Final Rule: OSC Rule - 31-506 - SRO Membership - Mutual Funds Dealers

Final Rule: OSC Rule - 31-506 - SRO Membership - Mutual Funds Dealers

OSC Rule



NOTICE OF RULE UNDER THE SECURITIES ACT

RULE 31-506

SRO MEMBERSHIP - MUTUAL FUND DEALERS

Notice of Rule

The Commission has, under section 143 of the Securities Act (the "Act"), made Rule31-506 SRO Membership - Mutual Fund Dealers (the "Rule"). The Rule and thematerial required by the Act to be delivered to the Minister of Finance were deliveredon October 12, 2000. If the Minister does not approve the Rule, reject the Rule orreturn it to the Commission for further consideration by December 11, 2000, or if theMinister approves the Rule, the Rule will come into force, pursuant to section 4.1 of theRule, on January 1, 2001. The date that the Rule comes into force is referred to in thisNotice of Rule as the effective date of the Rule.

Mutual fund dealers should begin to plan for the effective date and therequirements of the Rule immediately. If the Commission recognizes the MutualFund Dealers Association of Canada (the "MFDA") as a self-regulatoryorganization for mutual fund dealers, the requirements for mutual fund dealersimposed by the Rule flow from the date that the Commission so recognizes theMFDA. If the Commission recognizes the MFDA, the date of recognition will bepublished in the Bulletin of the Commission.

Mutual fund dealers should be aware that the processing of applications formembership by the MFDA requires adequate review and may take some time. TheDirector will have authority to grant exemptions from the Rule and may also considerapplications for temporary exemptions in certain circumstances.

Background

Since 1997, the Commission, together with other members of the Canadian SecuritiesAdministrators ("CSA"), has encouraged and supported the establishment of the MFDA.The MFDA was created in June 1998 as a non-share capital corporation with anobjective of acting as a self-regulatory organization ("SRO") for mutual fund dealers inCanada.

The Commission first published the proposed Rule for a 90-day comment period inOctober 1997(1) and published proposed changes to the proposed Rule for 30-daycomment periods on two occasions; first in June 1998(2) and most recently on June 16,2000.(3)

In December 1999, the MFDA submitted its application to the Commission forrecognition as a SRO for mutual fund dealers under section 21.1 of the Act.Concurrently with the June 16, 2000 publication of the proposed Rule, the Commissionpublished for a 90-day comment period:

  • The proposed criteria the Commission will use to assess the MFDA indetermining whether to recognize the MFDA as a SRO for mutual fund dealers(the "Proposed Criteria"); and
  • The response of the MFDA to the Commission's proposed Criteria forrecognition.

The draft rules and by-law of the MFDA were attached to the MFDA's response to theCommission's Proposed Criteria for recognition. The Proposed Criteria, the MFDAresponse to the proposed Criteria and the draft rules and by-law of the MFDA will bereferred to in this Notice of Rule as the MFDA Recognition Package.

Substance and Purpose of the Rule

The purpose of the Rule is to address certain regulatory issues that arise in connectionwith regulatory oversight of mutual fund dealers. The Rule requires all mutual funddealers to be members of the MFDA once the MFDA is recognized by the Commissionas a SRO for mutual fund dealers, within the times set out in the Rule.

The Rule conforms to the fundamental principle in paragraph 4 of section 2.1 of the Actunder which the Commission should, subject to an appropriate system of supervision,use the enforcement capability and regulatory expertise of recognized self-regulatoryorganizations.

Further background to the Rule is given in the Notices published with the October1997, the June 1998 and June 2000 versions of the Rule.

Summary of the Rule

The Rule will require all mutual fund dealers registered with the Commission in thatregistration category to:

  • Become members of the MFDA if the MFDA is recognized by the Commission asa SRO for mutual fund dealers, by the end of one year and 75 days after theDate of Recognition (this term is defined in the Rule); and
  • prepare and submit to the MFDA an application for membership in the formprescribed by the MFDA, together with the MFDA's prescribed fees by certainspecified deadlines.

Mutual fund dealers registered with the Commission on the Date of Recognition will berequired to file an application for membership and pay the MFDA's prescribed feeswithin 75 days after the Date of Recognition. Mutual fund dealers will be required to bemembers of the MFDA on the day that is one year and 75 days after the Date ofRecognition.

An applicant for registration as a mutual fund dealer after the Date of Recognition willalso be required to be a member of the MFDA on the day that is one year and 75 daysafter the Date of Recognition, if it became registered as a mutual fund dealer beforesuch date. This means that a new applicant can become registered with theCommission as a mutual fund dealer if it meets securities legislative requirementsbefore the day that is one year and 75 days after the Date of Recognition, but it mustbecome a member of the MFDA to continue to be a mutual fund dealer after that date.A new applicant after the Date of Recognition will be required to file an application formembership with the MFDA and pay the prescribed fees on the same date as it files itsapplication to the Commission for registration as a mutual fund dealer in order to beconsidered for registration as a mutual fund dealer. Any applicant for registration as amutual fund dealer submitting its application after the day that is one year and 75 daysafter the Date of Recognition will not be registered unless and until it becomes amember of the MFDA.

The MFDA will make available its application for membership, and details of theamount of the fee that will be levied upon filing of such application through a publicstatement expected during the fall of 2000.

Summary of Changes to the Rule from the Version Published in June 2000

This section describes changes made in the Rule from the version published forcomment in June 2000. As the changes to the Rule are not material, the Rule is notsubject to a further comment period. The changes made to the Rule were made inresponse to comments received.

Definitions

A new defined term "Date of Recognition" has been added. This definition providesthat the requirements in the Rule for mutual fund dealers become effective, if theCommission recognizes the MFDA as a SRO for mutual fund dealers, on the date ofrecognition which date will be published in the Bulletin of the Commission.

Section 3.1

The time period for filing an application for membership with, and paying theprescribed fees to the MFDA has been extended from 30 to 75 days after the date theMFDA is recognized as a SRO for mutual fund dealers. The drafting of this section hasbeen simplified to refer to the Date of Recognition and to delete subsection (2).

Section 4.1

The effective date of the Rule has been set for January 1, 2001.

Section 4.2

The effective date for section 2.1 of the Rule has been extended from one year and 30days from the effective date of the Rule to one year and 75 days from the Date ofRecognition. This change mirrors the change to section 3.1 of the Rule.

Summary of Written Comments Received by the Commission

No comments were received by the Commission in respect of the first publication of theproposed Rule in October 1997. During the comment period on the June 1998 versionof the proposed Rule, five comment letters were received and were summarized in theNotice of Proposed Changes to Proposed Rule 31-506 published in June 2000.

During the comment period on the June 2000 version of the proposed Rule and theMFDA Recognition Package, approximately 430 comment letters were received. All ofthe comment letters have been delivered to the MFDA for review and response.Copies of the comment letters may be viewed at the office of Micromedia, 20 VictoriaStreet, Toronto, Ontario (416) 312-5211 or (800) 387-2689.

Commentators on the proposed Rule and the MFDA Recognition Package ranged fromtrade associations commenting on behalf of their members, such as The InvestmentFunds Institute of Canada, the Federation of Independent Mutual Fund Dealers, theInvestment Counsel Association of Canada , the Independent Financial Brokers ofCanada, the Canadian Association of Insurance and Financial Advisors, the MutualFund Dealers' Compliance Officers Forum and the Canadian Bankers Association, tomany individual sales persons and officials of mutual fund dealer firms. Regulators ofinsurance distributors, including the Canadian Council of Insurance Regulators, alsoprovided comments on the MFDA Recognition Package.

The Commission thanks all commentators on the Rule and the MFDA RecognitionPackage for providing their comments. The Commission understands that the widerange of comments received and numbers of commentators are representative of theconcern on the part of many mutual fund dealers that the MFDA rules properly reflectthe nature of the mutual fund dealers' business.

All of the comments received on the MFDA Recognition Package will besummarized by the MFDA and revisions to the rules and by-laws of the MFDA areexpected to be made in response to those comments. The Commission hasasked the MFDA to provide a full accounting of the comments and its responsesto those comments as part of its revised application for recognition to bedelivered to the Commission during the fall of 2000.

Since most of the commentators did not comment specifically or solely on the Rule, theCommission reviewed all comment letters for comments that related specifically to theRule. The specific comments on the Rule are summarized in this Notice. Certain ofthe comments on the Rule were made in connection with the June 1998 version of theproposed Rule and the Commission provided its response to those comments in theJune 2000 Notice of Proposed Changes to Proposed Rule.

The Commission also reviewed all comment letters received for comments on itsproposed Criteria for recognizing the MFDA as a SRO for mutual fund dealers. TheCommission is presently considering these comments, many of which relate to thecurrent board of directors and on-going governance of the MFDA including the on-going involvement of the IDA in the affairs of the MFDA, and will respond to thesecomments in the course of its decision whether or not to recognize the MFDA.Commentators also commented on the proposed criteria of the Commission that therules of the MFDA be the same as other self-regulatory organizations unless businessreasons exist for a change. Changes to the Commission's criteria for recognition of theMFDA and the proposed terms and conditions of recognition of the MFDA may resultfrom the Commission's review of the comments. A summary of the comments thatrelate to the Commission's proposed criteria for recognition and the proposedterms and conditions of recognition published in June 2000 will be publishedprior to or contemporaneously with the Commission's recognition of the MFDAas a SRO.

The following is a summary of the comments received on the Rule, together with theCommission's responses and, where applicable, the changes adopted by theCommission. As the changes to the June 2000 version of the Rule are not material, theRule is not subject to a further comment period.

Stakeholders have been given insufficient time to comment on the proposed Rule andthe MFDA Recognition Package.

Commission Response: The Commission notes that the Rule was published forcomment three times, each time with a detailed description of the substance andpurpose of the proposed Rule. Commission staff have also communicated repeatedlywith registered mutual fund dealers since 1997 on the proposal to establish the MFDA.The Commission considers that the 90-day comment period on the MFDA RecognitionPackage, when coupled with the extensive consultation with industry participantscarried out by the staff of the MFDA, with the involvement of Commission staff over thecourse of the development of the proposed rules and by-law of the MFDA, wassufficient notice to industry participants of the proposed organization and rules of theMFDA.

Membership in the MFDA should not be mandatory for firms registered as advisers inthe category of investment counsel/portfolio managers and also as mutual fund dealers.

Substance of Comment: Membership in the MFDA is inappropriate for companiesregistered as advisers in the category of investment counsel/portfolio manager (ICPMs)and who are also registered as mutual fund dealers. Certain of these registrants alsosell units of mutual funds that are managed by them and sold to clients who havesigned discretionary management agreements with them. ICPMs acting in this mannershould be required to be registered as mutual fund dealers and therefore would beexpected to be members of the MFDA. However, where an ICPM manages assets on adiscretionary basis and in the course of such management, also distributes units of itsmanaged private pooled funds, an exemption from membership in the MFDA isappropriate. It was suggested that membership in the MFDA should be required to theextent that the ICPMs in question offer mutual funds on a non-discretionary basis (inrespect of the non-discretionary portion of their business).

Commission Response: The Commission has not amended the Rule to differentiateamongst the various companies registered as mutual fund dealers. The Commissionnoted in the June 2000 Notice of Proposed Rule that, for example, registrants that areregistered as mutual fund dealers, but that carry on the principal business of acting assponsor and manager of mutual funds, will be required to become members of theMFDA within the time limits established by the Rule. The Commission urged theseregistrants to review the draft rules and by-law of the MFDA to determine whether theywished to become members of the MFDA. If these registrants do not wish to becomemembers of the MFDA, the Commission advised these registrants to change theirbusiness structures and surrender their registration as mutual fund dealers. In light ofthe comments received on the June 2000 version of the proposed Rule, theCommission will consider further what guidance can be given to advisers alsoregistered as mutual fund dealers as to (i) the need for registration as mutual funddealers in respect of certain activities carried on by such registrants and (ii) thepossibility of exemptive relief being granted to these registrants if they ask for it inrespect of all or a portion of their business.

The "heavy hand of a regulatory environment" will not eliminate those who do notuphold appropriate standards and will instead create a heavy burden on those whouphold the standards of the industry.

Substance of Comment: Several commentators indicated that mandatory membershipin a SRO is unnecessary because of the commentators' experience and honesty.

Commission Response: While the MFDA will create additional responsibilities andcosts for registrants, these requirements help to ensure the integrity of the industry asa whole and provide the benefits of a SRO. The Commission has noted in this Noticeof Rule, as it has in the past Notices, the reasons why it is working towards all mutualfund dealers becoming members of a SRO. The Commission also notes that manycommentators acknowledged the necessity of the MFDA as a SRO for the mutual funddistribution industry in order to better protect the investing public.

Because of the timing of the coming into force of the Rule, future members will berequired to apply during the 2001 RRSP season, a busy period of the year.

Substance of Comment: The RRSP season (that is, from January 1 until March 31) istraditionally the busiest time of the year for mutual fund dealers. Since not allinformation has been provided, mutual fund dealers have limited ability to prepare thenecessary data in advance. In addition commentators noted that some dealers andsalespersons will want to rearrange their business operations prior to making theapplication for membership and accordingly need time to do this. Commentatorssuggested that the application period should commence effective April 1, 2001 and lastfor 60 days, provided that mutual fund dealers have been given a copy of theapplication in advance.

Commission Response: Mutual fund dealers should begin to plan for the transitionimmediately. The MFDA will post the application for membership and a description ofthe application fees on its website (www.mfda.ca ) during the fall of 2000. In responseto this comment, the Commission has amended the Rule to provide a longer timeperiod (75 days rather than 30 days) during which mutual fund dealers must apply formembership following the Date of Recognition. If the MFDA is recognized as a SROfor mutual fund dealers during January 2001, mutual fund dealers will be required toapply for membership with the MFDA during April 2001, which the Commission notes isafter the 2001 RRSP selling season.

The costs of and coverage to be provided by the MFDA Investor Protection Fundshould be determined and publicized prior to the Rule coming into force. It isinappropriate to force mutual fund dealers to join an SRO whose costs are unknown.

Substance of Comment: Commentators understand that mandatory membership in theMFDA will also mean mandatory participation in a MFDA Investor Protection Fund.Commentators indicate that they find it impossible to properly comment on the MFDAwithout knowing the levels of required participation in the MFDA Investor ProtectionFund and urge the MFDA and the Commission to publish a description for comment ofthe MFDA Investor Protection Fund prior to recognition of the MFDA.

Commission Response: An essential term and condition of any Commission recognitionof the MFDA is that the MFDA establish a MFDA Investor Protection Fund tailored formembers and the risks associated with members' business. Once the details of theMFDA Investor Protection Fund are known, these details will be published and madeavailable. The details of the MFDA Investor Protection Fund are appropriately beingworked out by the board of the Fund - and not by the board of the MFDA. The Fund isindependent from the MFDA, as is appropriate. The Commission will determinewhether a public comment period is necessary for the proposed levels of participationin the Fund by members.

The registration fees payable to the Commission should be reduced once the MFDA isoperative and members are paying fees to the MFDA to recognize that the Commissionwill no longer be required to perform or extend resources to the regulation of dealersand salespersons.

Substance of Comment: Commentators note that the Canadian securities regulatoryauthorities, including the Commission, will benefit from the establishment of the MFDAand should be paying for the MFDA regulatory services either directly or indirectlythrough a decrease in fees payable by mutual fund dealers to the Canadian securitiesregulatory authorities.

Commission Response: The Commission notes the commitment highlighted in its2000/2001 Statement of Priorities that it will develop and implement a more streamlinedfee structure which will align the Commission's revenues more closely with its costs.The Commission expects that its new fee structure will address this comment. Aconcept proposal describing the Commission's new fee structure will be published forcomment.

The Commission, and the other Recognizing Jurisdictions, should share the start-upcosts of the MFDA.

Substance of Comment: Commentators suggested that since the Commission and theother Recognizing Jurisdictions have been involved in, and have encouraged the start-up of the MFDA, these regulators should bear a portion of the start-up costs of theMFDA. One commentator suggests that the Commission, and the other RecognizingJurisdictions, should share the MFDA's funding requirements for the first five years ofits existence which will reduce the negative impact of any decision of current financialinstitution controlled mutual fund dealers transferring their business to their related oraffiliated investment dealer.

Commission Response: Commentators commenting on the funding of start-up costs ofthe MFDA and the fee structures of the Commission and the other RecognizingJurisdictions often made these comments in conjunction with comments on theproposed fee model of the MFDA. The comments on the fee model of the MFDA will beconsidered by the MFDA, but as noted above, the Commission has considered thecomments on the start-up costs and the fee structures of the Commission. TheCommission considers that its guarantee of the MFDA $12 million line of credit to beconsiderable financial support of the MFDA and does not propose to fund any costs ofthe MFDA directly.

The Commission should include a "three year maximum sunset clause" into the Rule.

Substance of Comment: Commentators urge the Commission to again consider a "threeyear maximum sunset clause" on the Rule, as the Rule "represents a major structuralchange in the industry, whose costs and effects cannot even begin to be determined".

Commission Response: The Commission considered this comment in conjunction withproposing the June 2000 version of the Rule and rejected it at that time as a overlycumbersome method of ensuring oversight of the regulatory regime for mutual funddealers. The Commission will oversee the MFDA, once it is recognized, and willthrough its oversight, consider the effects of the MFDA/SRO regulatory regime onmutual fund dealers.

Text of Rule 31-506 SRO Membership - Mutual Fund Dealers

The text of the Rule follows.

Dated: October 13, 2000

 

ONTARIO SECURITIES COMMISSION RULE 31-506

 

 

SRO MEMBERSHIP - MUTUAL FUND DEALERS

 

PART 1 DEFINITIONS

1.1 Definitions - In this Rule

1.1 "MFDA" means the Mutual Fund Dealers Association of Canada, a self-regulatory organization for mutual fund dealers.

"Date of Recognition" means, if the MFDA is recognized by theCommission as a self-regulatory organization for mutual fund dealersunder section 21.1 of the Act, the date of recognitionpublished in the Bulletin of the Commission.

PART 2 MEMBERSHIP REQUIRED

2.1 Membership Required - A mutual fund dealer shall be a member of theMFDA.

PART 3 APPLICATION FOR MEMBERSHIP

3.1 Mutual Fund Dealers on Effective Date - A mutual fund dealer which isa mutual fund dealer on the Date of Recognition shall file with the MFDA,within 75 days after the Date of Recognition:

(a) an application for membership in the form prescribed by the MFDA;and

(b) the fees prescribed by the MFDA for the application formembership.

3.2 New Applicants for Registration as Mutual Fund Dealers - A personor company that applies to the Commission for registration as a mutualfund dealer on or after the Date of Recognition shall file with the MFDA:

(a) an application for membership in the form prescribed by the MFDA;and

(b) the fees prescribed by the MFDA for the application formembership

on the same date as it files its application for registration with theCommission as a mutual fund dealer.

PART 4 EFFECTIVE DATE

4.1 Effective Date for Rule - This Rule shall come into force on January 1,2001.

4.2 Effective Date of Section 2.1 for Mutual Fund Dealers - Despite section4.1, section 2.1 shall be effective for a mutual fund dealer on the day thatis one year and 75 days after the Date of Recognition.

PART 5 EXEMPTION

5.1 Exemption - The Director may grant an exemption to this Rule, in wholeor in part, subject to such conditions or restrictions as may be imposed inthe exemption.

1 (1997) 20 OSCB 5051

2 (1998) 21 OSCB 3875

3 (2000) 23 OSCB (Supp.) 163