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Morningstar Associates Inc. and Portfolio Strategies Corporation
Headnote
National Policy 11-203 -- Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief granted from the requirement in subsection 3.2.01(1) of NI 81-101 to deliver a fund facts document to investors for subsequent purchases of mutual fund securities made pursuant to a model portfolio program, subject to certain conditions -- relief granted from the requirement in subsection 3C.2(2) of NI 41-101 to deliver an ETF facts document to investors for subsequent purchases of mutual fund securities made pursuant to a model pursuant to a model portfolio program, subject to certain conditions -- National Instrument 81-101 Mutual Fund Prospectus Disclosure, National Instrument 41-101 General Prospectus Requirements.
Applicable Legislative Provisions
National Instrument 81-101 Mutual Fund Prospectus Disclosure, ss. 3.2.01(1), 6.1.
National Instrument 41-101 General Prospectus Requirements, ss. 3C.2(2), 19.1.
November 5, 2020
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF MORNINGSTAR ASSOCIATES INC. (Morningstar) AND PORTFOLIO STRATEGIES CORPORATION (the Representative Dealer, and together with Morningstar, the Filers)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from Morningstar and the Representative Dealer for a decision under the securities legislation of the Jurisdiction (the Legislation) exempting each Dealer (as defined below) from the requirements in:
(a) subsection 3.2.01(1) of National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101) to deliver or send the most recently filed fund facts document (a Fund Facts) in the manner required under the Legislation (the Fund Facts Delivery Requirement); and
(b) subsection 3C.2(2) of National Instrument 41-101 General Prospectus Requirements (NI 41-101) to deliver or send the most recently filed exchange-traded mutual fund (ETF) facts document (an ETF Facts) in the manner required under the Legislation (the ETF Facts Delivery Requirement, and together with the Fund Facts Delivery Requirement, the Delivery Requirements, and each individually, a Delivery Requirement);
in respect of purchases of securities of the funds that are part of the model portfolio service (the Service) offered by Morningstar (the Funds) that are made in connection with Increase Trades (as defined below) and Additional Investment Trades (as defined below) (the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) the Filers have provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in all of the other provinces of Canada (the Other Jurisdictions, and together with Ontario, the Canadian Jurisdictions).
Interpretation
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
Representations
This decision is based on the following facts represented by the Filers:
Morningstar
1. Morningstar is a corporation incorporated under the laws of Ontario, with its head office located in Toronto, Ontario.
2. Morningstar is registered as a portfolio manager in each of the Canadian Jurisdictions.
3. Morningstar is in not in default of securities legislation in any of the Canadian Jurisdictions.
The Funds
4. Each of the Funds is, or will be, an open-ended mutual fund established under the laws of a Canadian Jurisdiction.
5. Each of the Funds is, or will be, a reporting issuer in one or more of the Canadian Jurisdictions, and subject to the requirements of National Instrument 81-102 Investment Funds (NI 81-102).
6. The securities of each of the Funds are, or will be, qualified for distribution in one or more of the Canadian Jurisdictions pursuant to a: (a) simplified prospectus, annual information form and Fund Facts prepared and filed in accordance with NI 81-101, or (b) long form prospectus and ETF Facts prepared and filed in accordance with NI 41-101.
7. The securities of each Fund that is an ETF are, or will be, listed and traded on a recognized exchange.
8. Each of the Funds is currently managed by a third-party investment fund manager that is unaffiliated with Morningstar (each, an Unaffiliated Fund Manager), but in the future, each of the Funds may be managed by Morningstar, an affiliate of Morningstar, or an Unaffiliated Fund Manager (each, a Fund Manager and collectively, the Fund Managers).
The Dealers
9. Securities of each of the Funds are, or will be, distributed through third-party dealers that are unaffiliated with Morningstar, including the Representative Dealer (the Dealers, and each, a Dealer). No Dealer is currently affiliated with any of the Fund Managers, but the Dealers may, in the future, be affiliated with one or more Fund Managers.
10. The Representative Dealer is a corporation incorporated under the laws of Alberta, with its head office located in Calgary, Alberta.
11. The Representative Dealer is a member of the Mutual Fund Dealers Association of Canada (MFDA).
12. The Representative Dealer is registered as a mutual fund dealer and exempt market dealer in Alberta, British Columbia, Manitoba, Northwest Territories, Ontario, Quebec and Saskatchewan, and as an investment fund manager in Alberta and Ontario.
13. Each Dealer is, or will be: (a) registered in the applicable Canadian Jurisdiction(s) as a dealer in the category of mutual fund dealer, and a member of the MFDA; or (b) registered in the applicable Canadian Jurisdiction(s) as a dealer in the category of investment dealer, and a member of the Investment Industry Regulatory Organization of Canada.
14. The Representative Dealer is not in default of securities legislation in any of the Canadian Jurisdictions.
The Service
15. The Service involves Morningstar using its valuation and selection methodologies to construct and maintain model investment portfolios for various stated investment objectives (the Model Portfolios, and each, a Model Portfolio), which will be offered to investors through the Dealers.
16. Each Model Portfolio will be comprised exclusively of the Funds, cash and cash equivalents, and will have investment guidelines governing the acceptable minimum and maximum allocation to various asset classes within the Model Portfolio (the Permitted Ranges, and each, a Permitted Range).
17. As part of the Service, provided that the Model Portfolio remains consistent with its stated investment objective at all times, Morningstar may, from time to time, use its discretion to make decisions regarding certain changes to the holdings of a Model Portfolio within the Permitted Ranges (the Optimization Changes).
18. As part of the Service, provided that the Client is given at least 60 days' advance written notice (the Written Notice) and the Model Portfolio remains consistent with its stated investment objective at all times, Morningstar may also, from time to time, use its discretion to make decisions regarding certain changes to the Permitted Ranges (the Weighting Changes).
19. The Optimization Changes and Weighting Changes will be effected by the relevant Dealer through the following types of trades:
a. purchase of securities to increase holdings of an existing Fund in a Model Portfolio (the Increase Trades);
b. sale of securities to decrease holdings of an existing Fund in a Model Portfolio (the Decrease Trades);
c. purchase of securities to add a new Fund to a Model Portfolio (the New Fund Trades); and
d. sale of securities to remove an existing Fund from a Model Portfolio (the Fund Removal Trades, and together with the Increase Trades, Decrease Trades and New Fund Trades, the Service Trades).
20. A Client may, from time to time, contribute additional funds to the Client's accounts with a Dealer for investment in the selected Model Portfolio through the Service. Such additional funds will be applied towards the purchase of additional securities of the Funds in accordance with the Permitted Ranges (the Additional Investment Trades).
21. The Written Notice will describe the proposed Weighting Change and specify that if the Client does not provide his or her objection to the proposed Weighting Change by a specified date, this non-objection will be deemed to be consent to make the appropriate Service Trades to the Client's Model Portfolio on the effective date.
22. The applicable Dealer will collect all of the relevant know-your-client (KYC) and suitability information for each client in the Service (each, a Client). Based on an assessment of the Client's KYC and suitability information, the Dealer's dealing representative will recommend a Model Portfolio for the Client.
23. The Client will discuss the recommended Model Portfolio and the Funds within the Model Portfolio with their Dealer's dealing representative, and the Client ultimately chooses the Model Portfolio. Model Portfolios are not changed or tailored for individual Clients.
24. Each Dealer has the option of imposing a minimum investment amount for Clients to participate in the Service, and the minimum investment amounts for different Dealers may vary. The Representative Dealer intends to impose a $50,000 minimum investment amount.
25. If the Client decides to invest in a Model Portfolio, an agreement (the Agreement) is entered into between the Client, the Dealer and Morningstar that sets out, amongst other matters, the following:
a. the name, investment objective and Permitted Ranges of the selected Model Portfolio, and the names of the underlying Funds that form part of the selected Model Portfolio at the time that the Agreement is entered into;
b. the role, duties and responsibilities of Morningstar, including Morningstar's discretion to make Optimization Changes and Weighting Changes;
c. the role, duties and responsibilities of the Dealer;
d. information about any advance written notice and Fund Facts or ETF Facts that will be delivered to the Client in connection with certain Service Trades;
e. any fees and expenses payable by the Client in respect of the Model Portfolio (including any fees and expenses charged in respect of an investment in the Funds) and Service, including the Dealer's fees, and the statement that Morningstar's fee (which is paid by the Dealer) is calculated based on the aggregate amount of assets held in Model Portfolios by all the Dealer's Clients; and
f. how a Client may terminate the Service.
26. The Dealer will provide a copy of the Agreement to the Client and be responsible for ensuring that the Client understands the Service and the topics covered in the Agreement as described in paragraph 25 above.
27. All Service Trades and Additional Investment Trades will be effected by the relevant Dealer and not by Morningstar.
28. Dealers will not have discretionary authority to participate in the management of the Model Portfolios or to recommend Optimization Changes or Weighting Changes.
29. Clients will have no direct contact with Morningstar in connection with Morningstar's management of the Model Portfolios and will interact solely with their Dealer and approved persons of their Dealer in connection with Morningstar's management of the Model Portfolios and the Dealer's administration of its accounts.
30. The Dealer will be responsible for gathering and periodically updating KYC information, including any material changes, concerning the Client and confirming the suitability of the Model Portfolio for the Client.
31. Where a Dealer determines that, as a result of a change in the Client's information, a Model Portfolio is no longer appropriate or that a different Model Portfolio would be more appropriate for the client, this will be communicated to Morningstar and the Client by the Dealer, and the Dealer will take appropriate action. A change to a different Model Portfolio will not be made without the Client entering into a new Agreement in respect of the new Model Portfolio.
32. Securities of the Funds that comprise each Model Portfolio are either directly held by each Client in his/her own account(s) established with the Dealer, or in the case of nominee accounts, in the Dealer's name, in trust for the Client.
33. A Client may terminate the Service at any time by instructing the Dealer to redeem or switch the Client's investment out of the Funds.
34. Each Client pays the Dealer a negotiated fee for the Service that is calculated as a percentage of the market value of the Client's investment in the Service. Independent of the Service, each Client also negotiates a separate fee for the services of their Dealer's dealing representative.
35. The Model Portfolios will be comprised of institutional series units of Funds that are conventional mutual funds, and, if applicable, regular units of ETFs. The management fees for institutional series units of Funds that are conventional mutual funds will be charged outside the Funds and are negotiable with the applicable Fund Manager. The Dealer is responsible for negotiating the management fees for these Funds, and these management fees will be included in the negotiated service fee that each Client pays the Dealer. Certain institutional series of Funds that are conventional mutual funds have operating expenses that will be charged within the Funds. The management fees and operating expenses for ETFs will be charged within the ETFs.
36. There will be no duplication of any fees or charges as a result of a Client's decision to use the Model Portfolio service.
37. For Model Portfolios comprised of Funds that are not ETFs, there will be no separate fees, such as sales charges, redemption fees, switch fees or early trading fees, charged in connection with the Service Trades.
38. For Model Portfolios comprised of Funds that are ETFs, there will be no separate fees, such as sales charges, redemption fees, switch fees or early trading fees, charged in connection with the Service Trades except for brokerage fees (also known as trading or transaction fees) charged by the Dealer for each Service Trade, if any, which will be charged to each Client on a proportional basis.
39. The fees and expenses charged in respect of an investment in a Model Portfolio, including both those charged directly to a Client in respect of the Service and those charged in respect of an investment in the Funds, as described in paragraphs 34 to 38 above, are described in the Agreement. The fees and expenses charged in respect of an investment in the Funds (through the Service) are described, in the case of Funds that are not ETFs, in the simplified prospectus and Fund Facts of the Funds, and in the case of Funds that are ETFs, in the long form prospectus and ETF Facts of the Funds.
40. The following monitoring and oversight procedures will be carried out in connection with the Service:
a. The Dealer will, at least annually, and in writing, request each Client to notify the Dealer of any material changes in the Client's information and, if any material changes are so identified, consider whether the changes would warrant the selection of another Model Portfolio; and
b. There will be ongoing oversight of each Model Portfolio by Morningstar advising representatives to determine whether the composition of the Model Portfolio remains suitable for its stated investment objective, risk profile and Permitted Ranges, or whether any changes to the underlying Funds or Permitted Ranges would be appropriate.
Account Reporting
41. The Dealer will reflect the Service Trades and Additional Investment Trades in each Client's account(s) on the next business day following such trades, subject to technological limitations.
42. Clients will be able to access their accounts via Dealer online access on a daily basis.
43. All trade confirmations will be provided by the Dealer.
44. The Dealer will send all statements of account to each Client in the Service on a quarterly basis.
45. The Dealer will provide each Client in the Service with an annual tax reporting package.
The Exemption Sought
46. The Service Trades will result in redemptions and purchases of securities of one or more Funds in the Model Portfolio. The Additional Investment Trades will result in purchases of securities of one or more Funds in the Model Portfolio. Each such purchase is a "distribution" under the Legislation, which triggers the Fund Facts Delivery Requirement or ETF Facts Delivery Requirement, as applicable.
47. The Fund Facts Delivery Requirement requires that a dealer, unless it has previously done so, deliver or send to a purchaser of a security of a mutual fund the most recently filed Fund Facts for the applicable class or series of securities of the mutual fund before the dealer accepts an instruction from the purchaser for the purchase of the security.
48. The ETF Facts Delivery Requirement requires that a dealer acting as agent for a purchaser who receives an order for the purchase of a security of an ETF, unless it has previously done so, deliver or send to the purchaser the most recently filed ETF Facts for the applicable class or series of securities of the ETF not later than midnight on the second business day after entering into the purchase of the security.
49. As part of the initial set-up of a new Model Portfolio for a Client, the Dealer will send or deliver the Fund Facts and/or ETF Facts, as applicable, in respect of each Fund in the selected Model Portfolio to the Client, in accordance with the applicable Delivery Requirement.
50. With respect to New Fund Trades, the Dealer will deliver or send to the Client the most recently filed Fund Facts or ETF Facts, as applicable, for any new Funds that are added to the applicable Model Portfolio in accordance with the applicable Delivery Requirement.
51. In the absence of the Exemption Sought:
a. in the case of a Fund that is not an ETF, unless the Dealer has previously done so, the Dealer would be required to deliver or send the most recently filed Fund Facts for each affected Fund in a Client's selected Model Portfolio prior to each Increase Trade and Additional Investment Trade; and
b. in the case of a Fund that is an ETF, unless the Dealer has previously done so, the Dealer would be required to deliver or send the most recently filed ETF Facts for each affected Fund in a Client's selected Model Portfolio not later than midnight on the second business day after effecting each Increase Trade and Additional Investment Trade.
Decision
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:
(a) each Client in a Model Portfolio is sent or delivered a notice that states:
(i) that except as provided for in paragraphs 49 and 50 above, the Client will not receive the Fund Facts and ETF Facts, as applicable, for the Funds in the Model Portfolio after the date of the notice, unless the Client specifically requests them;
(ii) that the Client is entitled to receive upon request, at no cost to the Client, the most recently filed Fund Facts and ETF Facts, as applicable, for the Funds in the Model Portfolio by calling a specified toll-free number, or by sending a request to the Dealer by mail or e-mail to a specified address or e-mail address;
(iii) how to access the Fund Facts and ETF Facts, as applicable, for the Funds in the Model Portfolio electronically;
(iv) that except for securities of new Funds that are purchased pursuant to New Fund Trades, the Client will not have a right of withdrawal under the Legislation for Increase Trades and Additional Investment Trades, but will continue to have a right of action if there is a misrepresentation in the prospectus or any document incorporated by reference into the prospectus; and
(v) that the Client may terminate the Agreement at any time;
(b) at least annually, the Client will be advised in writing of how they can request the most recently filed Fund Facts and ETF Facts, as applicable;
(c) the most recently filed Fund Facts and ETF Facts, as applicable, are sent or delivered to the Client if the Client requests it;
(d) Morningstar will provide to the principal regulator, on an annual basis, beginning 60 days after the date upon which the Exemption Sought is first relied upon by a Dealer, either:
(i) a current list of all such Dealers that are relying on the Exemption Sought; or
(ii) an update to the list of such Dealers or confirmation that there has been no change to such list; and
(e) prior to a Dealer relying on the Exemption Sought, Morningstar provides to the Dealer a disclosure statement informing the Dealer of the implications of this decision.
"Stephen Paglia"
Manager
Investment Funds and Structured Products Branch
Ontario Securities Commission