Compliance Memo

Compliance Memorandum 2010-03; Rationale for Certain Trade Recommendations

For more information, contact:

Compliance Team

Date Issued:

November 29, 2010

In a number of MFDA notices (Member Regulation Notices), the MFDA advised mutual fund dealers of their expectations regarding certain types of trade activity and the recording of evidence to demonstrate the proper authorization has been obtained from, and that the proper disclosure has been provide to, clients.

In this memo we would like to draw attention to the types of trades that draw increased scrutiny from the regulator because of the guidance they have provided and remind each of you as to the proper way to document such types of trades.

Trades to which the MFDA refers as “questionable” or “indicate a pattern of concern”

There are a number of different types of trades listed in MR-0065; Churning and MR-0069; Suitability Guidelines

. They are generally referred to by MFDA staff as “re-commissioning”.

Irrespective of the type of commission that may have been applicable initially, (DSC, LL, FE>0), the financial advisor has already received a commission when the account first came to the financial advisor. This could be from a transfer in, PAC or Initial Purchase. Regardless, this first commission is the only commission, other than trailer/service fees, that the MFDA would not consider “questionable”.

Any trades that result in commission after this trade would be “re-commissioning” and must have a documented rationale for the generation of addition commissions.

In MR-0065; Churning, dated October 4, 2007, the MFDA guidance regarding this type of transaction is:

“.....In the limited circumstances where such activity may be justifiable because it is in the best interests of clients, Approved Persons (financial advisor) must provide clients with appropriate disclosure in order to comply with the conflict of interest disclosure requirements under rule 2.1.4. In staff’s view, this disclosure would include, among other things:

  • A statement that the client’s DSC schedule will be reset, where applicable;
  • Specific detail of the amount of commissions the Approved Person will earn on the trade(s); and
  • Specific details of any direct costs to the client on the transaction(s).”

In light of this guidance we have developed the “Trade Rationale Form” with a view that when such transactions are justifiable we must properly record the rationale.

With every transaction, we would generally expect all financial advisors to be able to justify each and every recommendation in every client plan. However, for all transactions where a commission is generated after the initial purchase we will require that a “Trade Rationale Form” be completed.

In the space provided for the trade rationale, you must document the reason you have recommended this transaction or set of transactions.

Rationales that are not acceptable include those that are transaction based:

I believe the client will benefit from the value style of the manager at the new fund company.

(This would be a rationale for the fund selection, but not the fund load)

Potentially justifiable rationales include those that are based on fees for services provided:

After discussing my fees for providing (financial planning advice, investment planning services, preparation services, estate planning, etc.) with the client we agreed to purchase funds on a deferred sales charge basis. With this option, particularly given the client’s time horizon, my services will be compensated accordingly. Should the client require funds earlier than anticipated, we agree that, at a minimum, those fees have been deferred but may be reduced or eliminated depending on the amounts required and the timing of those requirements.

While this may seem a bit extensive, it is much less invasive than an MFDA exam.

In addition to the rationale, you must include the amount of the commission that will be generated by the transactions involved. Where you must approximate the total amount of commission generated due to market value fluctuations, mark the amount as approximate and it would be more appropriate to over-estimate rather than under-estimate.

The conversion of DSC mature or 10% free units to the front end version of the same fund

The MFDA has provided guidance in MR-0041; Automatic Conversion of Deferred Sales Charge to 0% Front End Load Units without Client Knowledge or Consent, that such transactions when not initiated by the fund company as disclosed in the fund prospectus, must be assessed as any other transaction.

With respect to suitability (in relation to Client Plan KYC), if the portfolio has drifted due to market fluctuations, a rebalancing transaction or Plan KYC update would be required for a branch manager, compliance officer or supervisory staff to approve the transactions.

As with all Plan KYC updates, it is important that we never make a Client Plan KYC match transaction recommendations but that we assess the Client Plan KYC properly and then make recommendations based on those facts.

Disclosure must be provided to the client that:

  • Remuneration is increasing as a result of the transaction;
  • There may be tax implications resulting from the disposition of securities

For all transactions of this type, the client must sign the “GPWM Free/Matured Unit Consent and Disclosure Form” in addition to a “Financial Account Changes Form”.

Transactions Made Without Written Client Authorization

The MFDA has provided guidance in MR-0035; Recording and Maintaining Evidence of Client Trade Instructions that when transactions are made pursuant to a Limited Trading Authorization (LTA) evidence of the client’s instructions must still be maintained.

For every transaction made pursuant to an LTA, a completed “Client Contact Record Form” must accompany the Financial Account Changes Form completed by the financial advisor. Both forms should be submitted to head office for our records in addition to being maintained in the branch or sub-branch files.

As always, if you have any questions or comments, contact the Compliance Department by email at