This Notice provides guidance to Dealer Members on best practices when entering into Portfolio Manager – Dealer Member Service Arrangements (PMDSA) with registered portfolio managers.
The Canadian Securities Administrators (CSA) Staff Notice 31-347 Guidance for Portfolio Managers for Service Arrangements with IIROC Dealer Members (dated November 17, 2016) (CSA Notice) provides additional information on acceptable practices under these arrangements primarily to help portfolio managers comply with their regulatory obligations under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103).
Structure of PMDSAs
Under a PMDSA, a Dealer Member will hold an investor’s cash and/or securities in an account over which a registered portfolio manager (PM) has discretionary trading authority. The Dealer Member (Dealer) will execute, clear, and/or settle the investor’s trades and positions in the account based on instructions it receives from the PM. The investor is considered to be a client of both the PM and the Dealer but, each has different roles and responsibilities, and different regulatory obligations, to the client.
Generally, PMDSAs operate as follows:
- An investor will enter into an investment management agreement with the PM that provides the PM with discretionary trading authority to manage its investments, and so becomes a client of the PM.
- The PM collects the know-your-client information in order to conduct a suitability assessment.
- The PM facilitates opening a trading account in the name of the client at the Dealer. The PM will provide the client with the Dealer’s account application to complete and collect all relevant client account records required by the Dealer to open an account. The PM will provide this information to the Dealer. After the Dealer’s designated Supervisor reviews and approves the new account, the PM client then also becomes the Dealer’s client.
- The Dealer will execute, clear and/or settle trades for the client based on the trading instructions it receives from the PM, and the Dealer will custody the client’s investments.
- The Dealer does not provide any trade recommendations to the client or perform any suitability assessments.
Purpose and Scope
The intent of this guidance is to help Dealers that enter into PMDSAs to understand their regulatory obligations under IIROC requirements.
This guidance covers PMDSAs where client investments are held at the Dealer on a fully disclosed basis; that is, a separate trading account for each client of the PM is opened in the client’s name at the Dealer.
This guidance does not apply where client investments are held on an undisclosed basis under an omnibus arrangement in the limited circumstances permitted under securities laws1 ; that is, investments of multiple clients of the PM are amalgamated and held in an account opened in the name of the PM only.
Also, this guidance does not cover other service arrangements between a PM and Dealer such as:
- prime-brokerage services
- sub-advisor arrangements
- referral arrangements.
Although there are no regulatory requirements specifically governing PMDSAs, there are several IIROC requirements that affect these arrangements2 . We discuss some of these below but, this guidance is not an exhaustive list of all the IIROC requirements applicable to a Dealer’s business activities.
Written agreement between the Dealer and PM
We expect Dealers to execute a written agreement with the PM that accurately explains the arrangement and clearly defines the roles and responsibilities of each party under the arrangement3 . This agreement should address4 :
- the services, responsibilities and obligations the Dealer will provide to each of the PM and the client
- the services, responsibilities and obligations the PM will provide to each of the Dealer and the client
- the fees that will be charged by the Dealer to the PM and/or the client for the arrangement
- termination provisions that address events such as PM insolvency, PM surrender of registration, and mergers.
Where a Dealer is considering executing a standard agreement provided by a PM, the Dealer should closely review the provisions of the agreement to ensure it thoroughly addresses the above key elements.
Under a PMDSA, the Dealer is responsible for opening an account in the client’s name and ensuring the PM has trading authority on the account. These client accounts must be identifiable in the Dealer’s books and records by setting up the clients either in a separate account range or with unique account identifiers.
Account opening and operation.
The Dealer is responsible for:
- reviewing the client’s identification information5 and other account opening documents received from the PM that the Dealer requires to open an account (including account agreements, client’s acknowledgement of receipt of disclosures, trading authorization).6
- maintaining accurate, complete and up-to-date client account records (including any agreements with the client, disclosures provided to the client, or any fee schedule), and revising that information where there are material changes7
- in the case of institutional clients, verifying that the client qualifies as an institutional client8
- where the client opens a margin account or uses leverage to trade, verifying that they are aware of the risk of trading on margin and providing each client with a leverage disclosure statement where applicable9
- complying with best execution obligations for all client orders10
- reporting information on any debt securities transactions directly to IIROC11
- monitoring and supervising client accounts (including daily and monthly supervision of trading activity, taking reasonable steps to identify any existing or potential material conflicts of interest between the Dealer and the client, complying with requirements under anti-money-laundering and terrorist-financing legislation and regulations)12
- maintaining records of business activities, client transactions, and communications with the PM and client in accordance with IIROC requirements (including maintaining an audit trail of instructions and orders received from the PM acting on behalf of the client and each trade transmitted or executed for a client, identification and segregation of client cash and securities, and monthly or quarterly account statements sent to the client)13
- ensuring that any assets of the client that the Dealer custodies are appropriately segregated and protected in accordance with IIROC requirements (including securities held in safekeeping)14
The Dealer is not responsible for performing a suitability assessment for the purchase, sale, hold, exchange or transfer of positions held in a client account15 .
Disclosure to clients
The Dealer must provide the client relationship disclosure information (RDI) as required under DMR 3500. As part of the Dealer’s RDI obligations, where a client has an account that is the subject of a PMDSA, the written disclosure must clearly explain:
- the purpose and material terms of the PMDSA
- the key services provided by the Dealer to the client
- the key responsibilities and obligations of the Dealer to the client
- that the PM has sole responsibility for the suitability of account holdings
- that only the PM is authorized to conduct trades in the account and perform any other actions that will alter the nature of the account holdings
- how the compensation arrangement under the PMDSA relates to the client account.
We expect the Dealer to customize the RDI to reflect the arrangement between the Dealer and the client. A Dealer may provide an RDI to the client directly or, to ensure the client receives consistent, complete and accurate information, the Dealer and PM may prepare a joint RDI that includes a discussion of the services provided by the PM and the responsibilities and obligations of the PM16 . We encourage you to discuss the use of a joint disclosure statement with us prior to proceeding in this way.
The Dealer must provide the RDI to the client at the time of account opening.17
If there are any material changes to the RDI after the account is opened, the Dealer must notify the client of the changes in a timely manner.18
Account information provided to clients
A Dealer must promptly send trade confirmations to the client for all investments purchased or sold based on the trading instructions received from the PM unless the client provides written authorization to send the trade confirmations to the PM only.19 We expect Dealers to retain an adequate record of each order and instruction received from the PM for a client account.
Since the Dealer is responsible for the custody of the client’s investments, the Dealer must send the client a monthly account statement (or quarterly, if applicable).20 A Dealer must apply to IIROC for an exemption if it wishes to deliver account statements in accordance with the frequency requirements applicable to PM’s under section 14.14.1(3) of NI 31-103.
Where the client has more than one account, the Dealer must provide a separate statement for each account. The account information for multiple accounts cannot be combined into a single summary statement as if it was one account or portfolio. For delivery of account statements to a client, each account statement may be included in one document or package. However, a Dealer may provide a consolidated account statement, in addition to the separate account statements, if the client requests this information to better understand their overall investment portfolio.
The account statements should be branded in the Dealer’s name only and include all necessary disclosures, including the Canadian Investor Protection Fund (“CIPF”) disclosure.21
Specifically for PMDSA’s, the Dealer should place the following CIPF disclosure prominently on the front page of the account statement:
This statement is being issued to you by [Dealer Member name]. [Dealer Member name] has agreed to act as the custodian for the assets disclosed on this statement. The assets that may be eligible for CIPF coverage, within specified limits, are limited to those disclosed in this account statement.
In addition, Dealers may modify the CIPF Explanatory Statement that is required to be included on all account statements as follows: “Customers’ accounts at IIROC Dealer Members are protected by the Canadian Investor Protection Fund within specified limits. A brochure describing the nature and limits of coverage is available [[upon request] or [upon request or at www.cipf.ca]]” 22
Where the Dealer plans to include the PM’s contact information as well on the client account statement, it should appear on the statement as follows:
Portfolio Manager contact information:
However, the Dealer should not place the PM’s contact information:
- near the IIROC logo or CIPF logo (i.e. directly above, below or beside it), or
- in a manner that suggests or implies that CIPF coverage applies to losses arising from the insolvency of a PM.
Performance report and fee/charge report
The Dealer is required to provide an annual performance report to the client23 . Where a Dealer enters into a PMDSA and the PM is providing the performance report in accordance with section 14.18 of NI 31-103, the Dealer may consider applying to IIROC for an exemption from this requirement.
Similarly, the Dealer must provide an annual fee/charge report to the client where it is responsible for collecting fees, charges or other payments, directly or indirectly, from the client24 , unless the arrangement meets the requirements of Notice 16-0113.25 Where the compensation arrangements associated with a PMDSA are complex, explanatory notes or reminders must be provided on the annual fee/charge report, to help clients understand how the fees associated with the PMDSA apply to their account.
Policies and procedures for PMDSAs
Dealers are required to have policies and procedures addressing their business activities and operations, including for PMDSAs, which are designed to ensure compliance with IIROC requirements and applicable laws.26
Dealers’ policies and procedures for PMDSAs should at a minimum:
- ensure the client has a clear understanding of the purpose of the PMDSA and the key services, responsibilities and obligations of the Dealer and the PM to the client
- address how proxy material, shareholder information, and corporate action notifications will be communicated to the PM, and how the PM’s or client’s instructions will be processed
- establish an efficient process for handling and resolving client complaints in relation to services provided under the PMDSA
- establish a process for expeditiously resolving any account statement discrepancies in relation to services provided under the PMDSA
- ensure the PM will provide information to and assist the Dealer in the event of an IIROC investigation or an investigation by a marketplace27 .
Termination of the relationship between the PM and the client
If the relationship between the client and the PM terminates for any reason, the Dealer must restrict the client’s accounts to paying out funds, delivering securities or transferring out positions. The Dealer will continue to custody the clients’ assets but cannot conduct any transactions for the client. If the client wishes to maintain a trading relationship with the Dealer, the Dealer must open a new account for the client and follow the new account opening process.
For more information, please contact the Financial and Operations Compliance and/or Business Conduct Compliance relationship manager assigned to your firm.
This guidance note relates to the following DMRs:
- 200.2(d), (f), (g) and (l)
- 1Please refer to section 14.5.3 of NI 31-103.
- 2To assist readers, we have included footnotes in this guidance referencing the applicable Dealer Member Rule (DMR) and Plain Language Rule (PLR) provisions. Since the PLR is not yet effective, we have included the PLR reference in square brackets. When PLR becomes effective, we will update this guidance referencing only the PLR provisions.
- 3DMR 17.2 and 200.1 [PLR subsection 3804(1)]
- 4The Investment Industry Association of Canada has developed a template agreement (“Portfolio Manager – IIROC Dealer Services Agreement”) for use by Dealers.
- 5A Dealer may appoint the PM as its agent for client identification requirements in accordance with anti-money laundering and terrorist financing legislation and regulations.
- 6DMR 1300.1(a) and 2500.II.A.1 [PLR sections 3103, 3202 and 3212]
- 7DMR 2500.II.A.4 and 2500.II.A.5 [PLR sections 3212 and 3213]
- 8DMR 1300.2 [PLR section 3212]
- 9DMR 200.2 and Guide to Interpretation (m) and DMR 29.26 [PLR sections 3217, 3246 and 3247]
- 10DMR 3300 [PLR sections 3120 and 3503]
- 11DRM 2800C [PLR section 7200]
- 12DMR 1300, 2500, and 2700 [PLR section 3900]
- 13DMR 200.2 [PLR section 3804]
- 14DMR 2000 and 2600 [PLR sections 4300 and 4400]
- 15DMR 1300.1(u) [PLR 3404(2)]
- 16The Dealer must ensure it complies with IIROC’s delivery requirements for RDI.
- 17 DMR 3500 [PLR section 3216]
- 18 DMR 3500 [PLR section 3216]
- 19DMR 200.2(l) [PLR section 3816]
- 20DMR 200.2(d) [PLR section 3808]
- 21DMR 700.1, 29.7A and 29.28 [PLR sections 2354, 2355 and 2356] and the IIROC Membership Disclosure Policy
- 22DMR 29.28 [section 2355 of the IIROC rules] and CIPF Disclosure Policy
- 23DMR 200.2(f) [PLR section 3810]
- 24DMR 200.2(g) [PLR section 3811]
- 25FAQ #27 of Notice 16-0113
- 26DMR 38.1(i) [PLR section 3904]
- 27As defined in IIROC General By-law No.1, Section 1.1.