insurance companies, federally regulated deposit-taking institutions, and federally regulated private pension plans. OSFI does not regulate mutual fund and investment dealers. OSFI’s mandate is to: protect the rights and interests of depositors, policyholders, pension plan members and creditors of financial institutions contribute to public confidence in the Canadian financial system Mutual Fund Legislation The mutual fund industry is mainly regulated through the following: The Securities Acts National Instruments developed through the CSA MFDA Rules This section provides an overview of the legislation that regulates mutual fund dealers. Individual firms are required to interpret the regulations and prepare policies and procedures for Dealing Representatives to follow. Mutual funds are securities and are therefore governed by the Securities Acts, which are extensive pieces of legislation that cover the entire field of securities. The Securities Acts contain important provisions regarding mutual funds. © 2022 IFSE Institute 13 Unit 1: Regulatory Environment The responsibility for administering and enforcing the Securities Act in each jurisdiction rests with the Securities Regulator. National Instruments National instruments are harmonized regulations made by the Securities Regulators through the CSA. The main instruments affecting mutual funds are: NI 31-103 – Registration Requirements and Exemptions NI 81-101 – Mutual Fund Prospectus Disclosure NI 81-102 – Mutual Funds NI 81-105 – Mutual Fund Sales Practices National Instruments NI 31-103 NI 31-103 Registration Requirements and Exemptions provides the harmonized registration rules for the registration of firms and individuals with the provincial or territorial securities commissions. NI 81-101 NI 81-101 Mutual Fund Prospectus Disclosure ensures that mutual funds disclose the information that investors should consider when deciding whether to invest, or remain invested, in a fund. It prescribes the content of key disclosure documents including the simplified prospectus, the Fund Facts and the annual information form. NI 81-102 NI 81-102 Mutual Funds is the main instrument regulating mutual funds. It regulates how mutual funds are managed, bought and sold. NI 81-105 NI 81-105 Mutual Fund Sales Practices ensures that mutual funds are sold on the basis of what is suitable for, and in the best interests of, investors. It sets minimum standards of conduct to be followed by managers, principal distributors, registered dealers and Dealing Representatives when distributing mutual funds. MFDA Rules The MFDA regulates the operations, standards of practice, and business conduct of its members in order to protect investors. 14 © 2022 IFSE Institute Canadian Investment Funds Course MFDA Rules set out detailed requirements for members, including particulars regarding: business structures capital requirements insurance books and records client reporting business conduct supervision suitability and trade review The MFDA also regulates Dealing Representatives by virtue of their relationship with their sponsoring mutual fund dealer. © 2022 IFSE Institute 15 Unit 1: Regulatory Environment Lesson 2: Legislation and Regulations Introduction As a Dealing Representative, you need to be aware of other important regulations that affect you. These include Anti Money Laundering (AML), Privacy (PIPEDA), and the Do Not Call List (DNCL). These regulations affect how you interact with your customers, the type of information you collect, and certain reporting responsibilities. This lesson provides an overview of the regulations. The Compliance Department of your mutual fund dealer will provide more information about your responsibilities. This lesson takes approximately 20 minutes to complete. At the end of this lesson, you will be able to: explain the purpose of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) discuss the role of Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) describe the Dealing Representative’s obligations under the PCMLTFA explain how the Privacy Act and the Personal Information Protection and Electronic Documents Act (PIPEDA) safeguard privacy define what qualifies as personal information under PIPEDA explain the requirements under the Do Not Call List (DNCL) explain the requirements under the Canada’s Anti-Spam Law (CASL) explain the requirements under the United States (US) Foreign Account Tax Compliance Act (FATCA) 16 © 2022 IFSE Institute Canadian Investment Funds Course Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) The Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) is an Act to combat the laundering of proceeds of crime and the financing of terrorist activities 1. This legislation was introduced to: help detect and deter money laundering and terrorist financing activities provide law enforcement officials with tools to investigate and prosecute money laundering or terrorist financing offences respond to Canada's international commitments to participate in the fight against multinational crime The Act implements reporting and other requirements for entities susceptible to being used for money laundering or terrorist financing. This includes financial entities, life insurers, money service businesses, those involved in real estate, securities dealers, dealers in precious metals and stones, and casinos. Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) is Canada’s financial intelligence unit. It collects, analyzes, and discloses information to help detect and prevent money laundering and the financing of terrorist activities in Canada and abroad. FINTRAC’s mission is to contribute to the public safety and help protect the integrity of Canada's financial system by detecting and deterring money laundering and terrorist financing. Under Canadian law, money laundering is any act intended to disguise the source of money or assets derived from criminal activity inside or outside Canada. The dirty money produced through criminal activity is transformed into clean money by making its criminal origin difficult to trace and integrating it into the legitimate economy. Once illegal money has entered the financial system and is held in cash accounts with financial institutions, a common money laundering method is to use it to purchase securities. Terrorist financing provides funds for terrorist activity. Terrorist groups must develop sources of funding and ways to obscure the links between those sources and the activities the funds support. Revised requirements under the Proceeds of Crime (Money Laundering) and Terrorist Financing legislation, regulations, and FINTRAC Guidelines came into force June 2020. The new requirements will be reflected in the next version of the course. For exam purposes, the content in this version of the course will apply. 1 © 2022 IFSE Institute 17 Unit 1: Regulatory Environment There are two primary sources of financing for terrorist activities: countries, organizations, or individuals revenue-generating activities The methods terrorist groups use to generate funds from illegal sources often resemble those used by traditional criminal organizations. Like criminal organizations, terrorist groups need to find ways to launder these illicit funds to be able to use them without attracting the attention of the authorities. Your Role As a Dealing Representative you have four key areas of responsibility under the PCMLTFA. These areas are: reporting to FINTRAC record-keeping confirming your client’s identity identifying politically exposed foreign persons Your mutual fund dealer’s Compliance Department will provide more training and guidance in these areas. Reporting to FINTRAC As a Dealing Representative, you must advise your dealer of completed and attempted suspicious transactions and certain other financial transactions. Your dealer must report these suspicious transactions to FINTRAC. FINTRAC publishes guidelines for when to file reports and offers instructions for how to file them. Record-keeping Securities dealers, portfolio managers and investment counsellors must keep the following records: Large cash transaction records - cash transactions of $10,000 or more Account-related records - account opening records and client statements Other records - other records designated by your Compliance Department such as records of suspicious transaction reports Records must be kept in such a way that they can be provided to FINTRAC within 30 days of a request to examine them. 18 © 2022 IFSE Institute Canadian Investment Funds Course Confirming Your Client’s Identity You and your employer have to confirm your client’s identity in the following circumstances: when opening a non-registered account when a client conducts a large cash transaction if you do not recognize the client when a client conducts or attempts to conduct a suspicious transaction when an individual is authorized to give instructions for an account about which you have to keep a record An individual may be identified by means of his or her birth certificate, driver's license, passport, record of landing, permanent resident card, social insurance number, old age security card, certificate of Indian status, provincial identification card or similar document. The documents may be Canadian or foreign equivalents. Note: Health Cards from Ontario, Manitoba and PEI are not allowed to be used for identification purposes. In Québec, you are not allowed to ask to see a client’s health card, but you may accept it if the client volunteers to use it for identification purposes. If you are unable to identify an individual at the time of opening an account you may accept an initial deposit, but may not carry out any further transactions until the client has been properly identified. If a client is evasive or unwilling to provide sufficient information for adequate identification, you must inform your Compliance Department. Identifying Politically Exposed Foreign Persons Individuals are considered politically exposed foreign persons2 if they or any of their immediate family hold or held any of these positions in a foreign country: head of state or government member of the executive council of government or legislature deputy minister (or equivalent) ambassador or ambassador’s attaché or counsellor military general (or higher rank) president of a state-owned company or bank head of a government agency Changes to the identification requirements came into force June 2020 to include Politically Exposed Persons (PEPs), both foreign and domestic, and the Heads of International Organizations (HIOs). Changes will be reflected in the next version of the course. For exam purposes, the content in this version of the course will apply. 2 © 2022 IFSE Institute 19 Unit 1: Regulatory Environment judge leader or president of a political party in a legislature Privacy Legislation Collecting Personal Information In your role as a Dealing Representative, it is your duty to collect personal information from your client. You have an obligation to keep that information confidential. The collection, use, and disclosure of an individual's personal information are protected by legislation. To protect personal information, the Federal Government has the Privacy Act and the Personal Information Protection and Electronic Documents Act (PIPEDA). Other provincial privacy acts may provide additional protection for personal information. Privacy Act This law imposes obligations on federal government departments and agencies to respect privacy rights by limiting the collection, use, and disclosure of personal information. The Privacy Act also gives individuals the right to access any personal information about themselves that these organizations hold and request correction if necessary. Personal Information Protection and Electronic Documents Act (PIPEDA) PIPEDA is Canada's private sector privacy law. PIPEDA establishes rules for how federally regulated private sector organizations may collect, use, or disclose personal information. PIPEDA does not apply in provinces that have enacted similar legislation (Québec, Alberta, and British Columbia). Even where provincial legislation has been enacted, organizations' sharing of personal information across provincial, territorial, or international borders is governed by PIPEDA. PIPEDA has rules for safeguarding the personal information that you collect about your clients. Personal information must be: collected for a reasonable purpose collected with an individual's consent used and disclosed for the purpose for which it was collected accurate accessible for inspection and correction stored securely 20 © 2022 IFSE Institute Canadian Investment Funds Course PIPEDA does not apply to: any government institution to which the Privacy Act applies someone who collects, uses, or discloses personal information strictly for personal purposes (for example, the collection of names and addresses for a wedding invitation list) an organization that collects, uses, or discloses personal information for journalistic, artistic, or literary purposes and does not do so for any other purpose Other Provincial Privacy Acts Alberta, British Columbia, Québec and Ontario (only with respect to personal health information held by health information custodians) have privacy laws which have been recognized by the Federal Government as substantially similar to PIPEDA. When operating within one of those jurisdictions, organizations are subject to the provincial privacy legislation instead of PIPEDA, and to the authority of the provincial privacy commissioner. What is Personal Information PIPEDA has rules governing what private sector organizations can do with "personal information". The definition of "personal information" under the Act is any factual or subjective information, recorded or not, about an identifiable individual. Personal information includes: age, weight, height, name where it appears with other personal information medical records ID numbers, income, ethnic origin, blood type opinions, evaluations, comments, social status, disciplinary action employee files, credit records, loan records, dispute with a merchant, intentions (for example, to acquire goods or services, or change jobs) It does not include: an employee's name, title, business address or telephone number (such as information on a business card) © 2022 IFSE Institute 21 Unit 1: Regulatory Environment Do Not Call List (DNCL) The Canadian Radio-television and Telecommunications Commission (CRTC) has established a National Do Not Call List (DNCL) as part of its Unsolicited Telecommunications Rules. The intention of the DNCL was to give consumers the choice about whether to receive telemarketing calls or not. Telemarketing refers to unsolicited telecommunications to sell or promote a product or service. If a person has registered a phone number on the DNCL, you are not permitted to call that person for telemarketing purposes if they have not given you express permission to do so. This prohibits you from coldcalling a possible new client, as well as former clients who have not done business with you in the last 18 months who are registered on the DNCL. You are also prohibited from cold-calling former clients who have done business with you in the last 18 months who are registered on the dealer’s own do not call list. You are permitted to call your existing clients or your dealer’s clients. Depending on your relationship, the client would expect to be contacted regarding investment advice, changing market conditions, or even due to regulatory requirements. Canada's Anti-Spam Legislation (CASL) In an effort to protect consumers from unwanted electronic messages, the Government of Canada introduced legislation to deal with unsolicited commercial electronic messages, also referred to as spam. Under the Electronic Commerce Protection Act (ECPA), senders of commercial electronic messages must obtain consent from the recipient before a message is sent. Senders must also identify themselves and allow the recipient to withdraw consent. CASL is designed to regulate the transmission of commercial electronic messages (CEMs). In addition to CEMs, CASL deals with other electronic threats to commerce, such as malware, spyware, pretexting, and the harvesting of electronic address and personal information. What is a commercial electronic message? The concept of a commercial electronic message (CEM) is central to CASL. CEMs are essentially emails or other electronic messages that that contain commercial or promotional information to encourage participation in a commercial activity. CEMs also include electronic messages that contain a request for consent to send such messages. CASL prohibits organizations from sending CEMs to consumers unless all of the following conditions are met: the recipient has consented to receive the message the message includes information that identifies the sender the message enables the recipient to withdraw consent and unsubscribe from all future messages 22 © 2022 IFSE Institute Canadian Investment Funds Course While organizations are permitted to provide consumers with the option to unsubscribe from only certain types of messages, they must also provide consumers with the option to unsubscribe from all future messages. Summarized below is an overview of CASL requirements. Overview of CASL Requirements Recipient must Opt In Recipient Consent Organizations cannot send CEMs to recipients who have not consented to receive the CEMs by opting in The recipient’s consent to receive CEMs may be express or implied Pre-checked boxes cannot be used to obtain express consent Penalties Recipients must positively opt in to receiving CEMs from the organization Recipients must take some positive action to indicate consent, such as checking a blank box The CRTC has the authority to impose administrative monetary penalties for violations of CASL: Maximum penalty for individuals: $1 million Maximum penalty for organizations $10 million Possible damages and statutory damages for businesses Possible liability for directors and officers As a Dealing Representative, it is important for you to familiarize your dealer’s policies and procedures regarding CASL. As a general rule, you will be prohibited from sending CEMs to recipients who have not opted in to receiving them. Referral Exemption The ECPA permits an exemption to the rule for referrals. Any person is permitted to send one commercial electronic message without consent, based on a referral by another individual with whom the sender has an existing business relationship. The Foreign Account Tax Compliance Act (FATCA) The government of the United States (US) has long been concerned that certain US taxpayers were evading the payment of taxes by investing offshore. The US Foreign Account Tax Compliance Act (FATCA) targets those taxpayers. © 2022 IFSE Institute 23 Unit 1: Regulatory Environment FATCA requires foreign financial institutions, including firms in the Canadian financial sector, to report about: financial accounts held by US taxpayers foreign entities in which US taxpayers hold a substantial ownership interest If a Canadian financial institution does not comply with FATCA, it faces a 30% withholding tax on certain USsource payments made to it. This is extremely punitive and constitutes a powerful incentive to comply. In order to facilitate compliance with FATCA, the Canadian and US governments have entered into an InterGovernmental Agreement (IGA) which has been incorporated into Part XVIII of the Income Tax Act of Canada (ITA). Under Part XVIII of the ITA, Canadian financial institutions, including mutual fund dealers, must: identify accounts held by clients who are a US person for US tax purposes report to the Canada Revenue Agency (CRA) specified information about the accounts identified as being held by US persons Identifying US Persons In general, a person is a US person for US tax purposes if that person is a US resident or a US citizen. However, a person that has economic and social ties that are closer to Canada than the US would not generally be considered to be a US resident. Existing Clients In order to identify existing clients under FACTA, Canadian financial institutions must review information already in its possession for indications that the client may be a US person, for example a US address. If there is such an indication, the Canadian financial institution must ask the client to certify whether they are a US person. The client may be asked to provide supporting documentation if they claim not to be a US person. New Clients In order to identify new clients under FACTA, Canadian financial institutions must ask clients to certify whether they are a US person at the time that the account is opened. The firm must then confirm the reasonableness of the client’s certification based on the other information provided by the client when opening the account. Alternatively, the firm may follow a process similar to that described above for existing clients, based on the information provided by the client when the account is opened. 24 © 2022 IFSE Institute Canadian Investment Funds Course Failure to Cooperate If a Canadian financial institution has information in its records that shows that a client may be a US person, and the client refuses to cooperate in clarifying his or her status, the firm must report the account as a US account to the Canada Revenue Agency (CRA). CRA will report information about the account to the US Internal Revenue Service (IRS). Accounts Identified as US Persons For accounts identified as being held by US persons, Canadian financial institutions (including mutual fund dealers) must report the following information to CRA: information about the account holder (e.g. name, address, the individual’s US taxpayer identification number) certain financial information pertaining to the account CRA, in turn, will automatically report the information to the IRS. By complying with Part XVIII of the ITA, Canadian financial institutions avoid being exposed to the punitive 30% withholding tax under FATCA. As a Dealing Representative, you should familiarize yourself with your dealer’s policies and procedures regarding FATCA. You may have responsibilities for identifying clients who are US persons, particularly at the time of account opening. © 2022 IFSE Institute 25 Unit 1: Regulatory Environment Summary Congratulations, you have reached the end of Unit 1: Regulatory Environment. In this unit you covered: Lesson 1: Regulatory Bodies Lesson 2: Legislation and Regulations Now that you have completed these lessons, you are ready to assess your knowledge with a 10-question quiz. To start the quiz, return to the IFSE Landing Page and click on the Unit 1 Quiz button. 26 © 2022 IFSE Institute Canadian Investment Funds Course Unit 2: Registrant Responsibilities Introduction Dealing Representatives have responsibilities to their clients, and they have ethical standards and legislation that they must follow. This unit introduces the standard of conduct of the Mutual Fund Dealers Association of Canada (MFDA) , as well as discussing how your mutual fund dealer’s Compliance Department will provide guidance. This unit takes approximately 1 hour and 30 minutes to complete. Lessons in this unit: Lesson 1: Ethics Lesson 2: Compliance Lesson 3: Conflicts of Interest Lesson 4: Compliance Issues Lesson 5: Registration Requirements © 2022 IFSE Institute 27 Unit 2: Registrant Responsibilities Lesson 1: Ethics Introduction Dealing Representatives have ethical standards to which they must adhere. Many of these standards are defined through legislation and codes of conduct. It is important for you to have an overall understanding of ethics and ethical behaviour. This lesson takes approximately 15 minutes to complete. At the end of this lesson, you will be able to: define ethics describe the MFDA’s standard of conduct rule discuss best practices for proper conduct 28 © 2022 IFSE Institute Canadian Investment Funds Course Ethics Defined The Merriam-Webster online dictionary defines ethics as “the principles of conduct governing an individual or a group”. In other words, ethics defines the standards of conduct to which you and members of your group are expected to adhere. Ethical conduct conforms to the approved standards, whereas unethical conduct does not. In order to decide whether a proposed course of action is proper, we need a yardstick. In everyday life, the yardstick is provided by our values. An unethical action may or may not also be a regulatory breach. Example Tom and Peter are using their office computers to book movie tickets during their lunch breaks. Tom’s company policy prohibits personal internet use on office computers. Peter’s company policy prohibits personal internet use on office computers during office time. Tom has performed an unethical act since his action is in violation of his company’s standard of conduct. Peter has not violated his company’s ethical standard as his action is within his company’s rules. Example Marianne, a Dealing Representative, has been given a cheque for $25,000 by one of her clients, with specific instructions to buy additional units for $5,000 in each of the 5 mutual funds in the client’s portfolio. Marianne deposits the cheque in her personal account. Marianne has acted unethically and has also committed an illegal act of misappropriation of client funds. Example 1 is an illustration of behaviour that is unethical, but does not involve a regulatory breach. Example 2 illustrates conduct that is both unethical and in breach of regulations. In the case of example 2, the mutual fund dealer must take disciplinary action, including reporting the breach to the MFDA. Companion Policy (CP) 31-103, Registration Requirements Under Companion Policy (CP) 31-103, Part 1.3 (Fitness for Registration (b) Integrity) it states: "Registered individuals must conduct themselves with integrity and have an honest character." © 2022 IFSE Institute 29 Unit 2: Registrant Responsibilities Further in CP 31-103, under Part 11.1 (Compliance System (a) Day-to-Day Monitoring) it states: "Anyone who supervises registered individuals has a responsibility on behalf of the firm to take all reasonable measures to ensure that each of these individuals: deals fairly, honestly and in good faith with their clients addresses conflicts of interest in the best interest of their clients puts the client’s interests first when making suitability determinations for their clients complies with securities legislation complies with the firm’s policies and procedures, and maintains an appropriate level of proficiency." MFDA Standard of Conduct Rule MFDA Rule 2.1.1 outlines the standard of conduct for ethical behaviour for you, as a Dealing Representative. You are expected to: deal fairly, honestly, and in good faith with clients observe high standards of ethics and conduct in the transaction of business not engage in any business conduct or practice which is unbecoming not engage in any business conduct or practice which is detrimental to the public interest be of proper character and have proper business repute have appropriate experience and training The MFDA Standard of Conduct assumes that you will have the training and experience that is expected of a Dealing Representative. The expectation that you will adhere to the standard of conduct applies not only to the letter of the regulation but also to the spirit of the regulation as well. 30 © 2022 IFSE Institute Canadian Investment Funds Course Rule 2.1.1 is actually an expression of plain business sense. Even in the absence of the rules, mutual fund dealers and their Dealing Representatives would adopt the standard of conduct to: Protect their reputation and that of the industry as a whole. Attract and retain clients. Be successful in the long as well as the short term. Best Practices for Proper Conduct Here is a list of best practices that follow from the standard of conduct: Understanding the client’s financial circumstances. Presenting all investment recommendations fairly and without false or misleading statements. Always making recommendations in the best interests of the client. Clearly distinguishing fact from opinion when making recommendations. Protecting the confidentiality of client information. Maintaining your proficiency by acquainting yourself with new laws and regulations and new products in the market. Some of these practices have been codified in specific rules, but they all follow logically from the standard of conduct. © 2022 IFSE Institute 31 Unit 2: Registrant Responsibilities Lesson 2: Compliance Introduction All mutual fund dealers are required to establish compliance practices that adhere to securities legislation. This lesson provides information about the role and responsibilities of a mutual fund dealer’s Compliance Department, and how the compliance function and processes support you as a Dealing Representative. This lesson takes approximately 15 minutes to complete. At the end of this lesson, you will be able to: discuss the Compliance regime of a mutual fund dealer describe the role of the Compliance Department and compliance officers explain the requirements under the client relationship model (CRM) and the client focused reforms (CFR) explain the requirements for Relationship Disclosure Information (RDI) explain the requirements for Client Communications explain prohibited practices including: pre-signed forms excess trading 32 © 2022 IFSE Institute Canadian Investment Funds Course The Compliance Regime All mutual fund dealers are required to establish, maintain and apply a system of controls and supervision to make sure that the firm complies with securities legislation and manages the risks associated with its business. This system is known as a compliance regime. The compliance regime includes a Compliance Department, as well as policies, procedures, documentation, and training. While the primary goal of the compliance regime is to ensure adherence to legislative and regulatory requirements, the other essential aspect of compliance is effective risk management, with the objective of identifying potential risks and proactively developing strategies to mitigate them. Role of Compliance Officers Everyone in a mutual fund dealer firm has a role to play in managing compliance. The importance of compliance can be judged by the fact that the regulators have assigned responsibility for oversight of the compliance function to the CEO or equivalent within the firm. MFDA rules require all mutual fund dealers to have an Ultimate Designated Person (UDP), usually the CEO of the firm, registered with the securities commissions. The UDP must supervise the firm’s compliance activities and promote compliance with securities legislation within the firm. In addition, all mutual fund dealers must designate a Chief Compliance Officer (CCO) who is an officer, partner or sole proprietor of the mutual fund dealer firm, and registered with the securities commissions. The CCO is responsible for establishing and maintaining compliance policies and procedures as well as monitoring and assessing compliance. The CCO must submit an annual report to the Board of Directors detailing the compliance assessment. Role of the Compliance Department The Compliance Department’s major role is to ensure that all individuals within the firm comply with the regulations, most of which are contained in the Policies and Procedures Manual of the firm and/or the MFDA’s Rules and Policies. © 2022 IFSE Institute 33 Unit 2: Registrant Responsibilities Example Giovanni is a Dealing Representative who joined from another firm six months ago. Since his arrival he has been found to have advised his clients to leverage their accounts, even when it was not appropriate. Compliance should impress upon Giovanni the importance of following the Policies and Procedures Manual. They will need to perform suitability reviews for all his leveraged clients. He may also be issued a warning letter and be required to compensate any clients who have suffered losses due to his inappropriate leveraging recommendations. If Giovanni continues with these activities, stronger action will be necessary such as additional training, close supervision and in extreme cases, termination. Example In order to better manage compliance risk, Giovanni’s firm has previously decided to manage the risks of inappropriate leveraging through policies, procedures and supervision rather than simply not permitting leveraged investments. The Compliance Department also manages compliance risk, which is the possibility of the firm facing losses due to its failure to manage its compliance function. The Compliance Department also provides guidance. When faced with an unfamiliar situation you can and should ask your Compliance Department for advice. How the Compliance Department Supports Dealing Representatives The Compliance Department performs vital business support functions by: overseeing and supervising all registerable activities of Dealing Representatives to ensure that they meet regulatory requirements, and internal policies and procedures monitoring the outside activities of Dealing Representatives to ensure that conflicts of interest are properly addressed or avoided educating and training Dealing Representatives to allow them to maintain, grow and protect their business in a compliant manner helping Dealing Representatives manage risks to their reputation and business operations providing advice to Dealing Representatives in situations in which they are in doubt as to the right course of action 34 © 2022 IFSE Institute Canadian Investment Funds Course reviewing trades and business practices periodically Client Relationship Model (CRM) and Client Focused Reforms (CFR) Under the Client Relationship Model (CRM), harmonized legislation has been enacted under National Instrument (NI) 31-103 (Registration), the Rules of the Mutual Fund Dealers Association of Canada (MFDA), and the Rules of the Investment Industry Regulatory Organization of Canada (IIROC) governing: Relationship Disclosure Information (RDI) Conflicts of Interest Enhanced Suitability Assessment Reporting to Clients Further amendments to the rules and legislation concerning conflicts of interest, suitability, and Relationship Disclosure Information (RDI) have since been enacted under the Client Focused Reforms (CFR). Client Relationship Model (CRM) and Client Focused Reforms (CFR) Relationship Disclosure Information (RDI) © 2022 IFSE Institute CRM introduced the Relationship Disclosure Information (RDI) requirement. The RDI must be provided to clients to provide them with key information about the account they open at the time they open the account. The standards for Relationship Disclosure Information (RDI) have since been amended further under the Client Focused Reforms (CFR) which requires registrants to: include specific disclosure about conflicts of interest disclose the registered firm’s obligation to put the client’s interests first when making a suitability determination 35 Unit 2: Registrant Responsibilities Client Relationship Model (CRM) and Client Focused Reforms (CFR) Conflicts of Interest CRM introduced higher standards for the treatment of conflicts of interest which established that conflicts of interest must be: Enhanced Suitability Assessment 36 addressed in a fair, equitable, and transparent manner, consistent with the best interests of the client The standards for the treatment of conflicts of interest have since been amended further under the Client Focused Reforms (CFR) which require that registrants must: address all material conflicts of interest in the best interest of the client avoid all material conflicts of interest where the conflict cannot be addressed in the best interest of the client CRM introduced new standards and suitability “triggers” for assessing the suitability of investment products and strategies. The standards for Know Your Client, Know Your Product, and Suitability Determination have since been amended further under the Client Focused Reforms (CFR) which requires registrants to: put the client’s interests first when making a suitability determination disclose, in the Relationship Disclosure Information (RDI) provided to clients, the registered firm’s obligation to put the client’s interests first when making a suitability determination © 2022 IFSE Institute Canadian Investment Funds Course Client Relationship Model (CRM) and Client Focused Reforms (CFR) Reporting to Clients Pre-Trade Cost Disclosure CRM introduced new standards for reporting to clients as summarized below: Trade Confirmations: must be issued to clients for each trade and must include prescribed details about the costs and charges. Account Statements: must be issued to clients on a quarterly basis and in each month that there is activity in the account, and must include prescribed details about position cost, market value, deferred sales charge (DSC) indicators, and other information and disclosures. The Report on Charges and Compensation: must be issued to clients annually and must provide clients with easy-tounderstand information about the amounts, in dollars and cents, of the charges and compensation paid to the dealer. The Performance Report: must be issued to clients annually and must provide clients with easy-to-understand information about the cost-adjusted performance return of their investments following prescribed standards. CRM introduced the new standard for pre-trade cost disclosure. Registered individuals, including the Dealing Representatives of mutual fund dealers, are required to disclose: the costs associated with the purchase or sale of a security before the transaction is made whether there are any investment fund management expense fees or other ongoing fees that the client may incur in connection with the security As with all other market participants, mutual fund dealers and their Dealing Representatives are subject to the regulatory requirements established under the Client Relationship Model and Client Focused Reforms. © 2022 IFSE Institute 37 Unit 2: Registrant Responsibilities Relationship Disclosure Information (RDI) The objective of the relationship disclosure requirement is to ensure that clients: understand their obligations and those of the mutual fund dealer know what to expect with respect to products, service levels, and costs The Relationship Disclosure Information (RDI) requirements are established in: National Instrument (NI) 31-103, s. 14.2, (k), Relationship Disclosure Information MFDA Rule 2.2.7, Relationship Disclosure Information When a new account is opened for a client, your mutual fund dealer is required to provide written disclosure of the Relationship Disclosure Information (RDI). As a Dealing Representative, you are expected to provide the RDI to your clients, discuss the RDI information with them, and be prepared to answer any questions. The RDI will include, at minimum, the following elements: Relationship Disclosure Information (RDI) RDI Section Account Type Description describes the nature/type of account includes an explanation of how and where the client’s assets are held Advisory Relationship describes the nature of the advisory relationship establishes responsibility for investment advice and investment decisions Products & Services describes the products and services provided by the registered firm provides specific disclosure about: 38 liquidity and resale restrictions investment fund management expense fees and ongoing fees other ongoing fees and expenses proprietary products mutual funds of a related investment fund manager © 2022 IFSE Institute Canadian Investment Funds Course Relationship Disclosure Information (RDI) RDI Section Cash & Cheques Description describes how the registered firm receives and handles deposits and cheques from clients establishes who the payee is for deposits and cheques Risks describes the risks that a client should consider when: making investment decisions borrowing to invest Conflicts of Interest describes the conflicts of interest that the registered firm is required to Suitability describes the registered firm's suitability obligation including: disclose to the client Know-Your-Client (KYC) the events that will trigger a suitability assessment the obligation to put the client’s interest first when determining suitability defines the terms for the KYC information collected describes how the KYC information will be used in relation to specific investments that may be recommended or accepted for the client's account describes how the KYC information will be used when assessing suitability Client Reporting describes the frequency and content of reporting that will be sent to the client for: - © 2022 IFSE Institute Trade Confirmations Client Account Statements Report on Charges and Other Compensation Performance Report 39 Unit 2: Registrant Responsibilities Relationship Disclosure Information (RDI) RDI Section Compensation and Benefits Description describes the nature of compensation that the firm may receive, for example: - commissions at the time of purchase trailer fees on an ongoing basis refers to other sources for more specific information on compensation describes the benefits to the firm from other parties in connection with the client’s investment with the firm Transaction Charges describes the types of transaction charges that the client may be required Impact on Returns explains the impact on a client’s investment returns from: to pay expenses and ongoing fees (described under Products and Services) charges (described under Transaction Charges) includes the effect of compounding over time Benchmarks explains how investment performance benchmarks might be used to assess the performance of the client's investments provides investment performance benchmarks available from the firm Complaint Obligations describes the firm’s obligations with respect to complaints and the process for pursuing recourse with the Ombudsman for Banking Services and Investments (OBSI) When you open a new account for a client, you are required to provide and explain the Relationship Disclosure Information (RDI). You are responsible for helping the client understand the nature of the relationship between you, your firm, and the client. Under the RDI requirements, you are expected to: spend sufficient time with your clients to explain the RDI information discuss the RDI information with your clients in an in-person or telephone meeting 40 © 2022 IFSE Institute Canadian Investment Funds Course be prepared to answer any questions follow their firm’s policies and procedures to evidence that you have done so You are expected to go through the RDI with your client at the beginning of your relationship to ensure that the client understands the information in the RDI. It may also be a good practice to re-visit the RDI with the client in subsequent meetings (e.g. in regular meetings or in subsequent meetings to discuss new investment products). Setting Expectations As part of the relationship discussion, you should discuss expectations and encourage the client to actively participate in the relationship. You should encourage clients to: Keep you and your dealer up to date about their Know-Your-Client (KYC) information. Clients should be encouraged to promptly notify you or your dealer about any change to their information that could result in a change to the types of investments appropriate for them, such as a change to their personal circumstances, financial circumstances, investment needs and objectives, risk profile, or time horizon. Be informed about their investments. Clients should be encouraged to fully understand their investments by asking questions, consulting professionals, and carefully reviewing the literature provided to them. Stay informed about their investments. Clients should be encouraged to review all account documentation provided to them and to regularly review portfolio holdings and performance. Clients should also be encouraged to request information from the dealer if they have concerns about their accounts, transactions, their relationship with the dealer, or their relationship with you. Maintaining Evidence of Relationship Disclosure You are required to maintain evidence that the RDI has been provided to your clients. If the relationship disclosure is incorporated into the New Client Application Form (NCAF) or account documentation and it is signed by the client, a copy of the relevant document in the client file is sufficient evidence. If the relationship disclosure is provided as a stand-alone document, evidence of delivery may include: a signed client acknowledgement a copy of the RDI in the client file accompanied by detailed notes about the client meeting including that the RDI was provided © 2022 IFSE Institute 41 Unit 2: Registrant Responsibilities Disclosure and Transparency All disclosures provided to a client must be: Accurate – the disclosure must be accurate and up-to-date Complete – the disclosure must contain all material information and must not have any omissions of material information Clear and understandable – the disclosure provided to a client must be clear and understandable (e.g. plain language) Relevant and useful to the client – the disclosure must be relevant to the client’s specific circumstances (e.g. relevant to the client’s type of account) Timely – the timing of the disclosure must permit the client to act upon the information where necessary. Specifically, disclosure of conflicts of interest in respect of a particular transaction should be provided to the client before the transaction so the client can decide whether or not to proceed with the transaction. Client Communications MFDA rules define client communications as any written communication by a mutual fund dealer or Dealing Representative to a client of the mutual fund dealer, including trade communications and account statements. It does not include advertisements or sales communication. Client communications must not: be false or aimed at misleading the client make exaggerated claims or go against the interests of the client violate any law or regulation be inconsistent with information given by the mutual fund dealer on any other document There are specific rules dealing with how rates of return are to be communicated to the client. The rules also require that any client communication containing or referring to the rate of return must be approved and supervised by your mutual fund dealer. Prohibited Practices As a Dealing Representative your conduct is governed by a number of rules. Some of the rules that may affect you on a daily basis include those that govern: 42 © 2022 IFSE Institute Canadian Investment Funds Course pre-signed forms excessive trading Pre-Signed Forms The use of pre-signed forms is prohibited. MFDA rules prohibit Dealing Representatives and mutual fund dealers from using blank forms that have been pre-signed by their clients, known as pre-signed forms. You can only use forms that are duly executed by your client after you have completed the information. The mere presence of pre-signed forms will be reported to the MFDA Enforcement Department. Excessive Trading Excessive trading is a practice in which a Dealing Representative recommends a trade that provides little or no benefit to the client, and has little or no purpose other than generating commissions or similar benefits for the Dealing Representative. Excessive trading is sometimes called “churning” an account. Mutual fund investing is typically geared toward a long-term buy-and-hold strategy. As such, MFDA staff would not expect to see frequent trading in client accounts as a general rule. A pattern of frequent trading may suggest that transactions are being carried out for the sole purpose of earning commissions. Example Hari Prasad recommends to his client that he should redeem his units in a Deferred Sales Charge fund where there is a penalty for redeeming the units before a certain number of years, usually seven years. He advises the client to pay the DSC redemption fee and buy another DSC fund. Hari Prasad will have to explain how and why he recommended this sell and buy transaction as it appears unlikely to yield any benefit to the client, but will benefit Hari with additional commission. If the Compliance Department determines that the transactions are unsuitable or not in the best interest of the client, the department will unwind them and Hari will be required to pay for any associated costs and losses. Dealing Representatives need to be aware of the ban on Deferred Sales Charge (DSC) Funds effective June 1, 2022.3 DSC Funds will be banned in all jurisdictions effective June 1, 2022. Further updates will be reflected in the next version of this course. For exam purposes, the content in this version of the course will apply. 3 © 2022 IFSE Institute 43 Unit 2: Registrant Responsibilities Lesson 3: Conflicts of Interest Introduction In this lesson you will learn about conflicts of interest and your responsibilities to identify and manage those conflicts. This lesson takes approximately 1 hour to complete. At the end of this lesson, you will be able to: provide an overview of conflicts of interest define conflict of interest explain the criteria to be considered when determining whether a conflict is material discuss how conflicts of interest must be identified discuss how conflicts of interest must be addressed provide an overview of common conflicts of interest 44 © 2022 IFSE Institute Canadian Investment Funds Course Conflicts of Interest All registrants in the Canadian capital markets have a duty to identify and address conflicts of interest. The obligations concerning conflicts of interest permeate throughout all levels of securities legislation and regulations including: National Instrument (NI) 31-103, s. 13.4, 13.4.1, Identifying, Addressing, and Disclosing Material Conflicts of Interest Mutual Fund Dealers Association of Canada (MFDA) Rule 2.1.4, Identifying, Addressing and Disclosing Material Conflicts of Interest Further interpretation and guidance is provided in: Companion Policy (CP) 31-103, Registration, s. 13.4, 13.4.1 The overriding theme in the regulatory requirements is the obligation for registrants to address conflicts of interest in the best interest of the client. Compliance with the conflict of interest requirements is an ongoing registrant obligation, not a one-time determination. You and your registered firm are required to take reasonable steps to identify both existing conflicts of interest and those conflicts of interest that are reasonably foreseeable. Definition of Conflict In general, a conflict of interest is a situation where there is a divergence between the interests of two or more parties. Under Companion Policy (CP) 31-103, Part 13, Division 2, s. 13.4.1, the Canadian Securities Administrators (CSA) specifically define a conflict of interest to include any circumstance where: the interests of a client and those of a registrant are inconsistent or divergent a registrant may be influenced to put their interests ahead of their client’s interests the trust that a reasonable client has in their registrant may be compromised as a result of: - monetary or non-monetary benefits available to the registrant potential detriments that the registrant may be subject to © 2022 IFSE Institute 45 Unit 2: Registrant Responsibilities As specified in the policy, you and your dealer are required to determine whether a conflict is material. When determining whether a conflict is material, you should consider whether the conflict may be reasonably expected to affect: the decisions of the client the recommendations or decisions you make Conflicts of Interest between Registrants and Clients The requirements governing conflicts of interest between registrants and clients have been developed under the Client Focused Reforms (CFR) and brought into force under NI 31-103 and the MFDA Rules. Under the reforms, you must take reasonable steps to: identify existing and reasonably foreseeable material conflicts of interest address all material conflicts of interest in the best interest of the client You, as a Dealing Representative, have specific responsibilities under the CFR requirements, as summarized below. Your Responsibilities for Conflicts of Interest You are responsible for: taking reasonable steps to identify existing and reasonably foreseeable material conflicts of interest promptly reporting material conflicts of interest to your firm addressing material conflicts of interest in the best interest of the client avoiding all material conflicts of interest where the conflict cannot be addressed in the best interest of the client You are prohibited from engaging in trading and/or advising activities unless: the conflict has been addressed in the best interest of the client; and your firm has approved the activity 46 © 2022 IFSE Institute Canadian Investment Funds Course Identifying Conflicts of Interest Conflicts of interest will arise in the ordinary course of business. Some conflicts are inherent to the firm’s business model. Other conflicts may arise from the business activities you carry out. Conflicts of interest may take various forms such as: existing - involving an actual conflict as a result of current activities potential - involving likely future conflicts perceived - involving circumstances creating the appearance of a conflict By their very nature, conflicts can interfere with your ability to deal fairly, honestly, and in good faith with clients. It is simply good business to know how conflicts arise and understand the duty to identify and address them. You are required to take reasonable steps to identify existing and reasonably foreseeable material conflicts of interest. As established in CP 31-103, reasonable steps to identify material conflicts of interest would include: taking proactive measures to anticipate reasonably foreseeable conflicts implementing policies and procedures to identify existing conflicts assessing the materiality of those conflicts to distinguish between those conflicts that are material and those that are not The duty to identify and address conflicts of interest is not viewed as a one-time exercise and compliance with the conflict of interest requirements is an ongoing obligation. Therefore, you are expected to assess and address new conflicts as they are identified. © 2022 IFSE Institute 47 Unit 2: Registrant Responsibilities Addressing Conflicts of Interest A conflict of interest can be addressed in one of three ways: avoidance control disclosure Where a conflict of interest between you and your client is identified, you are subject to specific regulatory obligations where the conflict is deemed to be material. You must: address all material conflicts of interest in the best interest of the client avoid all material conflicts of interest where the conflict cannot be addressed in the best interest of the client When addressing a material conflict of interest, you and your dealer are required to either: implement controls to mitigate the conflict sufficiently so that the conflict is addressed in the client’s best interest; or avoid the conflict. Your failure to identify and properly address a conflict could put you and your firm at risk of disciplinary action by the regulators or civil action by a client. Therefore, it is important that you understand and commit to the notion that you must address all material conflicts of interest in the best interest of the client and avoid those material conflicts of interest that cannot be addressed in the best interest of the client. Avoidance You are required to avoid all conflicts of interest that are prohibited by law. Examples of conflicts of interest that must be avoided include those practices prohibited under securities legislation and regulations, or other activity that is sufficiently contrary to the integrity of the capital market and/or the interests of investor(s). Even where a conflict of interest is not legally prohibited, it must be avoided if there can be no other reasonable response. Under CP 31-103, Part 13, Division 2, s. 13.4.1, you would be expected to avoid material conflicts of interest: where there are no appropriate controls available that would address the conflict in the best interest of the client where avoiding the conflict is the only reasonable response in order to address the conflict in the best interest of the client 48 © 2022 IFSE Institute Canadian Investment Funds Course even if avoiding the conflict means foregoing an otherwise attractive business opportunity or type of compensation Where you determine that a material conflict of interest should be avoided, you may do so by: refusing to engage in the activity ceasing to provide the product or service declining to deal with the client Control When determining how to address material conflicts of interest, your firm must consider what internal structures or policies and procedures can be implemented in order to address the conflict of interest in the best interest of the client. Conflicts Arising from Compensation and Incentives It is important to note that the regulators assign a great deal of importance to conflicts arising from compensation and incentives. As such, you should focus specific attention to your firm’s policies and procedures governing conflicts that arise from compensation and incentives to ensure that: you adhere to the firm’s requirements conflicts of interest are addressed in the best interests of clients Conflicts arising from internal compensation arrangements and incentive practices As stated in CP 31-103, s. 13.4.1: “It is an inherent conflict of interest for registered firms to create incentives to sell or recommend certain products or services over others. It is also an inherent conflict of interest for registered individuals to receive greater compensation from their sponsoring firm for the sale or recommendation of certain products or services over others. In our experience these are almost always material conflicts of interest.” The CP goes on to state: “In addition to controlling these conflicts in the best interest of clients, registrants must comply with the suitability determination obligation under section 13.3. If certain products or services available at a firm compensate its registered individuals better than others, in addition to determining that the recommendation is suitable, registered individuals must put their clients’ interest first when deciding which product or service to recommend. As a result, the client’s interests, not the registrant’s interests, must guide the recommendations made by a registrant to its clients. Registrants must not recommend a product or service just because it pays them better than the alternatives. This is also consistent with a registrant’s obligation to deal fairly, honestly and in good faith with its clients.” © 2022 IFSE Institute 49 Unit 2: Registrant Responsibilities Disclosure The purpose of disclosing a conflict of interest is to provide the client with adequate information so that they can decide for themselves whether the conflict is serious enough to lead them to withdraw from the transaction or service. Firms are required to provide written disclosure to clients to disclose all material conflicts of interest identified and reported to the firm. Where required, you may likely be responsible for providing disclosures prescribed by the firm. Disclosure about conflicts of interest must be: prominent, specific, clear, and meaningful to the client, so that they can understand the conflict of interest and how it could affect the product or service that is being offered made prior to or at the time of the investment recommendation or service, so the client has time to assess the information Written disclosure of material conflicts of interest must include: the nature and extent of the conflict the potential impact and risk the conflict may pose how the conflict has/will be addressed Where a material conflict of interest is identified that has not been previously disclosed to the client, the firm is responsible for providing disclosure to the client in a timely manner. In some cases, you will be required to provide disclosure to the client when these circumstances arise. While disclosure can be effective in addressing certain conflicts of interest, disclosure alone is not considered sufficient to address a material conflict of interest between a registrant and a client. Disclosure is meant to supplement other measures and controls taken to address the conflicts. 50 © 2022 IFSE Institute Canadian Investment Funds Course Example Jonas has a client, Adrian, who bought and then sold the PanCanada Fund, a return of capital mutual fund. Adrian needs help filing her T1 Return because she has never calculated her adjusted cost base on a return of capital fund before. Luckily, Jonas has an ownership interest in Pro-Tax Services Ltd., a tax preparation firm. Before Jonas can refer Adrian to Pro-Tax Services he must: obtain approval from his dealer for his outside activity, Pro-Tax Services Ltd. obtain approval from his dealer for the written disclosure for Pro-Tax Services Ltd., which must clearly disclose Jonas’ conflicts of interest (e.g. Jonas will profit from his interest in Pro-Tax when Adrian uses the service) provide the written disclosure for Pro-Tax Services Ltd. to his client, Adrian, before he refers her to Pro-Tax Disclosure of Compensation Conflicts As set out in CP 31-103, s. 13.4.1, you are expected to disclose to your clients any commissions or other compensation that you will receive for a transaction, before the transaction is executed. The CP also explicitly states: “If a representative’s compensation differs depending on the products or services provided, then this is a material conflict that must be disclosed to clients. With respect to the nature and extent of the conflict, the registrant should disclose a summary of the compensation conflict in plain language. For example, if particular products pay a larger percentage-commission than other products available to the client, the extent of the compensation difference should be explained.” Limitations of Disclosure In some cases, disclosure can play an effective part in addressing conflicts of interest. However, disclosure alone would not be considered sufficient to address a material conflict of interest. For example, compensation and transaction charges are disclosed in the Relationship Disclosure Information (RDI) that is provided to clients when they open an account and in the Pre-Trade disclosure before an order is executed. However, there is an added expectation that there is adequate supervision by the firm to ensure that the fees are competitive, reasonable, and appropriate for clients. There are also circumstances where disclosure would be clearly insufficient to address a conflict of interest. In such cases, you would need to avoid the conflict of interest. For example, disclosure may not be used to justify an unsuitable recommendation. © 2022 IFSE Institute 51 Unit 2: Registrant Responsibilities Example As established in the guidance provided by the MFDA under MFDA Staff Notice MSN - 0069, Suitability, disclosure cannot negate the obligations of registrants under regulatory requirements. As stated in the notice: “The obligation to make a suitability determination is a fundamental obligation owed by Members and Approved Persons to their clients and is critical to ensuring investor protection. It is a cornerstone of the registration regime and an extension of the duty to deal fairly, honestly and in good faith which Members and Approved Persons owe to their clients. It cannot be satisfied through the provision of disclosure or by obtaining a client waiver.” Once a conflict of interest has been identified and addressed, you must document the reasonable basis for your determination that the conflict of interest has been addressed in the best interests of the client(s). As the materiality of a conflict increases, there should be greater detail in the records maintained to demonstrate compliance. For example, the regulators would expect to see more detailed records for material conflicts related to sales practices, compensation arrangements, incentive practices, referral arrangements, and the use of proprietary products and services. Bottom Line You need to be mindful of any conflicts of interest, be very familiar with your obligations under MFDA Rule 2.1.4, and follow your dealer's policies and procedures for managing conflicts. You must position your practice to minimize, recognize, and manage conflicts and keep records of any conflicts that have arisen and how they were resolved. Transitional Relief related to Deferred Sales Charge (DSC) Investment Funds On June 23, 2021, the CSA issued a Notice which provides relief from the enhanced conflict of interest and suitability requirements under the Client Focused Reforms (CFR) which relate to the sale of investment funds with a deferred sales charge (DSC) option. The Order provides registrants with an exemption from the CFR requirements provided that you: comply with all other amendments related to the Client Focused Reforms (CFR) provide disclosure to clients, in a timely manner, of the nature and extent of the conflict of interest related to the sale of the DSC investment fund The order will cease to have effect and the transitional relief and exemptions will expire on June 1, 2022. At that time, DSC investment funds will be banned in all jurisdictions. 52 © 2022 IFSE Institute Canadian Investment Funds Course Common Conflicts of Interest As is inherent with any compensation-based industry, it is not uncommon for conflicts of interest to arise through the normal course of business conducted by you and your dealer. The important thing to do is to properly identify and address conflicts of interests that arise. Summarized below are some of the common conflicts of interest that can be expected to emerge at registered firms. Common Conflicts of Interest* Type/Activity Proprietary Products such as: Potential Conflicts of Interest can Arise From: deposit products structured products investment funds Compensation-Related Conflicts conflicts which stem from the competing interests of the firm, wanting the proprietary products to be successfully distributed, and clients’ needs to be suitably invested in appropriate investment products conflicts stem from the compensation structure of a given product which may motivate the sale of that product, for example: Referral Arrangements and Service Arrangements trailing commissions/fees deferred sales charge (DSC) 4 commissions syndication fees performance fees managed account/fee-for-service fees embedded fees the product offers a higher commission rate or an ongoing stream of income over time while other products offer lower or finite commission potential referral fees, trailer fees, split commissions other fees (e.g. syndication fees) other benefits DSC Funds will be banned in all jurisdictions effective June 1, 2022. Further updates will be reflected in the next version of this course. For exam purposes, the content in this version of the course will apply. 4 © 2022 IFSE Institute 53 Unit 2: Registrant Responsibilities Common Conflicts of Interest* Type/Activity Dual Occupations and Outside Activities Potential Conflicts of Interest can Arise From: Gifts, Gratuities, and NonMonetary Benefits compensation from the dual occupation/outside activity position of influence gained from the dual occupation/outside activity that could impact the relationship with clients gifts, gratuities, and non-monetary benefits received from clients * This is not meant to be an exhaustive list of all conflicts of interest. Other conflicts of interest may arise that are not included on this list, but would be material and would require that the registered firm and Dealing Representative address the conflict of interest in the best interest of the client. When making a determination of how the firm will address a conflict of interest, the steps that the dealer must take to address the conflict of interest will most often be established in the legislation, regulations, and guidance from the securities regulators. It is your responsibility to follow your firm’s policies and procedures, and any decisions the firm makes, to address conflicts of interest. 54 © 2022 IFSE Institute Canadian Investment Funds Course Lesson 4: Compliance Issues Introduction In your role as a Dealing Representative, you will face a number of compliance issues relating to your job duties and your dealings with clients. For the most part, your mutual fund dealer will have policies and procedures in place to guide you. This lesson provides information about common compliance issues, and instructions on what to do. This lesson takes approximately 30 minutes to complete. At the end of this lesson, you will be able to: discuss compliance issues that may affect a Dealing Representative and how to deal with them including: personal financial dealings with clients and control or authority over client accounts benefits to or from clients dual occupations and outside activities dual licensing referral arrangements discretionary trading sales communications trade names and business titles NOTE: If you are ever unsure about how to deal with a given situation, check with your firm’s Compliance Department. © 2022 IFSE Institute 55 Unit 2: Registrant Responsibilities Common Compliance Issues In your role as a Dealing Representative, you are likely to come across a number of compliance issues. It is important that you are aware of these issues, and that you understand the steps you must take when you encounter them. Activities that may cause compliance issues include: personal financial dealings with clients control or authority over a client’s account or financial affairs benefits to or from clients dual occupations and outside activities dual licensing as a life insurance agent referral arrangements discretionary trading sales communications trade names and business titles business cards and stationery Personal Financial Dealings and Control or Authority over Client Accounts Personal financial dealings with clients or having control or authority over a client account will often create a conflict of interest that can potentially impair your ability to fulfill your obligations to your clients. You must be aware of the restrictions and limitations imposed by the regulators and strictly follow your firm’s policies and procedures related to personal financial dealings with clients and control or authority over client accounts. Personal Financial Dealings with Clients & Control or Authority over Client Accounts Complete or Partial Control or Authority acting under a Power of Attorney (POA), as trustee, as executor, or under any other similar authorization, or over a Client Account otherwise having full or partial control or authority over the client’s account or financial affairs under MFDA Rule 2.3.1, you are prohibited from having authority over client accounts such as POA, trustee, etc. you are required to disclose your authority over any account to your firm the firm is required to re-assign the account to another Dealing Representative who does not have authority 56 © 2022 IFSE Institute Canadian Investment Funds Course Personal Financial Dealings with Clients & Control or Authority over Client Accounts Lending to Clients lending to clients is not permitted (Limited exceptions for advancing funds for redemptions may be permitted if permitted by your firm. You must follow your firm’s policies and procedures.) Borrowing from Clients borrowing from clients is not permitted (You must follow your firm’s policies and procedures for exceptions, where your firm allows such exceptions) Purchasing Assets from a Client purchasing an asset from a client outside the normal course of business (e.g. real property or other assets of significant value) would represent a material conflict of interest that should be avoided (You must follow your firm’s policies and procedures for exceptions, where your firm allows such exceptions) Private Investment Schemes private investment schemes include: - investment clubs where you and your clients invest together - co-investment by you and your clients in pyramid-like schemes or other questionable investments these arrangements are prohibited securities-related business outside of the firm is a breach of regulations Private Settlements Dealing Representatives are prohibited from entering into a private settlement with a client (for example, to resolve a dispute) all settlements must go through the dealer © 2022 IFSE Institute 57 Unit 2: Registrant Responsibilities Personal Financial Dealings with Clients & Control or Authority over Client Accounts Monetary or Non-Monetary Benefits non-monetary benefits such as gifts or charitable donations cannot flow directly or indirectly to or from you and your client all monetary and non-monetary benefits to or from clients must be approved by your dealer and flow through the dealer Positions of Influence in the Community you occupy a leadership role in the community (e.g. pastor at a local church, nurse at a nursing home) you must disclose your role to your firm the regulator will usually impose terms and conditions on you to restrict you from dealing with clients related to your role (e.g. restrict you from dealing with members of the church, patients of the nursing home, etc.) at minimum, the firm must implement procedures to protect clients from undue influence Power of Attorney A power of attorney (POA) is a legal document that allows a person to act on another person's behalf. There are two kinds of POA: limited POA general POA A limited POA restricts permitted actions to those of a specific nature, such as financial matters, whereas a general POA permits a broader range of activities. You should be fully aware of your firm’s policies and procedures for accounts which have appointed a POA for the account. Restrictions from having Control or Authority Under MFDA Rule 2.3.1, you are strictly prohibited from having partial or full control or authority over the financial affairs of a client including appointment as a: power of attorney 58 © 2022 IFSE Institute Canadian Investment Funds Course trustee executor any other similar authorization Subject to certain conditions, there is a limited exception which allows you to accept an appointment to have control or authority provided that all of the following conditions are met: the client is directly related to you, as defined under the Income Tax Act (i.e. spouse, parent, or child) you notify your dealer of the appointment you obtain written approval from your dealer prior to accepting or acting upon the control or authority For these special cases only, you may be allowed to accept an appointment to have control or authority. However, you must follow your dealer’s policies and procedures and certain conditions will apply. It is very important to remember that the exception above cannot be extended to other clients or other family members. Accepting or acting as a control or authority over the financial affairs of any other family member, client, or account is strictly prohibited. Example Derek has received an overseas assignment and wants his brother Justin, who is a Dealing Representative at the mutual fund dealer where Derek holds his accounts, to take care of his mutual fund investments held while he is away from the country. Derek gives a general power of attorney to Justin giving him full authority to manage his financial affairs. Although Derek is Justin’s family, the exception permitted under the MFDA rules applies to the immediate family – spouse, children and parents. Justin cannot accept the POA. Benefits To or From Clients Non-monetary benefits such as gifts or charitable donations are sometimes used as compensation for inappropriate activities carried on by Dealing Representatives. When used inappropriately, they are used as a means of private settlement where MFDA regulations may have been breached or in exchange for referrals. You are required to ensure that all such benefits of a material amount flow through your mutual fund dealer. You must get your mutual fund dealer’s approval prior to carrying out any such arrangement since the firm is responsible for ensuring that: any conflicts of interest are addressed in the best interests of clients: © 2022 IFSE Institute 59 Unit 2: Registrant Responsibilities activity is properly monitored In general, benefits of nominal value are not normally seen as a conflict of interest. Regardless, you are required to strictly follow your firm’s procedures for monetary and non-monetary benefits to or from your clients. Example Larry, a Dealing Representative with ABC Financial, has a condo in Florida. One of his high-net-worth clients was planning a month-long family holiday in Florida. Larry gave his client the keys to his Florida condo, and invited him to stay there at no charge for the duration of the client’s month-long stay. Larry did not see the need to inform his mutual fund dealer, since he owns the condo and he is free to let anyone use it. Larry has violated the MFDA requirements pertaining to monetary or non-monetary benefits from or to clients, since the rental cost of the condo for a month is clearly of material value. Dual Occupations and Outside Activities Dual occupations and outside activities are permitted under securities legislation and regulations where prescribed conditions are satisfied. Dual occupations are business activities that are not carried out on behalf of the firm and involve the payment of compensation. Generally speaking, dual occupations are those business activities that do not fall under your role with your firm, for example: insurance, mortgage brokerage, real estate, tax preparation, etc. Outside activity means any business carried on by you other than business done on behalf of your mutual fund dealer. Outside activities include dual occupations, and also include activities that are not dual occupations (with or without compensation), for example: acting as a board member, officer, director, or equivalent (whether or not remuneration or other benefit is received for the position) acting a member of a charitable organization acting as a volunteer in the community holding a position of influence, such as: - 60 religious leaders health care providers military officers any other positions of influence © 2022 IFSE Institute Canadian Investment Funds Course As can be reasonably expected, the

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