A recent review of mutual fund dealers by the Mutual Fund Dealers Association of Canada (MFDA) reaffirms a truism about regulatory reform: hammering out the details of a new rule is only half the battle; getting firms to adopt and follow those new requirements is equally critical.
In early February, the MFDA, a self-regulatory organization (SRO), published a report setting out the results of a recent round of compliance reviews that examined the policies and procedures that fund dealers have in place to implement recent regulatory reforms. These reforms include new pre-trade disclosure requirements of the second phase of the client relationship model (CRM2), and the forthcoming requirement that clients receive new mutual fund disclosure documents (Fund Facts) up front.
The review found incidents of both outright non-compliance and examples of half-hearted compliance, such as firms simply cutting and pasting the new MFDA rules into their policies without providing any genuine insight or assistance in applying those new requirements in the real world.
For example, the MFDA report states that MFDA examiners found firms whose policies and procedures “have not been updated to reflect the [new CRM2 pre-trade disclosure] requirements … We also noted instances where there is minimal guidance for [reps] on what types of fees and charges to disclose, how fees and charges should be disclosed, or how evidence of disclosure is to be maintained.”
Best practices
None of what the MFDA discovered calls for enforcement action, says Karen McGuinness, senior vice president, member regulation, compliance, with the MFDA. Instead, the SRO’s followup on its findings will focus on getting firms into compliance with the requirements. Beyond that, the MFDA is trying to educate firms on best practices in compliance, so that firms embrace the spirit of the reforms rather than simply doing the absolute minimum to meet regulatory obligations.
“The purpose of the report,” McGuinness says, “was not simply to test compliance with minimum requirements, but to give guidance to [dealers] on what an effective policy should look like.”
This means going beyond simply copying the SRO’s rules into a dealer’s own policies without any further insight or guidance for reps. “The better policies provided detailed explanations and examples of how to comply,” McGuinness says.
In addition, some firms go well beyond the bare minimum of what is required in the rules. Regarding pre-trade disclosure, for example, the MFDA report notes that some dealers require reps to bring the same level of fee disclosure to other products, such as guaranteed investment certificates and segregated funds, as they do when dealing in securities. Further, these firms require their reps to discuss other relevant factors with clients, such as the possible tax implications of a particular trade, as part of pre-trade disclosure.
The MFDA report sets out best practices and recommendations for crafting effective policies in several areas that the SRO reviewed. In addition to pre-trade disclosure, MFDA examiners also looked at firms’ policies for keeping “know your client” (KYC) information up to date, assessing concentration risk in clients’ portfolios and the use of professional titles that target seniors. In each of these areas, the MFDA found a range of practices among firms.
Regarding KYC practices, the report states that at one end of the spectrum, some firms don’t provide adequate guidance to reps on updating KYC information. Yet, other firms have policies to ensure regular updates, to flag accounts with outdated information, to restrict activity in those accounts and to alert reps to these issues.
Concentration limits
On the question of concentration risk, the MFDA report notes that while most firms have policies to monitor for excessive portfolio concentration in high-risk exempt securities, many firms don’t do the same with riskier mutual funds – or give guidance on how the concentration limits should be calculated and applied by reps.
The general lesson from this report for firms, McGuinness says, is: “Whenever there is a new regulatory requirement, prepare for it.”
In the next few months, a couple of major new requirements will take effect. The new mutual fund point-of-sale disclosure requirements come into force on May 30 (requiring reps to provide Fund Facts before a trade takes place). And the remaining CRM2 requirements (introducing new annual cost and performance reporting standards) will be in place on July 15. At that point, firms and regulators will face these sorts of implementation challenges once again.
“Training is key – not just for CRM2, but also [point of sale],” says McGuinness. “Those two regulatory initiatives will affect the advisory process significantly. So, it is important that [dealers] and advisors are prepared for the big changes that are coming.”
The MFDA’s report indicates that the SRO is preparing for those changes, too, and looking for ways to help improve compliance, whether through additional guidance statements or compliance tools. McGuinness says the MFDA is considering developing templates for pre-trade disclosure to help dealers and reps.
Further down the road, the MFDA may develop additional guidance for the pre-sale delivery of Fund Facts disclosure. This guidance probably won’t be developed until the requirements have been in effect for some time, McGuinness says, and the MFDA has an idea of the mistakes that some firms are making and the good practices that others have developed.
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