MFDA draft rules for self-regulation

In November 1999, the MFDA Board approved the application by the MFDA for recognition as a self-regulatory organization to the Ontario, British Columbia and Alberta Securities Commissions (the “Recognizing CSA Members”). This application was subsequently filed with the Recognizing CSA Members on December 22, 1999. Set out below is a summary of the draft Rules which form part of the application. The Board will not be asked to approve any final rules however, until the conclusion of the public comment process after the application is published by the Recognizing CSA Members.

RULE NO. 1 – BUSINESS STRUCTURES AND QUALIFICATION

Business Structures

(a) Permitted Relationships between Dealers and Approved Persons
The relationship between a mutual fund dealer (the “Member”) and any person carrying on business on account of the dealer can be that of:

i) employer / employee;
ii) principal / agent; or
iii) introducing dealer / carrying dealer.

(b) Trade Names
Any business carried on by the Member or by an Approved Person on behalf of the Member must be in the name of the Member. Additional rules will govern the use of trade or style names.

(c) Service Arrangements
A Member or Approved Person may engage a person or corporation who is not an Approved Person or Member to provide administrative services as long as certain conditions set out in the draft Rules are satisfied. One such condition is that the services provided can not be activities that require registration under securities legislation.

(d) Employees
A Member may conduct its business though Approved Persons who are employees provided certain conditions are met, including the requirement that the Member shall be responsible for the conduct of the employee and for ensuring that the employee complies with securities legislation and the draft Rules.

(e) Agents
A Member may conduct its business through Approved Persons retained or contracted by it as agents provided certain conditions are met, including the requirement that the Member shall be responsible for the conduct of the agent (in respect of the Member’s business) and shall be liable to third parties for the acts and omissions of the agent.

(f) Introducing and Carrying Arrangement
Permitted Arrangement – The accounts of one Member (the “Introducing Dealer”) may be carried by another Member (the “Carrying Dealer”) provided certain conditions are met, including the following:

i) the Introducing Dealer qualifies as a Level 1 dealer and the Carrying Dealer qualifies as a Level 4 dealer;
ii) the Introducing Dealer may not introduce accounts to more than one Carrying Dealer; and
iii) the Introducing Dealer and the Carrying Dealer must enter into a written agreement in a form prescribed by the MFDA and the arrangement or any changes (including termination) must be approved by the MFDA.

Insurance – Both the Introducing Dealer and the Carrying Dealer must provide financial institution bond coverage for fidelity insurance. The Carrying Dealer shall include all client accounts in nominee name, introduced to it by the Introducing Dealer, in its financial institution bond coverage.

Disclosure on Account Opening – The Introducing Dealer must advise each client in writing at the opening of the account, of the relationship with the Carrying Dealer.

Disclosure on Contracts, Statements and Correspondence – The name of the Carrying Dealer shall, and the name of the Introducing Dealer may (in smaller size), be shown on all contracts, correspondence and other documentation sent by either the Introducing Dealer or the Carrying Dealer. The Carrying Dealer is responsible for sending account statements and confirmations for all clients introduced to it as required under the draft rules.

Clients Introduced to the Carrying Dealer – Each client introduced to the Carrying Dealer by the Introducing Dealer is considered a client of the Carrying Dealer for the purposes of complying with the draft Rules.

Responsibility for Compliance – The Introducing Dealer and the Carrying Dealer are jointly and severally responsible for compliance with the MFDA By-laws and Rules.

Note: Additional Introducing Dealer/ Carrying Dealer arrangements may be developed over time and incorporated into the draft Rules if the MFDA becomes aware of other dealer relationships that would warrant the creation of a new model. It is anticipated that the MFDA’s introducer/carrier arrangements will develop and change over time.

Individual Qualifications

(a) Salespersons
Proficiency Requirements – All Approved Persons who are salespersons must have completed one of the required courses as set out in the draft Rules, offered by either the Canadian Securities Institute (“CSI”), the Investment Funds Institute of Canada (“IFIC”) or the Institute of Canadian Bankers (“ICB”).

Registration – Salespersons must be registered with the applicable securities commission and agree in writing to be bound by the draft Rules.

Training and Supervision – All newly registered Approved Persons who are salespersons will have 90 days to complete a mandatory training program and will be subject to enhanced supervision for a period of 6 months in accordance with the terms and conditions as may be prescribed from time to time by the MFDA.

Dual Occupation – An Approved Person may have another occupation as long as:

(i) the Member acknowledges in writing to the MFDA its responsibility for the supervision of its Approved Persons;
(ii) it is specifically permitted by the relevant securities commission;
(iii) the Member establishes and maintains procedures to ensure continuous service to clients and to address potential conflicts of interest; and
(iv) such occupation of the Approved Person may not be capable of bringing the MFDA, its members or the securities industry into disrepute.

Financial Planning – Any Approved Person that holds himself or herself out to the public as a financial planner must comply with the requirements of any applicable legislation.

Business Titles – Approved Persons may not hold themselves out in any manner that deceives or misleads a client or any other person as to the proficiency or qualifications of the Approved Person under the MFDA Rules or any applicable legislation.

(b) Branch Managers
Proficiency Requirements – An individual may not be designated as a branch manager unless he or she (i) has been previously registered as a trading partner, director, officer or compliance officer of a mutual fund dealer or (ii) has completed, in addition to one of the salesperson courses, one of the branch manager courses offered by either the CSI, IFIC or ICB.

Experience Requirements – Each branch manager must have (i) a minimum 2 years experience as a registered salesperson, partner, director, officer, compliance officer or 2 years of equivalent experience, and must be (ii) registered as a branch manager under securities legislation.

Note: The MFDA is proposing to delay the effective date of the rule requiring 2 years experience for branch managers in those jurisdictions where it is not already required in order to give members time to implement this requirement.

(c) Trading Partners, Officers and Directors and Compliance Officers
Proficiency Requirements – All trading partners, officers and directors and compliance officers, in addition to being registered under the applicable securities legislation, must have completed, in addition to one of the salesperson courses, one of the partners, directors and officers course offered by the CSI or IFIC.

Note: The MFDA is considering a transition period for trading partners, officers and directors of Introducing Dealers.

(d) Notification of Changes in Registration Information
All Members must notify the MFDA of certain changes as set out in the draft Rules, including the opening or closing of branch offices and the commencement or termination of Approved Persons.

RULE NO. 2 – BUSINESS CONDUCT

General

(a) Standard of Conduct
Each Member and each Approved Person of a Member must deal honestly with their clients and observe high standards of ethics and conduct in the transaction of business.

(b) Member Responsible
Each Member is responsible for the acts and omissions of each of its Approved Persons under the draft Rules and By-Laws.

(c) Confidential Information
Client information received by a Member must be kept confidential and may not be disclosed to any other person without the prior written consent of the client. Each member must maintain policies and procedures relating to the confidentiality and the protection of information held by it in respect of clients.

(d) Conflicts of Interest
Where there is a conflict of interest between a Member and its client, the Member must act in the best interests of the client. Any such conflicts must be immediately disclosed in writing to the client prior to the Member taking any action. Members must develop and maintain written procedures to encourage compliance with the Rules and to identify and resolve conflicts of interest.

New Accounts

(a) Know-Your-Client
Each Member shall use due diligence to learn the essential facts relative to each client and ensure any recommendations made for the client’s account are in keeping with the client’s objectives.

(b) New Account Application Form
A new account application form must be completed for each new client account and must be signed by the client.

(c) New Account Approval
Each Member shall designate a partner, director, officer or branch manager who shall be responsible for the approval of any new accounts and the supervision of account activity.

(d) Changes to the New Account Application Form
New account application forms must, at a minimum, be updated annually or when a Member or Approved Person becomes aware that a client’s circumstances have changed.

(e) Limited Trading Authorization
A Member or Approved Person may only accept a limited trading authorization from a client for the express purpose of facilitating trade execution, in the form prescribed by the MFDA. A general power of attorney may not be accepted. Each trade made under a limited trading authorization must be designated as such for supervisory purposes. A limited trading authorization shall not in any way confer general discretionary trading authority upon a Member or an Approved Person.

(f) Remuneration
All remuneration in respect of a Member’s business must be paid directly to and in the name of the relevant Approved Person. Further, no Approved Person may accept any remuneration or benefit from any person other than the Member, in respect of activities carried out on behalf of the Member.

(g) Mutual Fund Sales Incentives
Members and Approved Persons must comply with National Instrument 81-105 entitled “Mutual Fund Sales Practices”.

(h) Referral Arrangements
Referral arrangements may only be entered into if the following conditions are met:

i) written disclosure of the referral arrangement shall be made to clients prior to any transaction taking place;
ii) they are between Members and entities that are registered pursuant to applicable securities legislation or such other regulatory system prescribed by the MFDA;
iii) there is a written agreement governing the arrangement; and
iv) all fees or compensation is recorded on the books and records of the Member.

Minimum Standards for Supervision

(a) Compliance Officer
Each Member must designate a trading officer as a compliance officer who shall be responsible for ensuring the handling of client business is in accordance with the MFDA By-laws, Rules and Policies, and securities legislation. In the absence of the compliance officer, an alternate compliance officer must be designated.

(b) Branch Manager
Each Member must designate a branch manager for each branch office (as well as a co-branch manager to perform the branch manager’s duties in the absence of the branch manager) who must supervise the opening of new accounts and ensure that business is conducted in compliance with the MFDA By-laws, Rules and Policies as well as securities legislation. Where there are fewer than 4 salespersons at a branch office, the Member may designate a Branch Manager that is not normally present at such office.

(c) Leveraged Mutual Fund Sales
Each Member must provide a disclosure document to a client in a form prescribed by the MFDA where an Approved Person recommends leveraging or otherwise becomes aware that a client intends to use leveraged funds for the purchase of mutual funds.

(d) Advertising and Sales Communications
No Member may participate in any advertisement or sales communication that is untrue or misleading. Further, all advertisements and sales communications must be approved by a designated individual prior to being issued to the public.

(e) Internal Controls
Members must establish and maintain adequate internal controls as prescribed in MFDA Policies from time to time.

(f) Policies and Procedures Manual
Members must establish and maintain written policies and procedures (that have been approved by senior management) for dealing with clients and ensuring compliance with MFDA Rules, By-laws and Policies, as well as applicable securities legislation.

(g) Complaints
Members must maintain a complaints log and establish written policies and procedures for dealing with client complaints in a prompt and fair manner

@page_break@RULE NO. 3 – FINANCIAL & OPERATIONS REQUIREMENTS

Minimum Levels of Capital

Members must maintain at all times risk-adjusted capital (calculated in accordance with a form prescribed by the MFDA) greater than zero and minimum capital in the amounts referred to below:

Level Description

Level 1 $25,000 for a Member that is an Introducing Dealer.

Note: If additional introducer/carrier arrangements are developed it is likely that each type of introducer would be subject to a different capital level.

Level 2 $75,000 for a Member which:
a) does not hold client cash, securities or other property; and
b) does not act as an agent of a trustee in administering the accounts of client self-directed plans, which are registered for taxation purposes.

Level 3 $125,000 for a Member which:
a) does not hold client securities or other properties except client cash in a trust account; and
b) does not act as an agent of a trustee in administering the accounts of client self-directed plans which are registered for taxation purposes.

Level 4 $200,000 for any other Member, including a Member which acts as a Carrying Dealer.

Capital & Margin

(a) Client Lending and Margin
No Member shall lend or extend credit to clients or permit the purchase of securities by a client on margin.

(b) Advancing Mutual Fund Redemption Proceeds
Members may only advance mutual fund redemption proceeds to clients if the following conditions are satisfied:

i) the Member has received prior written confirmation of the redemption order from the issuer;
ii) the redemption proceeds are equal to or greater than the amount of funds or credit to be provided; and
iii) the client has authorized the issuer of the securities to pay the redemption proceeds to the Member.

Advances of redemption proceeds must be fully margined when calculating a Member’s risk adjusted capital until such time as the proceeds are received by the Member.

(c) Related Company Guarantees
Each Member must guarantee the obligations to clients incurred by each of its related companies, and each related company must similarly guarantee the obligations of the Member to its clients on the basis set out in the draft Rules.

Segregation of Client Property

(a) General
A Member must hold client cash, securities or other property in trust and apart from its own property in accordance with the MFDA Rules and Policies.

(b) Cash
All cash held by a Member on behalf of clients must be held in a designated trust account with a financial institution. Each Member must determine on a daily basis the amount of cash it holds for clients that is required to be held in segregation.

(c) Segregation Requirements
Client securities may be held in bulk segregation, but the Member must determine the market value and number of all securities to be held for the client. A member must determine at least twice weekly the securities required to be segregated and review on a daily basis compliance with the segregation requirements. Any segregation deficiency must be handled promptly.

Early Warning

A Member may be designated in early warning level 1 or 2 according to its capital, profitability and liquidity position, or at the discretion of the MFDA. If a Member has been so designated, the Member must comply with the requirements as set out in the draft Rules.

(a) Restrictions
The MFDA may prohibit a Member which is designated as being in early warning level 2 from opening any branch offices, hiring any new salespersons, opening new client accounts or changing its capital investments in any material respect.

(b) Duration
A Member shall remain designated as being in early warning level 1 or 2, as the case may be, until the latest filed monthly reports of the Member demonstrate to the MFDA that the Member is no longer required to be so designated.

Filing Requirements

(a) Monthly
Each Member must file monthly with the MFDA a copy of its unaudited financial report as at the end of each month.

Note: A transition period is being considered to allow Members to file quarterly during the first full year of membership.

(b) Annual
Each Member must file annually with the MFDA its audited financial statements as at the end of the fiscal year.

Audit Requirements

(a) Standards
The audit of a Member must be conducted in accordance with generally accepted auditing standards and must include a review of the accounting system and the system of internal account controls and procedures for safeguarding assets.

(b) Scope
The scope of the audit must include the audit tests and procedures that are set out in the draft Rules.

(c) Experience
The Members’ auditor must have a minimum of five years audit experience in connection with mutual fund dealers, securities dealers or financial institutions.

RULE NO. 4 – INSURANCE

(a) Financial Institution Bond
Every Member must maintain a financial institution bond with the coverage as specified in the draft Rules. The minimum amount of insurance to be maintained for each type of loss required to be covered shall be the greater of $500,000 (or $200,000 for an introducing dealer) and 1% of the base amount (as defined in the draft Rules), up to $25 million.

RULE NO. 5 – BOOKS, RECORDS & REPORTING

(a) Requirements for Records
Every Member must keep such books, records and other documents as are necessary for the proper recording of its business transactions and financial affairs, and the transactions that it executes on behalf of others, as well as other documents that may be required by the MFDA.

(b) Storage Medium
All records maintained by a Member may be kept by means of mechanical, electrical, electronic or other devices provided:

i) the method is not prohibited by any legislation;
ii) there are appropriate internal controls in place to guard against falsification; and
iii) the MFDA has prompt access to accurate, legible and complete copies of records.

Members will be required to have proper back-up and disaster-recovery plans in place.

(c) Client Reporting
Delivery of Account Statements – Each Member will be required to send account statements to clients on a regular basis.

Contents of Account Statement – The draft Rules will set out the minimum information that must be included in account statements.

(d) Trade Confirmations
Delivery of Confirmations – Every Member must promptly send a written confirmation to the client of any trade in a security, except where the trade is in a mutual fund security and the mutual fund manager sends the trade confirmation containing the required information.

Contents of Confirmation– Every trade confirmation must include the information specified in the draft Rules.

(e) Record Retention
Each Member must retain copies of their records and documentation for such time as may be prescribed by the MFDA.