Notice - Minister of Finance Request for Further Consideration: OSC Rule - 31-506 - SRO Membership - Mutual Funds Dealers

Minister of Finance Request: On October 11, 2000, the Commission delivered Rule 31-506 SRO Membership - Mutual Fund Dealers (the "Rule") to the Minister of Finance for approval under section 143.3 of the Securities Act.

On December 11, 2000, the Minister returned the Rule to the Commission for further consideration. In his letter returning the Rule to the Commission, the Minister indicated his support for the Commission’s initiative in encouraging the development of the Mutual Fund Dealers Association of Canada (the "MFDA") and acknowledged that the MFDA will be an important component in promoting investor confidence and consumer protection in the Canadian mutual fund sector. The Minister noted his understanding that two other provinces have concerns about implementation elements of the MFDA and requested that the Commission understand and consider their issues. The Minister also requested that the Commission continue to work with the MFDA to ensure that comments from the entire mutual fund industry are addressed appropriately.

The Commission is publishing this Notice as required by subsection 143.6(b) of the Securities Act.

Status of Application by the MFDA for Recognition as a SRO for Mutual Fund Dealers: On June 16, 2000, the Commission published for comment the MFDA’s application for recognition as a self-regulatory organization ("SRO") for mutual fund dealers and the Commission’s proposed criteria for recognition of a SRO for mutual fund dealers. As noted by the Commission in October 2000, in its Notice of Final Rule, during the comment period on the Rule and the MFDA Recognition Package, approximately 430 comment letters were received. All of the comment letters were delivered to the MFDA for review and response and are publicly available for review at the office of Micromedia, 20 Victoria Street, Toronto, Ontario (416) 312-5211 or (800) 387-2689. The Commission summarized the comments it received on the Rule in the Notice of Final Rule.

The Commission received the MFDA’s revised application for recognition as a SRO for mutual fund dealers on December 18, 2000. This revised application includes:

1.A summary of the comments the MFDA received on the MFDA Recognition Package and the response of the MFDA to those comments.

2.The By-law and Rules of the MFDA revised to reflect the changes made by the MFDA in response to comments received.

3.A description of those MFDA Rules that the MFDA has decided to suspend for specified transition periods. These MFDA Rules include, among others, (i) the Rule prohibiting dealers from paying commissions to personal corporations of salespersons, (ii) the Rules requiring specified levels of capital for different categories of dealers and (iii) the MFDA Rule requiring that annual statements be sent to clients.

The MFDA's revised application for recognition, including its summary of comments and responses to those comments, are available on the MFDA website at http://www.mfda.ca/.

Staff are presently reviewing the MFDA’s revised application for recognition and expect to present the MFDA’s application for recognition to the Commission by early February 2001. Staff may recommend that the Commission require, as a term of recognition, that the MFDA amend specified rules from the rules provided to the Commission in the revised application for recognition.

Should the Commission recognize the MFDA as a SRO for mutual fund dealers, the Commission will re-deliver the Rule to the Minister for his approval and the following will be published in the Bulletin:

1.The Rule, as re-delivered to the Minister.
2.The Commission’s Recognition Order and Terms and Conditions of Recognition of the MFDA as a SRO for mutual fund dealers.
3.The MFDA’s Summary of Comments and Responses to those Comments.
4.The final MFDA By-law and Rules.

Status of MFDA Investor Protection Plan: In the October 2000 Notice of Final Rule, the Commission indicated that an essential term and condition of any Commission recognition of the MFDA will be that the MFDA establish a MFDA Investor Protection Plan tailored for members and the risks associated with members’ business. The Commission expects to receive an application by the MFDA Investor Protection Plan for Commission approval of this Plan as a compensation fund or contingency trust fund for members of the MFDA in January 2001. The Commission will request public comment on the Plan upon receipt of the application, and will consider the Plan’s application after reviewing any comments received.

Status of Mandatory Membership in the MFDA by Mutual Fund Managers and Portfolio Managers: In the October 2000 Notice of Final Rule, the Commission addressed comments it received on the Rule regarding mandatory membership in the MFDA by mutual fund managers and portfolio managers who are also registered as mutual fund dealers. Staff of the Commission have considered the issues raised in this comment and on December 6, 2000 sent a letter to The Investment Funds Institute of Canada and the Investment Counsel Association of Canada describing staff’s views on the potential for these registrants to apply for certain exemptions. This letter is reproduced immediately following this Notice.

Proposed Format of MFDA Application Form: In the October 2000 Notice of Final Rule, the Commission noted that the MFDA will post its form of application for membership and a description of the application on its website during the fall of 2000. A Draft Membership Application Package for membership in the MFDA is now available, for information purposes only, on the website of the MFDA. The MFDA notes on its website, that it anticipates that the basic format and requirements included in the Draft Membership Application Package will be substantially similar to the final version that will be used for MFDA membership. It can be found at http://www.mfda.ca/draftapplicationpackage.pdf.

December 22, 2000.

For further information on the Rule or the status of the Commission’s consideration of the MFDA’s application for recognition as a SRO, please contact:

Rebecca Cowdery
Manager, Investment Funds
Capital Markets
(416) 593-8129
[email protected]

Toni Ferrari
Manager, Compliance
Capital Markets
(416) 593-3692
[email protected]

Antoinette Leung
Senior Accountant, Compliance
Capital Markets
(416) 595-8901
[email protected]

Tamara Hauerstock
Legal Counsel, Investment Funds
Capital Markets
(416) 595-8915
[email protected]

Letter Sent to The Investment Funds Institute of Canada and the Investment Counsel Association of Canada:

December 6, 2000

The Investment Funds Institute of Canada
151 Yonge Street
5th Floor
Toronto, ON
M5C 2W7

Attention: Honourable Thomas A. Hockin

Investment Counsel Association of Canada
61 Shaw Street
Toronto, ON
M6J 2W3

Attention:Colin Haddock

Dear Sirs:

RE: Firms registered as Mutual Fund Dealers who are also Mutual Fund Managers and/or Portfolio Managers

As you know, provincial securities regulators considering recognition of the Mutual Fund Dealers Association of Canada are at various stages of making rules requiring mutual fund dealers to join a self regulatory organization for mutual fund dealers (collectively, "Membership Rules"). Staff in these jurisdictions have received inquiries from registrants whose registration as mutual fund dealer is used to carry on what they perceive as an incidental or secondary part of their business. These registrants submit that mandatory membership in a SRO is not appropriate due to the nature of their business. These registrants carry on a primary business that falls into two broad categories:

(1)Mutual fund managers who do not sell their sponsored mutual funds directly to the public but are registered as mutual fund dealers to enable them to carry on incidental sales and marketing activities.

(2)Portfolio managers conducting a money management business and who are also registered as mutual fund dealers to enable them to sell their mutual funds (pooled funds) to their discretionary account clients or directly to the public.

Mutual Fund Managers

Staff understand that mutual fund managers not carrying on a direct mutual fund distribution business are nonetheless registered as mutual fund dealers for several reasons:

a)they are concerned that their marketing and wholesaling activities vis a vis their mutual funds subject them to the registration requirement;

b)they believe that they require this registration to fulfil their role as principal distributor of their funds;

c)they became registered when the provincial securities regulators required an underwriter certificate for mutual fund prospectuses and have maintained that registration;

d)they take purchase and redemption orders, including switch requests, directly from clients who hold mutual fund units in "client name", particularly when the client’s original dealer does not consider the client an active client; or

e)they believe that this registration is necessary to service house accounts of employees and family membersof employees and various service providers to the manager.

Mutual fund managers carrying on the activities listed in paragraphs (a), (b) or (c) should consider whether they wish to continue their registration or apply for an exemption from registration. Staff have concluded that it may be appropriate to exempt mutual fund managers carrying on the activities listed in paragraphs (a), (b), and (c) from the requirement to obtain registration as a mutual fund dealer.

In addition, provided the activities are limited and incidental to their primary activity of managing mutual funds, mutual fund managers who accept purchase and switch
orders in the circumstances described in (d), or who carry out the activities described in (e) may wish to apply for an exemption from the Membership Rules. Mutual fund managers should also review existing exemptions from registration in relevant provinces to determine if any are applicable to their businesses. Registrants making an application for exemption should explain the reasons why they are registered as mutual fund dealers and describe the full extent of their trading activities. Applications will be considered on a case-by-case basis by the applicable regulator. Staff will likely recommend relief from the Membership Rules in circumstances where staff agree that the registrable activities are limited and incidental to an applicant’s business. Registrants who are exempted from the Membership Rules must continue to maintain their registration as a mutual fund dealer and comply with applicable securities legislation and rules.

Portfolio Managers

Firms registered as advisers in the category of portfolio manager act on behalf of both institutional and private high net worth clients pursuant to investment management agreements. Registration as a portfolio manager permits registrants to manage the investment portfolio of clients through discretionary authority granted by one or more clients giving discretion to the portfolio manager to manage assets. According to the comments received during the MFDA recognition comment process, the reasons that a portfolio manager would seek registration as a mutual fund dealer are:

a)it has prospectus-qualified its pooled funds to enable it to manage all of a client’s assets, including those which might not meet a given jurisdiction’s exemption thresholds for investing in securities without a prospectus; or

b)it sells these mutual funds directly to the public.

Some portfolio managers have commented that if required to become a member of the MFDA, the rules of the MFDA would make it difficult or impossible to comply with the terms of the account management agreements they have with their clients. Most notably:

a)the assets under administration fee model adopted by the MFDA would assess fees based on all relevant assets of a given portfolio manager rather than being limited to those assets related to sales for which mutual fund dealer registration is required; and

b)the draft rules of the MFDA prohibit discretionary trading by members.

Portfolio managers have suggested that the regulators should consider providing an exemption from the Membership Rules or exemptions from certain of the MFDA rules.

Staff are of the view that, to the extent that a portfolio manager is selling its pooled funds (whether or not prospectus qualified) to clients for whom they have fully managed accounts governed by the terms of an investment management agreement, it may be appropriate for the portfolio manager to be granted an exemption from the requirement to obtain registration as a mutual fund dealer. A portfolio manager exempted from registration would not be required to become a member of the MFDA.

Registrants making such an application should explain the reasons why they are registered as mutual fund dealers and describe the full extent of their trading activities. Applications will be considered on a case-by-case basis by the applicable regulator. Staff will likely recommend relief from the registration requirements in circumstances where the portfolio manager confirms the nature of their trading activities is such that all clients receiving such fund securities do so pursuant to a discretionary account agreement with the portfolio manager. Staff would likely recommend a condition that such relief expire after a specified limited period after the coming into force of a rule related to pooled funds managed by portfolio managers.

Fund Managers and Portfolio Managers Selling Directly to the Public

Where a fund manager or a portfolio manager is selling mutual funds pursuant to a prospectus directly to the public, it is appropriate for that registrant to be registered as a mutual fund dealer and to be subject to the Membership Rules.

With respect to exemptions from certain MFDA rules, MFDA staff have noted the difficulties inherent in attempting to regulate only a portion of the assets administered by a member and therefore exemptions from the relevant MFDA rules may not be feasible. As a result, registrants concerned about the impact of MFDA rules upon their business may wish to consider the advice of the Ontario Securities Commission noted in the Notice of Rule 31-506 SRO Membership -Mutual Fund Dealers at (2000) 23 OSCB 7015 - namely, changing their business structure by creating a subsidiary to carry on their mutual fund distribution business, surrender their existing registration as mutual fund dealers and register the subsidiary instead. The subsidiary would then be required to be a member of the MFDA and subject to all of its rules.

Please note that I am writing this letter on behalf of staff in British Columbia, Alberta, Saskatchewan, Manitoba and Ontario. Questions on a registrant’s individual status in a particular jurisdiction should be directed to the relevant jurisdiction as follows:

Ross McLennan
Director, Registration
British Columbia Securities Commission
(604) 899-6685

Ken Parker
Director, Capital Markets
Alberta Securities Commission
(403) 297-3251

Barbara Shourounis
Director
Saskatchewan Securities Commission
(306) 787-5842

Bob Bouchard
Director, Capital Markets
Manitoba Securities Commission
(204) 945-2555

Tamara Hauerstock
Legal Counsel, Investment Funds
Capital Markets
Ontario Securities Commission
(416) 595-8915

Please let me know if you have any additional questions or concerns about the matters outlined in this letter. We ask that you distribute a copy of this letter to your members. We may also publish this letter in our respective Commission bulletins.

Yours very truly,

Rebecca Cowdery
Manager, Investment Funds
Capital Markets
(416) 593-8129

cc: CSA staff noted and MFDA working group
John Mountain (IFIC)
Larry Waite (MFDA)
Mark Gordon (MFDA)