In mid-June 2012, the Canadian Securities Administrators (the CSA) released for comment a revised version of proposed amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103), as well as to its Companion Policy [available here] that, when finalized, will require additional disclosure by registered firms in Canada to their clients.
These proposals – referred to by the CSA as the second phase of the client relationship model project or “CRM-2” – build on the client “relationship disclosure information” currently mandated under NI 31-103 (RDI). They will require a registered firm to provide disclosure of
- Account-level charges levied by the firm
- Charges relating to certain investments held in, and transactions made for, the accountC
- ompensation received by the firm and dealing representatives in respect of the client’s account – with a particular focus on trailing commissions and embedded commissions relating to fixed-income transactions
- Performance of the investments held in the accountR
Registered firms will be required to provide mandated information tailored to each client on account opening, on a pre-trade basis, in trade confirmations and on a quarterly and annual basis. Much of the new disclosure will not be required to be given to institutional “permitted clients”. The CSA propose transition periods for implementation of the new rules, which for the most part are more generous than those proposed with the first version of the amendments.
The first version of the CRM-2 proposals was published for comment in June 2011. BLG’s Investment Management Bulletin New Disclosure Rules Proposed for Registered Firms in Canada: Account-level Charges and Performance September 2011 [available here] describes the 2011 proposals.
Comments on the revised proposals are due on September 14, 2012. It is critical that industry participants affected by these new requirements, including members of self-regulatory organizations, understand the significant impact CRM-2, if enacted in this amended form, will have on their operations and make their views known to the CSA. The 2012 proposals are significantly more complex than those published in 2011 and the comment period is shorter. The CSA have posed specific questions on fixed-income commission disclosure, client name account reporting and percentage return calculation methods that should be answered. This may be the last chance we have to comment on CRM-2.
THE 2012 PROPOSALS - AT A GLANCE
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POTENTIAL IMPACT OF THE 2012 PROPOSALS
All registered firms, including in certain circumstances, a registered investment fund manager, will be required to comply with the proposed new disclosure requirements. Significantly, the CSA acknowledge that some of the proposed disclosure need not be provided to “permitted clients” that are not individuals (essentially, institutional investors). If a client has set up a “managed account”, certain of the information need not be provided to that client in respect of that account. The CSA’s focus is on “retail” investors, with an assumption that an individual (no matter how sophisticated) generally must always receive the mandated information.
It is very clear that much of the required disclosure is proposed in response to investor advocate submissions and the CSA’s own research, that investors still don’t understand the costs associated with investing, particularly in relation to mutual funds. Nor do investors understand how their advisors are paid (through commissions, trailing commissions or other incentives). These assumptions are also behind the CSA’s separate initiative to mandate enhanced disclosure in Fund Facts for mutual funds (and potentially other investment funds). It is instructive to note that the CSA are currently focusing on enhanced disclosure – and explain that they do not propose to move towards regulating compensation models in ways similar to other countries, such as the United Kingdom and Australia.
As with the 2011 proposals, for the most part, the CSA do not take into account the Fund Facts and other disclosure documents relating to mutual funds and other investment funds, where some of the required information is clearly set out. Except in relation to the required “pre-trade” disclosure (which can be provided verbally), the required written disclosure is supplemental to the Fund Facts and other disclosure documents and cannot be satisfied by delivery of these documents. The CSA’s proposed transition periods for the new requirements are generally longer than what they first proposed in 2011 in recognition that these disclosure changes will require potentially quite significant systems changes to capture and set out the new information.
The CSA explain that they intend for dealers that are members of the Mutual Fund Dealers Association of Canada (MFDA) and the Investment Industry Regulatory Organization of Canada (IIROC) to be exempt from most of the proposed requirements, but only where the CSA consider that the SROs of which they are members have substantially similar requirements.
Although not specifically highlighted in the 2012 proposals, there are substantive differences between the CSA’s revised proposals and the rules of the SROs. Further refinements will be necessary to the SRO rules (certain of these rules have been suspended pending final CSA rules) to ensure harmonization with the final CSA rules.
Mutual fund dealers registered in Quebec will be subject to local rules, which we expect will be proposed by the AMF to generally harmonize with those of the MFDA.
PROPOSED AMENDMENTS TO RDI
Consistent with the 2011 proposals, the revised proposals modify the existing rules requiring RDI to be provided to clients of registered firms, to use new proposed defined terms “operating charges” and “transaction charges” and to include a proposed requirement to give clients information about performance benchmarks that may be made available by the firm. Additional disclosure requirements will apply to scholarship plan dealers concerning the conditions applicable to payments out of scholarship plans.
The proposed amendments to the Companion Policy include detailed guidance on the information that must be provided in the RDI by registered firms. If adopted, this guidance may mean RDI currently being provided by registered firms will need enhancements, which may raise practical difficulties, since the CSA propose no transition for much of the proposed Companion Policy amendments, although a one-year transition period is proposed for the new benchmark and scholarship plan dealer disclosure.
The proposed Companion Policy amendments explain that the required cost and charges disclosure by a firm must include an explanation of the specified costs and fees paid by mutual funds if the client would likely be invested in mutual funds, in addition to the charges that will be levied against the account by the firm. Not only must disclosure about the charges associated with a mutual fund investment be provided, the RDI must also explain how these charges “may affect the investment”. It is clear that this disclosure may be generic investor education about investing in mutual funds and need not be tailored to a specific client.
Firms will also be required to provide their clients with 60 days written notice of any new or increased operating charge.
The new disclosure applicable to performance benchmarks must include a general description of the benchmarks, the factors relevant to their use with reference to the clients’ own investments and any options the firm may have for providing benchmark information to the client. The CSA have dropped the 2011 proposal that a firm must agree with its clients as to the use of specific benchmarks as part of the account agreement.
EXPANDED CLIENT STATEMENTS
The revised proposals expand the information required to be provided in account statements – now re-named “client” statements. Information is to be provided depending on whether the securities are held in nominee name or certificated form or held in “client name”. Client statements must include the “book cost” of each security. “Book cost” is defined as the total amount paid for a security, including any transaction charges related to its purchase, adjusted for reinvested distributions, returns of capital and corporate reorganizations. The CSA expect that this information is generally available, but where the information is unavailable, incomplete or inaccurate, registrants may use, as prescribed, market value information as at a certain point, an earlier date or at the date of implementation of the proposed amendments. Registrants will be required (as they are today) to provide monthly client statements at the request of a client or where there has been activity in the account over the past month. Otherwise quarterly statements will be required (at a minimum). The CSA clarify that registrants cannot have clients agree to receive client statements less frequently than quarterly.
PROPOSED PRE-TRADE/ RECOMMENDATION DISCLOSURE
Registered firms will be required to provide clients, other than “permitted clients” that are not individuals or clients setting up a “managed account”, with information about the “charges” in connection with each investment to be made for the account on a pre-trade/pre-recommendation basis. The firm must also inform the client
- that DSC that may be payable by the client on a future redemption of that security and provide the fee schedule that will applyw
- hether the firm will receive trailing commissions in respect of that security
The CSA explain in the Companion Policy that this disclosure is not required to be provided in writing; verbal explanations are sufficient and certain of this disclosure can be satisfied, as applicable, by directing the client to the disclosure provided for in the Fund Facts or prospectus.
PROPOSED ENHANCED DISCLOSURE ON TRADE CONFIRMATIONS
Registered dealers will be required to provide the following additional disclosure on trade confirmations.
- The annual yield of any fixed income security purchased. “Annual yield” is not defined, but the CSA provide additional guidance on what they consider would be appropriate disclosure in the Companion Policy.
- The exact amount of each “transaction” charge, deferred sales charge or other charge in connection with each transaction, as well as the total amount charged. The CSA acknowledge that DSC is charged by fund managers and taken off the redemption proceeds and propose to mandate that fund managers notify other registrants, as applicable, of the exact amounts charged. No transition period is proposed for these requirements, which we consider an important omission, given the difficulties inherent in instituting such reporting systems.I
- n respect of fixed income securities purchased or sold, specified disclosure regarding the amount of compensation paid to dealing representatives of the firm out of the price paid by the client as well as disclosure stating that dealer firm compensation may have been added to, or deducted from, the price of the securities, and that this amount is in addition to any commission shown as paid to individual dealing representatives.T
The CSA propose a one-year transition period for the requirement to disclose yield – the other proposed disclosure requirements presumably are intended to come into force on the same date the proposed amendments become effective. We question whether this is practically possible.
PROPOSED ANNUAL CHARGES AND COMPENSATION REPORT
To assist clients in understanding the costs that are associated with their account with a registered firm, as well as the compensation received by the firm, the CSA propose that firms report on certain mandated matters annually, in a written statement to each client – this written statement must be provided with or in the client statement. The CSA has included a sample form of the report as part of the Companion Policy. Registrants need not provide this information to permitted clients that are not individuals. A three-year transition period is proposed.
Investment fund managers will be required to send an annual statement to securityholders in their funds, if there is no dealer or adviser of record associated with those securityholders. The annual report on charges and compensation must include
- The firm’s current “operating charges” that may apply to the account.
- The total amount of each type of operating charge and transaction charge paid by the client during the previous 12 months, along with the total aggregate operating charges and the total aggregate transaction charges. Third-party charges, such as custodian fees that are not paid to the registered firm, are not to be included in operating charges or transaction charges.
- In respect of fixed income securities purchased or sold during the 12 month period, specified disclosure regarding compensation paid to dealing representatives of the firm as well as disclosure stating that dealer firm compensation may have been added to, or deducted from, the price of the securities and that this amount is in addition to any commission shown as paid to individual dealing representatives.
- The total amount of fees paid to the registered firm by any third party in relation to the client during the past 12 months. The CSA clarify in the Companion Policy that they intend for this provision to capture referral fees, success fees on the completion of a transaction or finder’s fees that are paid by a third party to a registered firm or any of its registered individuals in relation to a client of the firm. This disclosure must be accompanied by an explanation of each type of payment.
- Specific disclosure about the amount of trailing commissions received by the registered firm in respect of investments held in the client’s account. Investment fund managers will be mandated to provide this information to dealers and advisers, although there is no concept of being required to provide this information on request, simply a requirement to provide it, which raises many practical questions.
Firms will be permitted to consolidate the required information in one report that covers more than one account for a client if the client has consented to this (in writing) and if the consolidated report specifies which accounts it consolidates.
PROPOSED ANNUAL PERFORMANCE REPORTING
Like the 2011 proposals, the 2012 proposals require registered firms to provide clients with an annual report on performance of their accounts that would be either part of, or accompany, the annual client statement. Where more than one registered firm provides services pertaining to a client’s account, the responsibility for performance reporting rests with the firm with the client-facing relationship e.g. a portfolio manager with discretionary authority must provide the performance report and not the dealer who only executes adviser-directed trades or provides custodial services. Registrants are not required to provide this report to institutional “permitted clients”.
The CSA do not propose to prescribe the format for the annual performance report, but have included a sample form of report that they encourage firms to use as guidance.
A three-year transition period is proposed for the annual performance report, with longer transition for the requirement to disclose certain performance information The proposed required disclosure in the annual performance report includes
- The opening market value of all cash and securities in the account for the latest 12 month period
- The closing market value of all cash and securities in the account
- The market value of all deposits and transfers of cash and securities into the account and the market value of all withdrawals and transfers of cash and securities out of the account, in the preceding 12-month period
- The annual and cumulative change in value of the account, which is to be calculated according to specific formulas provided in the proposals
- Annualized total percentage returns calculated using a dollar weighted method for specified time periods – one, three, five, ten and “since inception periods” – periods of less than one year cannot be annualized
- The definition of “total percentage return” and a notification that the total percentage return in the investment performance report was calculated net of charges, using a dollar weighted methodF
- For scholarship plans (group RESPs), specific risk and cost disclosure that is unique to these investment vehicles.
The CSA propose a hierarchy of methodologies for calculating the market value of securities, reflecting available information, subject to adjustment, based on the registered firm’s exercise of professional judgment. This is intended to ensure that consistent and reliable standards will apply in client reports. The CSA also provide guidance on the disclosure of opening market value, deposits and withdrawals and provides formulas for calculating change in value.
The CSA do not propose to mandate that benchmarks be used to compare account performance. They do, however, encourage registrants to use benchmarks and have included detailed guidance about their expectations on benchmark usage in the Companion Policy.
Registrants will be permitted to consolidate performance reports for more than one account for a client if the client has consented to this in writing and if the consolidated report specifies which accounts and which securities held outside of an account it consolidates.