Final Companion Policy 81-105
Final Companion Policy 81-105
TO NATIONAL INSTRUMENT 81-105 - MUTUAL FUND SALES PRACTICES
TABLE OF CONTENTS
PART 1 PURPOSE
1.1 Purpose
PART 2 GENERAL DISCUSSION OF THE INSTRUMENT
2.1 Background
2.2 General Purpose of the Instrument
2.3 Application of the Instrument to Labour-Sponsored Venture
Capital Corporations
2.4 Indirect Avoidance of the Instrument
PART 3 DEFINITION OF "REPRESENTATIVE"
3.1 Definition of "representative"
PART 4 DISCUSSION OF CERTAIN ASPECTS OF PART 2 OF THE INSTRUMENT
4.1 The phrase "in connection with the distribution of securities"
4.2 Non-Monetary Benefits
4.3 The phrase "pay for or make reimbursement of a cost or expense
incurred or to be incurred by a participating dealer or a representative
of a participating dealer"
4.4 Exception for Some Participating Dealers and Representatives
PART 5 COMMISSIONS
5.1 Method of Calculation
5.2 Bonus Commissions
5.3 Trailing Commission Thresholds
PART 6 INTERNAL DEALER INCENTIVE PRACTICES
6.1 Internal Dealer Incentive Practices
PART 7 MARKETING AND EDUCATIONAL PRACTICES
7.1 Definition of "direct costs"
7.2 Cooperative Marketing Practices
7.3 Mutual Fund Sponsored Conferences
7.4 Third Party Sponsored Educational Events
7.5 Meaning of "Location"
7.6 Promotional Items and Business Promotion Activities
PART 8 RECIPROCAL COMMISSIONS AND PORTFOLIO TRANSACTIONS
8.1 Reciprocal Commissions and Portfolio Transactions
PART 9 OTHER SALES PRACTICES
9.1 Commission Rebates
9.2 Tied Selling
PART 10 DISCLOSURE REQUIREMENTS
10.1 Disclosure of Equity Interests
10.2 Disclosure Requirements
PART 11 EXEMPTIONS
11.1 Exemptions
PART 1 PURPOSE
1.1 Purpose - The purpose of this Policy is to state the views of the Canadian securitiesregulatory authorities on various matters relating to National Instrument 81-105 MutualFund Sales Practices (the "Instrument"), including
(a) a discussion of the general approach taken by the Canadian securities regulatoryauthorities in, and the general regulatory purpose for, the Instrument;
(b) the interpretation of various terms used in the Instrument; and
(c) examples of some of the matters described in the Instrument.
PART 2 GENERAL DISCUSSION OF THE INSTRUMENT
2.1 Background
(1) The Instrument has been adopted by the Canadian securities regulatory authoritiesas a response to the concern of many participants in the mutual fund industry thatthe pre-existing regulatory strategy of reliance on prospectus disclosure of salespractices, coupled with the discipline imposed by competitive market forces, werenot sufficient to discourage sales practices and compensation arrangements thatgave rise to questions as to whether participating dealers and their representativeswere being induced to sell mutual fund securities on the basis of the incentives theywere receiving as opposed to what was suitable for and in the best interests of theirclients.
(2) Mutual fund sales practices have been of interest and concern to the Canadiansecurities regulatory authorities and the mutual fund industry for a number ofyears. In August 1991, The Investment Funds Institute of Canada ("IFIC") issuedits report on mutual fund sales incentives (the "1991 IFIC Report"). The 1991IFIC Report was followed by the release, in October 1991, of the IFIC Code ofConduct (the "1991 IFIC Code") dealing with sales incentives.
The 1991 IFIC Code required enhanced disclosure of sales incentives offered ascompensation for sales of mutual fund securities and also required that investors inmutual funds be provided with a separate "point-of-sale" disclosure statementadvising investors of the sales incentives applicable to the purchase.
(3) A substantial review of the investment fund industry was undertaken by OntarioSecurities Commission ("OSC") Commissioner Glorianne Stromberg at the requestof the OSC in February 1994. Her report "Regulatory Strategies for the Mid-'90s -Recommendations for Regulating Investment Funds in Canada", was prepared forthe Canadian Securities Administrators ("CSA") and released in January 1995.
(4) Commissioner Stromberg noted in her report that as a result of competitivepressures "questionable sales practices and incentives have become commonplacein the industry". She concluded that the regulatory strategy referred to insubsection (1) above would be an appropriate regulatory strategy if certainrecommended fundamental changes were made to the regulation of salespractices.1
(5) In response to Commissioner Stromberg's report, IFIC, after extensive industryconsultation, released its recommendations for a Code of Sales Practices for theMutual Fund Industry dated March 29, 1996 (the "IFIC Code").2 The IFIC Codestated in its preamble:
"The Draft Code is designed to establish the industry standard of conductand to reflect its concern for investor protection. The sales practicessuggested in the Draft Code are designed to align the interests of theprincipal parties to the transaction, i.e. the investor, fund manager and,where applicable, third party fund distributor firm and salesperson, and toencourage long term relationships among them. If implemented, the DraftCode would prohibit many sales practices which could result in conflicts ofinterest between the interests of an investor and those of the distributorfirm, its salespersons and a fund manager. IFIC believes that it isimportant, in the case of sales practices permitted under the Draft Code,that there be full disclosure of the sales practice in order that an investor isfully informed of the circumstances surrounding investment in mutualfunds".
(6) In the absence of a self-regulatory organization which could adopt the IFIC Codeas a regulation applicable to all distributors of securities of mutual funds, IFICrecommended that the provisions of the IFIC Code be reflected in rules of theCanadian securities regulatory authorities. This request was endorsed by theInvestment Funds Steering Group.3
(7) The Instrument is based on, and in Ontario, is an amended version of, a proposedOntario rule regarding mutual fund sales practices (the "Ontario Draft Rule")published for comment in Ontario on August 30, 1996 at (1996), 19 OSCB 4734.The Ontario Draft Rule reflected the approach taken in the IFIC Code and alsoreflected certain of the by-laws and rules of the IDA. This Instrument reflects thediscussions of the Canadian securities regulatory authorities of comments receivedin Ontario in respect of the Ontario Draft Rule. The Canadian securities regulatoryauthorities have made the Instrument in order to make mandatory, on anindustry-wide basis across Canada, restrictions on certain sales and businesspractices followed by participants in the mutual fund industry.
2.2 General Purpose of the Instrument
(1) The purpose of the Instrument is to ensure that the interests of investors remainuppermost in the actions of participants in the mutual fund industry by settingminimum standards of conduct to be followed by industry participants in theiractivities in distributing mutual fund securities. The minimum standards ofconduct established by the Instrument are designed to minimize the conflictsbetween the legitimate commercial goals of industry participants and thefundamental obligations outlined in subsection (2) that are owed by industryparticipants towards investors.
(2) The Instrument prohibits certain sales practices and compensation arrangementsthat have developed and that the Canadian securities regulatory authoritiesconsider undermine, compromise or conflict with the following fundamentalobligations of industry participants to their investor clients:
(a) investment recommendations should be made by a representative of aparticipating dealer to an investor based on the investor's investmentobjectives and circumstances and must be suitable for that investor;
(b) a participating dealer and its representatives have a primary obligation toact in the best interests of clients;
(c) where an investor is relying on a participating dealer and a representative ofa participating dealer to provide him or her with independent expertise andadvice regarding options for mutual fund or other investments, theparticipating dealer and the representative of the participating dealer have afiduciary obligation not to compromise the provision of this expertise andadvice;
(d) a participating dealer, as a registrant under securities legislation, is requiredto exercise adequate and appropriate supervision of its representatives whoare dealing with clients to ensure compliance with all statutory and otherlegal obligations;
(e) members of the organization of a mutual fund providing managementservices to a mutual fund have an obligation to act honestly, in good faithand in the best interests of the mutual fund and its securityholders; and
(f) full, true and plain disclosure of all material facts concerning a mutual fund,including the compensation paid to participating dealers and theirrepresentatives and other sales practices followed in connection with thedistribution of mutual fund securities, is essential to ensure that investorsunderstand the nature of the investments they are making and the impact offees and charges on them.
(3) The Canadian securities regulatory authorities are aware that other salespractices or compensation arrangements could arise that also undermine orcompromise the focus of industry participants in complying with thefundamental obligations outlined in subsection (2). The Canadian securitiesregulatory authorities expect participants in the mutual fund industry to beand remain faithful to their fundamental obligations to the investing public,and not to allow practices or arrangements to develop that threaten thishigh standard of conduct. In this context, the restrictions on sales practicesarticulated by the Instrument should be seen as the minimum standards thatshould be followed by industry participants in order to fulfil theirfundamental obligations.
2.3 Application of the Instrument to Labour-Sponsored Venture Capital Corporations
(1) Labour-sponsored venture capital corporations ("LSVCCs") are investmentvehicles existing under the Income Tax Act (Canada) and legislation of somejurisdictions. LSVCCs that are structured as mutual funds are regulated as mutualfunds in a number of jurisdictions, including Ontario and British Columbia, subjectto certain exemptions. LSVCCs are considered not to be mutual funds in Quebecunder Quebec securities legislation. LSVCCs are also considered not to be mutualfunds in Manitoba; however, the Manitoba Securities Commission has issued alocal instrument that makes LSVCCs in Manitoba subject to the Instrument.
(2) The Canadian securities regulatory authorities consider LSVCCs to be subject tothe Instrument except in those jurisdictions in which LSVCCs are considered notto be mutual funds, in the case of Quebec, or have specifically been made subjectto the Instrument, in the case of Manitoba.
(3) Section 2.1 of the Instrument prohibits a mutual fund from making a payment ofmoney or providing a non-monetary benefit to a participating dealer or arepresentative of a participating dealer or paying for or making reimbursement of acost or expense incurred or to be incurred by a participating dealer orrepresentative of a participating dealer. Under the Instrument, all such paymentsor actions must be made by members of the organization of a mutual fund, not themutual fund itself.
(4) Costs relating to the distribution of securities of LSVCCs are currently paid by theLSVCCs themselves for reasons related to the specialized organizational and legalstructure of LSVCCs. Therefore, the applicable Canadian securities regulatoryauthorities will entertain applications from LSVCCs for relief from the provisionsof the Instrument that prohibit mutual funds from making the payments oreffecting the actions described in section 2.1 of the Instrument. The relief, ifgranted by the securities regulatory authority in a jurisdiction for an LSVCC, willpermit the LSVCC to make those payments or take those actions, subject to all ofthe other requirements of the Instrument. Under such relief, the LSVCC, forexample, would be permitted to pay trailing commissions directly to participatingdealers, but subject to the requirements of section 3.2 of the Instrument and anyother condition imposed in connection with such relief.
2.4 Indirect Avoidance of the Instrument
(1) The Canadian securities regulatory authorities have in connection with the IFICCode, on occasion, encountered creative ways in which arrangements have beenstructured that permit benefits to be provided by a mutual fund organization to aparticipating dealer in a manner that the Canadian securities authorities wouldregard as contrary to the clear spirit and intent of the IFIC Code.
(2) The Canadian securities regulatory authorities may examine arrangements thatraise the suspicion of being structured to permit a party to do indirectly what itcannot do directly. The Canadian securities regulatory authorities regard theprohibitions contained in the Instrument as prohibitions against both direct andindirect actions in relation to the subject matter of the prohibition.
(3) For example, Part 2 of the Instrument contains the basic prohibitions of theInstrument against members of the organization of a mutual fund makingpayments, among other things, to participating dealers or their representatives inconnection with the distribution of securities of the mutual fund. This provisionprohibits both the direct and indirect payment of money from mutual fundorganizations to dealers, and the Canadian securities regulatory authorities will nothesitate to look through an arrangement in which, for example, a mutual fundorganization paid money to a third party in connection with the distribution ofsecurities of the mutual fund, knowing that the money would flow back to theparticipating dealer.
(4) It is noted that the draft of the Instrument that was published for commentcontained a prohibition against indirect action. The Canadian securities regulatoryauthorities note that that provision was deleted from the final version of theInstrument because, as a matter of legislative drafting, it was consideredunnecessary to be included in the Instrument. No inference should be taken fromthe deletion that the principle contained in that provision is inapplicable to theInstrument.
PART 3 DEFINITION OF "REPRESENTATIVE"
3.1 Definition of "representative"
(1) The definition of the term "representative" contained in section 1.1 of theInstrument includes a person who is registered in the category of partner, director,officer or salesperson of a participating dealer, even though the relationship of theperson with the participating dealer may be one of independent contractor. Thedefinition of the term "representative" also includes employees of a participatingdealer, even if those employees are not registered with the securities regulatoryauthority.
(2) Paragraph (b) of the definition of "representative" includes personal holdingcompanies of the persons referred to in paragraph (a) of the definition. TheCanadian securities regulatory authorities have included this paragraph to ensurethat the provisions of the Instrument apply both to the persons who carry onactivities through personal holding companies and to the holding companiesthemselves.
PART 4 DISCUSSION OF CERTAIN ASPECTS OF PART 2 OF THEINSTRUMENT
4.1 The phrase "in connection with the distribution of securities" - The prohibitions andrestrictions contained in sections 2.1 and 2.2 of the Instrument relate to actions taken "inconnection with the distribution of securities" of a mutual fund. The Canadian securitiesregulatory authorities are of the view that this phrase includes, without limitation, anyactivity done in furtherance of the sale, distribution or marketing of securities of mutualfunds. This would include promotional activities relating to the investment in securities ormutual funds generally, or educational activities concerning financial, investment orretirement planning that could involve a discussion of the advantages and disadvantages ofmutual fund investments. Any compensation or non- monetary benefits given to solidify orpromote a relationship between a member of the organization of a mutual fund and aparticipating dealer and its representatives would fall within the scope of these sections.The phrase should not be interpreted restrictively or narrowly.
4.2 Non-Monetary Benefits
(1) Part 2 of the Instrument contains restrictions and prohibitions on the provision of,among other things, non-monetary benefits to participating dealers and theirrepresentatives.
(2) The Canadian securities regulatory authorities are of the view that the term"non-monetary benefits" includes any goods, services or other benefits that couldbe provided to or received by a person or company and that could be perceived bythat person as being of benefit, advantage or value to him, her or it. The mattersthat are included in the term include, without limitation
(a) domestic or foreign trips, food, beverages and accommodation, regardlessof whether these benefits are provided in connection with attendance at aconference or other event sponsored by a member of the organization of amutual fund;
(b) entertainment, including the provision of tickets to concerts, theatre orsporting events, or the ability to participate in events such as golftournaments;
(c) gifts and non-cash gratuities;
(d) invitations to educational seminars or conferences organized by membersof the organization of a mutual fund;
(e) attendance at educational seminars, conferences or courses; and
(f) computer hardware, including networking hardware and general businesssoftware systems.
(3) The term "non-monetary benefits" does not include the goods and services that areprovided by mutual fund organizations to participating dealers to facilitate themarketing of securities of the mutual fund, such as brochures, educational material,supplies of prospectuses or simplified prospectuses and financial statements.
(4) Some mutual fund organizations provide participating dealers with computersoftware that is designed to assist in determining which of the mutual funds of theorganization are most appropriate for a client of the participating dealer, havingregard to the investment objectives and financial condition of the client. TheCanadian securities regulatory authorities are of the view that the provision of thistype of proprietary software is not a non-monetary benefit to the participatingdealer and is in the nature of marketing materials as referred to in subsection (3).
(5) However, the Canadian securities regulatory authorities consider that the provisionof financial planning software of a more general nature, whether proprietary to themutual fund organization or not, would likely constitute a non-monetary benefit.In addition, other non-proprietary software that is provided to the participatingdealer would generally be considered to be a non-monetary benefit.
(6) The provision by a member of the organization of a mutual fund to a participatingdealer of computer software, the only purpose of which is to facilitate theelectronic interface between the participating dealer and the members of theorganization of the mutual fund, is not considered to be included in the term"non-monetary benefits".
4.3 The phrase "pay for or make reimbursement of a cost or expense incurred or to beincurred by a participating dealer or a representative of a participating dealer" - Section2.1 of the Instrument contains restrictions and prohibitions on the ability of a mutual fundand a member of the organization of a mutual fund to "pay for or make reimbursement ofa cost or expense incurred or to be incurred by a participating dealer or a representative ofa participating dealer". Section 2.2 contains corresponding restrictions and prohibitionson the ability of a participating dealer and its representatives to solicit or accept suchpayments. The Canadian securities regulatory authorities are of the view that this phraseincludes direct or indirect reimbursement of costs or expenses, any payment thatcompensates a participating dealer or representative for such costs or expenses or anyother method whereby the member of the organization of the mutual fund directly orindirectly bears the costs or expenses incurred.
4.4 Exception for Some Participating Dealers and Representatives
(1) Section 2.3 of the Instrument provides that nothing in the Instrument prohibits aperson or company that is both a member of the organization of a mutual fund anda participating dealer of a mutual fund in a different mutual fund family fromundertaking any activity, if
(a) the activity is undertaken in the person or company's capacity as aparticipating dealer of the mutual fund of which it is a participating dealer,and not in its capacity as a member of the organization of the mutual fundof which it is a member; and
(b) a participating dealer is not prohibited by the Instrument from undertakingthat activity.
(2) That section is designed to respond to the fact that many registrants that areparticipating dealers will also be members of organizations of mutual funds; forexample, a dealer that is owned by a bank will likely be an affiliate of the manageror principal distributor of a mutual fund sponsored by that bank and thus be amember of the organization of that mutual fund.
(3) The Canadian securities regulatory authorities intend that a participating dealerthat is also a member of the organization of a mutual fund will have the freedom tooperate as a participating dealer without concern over technically breaching therestrictions on members of the organizations of mutual funds contained in theInstrument. Some examples of how section 2.3 of the Instrument would berelevant to certain actions, assuming that the conditions of section 2.3 weresatisfied, are as follows:
(a) a participating dealer that is also a member of the organization of a mutualfund would not be constrained in how it compensates its ownrepresentatives or employees by the provisions of Part 2 of the Instrument;
(b) a participating dealer that is also a member of the organization of a mutualfund would not be limited by the operation of section 5.1 of the Instrumentin presenting an investor conference by the fact that the dealer may also bea member of the organization of the mutual fund;
(c) section 5.2 of the Instrument would not prevent a participating dealer thatis also a member of the organization of a mutual fund from paying thetravel, accommodation and personal incidental expenses for its ownrepresentatives to attend conferences sponsored by the mutual fundorganization; and
(d) section 5.5 of the Instrument would not operate to subject a participatingdealer to the limitations contained in that section if the dealer wassponsoring a conference for its own representatives; the dealer would beable to pay for its own costs even though technically, the dealer was amember of the organization of a mutual fund.
(4) Similarly, by reason of subsection 2.3(2), the Instrument will not affect the abilityof a representative of a participating dealer that is a member of the organization ofa mutual fund to receive compensation otherwise permitted by the Instrument fromthe participating dealer.
(5) The Canadian securities regulatory authorities note they would consider any actionin which the relationship between a mutual fund organization and a participatingdealer that was a member of the organization was used in an attempt to avoid theInstrument to be offensive to the Instrument.
PART 5 COMMISSIONS
5.1 Method of Calculation - Paragraphs 3.1(b) and 3.2(b) of the Instrument require thedisclosure of the method of calculation used in determining the amount of salescommissions and trailing commissions. The Canadian securities regulatory authorities areof the view that this requirement will be satisfied with disclosure of a general nature as tohow those commissions are calculated; the authorities expect that this disclosure woulddescribe, generally, that the amount of a commission is calculated through multiplying aspecified rate of commission by some aggregate dollar amount of securities sold or held asat a specified time.
5.2 Bonus Commissions - Subparagraphs 3.1(c)(iii) and 3.2(1)(d)(iii) of the Instrumentprevent the payment of "bonus commissions", in which the rates of commissions paid orearned during a particular period of the year are higher than the rates of commissions paidor earned for any other time. This provision should not be read to prevent a mutual fundfrom changing its general commission rates at some time during a year. It is noted that insuch circumstances, the mutual fund should amend its prospectus or simplified prospectusto disclose the change in general commission rates applicable to sales of its securities.
5.3 Trailing Commission Thresholds
(1) The Canadian securities regulatory authorities note that the IFIC Code permits amutual fund organization to pay, and a participating dealer to accept, trailingcommissions based on the assets in an individual representative's client accounts,on a representative by representative basis. The IFIC Code further provides that amutual fund organization could establish a payment policy whereby no trailingcommission would be paid to a participating dealer in respect of a particularrepresentative if the assets in the representative's client accounts did not exceed$100,000.
(2) The Canadian securities regulatory authorities consider that the effect of the rulesestablished by subsection 2.1(3) and section 3.2 of the Instrument mean thatmutual fund organizations can no longer establish the minimum asset thresholdsreferred to in the IFIC Code. These sections require that the percentage that atrailing commission represents of the aggregate value of securities of a mutual fundheld in accounts of clients of a participating dealer must be the same for thatparticipating dealer, regardless of the aggregate value of securities of the mutualfund in accounts of clients of the participating dealer at any time or the aggregatelevel of sales of securities of the mutual fund by the participating dealer.
(3) Subsection 3.2(3) of the Instrument provides a limited transitional exception to thegeneral provisions of section 3.2 concerning minimum thresholds in relation totrailing commissions. Subsection 3.2(3) permits a member of the organization of amutual fund not to pay a trailing commission in respect of securities of the mutualfund held in accounts of clients of the participating dealer in certain circumstances;namely that the non-payment be consistent with a policy established and followedon July 1, 1997, and that the securities with respect to which no trailingcommission is paid must have been acquired by those clients before the date thatthe Instrument came into force. The rules established by section 3.2 are notintended to retroactively affect existing arrangements between mutual fundorganizations and participating dealers respecting securities acquired before theInstrument came into force.
(4) The following examples are offered to illustrate the operation of subsection 3.2(3)of the Instrument. In each case, assume that a mutual fund organization had inplace on July 1, 1997 a policy of not paying trailing commissions in respect ofsecurities held in accounts of clients of a participating dealer, on a representativeby representative basis, if the aggregate value of securities in those accounts wasless than $100,000.
(a) At some time after the Instrument came into force, securities in clientaccounts totalled $75,000 in value, of which $50,000 were acquired beforethe Instrument came into force, and $25,000 were acquired after theInstrument came into force. The mutual fund organization is entitled underthe Instrument to decline to pay a trailing commission in respect of the$50,000 value of securities acquired before the Instrument came into force,but must pay a trailing commission on the $25,000 value of securitiesacquired after the Instrument came into force; and
(b) At some time after the Instrument came into force, securities in clientaccounts totalled $125,000 in value, of which $50,000 were acquiredbefore the Instrument came into force, and $75,000 were acquired after theInstrument came into force. The mutual fund organization is required topay trailing commissions on the $75,000 worth of the securities acquiredafter the Instrument came into force. Also, since the $100,000 thresholdestablished under the policy of the organization in place on July 1, 1997was exceeded, the mutual fund organization would pay a trailingcommission on all $125,000 value of securities held in the accounts.
(5) The Canadian securities regulatory authorities note that mutual fund organizationsare not required to continue to maintain those policies of not paying trailingcommissions in the circumstances described in subsections (3) and (4). Asprovided in paragraph 3.2(3)(c) of the Instrument, any non- payment of a trailingcommission under section 3.2 must be in conformity with the pre-establishedpolicy of the mutual fund organization.
(6) The Instrument is intended to remove the conflicts inherent in representativesseeking to achieve specific asset and sales thresholds in order to receivecompensation in respect of mutual fund sales. An internal compensation system ofa participating dealer whereby a representative is not paid any portion of acommission that is less than a specified dollar amount could be viewed as imposingindirectly an asset and sales threshold for that representative. The Canadiansecurities regulatory authorities are concerned that the internal compensationsystems of participating dealers not impose, in effect, an asset or sales threshold tobe achieved by representatives in order to receive a commission paid by a mutualfund organization in respect of mutual fund sales.
(7) The Canadian securities regulatory authorities have received questions as towhether a mutual fund organization is required to pay the same rate ofcommission, inclusive of trailing commissions, to all participating dealers that sellthe securities of the mutual fund organization's mutual fund family. The Canadiansecurities regulatory authorities note that the Instrument does not require the samerate of commission to be paid. However, the Canadian securities regulatoryauthorities would consider that the rules set out in Part 3 of the Instrumentprohibiting mutual fund organizations from setting minimum asset and salesthresholds in respect of commission payments would be offended if a mutual fundorganization established a practice of only paying participating dealerscommissions, or higher rates of commissions, if these dealers met a specified assetor sales threshold.
PART 6 INTERNAL DEALER INCENTIVE PRACTICES
6.1 Internal Dealer Incentive Practices - Sections 4.1 and 4.2 of the Instrument permitdifferent payments to be made by participating dealers to their representatives for differentmutual funds if the difference in payments is a result of the different commissions receivedby the dealer from mutual fund organizations. The Canadian securities regulatoryauthorities recognize that different mutual fund organizations may pay different levels ofcommissions to dealers and that there is no compelling reason to prevent thosedifferentials from flowing through to the representatives.
PART 7 MARKETING AND EDUCATIONAL PRACTICES
7.1 Definition of "direct costs"
(1) The phrase "out-of-pocket" costs and expenses, used in the definition of "directcosts" contained in section 1.1 of the Instrument, does not include internal salaryand overhead costs associated with the efforts of the participating dealer relatingto the applicable sales communication or event. The definition of "direct costs"specifically excludes any costs incurred by a participating dealer for travel,accommodation or personal incidental expenses associated with the attendance ofindividuals at applicable events. The Canadian securities regulatory authorities areof the view that those types of expenses form part of the cost of doing business forthe participating dealer and may not be borne by mutual fund organizations.
(2) Part 5 of the Instrument permits a member of the organization of a mutual fund topay direct costs incurred by a participating dealer relating to certain salescommunications or events on the conditions indicated, which include, in somecircumstances, a condition that the participating dealer provide invoices or receiptsfor the costs to be paid by the member. The Canadian securities regulatoryauthorities expect members of organizations of mutual funds to exercise reasonablediligence to ensure that the direct costs indicated on invoices or receipts receivedfrom participating dealers represent direct costs that are reasonable in thecircumstances. The Canadian securities regulatory authorities also expectparticipating dealers to exercise reasonable diligence to ensure that the direct costsindicated on invoices or receipts delivered to members of organizations of mutualfunds represent direct costs incurred by the participating dealer.
7.2 Cooperative Marketing Practices
(1) Section 5.1 of the Instrument is designed to permit some cooperative marketingbetween mutual fund organizations and participating dealers, within the parametersset out in that section. The Canadian securities regulatory authorities are awarethat participating dealers conduct certain marketing on behalf of mutual fundorganizations and accordingly have permitted a limited sharing of the costs of salescommunications and investor conferences and seminars that are organized andpresented by participating dealers on the conditions contained in section 5.1.Section 5.1, however, does not permit a participating dealer to receivecompensation or reimbursement from a mutual fund organization for its generalmarketing expenses, such as, for example, costs associated with client appreciationevents or general client mailings or sales communications that relate generally tothe business or operations of the participating dealer. Those costs may not beborne by mutual fund organizations.
(2) Paragraph 5.1(c) of the Instrument requires a participating dealer to provideinvoices for, or receipts evidencing payment of, the direct costs permitted undersection 5.1 to be paid by a member of the organization of the mutual fund. TheCanadian securities regulatory authorities are of the view that a participating dealermay establish procedures to facilitate the efficient payment or reimbursement ofthese costs, and note the following in that regard.
(a) It is not necessary that the reimbursement of these costs be processed bythe head office of a participating dealer; participating dealers may deal withmutual fund organizations at an appropriately local office level. However,the Canadian securities regulatory authorities emphasize that theInstrument makes a distinction between actions taken by a "participatingdealer" and by a "representative". Paragraph 5.1(c) of the Instrumentrequires a participating dealer to provide the invoices and receipts to themutual fund organization, and this action cannot be taken directly byrepresentatives of the participating dealer;
(b) The Canadian securities regulatory authorities would not object toparticipating dealers directing mutual fund organizations to pay suppliers orservice providers directly, so long as the payment is otherwise permitted tobe made under section 5.1 of the Instrument. There is no need for themutual fund organization to pay the participating dealer the relevantamount of the costs, who then must pay the supplier.
(3) Paragraph 5.1(e) of the Instrument requires written disclosure of the identity of theparties paying for a portion of the costs of a sales communication, investorconference or investor seminar. The Canadian securities regulatory authoritiesconsider that this disclosure should be in sufficient detail to make clear that aclearly-identified party has paid a portion of the costs. As a result, the meredisplay of a party's logo would be considered insufficient disclosure both becausethe display may not adequately identify the party or make clear that the party haspaid some of the costs of the event.
7.3 Mutual Fund Sponsored Conferences
(1) Section 5.2 of the Instrument requires that the costs relating to the organizationand presentation of a conference or seminar described in that section bereasonable, having regard to the purpose of the conference or seminar. TheCanadian securities regulatory authorities are of the view that "reasonable" costs inthis context could include the provision of food and beverages for attendees at theconference or seminar, the provision of conference or seminar materials and thepayment or waiver of registration fees at the conference or seminar. The term"reasonable" costs would not include gifts or entertainment provided to attendeesother than as permitted by section 5.6 of the Instrument.
(2) Section 5.2 of the Instrument requires that the selection of the representatives of aparticipating dealer to attend a mutual fund sponsored conference or seminar is tobe made exclusively by the participating dealer, uninfluenced by the mutual fundorganization. The Canadian securities regulatory authorities note that therestriction does not prevent mutual fund organizations from organizing events thatare tailored to the interests of particular categories of representatives, and advisingthe participating dealers of the nature of those events. So, for instance, a mutualfund organization would be free to organize events designed for juniorrepresentatives in which entry-level information concerning mutual funds wasprovided; the organization could advise the participating dealers that it would beappropriate that junior representatives attend. Identifying specific representativeswould not constitute compliance with section 5.2 of the Instrument.
7.4 Third Party Sponsored Educational Events - Section 5.3 of the Instrument permits amember of the organization of a mutual fund to pay the registration fees of arepresentative of a participating dealer for a third party sponsored educational eventreferred to in that section. The term "registration fees" should be read with its ordinarymeaning and should not be read to include travel, accommodation or other incidental costsassociated with the attendance of the representative at the event.
7.5 Meaning of "Location" - Subparagraphs 5.2(c)(iii) and 5.5(e)(iii) of the Instrument permitthe events to which sections 5.2 and 5.5 apply to take place in a location where a portfolioadviser of a mutual fund carries on business, subject to the condition contained in thesesubparagraphs. The Canadian securities regulatory authorities note that the term"location" will be interpreted by them to mean the city or immediate locale where theportfolio adviser carries on business. The Canadian securities authorities will regard asabusive any attempt to construe the term "location" in an excessively wide manner. So,for example, for a portfolio adviser carrying on business from an office in London,England, "location" means London or the immediate vicinity; it does not mean England,the British Isles or Europe.
7.6 Promotional Items and Business Promotion Activities
(1) Section 5.6 of the Instrument permits the provision of "non-monetary benefits of apromotional nature" of minimal value. Examples of this type of benefit includereminder advertising such as pens, calendars, t-shirts, hats, coffee mugs,paperweights and golf balls.
(2) Section 5.6 of the Instrument permits a member of the organization of a mutualfund family to engage in reasonable business promotion activities. Examples ofsuch activities include occasional meals or drinks, tickets to sporting events,concerts or the theatre or the ability to participate in events such as golftournaments and other comparable entertainment.
PART 8 RECIPROCAL COMMISSIONS AND PORTFOLIO TRANSACTIONS
8.1 Reciprocal Commissions and Portfolio Transactions
(1) Part 6 of the Instrument is designed to ensure that "best execution" practices arefollowed in making brokerage arrangements for mutual funds. It limits theconnection between a participating dealer's distribution activities in respect of amutual fund and its activities in carrying out portfolio transactions for the mutualfund. In this regard, subsection 6.1(2) and section 6.2 of the Instrument requirethat portfolio transactions for a mutual fund are to be carried out only through arepresentative of a participating dealer who has been designated as an institutionalrepresentative by that participating dealer. The Canadian securities regulatoryauthorities expect that industry participants will not attempt to circumvent theintent of the Instrument by designating persons as institutional representatives toundertake portfolio transactions for mutual fund organizations if those personshave little or no other dealings with institutional accounts.
(2) The Canadian securities regulatory authorities recognize that certain types ofinformation sharing between a member of the organization of a mutual fund and aparticipating dealer or a principal distributor are legitimate. For example,disclosure of trading history to a participating dealer while negotiating commissionrates for future trades would not offend subsection 6.1(3) of the Instrument.
PART 9 OTHER SALES PRACTICES
9.1 Commission Rebates - Subsection 7.1(2) of the Instrument requires disclosure of the taxconsequences of a redemption. The Canadian securities regulatory authorities expect thatthis disclosure will be of a general nature, showing the tax effects of a redemption fortaxpayers at different marginal rates.
9.2 Tied Selling
(1) The Canadian securities regulatory authorities note that the "products or services"referred to in paragraph 7.4(b) of the Instrument include the opening of anaccount.
(2) The Canadian securities regulatory authorities made section 7.4 of the Instrumentin response to a similar provision in the IFIC Code, but also as a result of theirconcern that certain industry participants could use their ability to provide services(such as making loans) to investors and use undue influence to require orotherwise improperly require or coerce such investors to acquire mutual fundsecurities as a condition of providing these services. The Canadian securitiesregulatory authorities are aware that certain industry participants offer financialincentives or advantages to certain clients; the practice of offering these financialincentives or advantages is commonly referred to as "relationship pricing". Section7.4 is not intended to prohibit so-called "relationship pricing" or other beneficialselling arrangements similar to relationship pricing. For example, the Canadiansecurities regulatory authorities would consider that section 7.4 was not offendedif a financial institution offered to make a loan to a customer on more favourableterms or conditions than the financial institution would otherwise offer to thecustomer, if as a condition to obtaining the favourable terms or conditions, thecustomer acquired securities of mutual funds sponsored by the financial institution.Section 7.4 would be offended, however, if the financial institution refused tomake a loan to that customer unless the customer acquired securities of mutualfunds sponsored by the financial institution in circumstances, for example, wherethe customer otherwise met the financial institution's criteria for making loans.
PART 10 DISCLOSURE REQUIREMENTS
10.1 Disclosure of Equity Interests - Section 8.2 of the Instrument requires a mutual fund todisclose equity interests held by participating dealers and their representatives in membersof the organization of the mutual fund. The Canadian securities regulatory authoritiesnote that the term "equity interest" is a defined term and has a different meaningdepending on whether the relevant member of the organization of a mutual fund is areporting issuer whose securities are listed on a Canadian stock exchange or not. Forexample, for a member of an organization that is a reporting issuer whose securities arelisted on a Canadian stock exchange, the threshold for disclosure of an equity holding by aparticipating dealer or a representative of a participating dealer is 10 percent of any classof securities of that member. The Canadian securities regulatory authorities expect themutual fund to use its reasonable best efforts to seek the relevant information from amember of the organization of the mutual fund that is a reporting issuer whose securitiesare listed on a Canadian stock exchange. The Canadian securities regulatory authoritieswould not object to a mutual fund organization disclosing that the information disclosed inthe prospectus is to the best of its knowledge.
10.2 Disclosure Requirements - Section 8.3 of the Instrument sets out the disclosurerequirements for distributions of securities of a mutual fund subject to the Instrument thatare made under an exemption from the prospectus requirements of the securitieslegislation and in circumstances in which the mutual fund does not have a currentprospectus or simplified prospectus available to be delivered to the purchaser of thesecurities of the mutual fund.
PART 11 EXEMPTIONS
11.1 Exemptions
(1) The procedure to obtain, in more than one jurisdiction, an exemption from theInstrument is as follows:
(a) the applicant should file an application in writing simultaneously in alljurisdictions in which it requires an exemption;
(b) the application should indicate the name of the principal jurisdictionselected by the applicant for the purpose of dealing with the applicationand, if applicable, any related prospectus filing and of each otherjurisdiction where the application and, if applicable, a related prospectus isbeing filed;
(c) the Canadian securities regulatory authority of the principal jurisdiction orthe regulator in the principal jurisdiction will, on behalf of the applicant,contact the Canadian securities regulatory authorities or regulators in theother jurisdictions in which the application has been made for theircomments concerning the application and will forward all comments to theissuer; and
(d) the applicant should respond in writing to all comments to the Canadiansecurities regulatory authority in the principal jurisdiction, which willforward the response to the Canadian securities regulatory authorities inthe other jurisdictions and again coordinate comments.
(2) In order to enable the Canadian securities regulatory authorities to deal withapplications on a timely basis, issuers are encouraged to file applicationssimultaneously in all jurisdictions in which they require an approval or anexemption.