Amendments to National Instrument 81-105 Mutual Fund Sales Practices (NI 81-105) will prohibit the payment of trailing commissions to dealers that do not have an obligation to make a suitability determination.
- Changes to NI 81-105 (the Amendments) are a result of a consultation process that sought ways to address the potential conflicts of interest arising from embedded commissions.
- The Canadian Securities Administrators (CSA) announced the adoption of the Amendments in September 2020.
- With the exception of changes to the definition of “suitability determination” and exemptions from the delivery of fund facts and ETF facts documents for no-trailing-commission switches, the Amendments will come into force on June 1, 2022.
The Amendments will prohibit fund organizations from paying trailing commissions to, and the solicitation and acceptance of trailing commission by, dealers who are not subject to a regulatory obligation to make a suitability determination. Such dealers will include order-execution only (OEO) dealers and dealers acting on behalf of a “permitted client” that has waived suitability requirements.
Consequential amendments to National Instrument 41-101 General Prospectus Requirements (NI 41-101) and National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101) (the Consequential Amendments) will provide for exemptions from the delivery requirements for fund facts documents and ETF facts documents where a client of a dealer who is not required to make a suitability determination is switching from a series or class of mutual funds that pays trailing commissions to a series or class of the same mutual fund that does not pay trailing commissions.
The CSA's concern with mutual fund fees stretches back to at least 2012. At that time, the CSA published a discussion paper on the investor protection and fairness issues resulting from the mutual fund fee structure in Canada. In 2017, the CSA released CSA Consultation Paper 81-408, which sought industry feedback on the issue of embedded commissions, including sales and trailing commissions, and whether to mandate a transition to direct pay arrangements.
In September 2018, the CSA published specific proposals on the subject with the release of proposed amendments to National instrument 81-105 Mutual Fund Sales Practices and related consequential amendments (the 2018 Amendments). The 2018 Amendments proposed:
- prohibiting fund organizations from paying upfront commissions to dealers, resulting in the discontinuation of the deferred sales charge (DSC) option, and
- prohibiting the payment of trailing commissions to dealers who are not subject to a regulatory obligation to make a suitability determination, including order-execution only (OEO) dealers and dealers acting on behalf of a “permitted client” that has waived suitability requirements.
In December 2019, the CSA announced in CSA Staff Notice 81-332 that final amendments prohibiting the DSC option would be published for adoption in early 2020, with final amendments regarding trailing commissions to be published later this year. We wrote about Ontario's decision to restrict rather than prohibit DSC options in a blog post earlier this year.
The Amendments published on September 17, 2020 and subject of this post will ultimately adopt, with minor changes, the portion of the 2018 Amendments relating to trailing commissions.
The Consequential Amendments to NI 41-101 and NI 81-101 will come into force on December 31, 2020 along with the definition of “suitability determination” which is cross-referenced in the exemptions that the Consequential Amendments provide. The amendments to NI 81-105 will later come into force on June 1, 2022 (the Effective Date).
As a result of the Amendments, mutual fund securities that are currently subject to a trailing commission will no longer be permitted in the account of a client for whom a dealer was not required to make a suitability determination. The CSA has thus outlined the following steps to be taken prior to the Effective Date to ensure compliance with the new rules:
- Mutual fund securities that are not purchased under a DSC option and that are subject to a trailing commission must be switched to a series or class of the same mutual fund with no trailing commission. Where this is not possible, other alternatives should be considered, such as transferring the mutual fund securities to a dealer who is required to make a suitability determination.
- With respect to mutual funds purchased under the DSC option, the CSA expect that fund organizations and dealers take any necessary measures to ensure investors with DSC holdings will not be required to pay redemption fees as a result of the implementation of the amendments.
- Pre-authorized purchase plans that provide for the periodic purchase of mutual fund securities that are subject to a trailing commission will either need to be switched, terminated or amended in consultation with the client.
- When investors transfer their accounts from a full-service dealer to an OEO dealer, any mutual funds that are subject to a trailing commission must be switched to a no-trailing commission series or class of the same mutual fund. To avoid triggering a redemption fee, DSC holding should not be transferred to OEO dealers after the Effective Date.
The CSA expect that the two-year transition period will provide enough time for dealers not currently required to make a suitability determination to take the necessary steps to comply with the Amendments. According to the CSA, the transition period may also provide an opportunity for dealers to reassess their compensation arrangements and consider direct-fee charging systems.
In Ontario, the Amendments received Ministerial Approval on December 1, 2020.
Originally Published by Stikeman Elliott Perspectives, January 2021
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