MFDA Bulletin. Compliance. For Distribution to Relevant Parties within your Firm. CRM2 Implementation Guide and Tips

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1 Contact: Marc Guerin Director, Member Education Phone: BULLETIN #0657 C September 14, 2015 MFDA Bulletin Compliance For Distribution to Relevant Parties within your Firm CRM2 Implementation Guide and Tips On March 28, 2013, the Canadian Securities Administrators ( CSA ) published Client Relationship Model Phase 2 ( CRM2 ) amendments to National Instrument Registration Requirements, Exemptions and Ongoing Registrant Obligations ( NI ) and the Companion Policy to the Instrument. The CRM2 amendments introduce requirements under NI in the areas of client statements, charges and compensation disclosure and performance reporting. These amendments came into force on July 15, Various transition periods been provided for most of the new requirements. Conforming amendments with the same effective dates have been made to MFDA Rules. The MFDA recognizes that Members may face a number of decisions with respect to implementing these new requirements. Accordingly, the MFDA has developed a guide titled CRM2 Implementation Guide and Tips to assist with the implementation of the CRM2 requirements. Members are encouraged to speak to their MFDA Sales Compliance Manager to address issues or concerns which arise at any stage during the implementation period. DM#428174v3 Page 1 of 1

2 CRM2: Implementation Guide and Tips Mutual Fund Dealers Association of Canada Association canadienne des courtiers de fonds mutuels 121 King Street West, Suite 1000, Toronto, Ontario, M5H 3T9 TEL: FAX: WEBSITE: September, 2015

3 Table of Contents 1. BACKGROUND PLANNING TIPS ACCOUNT STATEMENT CONTENT... 3 Important Dates... 3 Position Cost... 3 Market Value... 5 Deferred Sales Charges... 6 IPC Disclosure... 7 The Name of the Party that Holds or Controls each Investment and a Description of the Way it is Held REPORT ON CHARGES AND OTHER COMPENSATION... 7 Important Dates PERFORMANCE REPORTING Important Dates TRADE CONFIRMATIONS Important Dates... 13

4 This document is intended to assist Members and their Approved Persons in the interpretation, application of and compliance with CRM2 amendments under MFDA Rules, Policies and Notices. Examples and sample disclosures provided are for illustration and are not exhaustive or intended to imply particular rules or requirements. 1. BACKGROUND The MFDA has made a number of changes to its Rules and Policies as a result of the publication of the Client Relationship Model Phase 2 ( CRM2 ) amendments to National Instrument Registration Requirements, Exemptions and Ongoing Registrant Obligations and the Companion Policy to the Instrument. These changes include the creation of, or amendments to, MFDA Rules 2.2.5, 2.4.3, 2.4.4, 2.8.3, 5.3, 5.4 and Policy No. 7. The Rule and Policy changes are subject to various transition periods. This document contains guidance and tips for Members on the new requirements coming into effect in 2015 and July 15, 2014 July 31, Minor clarifications to MFDA Rule 2.2.5(h) (Relationship Disclosure) including investment performance benchmark disclosure. Changes to MFDA Rule (Transaction Fees or Charges) including pre-trade disclosure of: Deferred sales charges that may apply, including a copy of the fee schedule; and Whether the Member will receive trailing commissions in respect of the security. Changes to account statements (Pages 3-7), including: Position cost; Market value; Which securities may be subject to a deferred sales charge if they are sold; MFDA Investor Protection Corporation ("IPC") coverage disclosure; and The name of the party that holds or controls each investment, including a description of the way it is held. July 15, 2016 New requirements including: Report on Charges and Other Compensation (Page 7); Performance Reporting (Page 10); and Trade Confirmation (Page 13). 1 In accordance with relief granted under CSA Staff Notice , Members will be permitted to meet new requirements under Rule 5.3 by delivering quarterly account statements for the period ending December 31, P age

5 2. PLANNING TIPS Ensure you have read: MFDA Rules: MFDA Rule Rates of Return MFDA Rule 5.3 Client Reporting MFDA Rule Delivery of Account Statement MFDA Rule Content of Account Statement MFDA Rule Report on Charges and Other Compensation MFDA Rule Performance Report MFDA Rule Delivery of Report on Charges and Other Compensation and Performance Report MFDA Rule 5.4 Trade Confirmations MFDA Policies: MFDA Policy No. 7 Performance Reporting MFDA Notices: MSN-0078 MFDA Rules (Transaction Fees or Charges) and 5.1(b)(iv) (Requirement for Records) MSN-0083 Account Statement Disclosure Respecting MFDA IPC Coverage MFDA Bulletins: Bulletin #0638-P - CRM2 Frequently Asked Questions Plan ahead to ensure there is sufficient time to develop, test and implement changes. Contact your system provider to discuss the changes and consider asking them to provide a demonstration to you and the MFDA. Train and educate staff and Approved Persons on the new requirements and changes made to Member practices as a result of the new requirements. Develop a communication plan to update clients on the new information they will be receiving. Contact your MFDA Compliance Manager or Membership Services if you have any questions or identify any issues. 2 P age

6 3. ACCOUNT STATEMENT CONTENT Important Dates For Members operating on a calendar year-end basis, the first quarterly statement that must address the new requirements is the quarterly account statement issued for the period October 1, 2015 to December 31, Under the amendments to MFDA Rule 5.3.2, Members will need to include the following information in account statements: Position cost; Market value; Which securities may be subject to a deferred sales charge if they are sold; The MFDA IPC coverage disclosure; and The name of the party that holds or controls each investment and a description of the way it is held. Position Cost the account statement must contain cost information for each investment position held in the account and a definition of the cost basis used It is our understanding that Members intend to use book cost rather than original cost. Accordingly, book cost has been referred to throughout this document. Things to Consider: Do you have accurate book cost information for each position held prior to January 1, 2016? Members will need to investigate all client holdings and assess if they can obtain reliable book cost information for each position held. For many products, including investment funds, book cost information should be available from the product issuer or fund company. There may be some products, or situations, where reliable cost information is not available. In these instances Members may use the market value of the position as at the transfer-in date. If the transfer-in date is not known, the Member may select, using a reasonable basis, the market value from any date prior to January 1, 2016, as long as that same date and value is used for all similar accounts holding that same product. For example, where the Member underwent a system conversion for a group of accounts, the Member may use the market value as at the system conversion date to calculate cost information for the applicable accounts. 3 P age

7 Each account statement must include the following definition of book cost : Book cost means the total amount paid to purchase an investment, including any transaction charges related to the purchase, adjusted for reinvested distributions, return of capital and corporate reorganizations. If market value was used for any position to calculate cost information, the account statement must identify such position(s) and include additional disclosure. We encourage Members to include as much information as practical in the additional disclosure. For example, where the market value as at the position transfer-in date was used for any position in the account, the Member may use the following disclosure or similar disclosure: Book cost information for this position has been estimated by using an average of market value of positions transferred in, as at the transfer dates, and actual book cost for any additional purchases. Market value has been used because the book cost information was not available as at the transfer in dates. As another example, where the market value as at a system conversion date was used for any position in the account, the Member may use the following disclosure or similar disclosure: Book cost information for this position has been estimated by using an average of market value of positions as at [insert system conversion date], and book cost information for purchases since [insert system conversion date]. Market value has been used because the book cost information was not available for this position prior to [insert system conversion date] due to a system conversion. 4 P age

8 Market Value the account statement must contain the market value of each investment position (including non-securities) in the account. Things to Consider: Do you have reliable market value information for each product? When determining the market value of investments, including GICs and exempt products, Members should refer to the market value of a security definition set out under MFDA Form 1, Part 5 (Market Value of a Security) and the International Financial Reporting Standards fair value standards. Members will need to investigate all client holdings and assess if they can obtain reliable market value information for each product held. The market value of investment funds and segregated funds is their Net Asset Value, which should be available through FundSERV or the product issuer. Members may choose to provide additional disclosure respecting the guarantee feature for segregated funds. The market value of other securities (e.g. flow-through shares) may be available from an active market quote or from published market reports or inter-dealer quotation sheets. For GICs, Members may report market value as principal plus accrued interest. For market-linked GICs (or similar investments), Members may report market value as principal plus an estimate of the accrued interest, along with an explanation that sets out the basis for the estimate. If there is no active market for an investment, Members may use a reasonable methodology to estimate market value, including any price adjustments considered by the Member to be necessary to accurately reflect the market value. The methodology must include procedures to assess the reliability of valuation inputs and assumptions and provide for: (i) (ii) the use of inputs that are observable, and the use of unobservable inputs and assumptions, if observable inputs are not reasonably available. Observable inputs include market prices or yield rates for comparable securities and quoted interest rates. Unobservable inputs are developed by the Member using the best information available in the circumstances, which might include the Member s own data, taking into account all information about market participant assumptions that is reasonably available. 5 P age

9 Where the Member estimates market value using a reasonable methodology, the account statement must include the following disclosure or similar disclosure: There is no active market for this position so we have estimated its market value by [insert a summary of the valuation methodology, including any assumptions used to estimate the market value]. If the market value of investment position(s) cannot be reasonably determined using any of the above methods, the Member should not report a market value for such investment position(s) and must include the following disclosure or similar disclosure: Market value is not determinable for this position [insert a summary of any assumptions in making this determination]. Deferred Sales Charges the statement must identify which securities may be subject to a deferred sales charge if they are sold. Things to Consider: Members will have to ensure that product information in their trading system has been updated to identify which products are subject to a deferred sales charge. In many instances, the name of the specific fund product includes information regarding the sales charge type, such as LSC for low-load funds and DSC for back-end/deferred sales charge funds. How can products that may be subject to a deferred sales charge be identified on the statement? Products that may be subject to a deferred sales charge can be identified in a variety of ways such as: Using the LSC and DSC identifiers in the product name description along with an explanation of the acronyms. Placing an indicator (e.g. an asterisk) on the security name or security code along with an explanation of the asterisk reference. Inserting a separate sales charge column in the account statement that identifies which products may be subject to deferred sales charge. A footnote in the statement could explain the column content. 6 P age

10 The Member may use the following disclosure or similar disclosure: This investment may be subject to a deferred sales charge upon redemption. For mutual funds, the sales charge is usually based on the net asset value of your units/shares at the time that you redeem, and is deducted from the amount you receive for the units/shares. Deferred sales charges decline to zero after a specific number of years. IPC Disclosure the account statement must contain a prescribed IPC disclosure. To satisfy this requirement, Members must use the following disclosure prescribed by the MFDA IPC, as set out under MSN-0083: Customers accounts are protected by the MFDA Investor Protection Corporation ( IPC ) within specific limits. Customers with accounts in Quebec are generally not covered by the IPC. Please refer to the IPC Coverage Policy on the website at for a description of the nature and limits of coverage, or contact the IPC at Additional disclosure is required for Members registered in the province of Quebec. The Name of the Party that Holds or Controls each Investment and a Description of the Way it is Held Guidance on this requirement will be provided in a subsequent update to this guide. 4. REPORT ON CHARGES AND OTHER COMPENSATION Important Dates For Members operating on a calendar year-end basis, the initial Report on Charges and Other Compensation must be issued for the 12 month period ending December 31, In these instances, Members will have to begin recording charges and compensation in their trading system as of January 1, P age

11 Effective July 15, 2016, Members will be required to provide clients with an annual summary of charges paid as well as compensation received by the Member during the 12 month period covered by the report, under new MFDA Rule Things to Consider: Operating and Transaction Charges Paid to the Member Operating and transaction charges must be included on this report. Examples of these charges include: Switch fees; Account fees (e.g. annual fees, registered plan fees); Transfer out/de-registration fees; Sales taxes charged on fees; and Financial planning fees. Where fees or charges were rebated to the client, the report should show the total fees/charges and the rebated amounts separately. Sales Charge Compensation Sales charge compensation (e.g. FEL, DSC) must be included in this report. Trailer Commissions Trailer commission compensation must be included in this report. Fee Based Accounts The total fees paid to the Member for a fee based account must be included in this report. Additional Considerations: Fees and Charges Paid to Other Parties Client account statements must reflect all transactions for a client account, including all fees and charges paid to other parties. Although these fees and charges are not required to be included on the Report on Charges and Other Compensation because they were not paid to the Member, we strongly encourage Members to include fees and charges not paid to the Member on the report in a section entitled Fees and Charges Paid to Other Parties. Examples of these fees and charges include: 8 P age

12 Redemption charges paid to the issuer; Short term trading fees paid to the issuer; and Custodial fees paid from the account to a custodian. Investments that are not securities (e.g. GICs, Segregated Funds) Compensation from investments that are not securities are not required to be included in this report, but it is strongly encouraged. If it is impractical to establish reporting for these investments, the report must identify such position(s) and disclose that compensation was received on these investments, but not included in the report. The Member may use the following disclosure or similar disclosure: Compensation received by the Member for [insert type(s) of investment] has not been included in this report. Referral Fees Which referral fees must be reported to clients? Only referral fees paid to the Member by a securities registrant (e.g. portfolio manager, investment dealer) must be reported to an individual that remains a client of the Member. Referral fees do not have to be reported if the individual is no longer a client of the Member (i.e. the client has no accounts remaining at the Member). Integrated Members Certain MFDA Members are part of large integrated corporate groups. In certain circumstances, Members who are part of such corporate groups do not receive commission revenue. Instead, such dealers receive internal transfer payments from affiliates based upon a management agreement with the corporate group. In circumstances where the Member receives transfer payments which are not directly tied to activity in client accounts, what should be reported on the Charges and Compensation Report? If compensation has to be disclosed, how are Members expected to determine the amount? 9 P age

13 Members are required to determine and provide fair and reasonable disclosure in respect of costs associated with registerable services provided to the client, even in circumstances where such Member revenue is not directly tied to account activity. Members who receive transfer payments instead of commission revenue must make a reasonable estimate of what the Member would have received if it earned commission revenue. For example, Members can base their estimate on compensation that would have been earned by third party dealers from the sale of the same or similar products. Some integrated Members currently disclose total costs paid by the client to the combined corporate entity, which includes revenue earned by the corporate group for both product management and dealer services. An example of this is disclosure, in dollars, of the Management Expense Ratio. Either of the above methods can satisfy the regulatory requirements. The report must also include an explanation of each type of payment. The description should be sufficiently clear so as to provide clients with an understanding of the services to which the compensation relates. 5. PERFORMANCE REPORTING Important Dates For Members operating on a calendar year-end basis, the initial Performance Report must be issued for the 12-month period ending December 31, The initial Performance Report must include, at a minimum, the annualized total percentage return for the 12-month period covered by the statement, and the annualized total percentage return since inception. Performance Reports are not required to be provided if: The account has existed for less than a 12-month period; or The Member reasonably believes there are no investments in the account for which a market value can be determined. For Members operating on a calendar year-end basis, the Performance Report is not required to include the annualized total percentage return for a 3, 5, and 10 year period until the following statement dates: 3-year return statement period ending December 31, year return statement period ending December 31, year return statement period ending December 31, 2025 Members with accurate historical information may choose to report the annualized total percentage return for the 3, 5, and 10 year period prior to the above dates. 10 P age

14 Under new MFDA Rule 5.3.4, Members will need to include the following information in annual investment performance reports to clients from July 15, 2016: Change in account value; Cumulative change in account market value since inception; Annualized total percentage return using a dollar-weighted methodology for a 1, 3, 5 and 10 year period, as well as since inception; and must otherwise meet the requirements set out under MFDA Policy No. 7 (Performance Reporting). Things to Consider: How should the change in market value since inception be determined when there is no available data as at the account inception date? Account information at inception may not be available, or may be impractical to obtain, for all or some investments in the account. Where no reliable historical account value information is available or is impractical to obtain, the Member may select another date as the since inception date for such investments and use the account information from that date to determine the change in market value since inception. In these instances, the Member must have a reasonable basis for selecting a specific date and use that date for all similar situations. For example, where the Member has accurate historical data that does not date back to account inception, but rather to some other date related to a dealer acquisition or system conversion, it would be reasonable to use the acquisition or system conversion date. It would not be reasonable for the Member to pick a date based on a time when the market was historically low in order to present the most favorable performance data. The performance report should also address the following: Cash, Securities and Other Investment Products All assets, including cash, must be included in the performance report. Change in Account Value In order to show the change in account value (for both the statement period and since account inception), the statement must include the following: Beginning period account value; Total deposits (after costs); 11 P age

15 Total withdrawals (after costs); Change in the market value; and Ending period account value. Total Percentage Return How do total percentage returns need to be displayed on the performance report? Total percentage returns must be presented using text, tables and charts, and must be accompanied by notes explaining: the content of the report and how a client can use the information to assess the performance of their investments; and the changing value of their investments as reflected in the information in the report. The Member may consider using a bar chart with percentage returns for each of the 1, 3, 5, 10 year and since inception calculations. Where the account has not been opened for 3, 5, or 10 years, the statement does not have to include a field for that calculation. Where the account has been opened for less than one year, no performance reporting is required. However, where Members want to provide performance reporting for accounts opened less than one year, the information must not be presented on an annualized basis. The statement must include a definition of total percentage return and a disclosure indicating the following: that the total percentage return in the investment performance report was calculated net of charges; the calculation method used; and a general explanation in plain language of what the calculation method takes into account. 12 P age

16 Members must use the following definition of total percentage return, as set out under MFDA Policy 7: Total Percentage Return means the cumulative realized and unrealized capital gains and losses of an investment, plus income from the investment, over a specified period of time, expressed as a percentage. 6. TRADE CONFIRMATIONS Important Dates Trade confirmations for transactions with a trade date on or after July 15, 2016 must address the new requirements. Effective July 15, 2016, every confirmation of a trade sent to a client must disclose the amount of each transaction charge, deferred sales charge or other charge in respect of the transaction and the total amount of all charges in respect of the transaction. Things to Consider: Members may continue to rely on fund companies to prepare and deliver trade confirmations to the client provided that the confirmations contain the information required under MFDA Rule For products where the Member is required to prepare and deliver trade confirmations the confirmations must contain the information required under P age