January 1999

TO: COMPLIANCE OFFICER

SUBJECT: MUTUAL FUND DEALER COMPLIANCE ISSUES

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Background

In response to Glorianne Stromberg's report, "Regulatory Strategies for the Mid-90s: Recommendations for Regulating Investment Funds in Canada", and in response to the increased appeal and growth of mutual funds, the Compliance Team of the Ontario Securities Commission (the "OSC") initiated compliance examinations of mutual fund dealers. Over approximately a three year period, 20% of the total number of mutual fund dealers registered with the OSC have been reviewed; including three national compliance reviews performed in conjunction with other provinces.

Purpose

The main purpose of our compliance examinations is to ensure that the operations of registrants are in compliance with Securities Law in Ontario. The Compliance Team, however, also examines internal controls and reports to registrants weaknesses which could increase the risk of non-compliance with Securities Law.

Selection Process

In the majority of reviews performed, the process for selecting a mutual fund dealer has been random. In a few cases, the selection has been based on criteria such as capital adequacy problems, failure to file financial information with the OSC and investor complaints.

Deficiencies

Based on our review of mutual fund dealers, we have compiled a summary of deficiencies which is attached. This summary lists many of the deficiencies that we have found during our reviews. The purpose of making this summary available is to inform and assist mutual fund dealers in identifying problems that arise in the course of complying with the requirements of Securities Law, and in the hope that this will reduce the incidence of non-compliance.

This list is not intended to be exhaustive nor representative of the industry as a whole. It is important to note that not all deficiencies were found at every mutual fund dealer reviewed by the OSC. It should also be noted that the deficiencies represent varying degrees of severity, ranging from serious breaches in Securities Law to poor business practices.

Final Word

Our experience has been that most mutual fund dealers want to comply with Securities Law but are either unaware or lack understanding of compliance with the requirements. It is the responsibility of all registrants to be knowledgeable of Securities Law and to ensure their organization is in compliance.

We recommend mutual fund dealers and their advisers review this summary of deficiencies carefully, and if you have any questions please contact the Compliance Team, at the OSC, at (416) 597-0681.

SUMMARY OF DEFICIENCIES IDENTIFIED IN
OSC COMPLIANCE EXAMINATIONS OF MUTUAL FUND DEALERS

The following is a list of deficiencies that has been identified by staff of the Ontario Securities Commission (the "OSC") during compliance examinations of mutual fund dealers. It has been prepared to inform mutual fund dealers and their advisers of the types of deficiencies noted by the OSC in performing compliance reviews. It is hoped that by sharing this information with you, the incidence of non-compliance will decline. Please note that preventing all of the attached deficiencies in your operation may not ensure compliance with all requirements. Your experienced compliance staff and your legal counsel should assist you in determining compliance.

NOTE: The frequency and severity of each deficiency has not been provided. It would be inappropriate to assume that all dealers subject to a compliance examination by the OSC exhibited every deficiency listed. It would also be inappropriate to assume that the list reflects all mutual fund dealers.

TRUST ACCOUNTS

• commingling client trust funds with other assets
• bank reconciliations are not prepared
• when prepared, bank reconciliations are not accurate, are not prepared on a timely basis, are not reviewed by a supervisor or are not maintained on file
• trust account is not interest bearing as is required by National Policy No. 39
• a lower interest rate on the trust account is negotiated with the bank in order to obtain other benefits from the bank on the operating account
• interest earned on the trust account is not distributed on a monthly basis to investors or fund companies

BOOKS AND RECORDS

• do not maintain daily trade blotters and records itemizing client transactions
• records are not readily accessible
• sales representatives maintain their own system of record keeping which is not controlled by management of the dealer
• trades processed directly with the mutual fund company bypassing the registrant's administration department therefore resulting in "off-book" transactions
• trades missing on the daily trade blotters
• lack of current accounting records prepared on an accrual basis and therefore unable to properly complete monthly capital calculation

NEW CLIENT ACCOUNTS AND SUPERVISION

• new client application forms (the "NCAF") that are inadequate as they do not request sufficient and appropriate "know your client" information
• NCAF not completed for all new client accounts

• NCAF not properly completed by the sales representatives
• know your client information not updated to reflect changes in the client's circumstances

• NCAF not reviewed by a supervisor or no evidence of a supervisory review indicated
• no written procedures for approving the opening of new client accounts and no procedures for designating individuals with such supervisory responsibility

SUITABILITY OF TRADES AND SUPERVISION

• lack of proper supervision of sales representatives' activities including: trading, sales practices, sales communications with clients
• supervisors do not assess suitability of trades

• no evidence of supervisory reviews indicated
• unsuitable trades based on documented investment needs and objectives of clients
• no written procedures designating person(s) responsible for supervising trading and outlining method of supervision

KNOW YOUR CLIENT (KYC) INFORMATION

• KYC information is not up-to-date to reflect the current situation of the client
• no KYC information maintained on file for clients or data is incomplete

PURCHASE AND REDEMPTION TRANSACTIONS

• not processed within time frames prescribed by National Policy No. 39

• missing client transaction forms, not complete and/or not signed
• original documentation not retrievable

POWER OF ATTORNEY / LETTER OF AUTHORIZATION

• poorly written letters of authorization granting more authority to sales representatives than what is permitted under securities legislation
• use of letters to exercise discretionary trading authority over clients' accounts
• lack of supervision/monitoring of the use of powers of attorney/letter of authorization

ADJUSTED LIABILITIES AND MINIMUM CAPITAL

• failure to inform the OSC of capital deficiencies and of the action taken to rectify the deficiency
• audited Statement of Adjusted Liabilities, along with audited financial statements, not filed within 90 days of the fiscal year end
• incorrect calculation of minimum free capital
• do not maintain monthly records of calculation of adjusted liabilities and minimum free capital
• lack of awareness of minimum capital requirements

REFERRAL ARRANGEMENTS

• management not aware of referral arrangements which its sales representatives are involved in; therefore not properly monitored

• lack of disclosure to clients regarding referral arrangements and the commission splitting or fees paid pursuant to those arrangements
• acts in the furtherance of trades in securities not registered to trade in

STATEMENTS OF ACCOUNT AND UNITHOLDERS' COMMUNICATIONS

• no statements of account produced for clients
• statements not produced independently of the sales representative, therefore increased risk of fraud and falsification of information
• lack procedures to ensure accuracy and completeness of client statements of account

HANDLING CLIENT COMPLAINTS

• no formal written policies and procedures for dealing with client complaints
• where procedures are established, staff are unaware of company policies
• do not understand difference between a customer service problem and a complaint
• complaints not forwarded to the company compliance officer for appropriate resolution
• no written record of complaints maintained

TRADE NAMES

• use of trade names by sales representatives which are not registered to the dealer or which are not on record at the OSC
• no written procedures regarding the use of trade names by sales representatives and branches

LEVERAGING

• no policies and procedures regarding leveraging of client accounts which the sales representatives can use as a reference
• lack of appropriate disclosure to clients of the added risks associated with leverage
• unsuitable leveraged trades based on documented investment needs and objectives of clients

SALES REPRESENTATIVES

• lack of proper supervision of sales representatives, especially where they act as independent contractors
• guarantees made regarding rates of return to their clients
• client orders not forwarded to head office on a timely basis
• lack of knowledge of regulatory requirements under National Policy Statement No. 39, the Ontario Securities Act (the "Act") and the Regulation made under the Act
• no training programmes
• where training programmes are in place, sales representatives are not aware of them or the training programmes do not adequately deal with the sales practices code, code of ethics, regulation and compliance issues

COMPLIANCE FUNCTION

• failure to inform the OSC of changes regarding sales representatives, branches, sub-branches and company officers which require fees to be paid to the OSC
• failure to provide written notice to the OSC of networking arrangements entered into with banking organizations for the purposes of RRSP loans
• branch managers not properly supervised by head office
• branch offices not regularly visited by the compliance officer for assessment of compliance with the company's policies and procedures and regulatory compliance
• compliance function not well defined in the company
• not enough resources dedicated to the compliance function

ADVERTISING

• no review of sales representatives' advertising and promotional materials sent to clients
• inappropriate claims noted in ads - e.g. performance data
• inadequate controls and supervision over the use of the Internet as a means of advertising/sales communication

OTHER AREAS OF CONCERN

Written policies and procedures

• no written procedures for new account openings; proper processing of purchase/redemption transactions; supervision of trades; compliance officer duties and responsibilities; and other job descriptions
• no written policies and procedures of any kind; staff develop own practices and procedures

Internal control procedures

• lack adequate controls or procedures to handle redemption cheques received by the registrant for subsequent delivery to clients

• provide sole signing authority to one individual for all bank accounts and for any dollar amount
• maintain cheque books in open work areas, easily accessible by anyone in the office
• pre-signing blank cheques
• pre-signing blank transaction order forms

• lack of segregation of duties
• failure to maintain appropriate data back-up of client records and a disaster recovery plan in the event of an emergency

Out-of-province clients

• transact with non residents without compliance with requirements of client's home jurisdiction