The Ontario Securities Commission has issued a staff notice providing guidance for fund managers and dealers on the selling of model portfolios of mutual funds.

The guidance follows from three decisions concerning issues raised in exemptions sought by RBC Asset Management Inc. and Royal Mutual Funds Inc., which are also published in today’s OSC bulletin.

Today’s notice addresses the issues raised in those decisions. The intention of the notice is to provide guidance about exemptions required by market participants planning to introduce products and services in similar situations.

The decisions provide exemptive relief for the two firms concerning decisions about rebalancing changes in model portfolios of mutual funds, including changes within pre-determined parameters as well as replacing existing funds with new funds.

OSC staff consider that the rebalancing activity undertaken by the portfolio manager is discretionary management that affects the client’s holdings directly. “It is as though the IC/PM is advising the client directly, through its own actions as passed on through the mutual fund dealer. This situation differs from a fund of funds, where discretionary activity carried out in the top fund affects only that fund, and not the actual holdings in a client’s account,” the notice explains.

“The mutual fund dealer through which the model portfolio product is sold to clients is therefore considered to be providing discretionary management to the client,” it adds, noting this is not permitted for a mutual fund dealer without an exemption from the adviser registration requirement.

The notice indicates that if an IC/PM-Fund Manager trades to implement decisions made in its discretionary authority, it is required to be registered as a dealer in an appropriate category or obtain exemptive relief from the dealer registration requirements.

It also sets out disclosure requirements for model portfolio products, which are not offered as separately qualified funds under a prospectus, like a fund of funds, but are generally described as a service. After reviewing similar products in the market, the OSC found that, “The requirement to describe the model portfolio products is not particularly specific, and the result is that descriptions in both prospectuses and account opening documentation vary significantly, from very good to very unclear. Staff also found that some descriptions were quite detailed, while others were not; these differences made it impossible to compare the model portfolio products.”

In the RBC cases, the OSC allowed exemptions to the mutual fund dealer from providing clients with trade confirmations for the trades carried out in connection with model portfolios of mutual funds, provided that the account agreement discloses that the clients will not receive trade confirmations for those trades, and that they will receive quarterly statements from the adviser to the model portfolios of mutual funds. It also allowed an exemption from registration as an adviser, subject to certain conditions. The fund manager was similarly exempt from registration as a dealer, provided that it is registered as a portfolio manager.