Settlement Agreement

I. INTRODUCTION

1. By Notice of Settlement Hearing, the Mutual Fund  Dealers  Association  of  Canada (the “MFDA”) will announce that it proposes to hold a hearing to consider whether, pursuant to s. 24.4 of MFDA By-law 1 (“By-law No. 1”), a hearing panel of the Central Regional Council of the MFDA (“Hearing Panel”) should accept the settlement agreement (“Settlement Agreement”) entered into between Staff of the MFDA (“Staff”) and the Respondent, Quadrus Investment Services Ltd. (“Quadrus” or the “Respondent”).

II. JOINT SETTLEMENT RECOMMENDATION

2. Staff concluded that the Respondent has engaged in activity for which the Respondent could be penalized on the exercise of the discretion of the Hearing Panel pursuant to s. 24.1 of MFDA By-law No. 1.
3. Staff and the Respondent recommend settlement of the matter in accordance with the terms and conditions set out below. The Respondent agrees to the settlement on the basis of the facts set out in Part IV herein and consents to the making of an Order in the form attached as Schedule “A”.
4. Staff and the Respondent agree that the terms of this Settlement Agreement, including the attached Schedule “A”, will be released to the public only if and when the Settlement Agreement is accepted by the Hearing Panel.

III. ACKNOWLEDGEMENT

5. Staff and the Respondent agree with the facts set out in Part IV herein for the purposes of this Settlement Agreement only and further agree that this agreement of facts as well as the admissions in Part V are without prejudice to the Respondent or Staff in any other proceeding of any kind including, but without limiting the generality of the foregoing, any proceedings brought by the MFDA (subject to Part IX) or any civil or other proceedings which may be brought by any other person or agency, whether or not this Settlement Agreement is accepted by the Hearing Panel.

IV. AGREED FACTS

Registration History

6. The Respondent is registered in all provinces and territories in Canada as a mutual fund dealer and has been a Member of the MFDA since 2002.
7. The Respondent’s head office is located in London, Ontario.

Background

8. In 2016, the MFDA, in conjunction with the Ontario Securities Commission (“OSC”), other provincial securities regulators, and the Investment Industry Regulatory Organization of Canada, commenced a project known as the Targeted Review of Member Compensation and Incentive Programs (the “Review”). The Review was part of a larger initiative to coordinate compliance efforts on common issues such as sales incentives and related conflicts of interest.
9. To obtain the necessary information for the Review, in March 2016, the MFDA required all Members to submit information respecting the compensation structure for their representatives, including all incentive and rewards programs.
10. Based on a review of the Respondent’s submissions to the compensation/sales incentive questions and further investigation conducted by Staff in cooperation with the Respondent, Staff identified that some aspects of the compensation structure and sales incentive practices related to monetary and non-monetary incentives available to Approved Persons (as described in Issue #1 below) were not in compliance with Part 4 of National Instrument 81-105 and were a potential or actual conflict of interest contrary to MFDA Rule 2.1.4.
11. In addition, the Respondent identified the conduct described in Issue #2 below as a result of an investigation conducted by Staff in cooperation with the Respondent in response to a complaint received in late 2018. This investigation identified that some aspects of the Respondent’s operations were not in compliance with an exemption order relating to National Instrument 81-105 granted to the Respondent.

Issue #1: Monetary and Non-Monetary Incentives to Sell Proprietary Mutual Funds

12. The Respondent is the exclusive distributor of certain proprietary mutual funds. The Respondent also distributes certain third party mutual funds.
13. At the material time (defined below), the Respondent had two general classes of Approved Persons (“APs”). First, those who are authorized to sell only proprietary mutual funds (known as “Category I Advisors”). Second, those who are authorized to sell proprietary mutual funds and third party mutual funds (known as “Category II Advisors”).
14. Issue #1 relates to the Respondent’s Category II Advisors.
15. The Respondent’s APs were licensed to sell life insurance and contracted either with The Great-West Life Assurance Company (“GWL”) or London Life Insurance Company (“LL”) (collectively the “Insurers”). The Insurers administered mutual fund compensation payments to their respective dual licensees who were also APs on behalf of the Respondent. The Respondent remained responsible for ensuring that compensation paid to its APs for business of the Member complied with all MFDA Rules and other applicable securities law requirements.
16. From 2002 to December 31, 2016 (the “material time”), the Respondent’s APs participated in three programs (described in greater detail below), each of which created incentives that may have encouraged APs to recommend proprietary mutual funds over mutual funds offered by third parties:
    1. the Gold Key Recognition Credits
    2. the LL Recognition Program
    3. the LL Sales Commission Bonus

Gold Key Recognition Credits

17. During the material time, the Respondent maintained the Gold Key Recognition Credits program for the Respondent’s APs associated with GWL, which consisted of approximately 530 APs (“GK APs”).
18. Gold Key Recognition Credits made GK APs eligible for non-monetary rewards such as performance recognition and business development meetings and conferences.
19. GK APs were able to recommend and sell propriety mutual funds (any load type) and segregated funds, and third party mutual funds (any load type).
20. Gold Key Recognition Credits were calculated only on the net sales and assets under administration of proprietary mutual funds and proprietary segregated funds, thereby creating an incentive for GK APs to favour the recommendation and sales of proprietary mutual funds over third party mutual funds.

The LL Recognition Program

21. During the material time, the Respondent maintained the LL Recognition Program for eligible LL APs, which consisted of approximately 307 APs or 10% of the total sales force (“Eligible LL APs”).
22. The LL Recognition Program made Eligible LL APs eligible for non-monetary rewards such as performance recognition and business development meetings and conferences.
23. Eligible LL APs were able to recommend and sell proprietary mutual funds (any load type) and segregated funds, and third party mutual funds (any load type).
24. LL Recognition Program credits were calculated only on the sale of LL segregated funds and proprietary mutual funds. Sales of third party funds (other than LSIF and Mackenzie RESP funds) did not generate LL Recognition Program credits, thereby creating an incentive for the Eligible LL APs to favour the recommendation and sales of proprietary mutual funds over third party mutual funds.

The LL Sales Commission Bonus

25. During the material time, the Respondent maintained the LL Sales Commission Bonus program for the Eligible LL APs.
26. The LL Sales Commission Bonus program for Eligible LL APs was structured as follows:
    • Eligible LL APs were paid a sales bonus, which was determined based on sales commissions (for certain products) over a rolling 26 week pay sales commission period, multiplied by a bonus rate percentage.
    • The bonus rate percentage was calculated based on sales commissions. Whereas deferred sales commission (“DSC”) mutual funds generate a sales commission for advisors, front-end load zero (“FEL-0”) mutual funds do not generate a sales commission for advisors. Therefore, when calculating the bonus rate percentage, a ‘notional commission’ was calculated on FEL-0 sales in order to match the commissions that would otherwise be earned on sales of DSC mutual funds.[1]
    • When calculating the bonus rate percentage, the ‘notional commission’ was applied to (and calculated on) FEL-0 sales of LL segregated funds and proprietary mutual funds, but was not applied to (and not calculated on) non-proprietary FEL-0 mutual funds.
    • The ‘notional commission’ was used solely as a basis for calculating the bonus rate percentage. The bonus rate percentage was calculated using the rolling 26 week pay sales commission period (including any ‘notional commission’) on eligible funds, and ranged from 20% to 70% of all actual commission received by the Eligible LL APs during the year, including commissions from the sale of LL segregated funds, proprietary mutual funds, and third party mutual funds.
27. The exclusion of notional commission on third party FEL-0 mutual funds from the calculation of the bonus rate percentage allowed an Eligible LL AP to potentially increase their bonus rate percentage by selling proprietary FEL-0 mutual funds instead of third party FEL-0 mutual funds, thereby creating an incentive for Eligible LL APs to favour the recommendation and sales of proprietary FEL-0 mutual funds over third party FEL-0 mutual funds.[2]

Remediation

28. Beginning September 2016, after the impugned conduct had been identified by the MFDA (as described in paragraphs 16 to 27 above), the Respondent voluntarily and proactively commenced efforts requiring that the noted programs be appropriately amended or terminated. In particular, in January 2017, the programs were amended to include third party mutual funds in the recognition credits calculation, and to include notional commissions on third party mutual fund sales in the determination of the bonus rate.
29. In June 2017, the LL Sales Commission Bonus program was amended again to eliminate the sales bonus rate determination and replace it with the asset bonus rate which always included third party fund assets in its determination. The asset bonus rate is applied to all sales and trailer commissions earned on all segregated funds, proprietary mutual funds and third party mutual funds.
30. The Respondent took reasonable steps, in consultation with MFDA Staff, to investigate whether the programs described above in Issue #1 resulted in clients being advised to purchase proprietary mutual funds in circumstances where those funds were unsuitable for them or caused financial harm to them. No evidence was identified that proprietary mutual funds sold by GK APs or Eligible LL APs were unsuitable or caused financial harm.  There is no evidence that any specific APs recommended specific trades based on the incentives that were available to them. In addition, the programs described above in Issue #1 were not paid for from monies that would have otherwise been payable to investors. The availability of the programs described in Issue #1 had no bearing on the fees charged to clients for any of the funds. As such, no evidence of direct financial harm to clients from any specific trades was identified.
31. Between 2008 and 2017, both GK APs and Eligible LL APs sold substantially more third party mutual funds than proprietary mutual funds. During this time, the sale of third party mutual funds by both GK APs and Eligible LL APs as a proportion of the Respondent’s total mutual fund sales also significantly increased.
32. Certain APs who had already achieved the maximum bonus rate percentage would not have benefitted further by the inclusion of notional commissions on FEL-0 third party mutual fund sales, because once the maximum bonus rate percentage has been achieved, no further increase is possible. Also, certain APs who were already eligible to receive all benefits under the Gold Key Recognition Program or the LL Recognition Program would not have benefitted further from the inclusion of third party mutual fund sales in these calculations, because there are a finite number of benefits, and once eligibility for all benefits is achieved, no further benefits are available.
33. As of 2017, the Respondent discontinued its ‘Gold Key’ distribution channel, and thereby also discontinued the Gold Key Recognition Credits program.

Issue #2: Failure to Supervise Compliance with a Sales Incentives Exemption Order

34. Issue #2 described below relates to the Respondent’s Category I Advisors. As stated above, Category I Advisors are authorized by the Respondent to sell only proprietary mutual funds.
35. On February 27, 2009, the Ontario Securities Commission granted the Respondent an exemption from the requirements in National Instrument 81-105 thereby allowing third party mutual funds to be held in accounts serviced by Category I Advisors on an “accommodation” basis where no sales commission would be paid by the Respondent to Category I advisors in respect of the third party mutual funds (“Exemption”).[3]
36. The Respondent required an exemption from the requirements in National Instrument 81-105 because Category I Advisors may receive sales commissions at the time of the initial sale of proprietary mutual funds but may not receive sales commission in respect of third party funds sold on an accommodation basis; the Respondent would therefore have incentivized the sale of proprietary mutual funds.
37. The Respondent was granted the Exemption based on, among others, the following representations that it made regarding its structure and practices:
    • third party funds are held in client accounts serviced by Category I Advisors only at the request of the investor, and on an “accommodation” basis only for clients who either already held them in their account moved to the Respondent or who wish to incorporate them into their financial plan;
    • “accommodation” means that the Respondent does not promote or advertise the purchase of third party mutual funds through its Category I Advisors, or encourage Category I Advisors to promote or advertise the purchase of third party mutual funds;
    • third party mutual funds may only be purchased in client accounts serviced by Category I Advisors on a “no load” basis or FEL basis where the FEL is reduced to nil (third party mutual funds may not be sold with a sales commission);
    • Category I Advisors receive trailing commissions, but no sales commissions, in respect of third party mutual funds purchased by clients on an accommodation basis.
38. The Respondent was required by MFDA Rule 2.5.1 to establish, implement and maintain policies and procedures and have an adequate system of controls and supervision to ensure the handling of its Business was in accordance with the representations in the Exemption.
39. To comply with the representations in the Exemption, the Respondent implemented a process to adjust trades involving the purchase of third party mutual funds in accounts serviced by Category I Advisors to ensure that clients purchased the third party mutual fund on a no load basis, or an FEL basis where the FEL is reduced to nil (the “Adjustments Process”).
40. The Adjustments Process generated a weekly report identifying trades of third party mutual funds submitted by Category I Advisors which required adjustments to comply with the Exemption. However, the Respondent’s staff were required to manually adjust the trades to ensure clients purchased third party mutual funds on a no load basis, or an FEL basis where the FEL is reduced to nil. This required the Respondent to reverse the purchase of any third party mutual fund with a sales commission (including remitting any sales commission received from the mutual fund company), and rebook the trade at FEL-0/no load (if a sales commission was received from the client, that sales commission amount would be added to the repurchase amount).
41. Commencing in about 2009 and continuing to late 2018, the Respondent failed to establish, implement and maintain policies and procedures, and have an adequate system of controls and supervision as required by MFDA Rule 2.5.1, necessary to ensure that it consistently complied with the representations in the Exemption. As a result, during this period:
    • third party mutual fund trades in accounts of approximately 1,700 clients serviced by Category I Advisors were not adjusted as required;
    • the Respondent received approximately $219,000 in DSC or low load sales commissions in respect of third party mutual fund trades in accounts serviced by Category I Advisors that could not be reversed and rebooked in accordance with the Respondent’s process (and as a result was not remitted to the mutual fund companies);
    • in approximately 525 instances a client incurred a DSC or low load charge in respect of a third party mutual fund trade in an account serviced by a Category I Advisor. The approximate remediation cost for these clients is $43,000 and, in some instances, the Respondent will pay clients more than the DSC/low load charge that the client incurred in respect of third-party funds purchased while a client of the Respondent; and
    • in approximately 31 instances a client paid a FEL charge (approximately $4,300 in total FEL charges paid by clients) in respect of a third party mutual fund trade in an account serviced by a Category I Advisor that could not be reversed and rebooked in accordance with the Respondent’s processes.
42. The Adjustments Process included a feature which automatically prevented any sales commission from being paid to a Category I Advisor in respect of the purchase of a third party mutual fund in an account serviced by the advisor. Accordingly, the Respondent did not pay any sales commission to Category I Advisors in respect of third party mutual funds sold on an accommodation basis.
43. Most of the third party mutual fund purchases processed in accounts serviced by Category I Advisors consisted of small value pre-authorized contributions. These trades represented a small proportion of the total dollar value of mutual fund trades processed for clients serviced by Category I Advisors during the relevant period.

Remediation

44. The Respondent voluntarily implemented a remediation plan to address the conduct described in Issue #2 above. This remediation plan included:
    • a process to identify and contact current and former clients who were impacted;
    • a compensation plan for current and former clients who paid sales charges or incurred DSCs or low load charges in respect of third party mutual funds in accounts serviced by Category I Advisors;
    • a process to identify and take corrective action in respect of current or former clients who purchased third party mutual funds in accounts serviced by Category I Advisors where these funds may be subject to DSCs in the future, in accordance with the compensation plan;
    • modifications to the Adjustments Process to ensure that trades involving the purchase of third party mutual funds in accounts serviced by Category I Advisors are identified and adjusted within a reasonable time period to prevent clients from incurring a sales charge or being subject to a DSC;
    • additional record-keeping requirements with respect to trades involving the purchase of third party mutual funds in accounts serviced by Category I Advisors;
    • changes to its supervision structure to provide additional oversight and management of the modified Adjustments Process; and
    • weekly random audits of trades identified and adjusted through the modified Adjustments Process to ensure that it is working properly.
45. Following the completion of the remediation measures, the Respondent had received a small net benefit on an aggregate basis, and the Respondent has made a charitable donation in an amount equal to this excess amount.

Additional Factors

46. The Respondent has fully cooperated with the MFDA’s review of the issues that form the subject matter of this Settlement Agreement.
47. The Respondent has met with MFDA Staff and provided updates on remediation actions it has taken regarding the conduct described above.
48. As a result of the events described in this Settlement Agreement, the Respondent has reviewed all compensation structures relating to its APs and, where necessary, has taken steps to ensure that its compensation structures are compliant with regulatory requirements.
49. As of the date of this Settlement Agreement, the Respondent’s compensation structures for Category II Advisors, including its standard sales and trailing commission rates payable in respect of mutual fund sales, do not differentiate between proprietary and third party mutual funds.

V. CONTRAVENTIONS

50. The Respondent admits that from 2002 to 2018, it failed to establish, implement and maintain adequate policies and procedures and an adequate system of controls and supervision to ensure that it complied with securities legislation including requirements relating to internal dealer incentive and sales practices, contrary to MFDA Rules 2.5.1 and 2.1.1.

VI. TERMS OF SETTLEMENT

51. The Respondent agrees to the following terms of settlement:
    1. The Respondent will pay a fine in the amount of $600,000 pursuant to section 24.1.2 of MFDA By-law No. 1;
    2. The Respondent will pay costs in the amount of $25,000 pursuant to section 24.2 of MFDA By-law No. 1;
    3. The Respondent shall in the future comply with MFDA Rules 2.5.1. and 2.1.1;
    4. A senior officer of the Respondent shall attend on the date set for the Settlement Hearing.

VII. STAFF COMMITMENT

52. If this Settlement Agreement is accepted by the Hearing Panel, Staff will not initiate any proceeding under the By-laws of the MFDA against the Respondent or any of its officers or directors in respect of the facts and the contraventions described in this Settlement Agreement, subject to the provisions of Part IX below. Nothing in this Settlement Agreement precludes Staff from investigating or initiating proceedings in respect of any facts and contraventions that are not set out in this Settlement Agreement or in respect of conduct that occurred outside the specified date ranges of the facts and contraventions set out in this Settlement Agreement, whether known or unknown at the time of settlement. Furthermore, nothing in this Settlement Agreement will relieve the Respondent from fulfilling any continuing regulatory obligations.

VIII. PROCEDURE FOR APPROVAL OF SETTLEMENT

53. Acceptance of this Settlement Agreement shall be sought at a hearing of the Central Regional Council of the MFDA on a date agreed to by counsel for Staff and the Respondent. MFDA Settlement Hearings are typically held in the absence of the public pursuant to s. 20.5 of MFDA By-law No. 1 and Rule 15.2(2) of the MFDA Rules of Procedure. If the Hearing Panel accepts the Settlement Agreement, then the proceeding will become open to the public and a copy of the decision of the Hearing Panel and the Settlement Agreement will be made available at mfda.ca.
54. Staff and the Respondent may refer to any part, or all, of the Settlement Agreement at the settlement hearing. Staff and the Respondent also agree that if this Settlement Agreement is accepted by the Hearing Panel, it will constitute the entirety of the evidence to be submitted respecting the Respondent in this matter, and the Respondent agrees to waive its rights to a full hearing, a review hearing before the Board of Directors of the MFDA or any securities commission with jurisdiction in the matter under its enabling legislation, or a judicial review or appeal of the matter before any court of competent jurisdiction.
55. Staff and the Respondent agree that if this Settlement Agreement is accepted by the Hearing Panel, then the Respondent will be deemed to have been penalized by the Hearing Panel pursuant to s. 24.1.2 of By-law No. 1 for the purpose of giving notice to the public thereof in accordance with s. 24.5 of By-law No. 1.
56. Staff and the Respondent agree that if this Settlement Agreement is accepted by the Hearing Panel, neither Staff nor the Respondent will make any public statement inconsistent with this Settlement Agreement. Nothing in this section is intended to restrict the Respondent from making full answer and defence to any civil or other proceedings against it.

IX. FAILURE TO HONOUR SETTLEMENT AGREEMENT

57. If this Settlement Agreement is accepted by the Hearing Panel and, at any subsequent time, the Respondent fails to honour any of the Terms of Settlement set out herein, Staff reserves the right to bring proceedings under s. 24.3 of By-law No. 1 against the Respondent or any of its officers or directors based on, but not limited to, the facts set out in Part IV of the Settlement Agreement, as well as the breach of the Settlement Agreement. If such additional enforcement action is taken, the Respondent agrees that the proceeding(s) may be heard and determined by a hearing panel comprised of all or some of the same members of the hearing panel that accepted the Settlement Agreement, if available.

X. NON-ACCEPTANCE OF SETTLEMENT AGREEMENT

58. If, for any reason whatsoever, this Settlement Agreement is not accepted by the Hearing Panel or an Order in the form attached as Schedule “A” is not made by the Hearing Panel, each of Staff and the Respondent will be entitled to any available proceedings, remedies and challenges, including proceeding to a disciplinary hearing pursuant to s. 20 and 24 of By-law No. 1, unaffected by this Settlement Agreement or the settlement negotiations.
59. Whether or not this Settlement Agreement is accepted by the Hearing Panel, the Respondent agrees that it will not, in any proceeding, refer to or rely upon this Settlement Agreement or the negotiation or process of approval of this Settlement Agreement as the basis for any allegation against the MFDA of lack of jurisdiction, bias, appearance of bias, unfairness, or any other remedy or challenge that may otherwise be available.

XI. DISCLOSURE OF AGREEMENT

60. The terms of this Settlement Agreement will be treated as confidential by the parties hereto until accepted by the Hearing Panel, and forever if, for any reason whatsoever, this Settlement Agreement is not accepted by the Hearing Panel, except with the written consent of both the Respondent and Staff or as may be required by law.
61. Any obligations of confidentiality will terminate upon acceptance of this Settlement Agreement by the Hearing Panel.

XII. EXECUTION OF SETTLEMENT AGREEMENT

62. This Settlement Agreement may be signed in one or more counterparts which together will constitute a binding agreement.
63. A facsimile copy of any signature will be effective as an original signature.

[1] The Respondent adopted this element of its commission structure to avoid incentivizing the sale of DSC mutual funds versus the sale of FEL-0 mutual funds.
[2] This commission structure did not create an incentive to sell other categories of proprietary mutual funds sold on a DSC or low load basis.
[3] The Respondent is able to rely upon the Exemption in other provinces and territories pursuant to section 4.7(1) of the Multilateral Instrument 11-102 Passport System (MI 11-102).