On June 18, 2015, the British Columbia Securities Commission (“BCSC”) published for public comment Proposed Amendments to MFDA Rule 1.2. (Individual Qualifications).
The proposed amendments are intended to conform MFDA Rules with similar requirements under securities legislation by adopting the National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”), Form 33- 109F4 Registration of Individuals and Review of Permitted Individuals (“Form 33-109F4”) and Companion Policy to NI 31-103 (“31-103CP”) changes in respect of requirements pertaining to proficiency and outside activities.
A. Consultation Document – Proficiency Standard for Approved Persons Selling Exchange-Traded Funds (ETFs)
In conjunction with the proposed amendments to Rule 1.2, MFDA staff is issuing for comment a consultation document that sets out details of a proposed proficiency standard that would satisfy the requirements under MFDA Rule 1.2.3 for Approved Persons selling ETFs.
The consultation document (Proficiency Standard for Approved Persons Selling Exchange-Traded Funds (ETFs)) is attached to this Bulletin as Schedule “A”.
B. MSN-0040 Outside Activity
In conjunction with the proposed amendments to Rule 1.2, MFDA staff is also proposing revisions for comment to MFDA Staff Notice MSN-0040 Outside Activity. The revised MFDA Staff Notice is attached to this Bulletin as Schedule “B”.
C. Comment on MFDA Staff Notices
Members and other interested parties are requested to provide comment on the consultation document (Proficiency Standard for Approved Persons Selling Exchange-Traded Funds (ETFs)) and on the proposed revised MSN-0040 Outside Activity.
Comments on the consultation document and MFDA Staff Notice should be delivered by September 16, 2015 to:
General Counsel, Corporate Secretary and Vice-President, Policy,
Mutual Fund Dealers Association of Canada,
121 King St. West, Suite 1000,
Toronto, Ontario, M5H 3T9
or emailed to firstname.lastname@example.org.
MFDA Consultation Document
PROFICIENCY STANDARD FOR APPROVED PERSONS SELLING EXCHANGE TRADED FUNDS (ETFs)
On June 18, 2015, the British Columbia Securities Commission (“BCSC”) published for public comment proposed amendments to MFDA Rule 1.2 (Individual Qualifications). Proposed Rule 1.2.3 sets out a general proficiency principle that would apply in situations where additional education, training and proficiency may be appropriate (e.g. where Members and Approved Persons trade in investment products that have unique features such as ETFs). The purpose of this consultation document is to solicit comment on details of a proficiency standard for Approved Persons selling ETFs that would satisfy proposed MFDA Rule 1.2.3.
Subject to appropriate registration and proficiency, MFDA Members and their Approved Persons may sell ETFs that meet the definition of a mutual fund. However, there are important differences between ETFs and conventional mutual funds, including how they are transacted, that Approved Persons must know and understand to meet the general proficiency principle under proposed Rule 1.2.3 and NI 31-103. Existing courses and examinations used by Approved Persons to satisfy proficiency requirements under NI 31-103 to sell conventional mutual funds do not adequately address the sale of ETFs.
NI 31-103 establishes a general proficiency principle for registrants. As set out under Part 3.4(1) of NI 31-103: “An individual must not perform an activity that requires registration unless the individual has the education, training and experience that a reasonable person would consider necessary to perform the activity competently.” Members must ensure that each Approved Person offering ETFs has adequate proficiency.
Proposed Rule 1.2.3 states: “An Approved Person must not perform an activity that requires securities registration unless the Approved Person has the education, training and experience that a reasonable person would consider necessary to perform the activity competently, including understanding the structure, features and risks of each security that the individual recommends.”
In order to satisfy the proficiency principle under proposed Rule 1.2.3, Approved Persons would need to receive training on information about characteristics and features of ETFs, as well as, training on how ETFs will be offered through the Member.
Training on Member Policies and Procedures
Member specific training would focus on the information that Approved Persons would need to know about the Member’s policies and procedures for transacting in ETFs. Training would include, but not be limited to, the following:
- Detailed product information for the ETFs approved for sale by the Member;
- How market quotes will be obtained;
- The types of trades accepted and the information required for each trade accepted;
- The disclosure information required for each transaction;
- How evidence of trade instructions and disclosures will be maintained; and
- How trade orders will be processed.
Training should focus on new information that an Approved Person would need to know about ETFs. In addition, there are certain topics/concepts that are applicable to both ETFs and conventional mutual funds. ETF training should highlight the key differences between ETFs and conventional mutual funds.
Content should be explained in detail.
Generally a higher level of detail is expected.
Should include comparison of ETFs and conventional mutual funds.
Existing Topics and Concepts
Existing topics and concepts should be explained in the context of ETFs.
Should include comparison of ETFs and conventional mutual funds.
Introduction to ETFs
Definition of an Exchange-Traded Fund
Provide an ETF definition.
Explain how they have attributes of both conventional mutual funds and stocks.
Registration/licensing requirements and limitations
Review the registration requirements to sell mutual funds and the limitations of registration for Dealing Representatives.
Review what products Dealing Representatives can and cannot sell.
Description of ETFs that can be sold by Approved Persons:
Describe in detail the types of ETFs that can be sold by Dealing Representatives.
Description of ETFs that cannot be sold by Approved Persons:
Describe in general the types of ETFs that cannot be sold by Dealing Representatives.
Regulation of ETFs
Independent Review Committee
Generally describe the regulation of ETFs including the offering documents, disclosure requirements, investment restrictions and the role of the Independent Review Committee.
May include a summary of how the regulation of ETFs is similar/different than conventional mutual funds.
Characteristics of ETFs
Description of investment management styles:
Describe Passive vs. Active investment management styles.
Describe Quasi Passive/Active investment management styles.
Provide examples of each style.
Define what is an Index and describe in detail the different methods for tracking an Index.
Explain and give examples of a tracking error.
Creation and Redemption of Units
Describe generally the various roles and responsibilities of: Designated Brokers; Dealers; Market Makers.
Describe in detail how new ETFs are created and funded.
Describe how new units are created for existing ETFs.
Describe how existing ETF units are redeemed.
Describe circumstances where ETF units may be created or redeemed.
Generally describe the various operating costs that can apply to ETFs with a focus on differences between ETFs and conventional mutual funds.
Features and Benefits
Generally describe the features and benefits of ETFs with a focus on differences compared to conventional mutual funds.
Explain that some features may only apply to certain ETFs. For example, an ETF may not be diversified.
Generally describe, with examples, each risk that can apply to ETFs.
Explain in detail the risk of market price. Explain how market price differs from NAV pricing and that market price risk applies to ETFs and not conventional mutual funds.
Compare ETFs to:
Introduction to Financial Markets
Define the terms Primary Market and Secondary Market.
Describe in detail the various Secondary Markets focusing on the markets that ETFs will be traded. Details should include type of markets, market hours and any specific trading rules and requirements.
Trading on an Exchange
Explain that ETFs have both a market price and a NAV calculation.
Explain the difference between calculating a NAV and market price.
Explain that ETFs may not trade at their NAV.
Define the terms Bid, Ask and the Bid/Ask spread.
Explain in detail how to properly quote an ETF.
Define the terms Last Trade Price, Market Open and Market Close.
Define terms Board Lot, Odd Lot, Market Depth.
Explain liquidity and the role of Market Makers for exchange traded securities.
Define terms ex-distribution and cum-distribution and what they mean for trading purposes.
Describe distribution re-investment plans for ETFs.
Provide an overview of UMIR Rules and who has to follow them.
Explain trading halts and circuit breakers including their purpose and when they are triggered.
Describe the various types of orders including the information required for each order as well as the risks and benefits.
Describe situations where certain order types may be better than others.
Describe how orders must be processed on exchanges including best execution requirements (e.g. immediate execution), exchange rules and how orders are filled.
Describe how to change and cancel open orders.
Discuss Settlement, Confirmations and costs.
Briefly explain trading as Principal vs. Agent.
Investing in ETFs
Review existing obligations for:
Explain that existing obligations for KYC, KYP and Suitability apply to the sale of ETFs.
Explain that not all ETFs provide the same level of information as conventional mutual funds, such as risk rating, and that this information would have to be assessed by the Member in order to satisfy existing obligations.
Briefly explain the concepts of Alpha, Beta and Efficient Market Hypothesis.
Describe in detail the roles an ETF can fill when constructing a portfolio.
Review the following and how they apply to ETFs:
Review these common topics with a focus on how they are applicable to trading in ETFs.
Describe in detail nominee name account records including a comparison of how this differs from client name account records.
*Additional resource materials providing more detail on the different trading exchanges and common market indices may be helpful for Approved Persons.
MFDA STAFF NOTICE
This Notice discusses the following topics:
- Definition of ‘Outside Activity’
- Activities of the Member
- Activities Allowed Outside of the Member
- Obligation to Disclose Outside Activities
- Member Policies and Procedures
- Member Approval of Outside Activities
- Ongoing Member Supervisory Obligations
- Member Response to Supervisory Issues
- Positions of Influence
1. Definition of ‘Outside Activity’
In accordance with MFDA Rule 1.3.1 (Outside Activity – Definition), “outside activity” is defined as any activity conducted by an Approved Person outside of the Member:
- for which direct or indirect payment, compensation, consideration or other benefit is received or expected;
- involving any officer or director position and any other equivalent positions; or
- involving any position of influence.
An outside activity includes activities for which the Approved Person does not receive, or expect to receive, payment, compensation, consideration, as set out in clauses (b) and (c) of Rule 1.3.1, and activities for which the Approved Person receives, or is expecting to receive, payment, compensation, consideration, as set out in clause (a) of Rule 1.3.1.
In addition, an outside activity can include a single transaction or event and does not necessarily have to occur with repetition, regularity or continuity.
The requirements of Rule 1.2.2 (Reporting Requirements) cannot be avoided by structuring transactions so that the benefit does not flow directly to the Approved Person. For example, an activity or occupation carried on by an Approved Person that could or does result in a benefit to the Approved Person’s spouse, or to a corporation in which the Approved Person has an interest or exercises control, would fall within the definition of outside activity as an indirect benefit.
Members and Approved Persons must be aware of their obligations with respect to completing Form 33-109F4 Registration of Individuals and Review of Permitted Individuals which requires all registrants to disclose their current employment, other business activities, officer positions held and directorships. The Canadian Securities Administrators has issued guidance in this regard in Companion Policy 31-103 CP Registration Requirements, Exemptions and Ongoing Registrant Obligations.
2. Activities of the Member
MFDA Rule 1.1.1 (Members) requires that all “securities related business” must be conducted through the Member, with exceptions for the sale of deposit instruments not on account of the Member and the activities of bank employees conducted in accordance with the Bank Act (Canada). “Securities related business” is defined in MFDA By-law No. 1 to mean any business or activity that constitutes trading or advising in securities for the purposes of applicable securities legislation in any jurisdiction in Canada. This includes securities sold pursuant to exemptions under applicable securities legislation.
Apart from the specific exceptions noted in Rule 1.1.1, Approved Persons are prohibited from personally engaging in the sale of any investments that would be considered securities under applicable legislation, or selling or advising on such investments through any entity other than their MFDA Member dealer (often referred to as “selling away” or “off book trading”).
3. Activities Allowed Outside of the Member
Pursuant to MFDA Rule 1.3.2 (Requirements for Outside Activity), an Approved Person may have, and continue in an outside activity provided that:
- The MFDA and the securities regulatory authority in the jurisdiction in which the Approved Person carries on or proposes to carry on the outside activity does not prohibit the Approved Person from engaging in such outside activity;
- The Approved Person discloses the outside activity to the Member;
- The Approved Person obtains written Member approval of the outside activity prior to engaging in such activity;
- The outside activity of the Approved Person must not be such as to bring the MFDA, its Members or the mutual fund industry into disrepute; and
- To the extent that the outside activity could be confused with Member business, clear written disclosure is provided to clients that any activities related to the outside activity are not the business of the Member and are not the responsibility of the Member.
4. Obligation to Disclose Outside Activities
(a) Disclosure to Member
Approved Persons are required to disclose all outside activities to their Member prior to engaging in the activities.
(b) Disclosure to Client
Pursuant to Rule 1.3.2 (e), clear written disclosure must be provided to clients that the outside activity is not the business of the Member and not the responsibility of the Member. With respect to new clients, Approved Persons are expected to provide such disclosure at the time the client relationship is established. Where the Approved Person has an existing relationship with a client and the outside activity is a new activity or there is a change to an existing outside activity, written disclosure to the client is required at the time when the Approved Person first engages in the outside activity with the client.
Members and their Approved Persons are required to provide written disclosure to the client in respect of any outside activity where the outside activity could be confused with Member business. For example, where the outside activity deals with financial services such as financial planning, insurance, mortgages, real estate, and tax and estate planning, the outside activity must be disclosed. Where there is uncertainty as to whether an outside activity should be disclosed to a client, Members and their Approved Persons should provide the required disclosure.
In addition, the nature of the outside activity and the name of the legal entity through which the activity is conducted should be disclosed to the client.
(c) Disclosure to Securities Regulatory Authority
Members and Approved Person must comply with securities legislation, which generally requires full disclosure to the applicable securities regulatory authority of any outside activity. In accordance with National Instrument 33-109 Registration Information Requirements and specifically Form 33-109F4 Registration of Individuals and Review of Permitted Individuals, Approved Persons must disclose activities engaged in outside of their sponsoring firm, including all officer and director positions and any other equivalent positions held, as well as positions of influence. This disclosure is required whether or not the Approved Persons receives compensation and whether or not any such position is business related.
5. Member Policies and Procedures
Members are required to establish, maintain and implement policies and procedures designed to approve outside activities and to ensure subsequent compliance with MFDA Rules and By-laws as these relate to the activities. These policies and procedures should include reasonable measures for detecting undisclosed outside activity. Members should review the MFDA Policies and Procedures Manual and Reference Guide to assist in the development of these policies and procedures.
Members should ensure that their policies and procedures respecting outside activities address:
- the requirement for Approved Persons to disclose all outside activities, obtain pre-approval of outside activities and the process by which Approved Persons may seek such pre-approval;
- the Member’s criteria for the approval of outside activities;
- the requirement to communicate to the Branch Manager or supervisor the details of the Member’s approval of, and any refusal to approve, the Approved Person’s outside activities;
- the requirement for the Approved Person to notify the Member in the event of any material changes to significant aspects or termination of an outside activity; and
- the requirement for records to include complete supporting evidence regarding the Member’s handling of all outside activity approval requests, including any special conditions, policies, procedures and controls that have been imposed and how compliance will be monitored.
6. Member Approval of Outside Activities
Members that allow Approved Persons to engage in outside activities must have a process in place that allows for the assessment and prior approval of any such activities. This process should ensure that Approved Persons are not involved in the approval of their own outside activities. As a preliminary step in the approval process, the Member must obtain from the Approved Person basic information about the activity, including the business name, the location where the activity will take place and the nature of the activity, the title or position of the Approved Person, the number of hours to be devoted to the activity and a description of any potential for confusion or conflicts of interest. Members should assess if the activity should be considered to be an outside activity based on the specifics facts of the Approved Person’s activity and circumstances.
Member approval of outside activities must take into consideration any terms and conditions that have been imposed by the applicable securities regulatory authority on the Approved Person’s registration related to the activity. Members should be aware of these terms and conditions and supervise for their compliance. In any case, whether or not the securities regulatory authority has imposed any such terms and conditions, Members may decide to impose their own terms and conditions with respect to the approval of the outside activity. Evidence of the review and due diligence undertaken by the Member, as well as the approval, must be maintained in accordance with the record keeping requirements under the MFDA By-laws, Rules and Policies.
For approval of a position of influence as an outside activity, Members should review Section 9 of this Notice which discusses the specific considerations for the approval of positions of influence.
In addition, Members must maintain records of the process under which the outside activity was approved and specific details on the nature of the outside activity approved. The approval process should require the Approved Person to notify the Member of a material change and require the Member to approve that change. A material change could include the expansion of the activity initially approved by the Member or the offer of new services or products.
Some of the issues Members should consider before approving outside activities include:
(a) Conflicts of Interest
The Member must consider issues relating to all potential conflicts of interest that may arise from the Approved Person’s duties as a salesperson and his or her outside activity. This would include consideration of the compensation to be paid under the arrangement, the nature of the relationship between the Approved Person and the outside entity, and any other potential conflicts that are identified. If any such conflict cannot be properly managed, the outside activity must not be permitted.
(b) Potential Client Servicing Issues
Members must ensure that the outside activity does not impair the ability of the Member or Approved Person to provide continuous service to clients. This would include the inability to place trades in a timely manner.
(c) Standards of Conduct
The Member must be satisfied that the outside activity will be consistent with the general standards of conduct imposed under MFDA Rule 2.1.1 (Standard of Conduct) and will not bring the MFDA, its members, or the mutual fund industry into disrepute. Accordingly, the background, history and experience of the others involved with the outside activity should be considered.
(d) Nature of the Activity and Related Proficiency
The standard of review in considering whether to approve outside activity will depend on the nature of the activity. The review process regarding the investment of client funds or financial services provided outside of the Member should be more stringent than that applied with respect to outside activities that are clearly unrelated to the Member’s business. As a best practice, such review should include consideration of educational, experience or other relevant competency thresholds that may reasonably be expected as a prerequisite to allowing certain financial service activities.
(e) Risk Management Issues
Members should determine the extent to which there is the potential for the client to be confused between Member business and the Approved Person’s outside activity. The Member should recognize the potential exposure to complaints and litigation against the Member in the event the outside activity is permitted.
(f) Ability to Supervise
The Member should evaluate its ability to satisfy supervisory requirements regarding the outside activity and consider the effect such requirements will have on resources.
7. Ongoing Member Supervisory Obligations
While Members do not have specific obligations under the Rules to supervise the approved outside activity itself on an ongoing basis, Members must monitor the activities of their Approved Persons in relation to compliance with MFDA Rules and applicable securities legislation. Accordingly, Members should take reasonable measures to ensure that there is no change in the outside activity that was approved.
Approved Person and Member obligations also include ensuring that the distinction between Member business and outside activity is properly disclosed to clients. Such disclosure should clarify that the outside activity is not the responsibility of the Member. In addition, Members must monitor for conflicts of interest and must follow up on all client complaints that relate to the outside activity.
Members are required to take measures to detect and look for evidence of undisclosed outside activities of their Approved Person.
Effective processes to detect undisclosed outside activity can be implemented using many of the Member’s existing review procedures including:
- Advertising, website and other social media reviews – MFDA Rule 2.7.3 (Review Requirements)
- Approval of trade names – MFDA Rule 1.1.7 (Business Names, Styles, Etc.)
- Branch reviews – MFDA Policy No. 5 Branch Reviews
- Trend analysis and trade reviews – MFDA Policy 2 Minimum Standards for Account Supervision
- Due diligence in recruitment
- Complaint handling
- Annual Approved Person questionnaires
8. Member Response to Supervisory Issues
Where a Member becomes aware of an Approved Person’s undisclosed outside activity, it would generally be expected that the Member conduct a reasonable investigation to ensure that the issues noted above have been properly addressed.
In order to meet their supervisory obligations under MFDA Rules, Members must ensure that they have access to any files necessary to complete the investigation into the nature and extent of any undisclosed or unauthorized outside activity. Members must be aware of potential client privacy issues since information that clients disclose to the Approved Person as part of an outside activity may be deemed to be confidential. For more information on the collection, use and disclosure of personal client information, Members should review MFDA Staff Notice – Joint Regulatory Notice on Federal and Provincial Privacy Legislation, issued in December 2003.
The Member must take steps appropriate for the type of activity identified, being particularly alert to potential client concerns. Members must take action to resolve any issues, such as by providing disclosure to clients, consideration of discipline, or other suitable measures.
Any information received by a Member that would suggest the outside activities of an Approved Person may bring the Member or the mutual fund industry into disrepute must be followed up. Any client complaints received by the Member that relate to outside activity must be dealt with in accordance with the provisions of MFDA Policy No. 3 Handling Client Complaints. As required under Policy No. 3, complaints involving allegations of theft or misappropriation of funds or securities or of forgery must be promptly reported to the MFDA.
9. Positions of Influence
Examples of positions of influence may include, depending on the circumstances, religious leaders, health care providers and military officers.
The processes by which positions of influence are approved and supervised as outside activities include all the requirements and best practices discussed throughout this Notice. However, as discussed below, there are several unique considerations with respect to approving and supervising positions of influence.
When considering the approval of positions of influence, Members must assess the nature of the position and the degree of influence that the Approved Person holds through that position. If the Approved Person’s influence is deemed to be significant enough that it would be difficult to separate the influence from the activities that the Approved Person performs as an Approved Person, the outside activity should not be approved. It would be inappropriate in this case for the Approved Person to hold the position of influence and also engage in financial dealing activities as an Approved Person.
In certain cases, the Member may decide that a conflict of interest may arise from the position of influence can be addressed through terms and conditions. For example, the Member may consider imposing terms and conditions to prevent the Approved Person from using the position of influence to influence an individual to become a client or to affect the ongoing relationship between the Approved Person and the client. The Member may also decide to implement processes that monitor how the Approved Person’s relationship with his/her clients was established in an effort to ensure that the Approved Person is not using the position of influence to manipulate individuals to become clients.