As part of a recent Settlement Agreement, the Ontario Securities Commission (“OSC”) has ordered 1832 Asset Management LP (“1832”), a Toronto-based investment fund manager wholly owned by The Bank of Nova Scotia, to pay an administrative penalty in the amount of $800,000 for gifts and payments impermissibly made to dealing representatives (“DRs”) between November 2012 and October 2017, and the failure to maintain adequate internal controls related to same. This is the third such OSC settlement in a year to address improper payments and gifts made by investment fund managers, as well as the inadequate internal compliance regimes which allowed these violations to occur.
As part of the Settlement Agreement, 1832 admitted that it had failed to:
- “meet the minimum standards of conduct expected of industry participants in relation to certain of its sales practices”;
- “have systems of controls and supervision over its sales practices that were sufficient to provide reasonable assurances that it was complying with its obligations under NI 81-105”; and
- “maintain adequate books, records and other documents to demonstrate 1832’s compliance with NI 81-105.”
The legislative requirements
National Instrument 81-105 (“NI 81-105”) contains a number of regulations that govern mutual fund sales practices in Canada. Among other things, it prohibits investment fund managers and their employees from making a payment of money or providing a non-monetary benefit to DRs in connection with the distribution of securities, except in limited circumstances – such as where the benefit is of a promotional nature and minimal in value. The Companion Policy to NI 81-105 sets out that NI 81-105 was adopted “in order to discourage sales practices and compensation arrangements that could be perceived as inducing dealers and their representatives to sell mutual fund securities on the basis of incentives they were receiving rather than on the basis of what was suitable for and in the best interests of their clients.”
NI 81-105 was adopted in the late 1990s, amid concerns over conflicts of interests as fund managers competed for distribution of their products. More recently, these concerns have re-emerged, with regulatory bodies considering policy action on certain mutual fund sales practices including embedded compensation structures.
1832’s prohibited conduct and compliance program issues
1832 admitted to failing to have met the minimum standards set out by NI 81-105 for a variety of reasons, primarily related to “excessive spending on promotional activities”. This included providing DRs with tickets to numerous sporting events and concerts – including NHL tickets which cost between $740 and $863 for each DR. The Settlement Agreement noted that in some cases, these events were attended alone by the DR without a representative from 1832.
Other prohibited conduct included the gifting of items which were neither promotional in nature nor of minimal value – including the gifting of Bose music systems and bottles of Dom Perignon. In addition, the OSC found that the gifting of iPads to DRs attending a conference was in violation of NI 81-105 – despite 1832’s contention that the purpose of issuing the iPads was to allow participants to access conference materials, thereby eliminating the printing and shipping costs for physical materials. In responding to this justification, the OSC stated that this goal should have been pursued in a manner that did not result in DRs receiving items that were not of minimal value.
Beyond the prohibited conduct itself, 1832’s compliance program was also found to have been inadequate. These problems were twofold – first, the compliance program guidelines were not themselves compliant with NI-81-105, as they allowed for the gifting of non-promotional items which were not minimal in value. Second, the compliance program was often not followed, with items being gifted to DRs that exceeded the value limits set out in the program’s guidelines.
In considering 1832’s conduct, the Settlement Agreement laid out a number of mitigating factors that the OSC had taken into account in reaching the settlement, including the fact that 1832 had fully cooperated with the OSC’s investigation and in 2017 had hired a third party consultant to assist in enhancing its compliance program and developing an action plan to train employees to ensure compliance with securities laws.
A pattern develops
As noted, this is the third OSC settlement within a year addressing an investment fund providing prohibited monetary and non-monetary benefits to DRs. As we previously noted, in April 2017 the OSC ordered Sentry Investments Inc. to pay $1.5 million in penalties in a settlement for misconduct similar to that of 1832 – providing high value sports and concert tickets, as well as gifts of custom made clothing and champagne, to DRs. More recently, Mackenzie Financial Corp. also settled with the OSC, agreeing to pay a $900,000 administrative penalty, again for conduct similar to that of 1832.
This pattern demonstrates a clear indication that securities regulators are intent on ensuring compliance with the Mutual Fund Sales rules set out in NI-81-105, and will pursue significant monetary penalties in the furtherance of that goal. Investment funds ought to immediately take steps to review their internal compliance measures to ensure not only that their employees are following them, but also that their compliance guidelines are themselves onside the rules set out in NI 81-105.