NIN 97/32 - Proposed National Instrument 81-105 and Companion Policy 81-105CP Mutual Fund Sales Practices [NIN - Rescinded]

The Commission, together with other members of the Canadian Securities Administrators ("CSA"), is publishing for comment the text of proposed National Instrument 81-105 and Companion Policy 81-105CP, which deal with mutual fund sales practices. The National Instrument and Companion Policy contain footnotes that are not part of the proposed instrument or policy, but which have been included to provide background and explanation.

The proposed National Instrument and Companion Policy are initiatives of the CSA, and the proposed National Instrument is expected to be adopted as a rule in each of British Columbia, Alberta, Ontario and Nova Scotia, as a Commission regulation in Saskatchewan, and as a policy in all other jurisdictions represented by the CSA. The proposed Companion Policy is expected to be implemented as a policy in all of the jurisdictions represented by the CSA.

Background

The proposed National Instrument is based on and is largely consistent with the Ontario Securities Commission ("OSC") proposed Rule 81-503 Sales Practices Applicable to the Sale of Mutual Fund Securities (the "Ontario Draft Rule"). The Ontario Draft Rule with proposed Companion Policy 81-503CP (the "Ontario Draft Policy") was published for comment on August 30, 1996.¹

¹ (1996), 19 OSCB 4727.

The CSA agreed to use the Ontario Draft Rule as the basis for a national instrument that will regulate substantially the same matters as the Ontario Draft Rule.

The comments received on the Ontario Draft Rule and the Ontario Draft Policy were considered in conjunction with the development of the proposed National Instrument and Companion Policy.²

² For a summary of the comments received, see the appendices to the OSC Notice that accompanies the publication of the proposed National Instrument in the OSC bulletin for the week ending July 25, 1997.

The instruments reflect the decisions of the CSA on the comments received. An explanation of the changes made to the Ontario Draft Rule and the Ontario Draft Policy as a result of comments received, are contained in the footnotes to the proposed National Instrument and the Companion Policy. Drafting changes to the Ontario Draft Rule and the Ontario Draft Policy have also been made throughout the proposed National Instrument and Companion Policy and are noted, where material, in the footnotes to the instruments.

The OSC outlined the regulatory history of the CSA’s regulation of mutual fund sales practices in the Notice accompanying the publication of the Ontario Draft Rule and the Ontario Draft Policy for comment. The OSC noted that prior to the release of the report of Ontario Commissioner Glorianne Stromberg

³ "Regulatory Strategies for the Mid-‘90s - Recommendations for Regulating Investment Funds in Canada" prepared by Glorianne Stromberg for the Canadian Securities Administrators, January 1995.

(the "Stromberg Report"), the CSA relied on competitive market forces to moderate sales practices in the mutual fund industry and mandated that full disclosure of sales incentives and practices be given to investors. Commissioner Stromberg reviewed the sales and business practices followed by industry participants in the distribution of mutual fund securities. She noted in her report that as a result of competitive pressures, "questionable sales practices and incentives have become commonplace in the industry."⁴

⁴Supra, note 2 at page 44.

After discussions with The Investment Funds Institute of Canada ("IFIC") and with the Investment Funds Steering Group, an industry-regulatory advisory group established by the OSC to review and comment on the Stromberg Report, the OSC decided in June 1996 to promulgate a rule to govern the sales and business practices dealt with by the draft recommendations for a Code of Sales Practices for the mutual fund industry released by IFIC in March 1996 (the "IFIC Code").

⁵ "Recommendations for a Code of Sales Practices for the Mutual Fund Industry" released by The Investment Funds Institute of Canada on March 29, 1996. The IFIC Code was published as an appendix to the Investment Funds Steering Group - Status Report of April 29, 1996 ((1996), 19 OSCB 2170).

As the Ontario Draft Rule was based on the IFIC Code, the proposed National Instrument has its origins in the IFIC Code. The proposed National Instrument also reflects the by-laws and rules of the Investment Dealers Association of Canada as they relate to mutual fund sales practices.

Although the CSA have determined to make the proposed National Instrument, they agree with the OSC that, optimally, sales practices followed by participants in the distribution of mutual fund securities should be regulated by a self-regulatory organization. The CSA will continue to encourage the development of self-regulatory organizations to regulate registered dealers, including distributors of mutual fund securities.

The CSA note that the two existing CSA Notices that deal with some of the same subject matter as the proposed National Instrument will be revoked in connection with the coming into force of the proposed National Instrument. Those notices are CSA#93/1 "Mutual Fund Sales Incentives" and CSA#95/2 "Mutual Fund Sales Incentives - Point of Sale Disclosure Statement".

Substance and Purpose of Proposed National Instrument and Companion Policy

The proposed National Instrument regulates the sales and business practices followed both by managers and principal distributors of publicly offered mutual funds, and by registered dealers and their sales representatives in connection with the distribution of securities of publicly offered mutual funds. The proposed National Instrument is designed to make mandatory, on an industry-wide and on a national basis, restrictions on certain sales and business practices that may have been followed in the distribution of mutual funds.

The CSA seek to ensure a level playing field for all participants in the distribution of mutual funds in Canada through the proposed National Instrument. The proposed National Instrument will require these participants to adhere to common rules in the distribution of publicly offered mutual funds, whether or not they are members of a self-regulatory organization and without regard to where they are located in Canada.

Although the proposed National Instrument applies only to the distribution of publicly offered mutual funds, the CSA consider that the regulatory objectives of the proposed National Instrument are equally applicable to the distribution of all collective money management schemes in Canada. Ultimately, the distribution of all schemes should be subject to the same or equivalent rules and standards.

The CSA are of the view that regulatory reliance on competitive forces and disclosure alone has not been sufficient to govern the conflict between the interests of those involved in the distribution of mutual fund securities, including the various members of a mutual fund organization, and their respective duties towards the investing public. Accordingly, the CSA have concluded that the restrictions on the sales and business practices provided for in the proposed National Instrument are necessary.

In formulating the proposed National Instrument, the CSA agreed with, and were guided by, the OSC’s articulation in the Ontario Draft Policy of certain fundamental principles that the OSC considered should govern the conduct of participants in the mutual fund industry. The CSA has retained the description of these principles in the proposed Companion Policy and consider them a necessary underpinning to the proposed National Instrument.

The OSC in its August 1996 Notice also noted the concern that arises with the use of certain sales incentives or practices by industry participants in the distribution of mutual fund securities; that is, that investment recommendations cannot be said to be made solely on the basis of an investor’s investment objectives or circumstances, but rather are influenced by the incentives being paid to a dealer or sales representative. The CSA agrees with this concern and accordingly proposes the National Instrument.

The proposed Companion Policy is designed to provide a regulatory background and context for the proposed National Instrument and to outline the CSA’s general regulatory purpose in making the proposed National Instrument.

Summary of Proposed National Instrument and Companion Policy

The proposed National Instrument applies to a distribution of securities of a mutual fund that offers or has offered securities under a prospectus or simplified prospectus⁶

⁶ The proposed National Instrument applies to all mutual funds that are reporting issuers, including those listed and labour-sponsored mutual funds.

and to industry participants whose activities relate to such mutual funds. It regulates members of the organization of a mutual fund ("MOMF"), participating dealers and representatives of participating dealers. An MOMF includes the manager, portfolio adviser and principal distributor of a mutual fund and their affiliates.

The proposed National Instrument imposes a number of restrictions, prohibitions and requirements on sales practices used by industry participants, including

• prohibiting a mutual fund from providing monetary and non-monetary benefits to, or paying a cost or expense incurred by, a participating dealer or its representatives, in connection with a distribution of mutual fund securities,
• restricting the manner in which an MOMF may provide monetary⁷

⁷ Other than prohibiting bonus commissions, the proposed National Instrument does not regulate the rate or amount of commissions paid by MOMFs, provided the mutual fund’s prospectus discloses the range of commissions paid.

• and non-monetary benefits to a participating dealer or its representatives, in connection with a distribution of mutual fund securities,
• prohibiting an MOMF from providing monetary and non-monetary benefits (other than those promotional in nature and of minimal value) directly to representatives of a participating dealer, in connection with a distribution of mutual fund securities,
• restricting the payment by an MOMF of the costs relating to sales communications and educational conferences or seminars,
• restricting an MOMF’s business promotional activities that give non-monetary benefits to representatives of participating dealers, 
•  restricting the practice of rebating redemption fees payable by securityholders of a fund who move their holdings to another fund, 
•  prohibiting an MOMF from providing financial assistance to a participating dealer, a representative of a participating dealer or their respective associates or affiliates, other than financial assistance provided by a financial institution in the ordinary course of business or by an affiliate, 
•  prohibiting an MOMF from making charitable donations on behalf of a participating dealer or its representatives, 
•  prohibiting tied selling, i.e., requiring a person to purchase a product or service as a condition to the purchase of mutual fund securities, and
• requiring certain disclosure in prospectuses and point-of-sale documents.

The proposed Companion Policy emphasizes that the proposed National Instrument establishes only minimum standards of conduct for industry participants. It also provides guidance as to the CSA’s interpretation of some provisions of the proposed National Instrument and brings certain matters to the attention of participants in the mutual fund industry.

Anticipated Costs and Benefits

The OSC outlined the anticipated costs and benefits of the Ontario Draft Rule in its August 1996 Notice. The CSA are of the view that the description of the anticipated costs and benefits in that Notice is largely accurate and re-affirms the following paragraph as being applicable to the proposed National Instrument.

The proposed Rule is designed to benefit mutual fund investors and industry participants equally, by restricting sales and business practices that could be seen to be compromising the integrity of the mutual fund industry. It is anticipated that mutual fund investors will benefit both through enhanced disclosure of incentives paid to participating dealers and through investment recommendations made, and services provided, by industry participants that have, and can be seen to have, their best interests at the forefront. Similarly, industry participants will benefit by the enhanced confidence that investors and prospective investors may have in the overall integrity, professional responsibility and trust inherent in the mutual fund industry.

During the comment period in respect of the Ontario Draft Rule, the OSC received submissions to the effect that the Ontario Draft Rule, and in particular certain provisions of the Ontario Draft Rule, would significantly increase the costs of doing business by mutual fund participants. Fund organizations argued that they would experience higher cost due to the lack of an asset or sales threshold in respect of trailing commissions, which is permitted under the IFIC Code. Rules that circumscribe how fund organizations allocate payments for educational and marketing costs of dealers would increase costs to the fund organization. Participating dealers commented that restrictive rules regarding their costs that could be paid for by fund companies would increase their costs.

The CSA have considered these comments, but has concluded that the benefits of the proposed National Instrument outweigh any potential costs that may be associated with it. The OSC noted that the costs to the mutual fund industry are difficult to quantify. The CSA agree with this statement and also with the statement that the proposed National Instrument may reduce the range and amount of compensation and non-cash benefits that have been paid or given to distributors of mutual fund securities in the past.

Comments

Interested parties are invited to make written submissions with respect to the proposed National Instrument and proposed Companion Policy. Submissions received by September 30, 1997 will be considered.

Submissions should be sent to all of the Canadian securities regulatory authorities listed below in care of the Ontario Securities Commission, in duplicate, as indicated below:

British Columbia Securities Commission
Alberta Securities Commission
Saskatchewan Securities Commission
The Manitoba Securities Commission
Ontario Securities Commission
Office of the Administrator, New Brunswick
Registrar of Securities, Prince Edward Island
Nova Scotia Securities Commission
Securities Commission of Newfoundland
Securities Registry, Government of the Northwest Territories
Registrar of Securities, Government of the Yukon Territory

c/o Daniel P. Iggers, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario M5H 3S8

Submissions should also be addressed to the Commission des valeurs mobilières du Québec as follows:

Jacques Labelle, General Secretary
Commission des valeurs mobilières du Québec
800 Victoria Square
Stock Exchange Tower
P.O. Box 246, 17th Floor
Montréal, Québec H4Z 1G3

A diskette containing the submissions (in DOS or Windows format, preferably WordPerfect) should also be submitted. As securities legislation in certain provinces requires that a summary of the written comments received during the comment period be published, confidentiality of submissions received cannot be maintained.

Questions may be referred to any of:

Lata Casciano
Senior Policy Advisor, Policy and Legislation
British Columbia Securities Commission
(604) 660-4785

Ian Kerr
Legal Counsel
Alberta Securities Commission
(403) 297-4225

Rebecca Cowdery
Special Counsel, Market Operations
Ontario Securities Commission
(416) 593-8129

Pierre Martin
Legal Counsel, Service de la reglementation
Commission des valeurs mobilières du Québec
(514) 873-5326