Oversight Review Report of the Mutual Fund Dealers Association of Canada (MFDA)

T&C #3 of the RO requires that the MFDA’s Board of Directors secure a proper balance between the interests of the different members of the MFDA in order to ensure diversity of representation on the Board. In recognition that the protection of the public interest is a primary goal of the MFDA, a reasonable number and proportion of directors on the Board and on the committees of the Board shall be and remain during their term of office Public Directors as defined in the MFDA by-law.

Staff focused their review on the findings of the 2009 oversight review and the 2011 BCSC decision regarding governance and proxy solicitation at the MFDA. Staff reviewed the report of the governance task force established by the MFDA and the steps taken by the MFDA to address the issues raised in the decision. Staff also reviewed documentation relating to the:

• procedures for proxy solicitation
• procedures for selecting and nominating board members
• Annual General Meetings
• board committee work plans
• board committee Terms of Reference
• agendas and minutes of the Board of Directors and board committee meetings including those of the Governance Committee
• MFDA Directors Manual and Directors Handbook

Staff interviewed the Chair of the Board and Chair of the Governance Committee, a member of the Board of Directors and the Governance Committee, and the Corporate Secretary.

Staff found that the MFDA adopted policies and procedures that address the issues raised in the BCSC decision and otherwise complied with the terms of the RO.

T&C #7 of the RO requires the MFDA to conduct periodic examinations of its members and Approved Persons (APs) to ensure their compliance with MFDA rules.

The primary responsibility of the MFDA’s Sales Compliance department is to perform on-site sales and business conduct examination of members. In 2012, Sales Compliance adopted a new risk-based approach for selecting members to examine. Previously, Sales Compliance reviewed all members once every three years. Under the new approach, the MFDA will examine members once every two or four years depending on the risk rating of the member.

A primary objective of this part of the oversight review was to evaluate the new selection process, including whether the process appropriately identified higher risk members for more frequent reviews.

Staff also focused on:

• adequacy of the compliance examination process, including the timely completion of examinations and closing of files after report issuance
• concerns raised in the previous oversight review about the extent of branch office reviews conducted in the Maritimes region
• quality of the compliance examinations performed by MFDA staff, including whether MFDA compliance staff followed new procedures for referring files to enforcement
• concerns raised in the previous oversight review about the adequacy of follow up procedures on members’ BCP

Staff interviewed the Vice-President of Compliance and the Director of Sales Compliance in addition to individual Sales Compliance Managers and staff. Staff reviewed the policies and procedures used by Sales Compliance staff, including the Sales Compliance Risk Model, Sales Compliance Examination Program, the Compliance Officer Manual and the Sales Compliance examination schedules. To assess the quality of examinations performed, Staff reviewed a sample of 30 compliance examination files including examinations of head and branch offices.

Staff found that the MFDA’s new member selection process is adequate and considers risk factors such as sales practices that include leveraging and exempt products in addition to know your client considerations. Staff were generally satisfied with the examination process with the exception of the finding below. MFDA staff adequately followed the examination program and documented files to support the findings in reports to members. Staff were also satisfied with the procedures the MFDA put in place to address the BCP finding from the previous oversight review.

Findings

Follow-up on deficiencies with unresponsive or uncooperative members

Staff identified a few instances where members were unresponsive or uncooperative when dealing with deficiencies identified during the examination process. In cases that do not warrant enforcement action, the MFDA lacks the necessary regulatory tools to adequately deal with these members.

With respect to the few instances noted in the finding, the Members provided MFDA staff with responses to the examination findings and MFDA staff promptly followed up on the issues. In certain cases, MFDA staff also performed a subsequent targeted examination of the Member in order to test resolution.

We agree that timely resolution of examination deficiencies is important. Accordingly, we have implemented a number of initiatives in recent years that have resulted in expediting resolution of examination findings.

As a further initiative, the MFDA undertook a benchmarking analysis and reviewed the regulatory tools used by other securities regulators to promote timely resolution of examination findings. Unlike other securities regulators, the MFDA is unable to address resolution of certain deficiencies through a registration function as the MFDA was not delegated this authority under its various provincial recognition orders. However, consistent with the practice of other securities regulators, the MFDA will consider developing a process to charge fees to Members that require excessive attention to resolve examination deficiencies.

T&C #7 of the RO requires the MFDA to conduct periodic examination of its members and APs to ensure their compliance with MFDA rules.

In order to ensure member compliance with prudential requirements, the MFDA’s Financial Compliance staff:

• review member financial filings to ensure that members maintain and report adequate capital in accordance with MFDA Rules
• conduct on-site financial compliance examinations of members
• review working paper files of the members’ auditors

An important objective of this part of the oversight review was to evaluate whether the MFDA had adequate resources and qualified staff to perform financial compliance reviews, particularly for Level 2 and 3 members¹.

Staff also focused on:

• adoption of International Financial Reporting Standards in the examination program procedures and compliance with executing these procedures in the examination program
• processes for resolving financial compliance issues with the member or, where necessary, the referral of such matters to Enforcement
• concerns raised in the previous oversight review about performance benchmarks used by Financial Compliance staff, including benchmarks for reviewing audit working papers
• timeliness and quality of on-site financial compliance examinations and in office desk reviews of members’ filings
• changes to the examination program, in particular, relating to the areas of trust accounting and segregating client cash that resulted from amendments to MFDA rules on segregating client property

Staff interviewed the Vice-President of Compliance and the Director of Financial Compliance. Staff reviewed policies and procedures including the Financial Compliance Program for examinations and desk reviews, and the Compliance Officer Manual. To assess the quality of financial compliance examinations, Staff reviewed a sample of 19 Financial Compliance examination files of Level 2 and 3 members, 17 Financial Compliance examination files of Level 4 members², and 39 Financial Questionnaires and Reports.

Findings

1. Review of Level 2 and 3 Financial Compliance examination files (see below)
2. Benchmark for Auditors’ Working Papers review (see below)

There were also low-priority Financial Compliance findings (see Appendix A).

T&C #8 of the RO requires that the MFDA appropriately discipline its members and their APs who violate the rules of the MFDA and cooperate with the Recognizing Regulator(s) in the enforcement of applicable securities legislation. The MFDA Enforcement Department is responsible for enforcing compliance by its members and their APs with its rules.

The primary objective of this part of the oversight review was to evaluate whether Enforcement functions were conducted in an effective and efficient manner. Staff focused on the:

• performance benchmarks and sub-benchmarks used by Enforcement staff and assessed whether MFDA staff met them
• new procedures in Case Assessment and Investigation implemented since the last oversight review
• communication between Enforcement staff and other MFDA departments to assess referral processes
• quality and timeliness of MFDA enforcement files, including whether MFDA staff followed appropriate case screening procedures, whether MFDA staff prioritized and completed cases in a timely manner, and whether the disposition of cases was reasonable and supported by documentation in the file

Staff also followed up on a recommendation from the 2009 oversight review to determine whether the MFDA had implemented a more comprehensive procedure for file and documents management.

Staff interviewed the Vice-President of Enforcement, Enforcement managers, and other Enforcement staff. Staff reviewed the MFDA’s Enforcement policies and procedures. To assess the quality of Enforcement files, Staff reviewed a sample of 77 enforcement files, including 53 case assessment files, 17 investigation files, and 7 litigation files.

Staff found that the files were well documented and completed in a timely manner and within the benchmarks. Staff were generally satisfied with the analysis of the issues and that the evidence gathered were sufficient and appropriate to support the disposition of the case. The Enforcement Department’s internal procedures were adequate and followed by MFDA staff.

T&C #10 of the RO requires that the MFDA establish by-laws, rules, regulations, policies, forms, and other similar instruments necessary or appropriate to govern and regulate all aspects of its business and affairs. The Policy Department is responsible for:

• policy initiatives that address regulatory issues
• rule interpretation through Member Regulation Notices (Notice)

The primary objective of this part of the oversight review was to assess whether MFDA members’ right to vote on rule proposals, under MFDA By-law No. 1, had any impact on the effectiveness of the MFDA’s policymaking process.

Staff also focused on a BCSC hearing and review of a 2009 MFDA hearing panel decision. The BCSC hearing panel found that language in a Notice about churning was inconsistent with the guidance only role of Notices. Staff reviewed whether the MFDA addressed the concerns raised by the BCSC.

Staff interviewed the MFDA’s General Counsel and Vice-President of Policy, and other senior management. Staff reviewed:

• Policy Advisory Committee, Regulatory Issues Committee, and Board of Directors minutes and materials
• Member Regulation Forum materials
• Annual General Meeting materials
• sample of three policy files
• other policy-related documents

Staff found no evidence that members’ ability to vote on rule proposals compromised the effectiveness of the MFDA’s policymaking process. Staff found that the Policy Department’s policymaking process is generally adequate. Staff noted that Policy staff consulted regularly and appropriately with its policy committees and members. The Policy Advisory Committee appeared to consider adequately and objectively regulatory instruments that the MFDA presented to them. MFDA staff also appeared to take into account comments from committees and members, and revised proposals, when appropriate, based on those comments.

Findings
Clarity in the regulatory implications of Member Regulation Notices
The MFDA recognized the concern raised in the BCSC decision, and took steps to clarify the regulatory effect of Notices prior to this oversight review, including:

• enhancement of the MFDA website by adding a description of MFDA regulatory instruments and their regulatory effect
• presentation on the regulatory effect of MFDA policy instruments at the Spring 2012 Member Regulation Forum
• presentation at the 2012 Annual Staff Training
• training of Regional Council Hearing Panel

The MFDA is also undertaking a Policy Instrument Review Project that will, when completed, clarify the regulatory intent of Notices. Staff recognize that MFDA staff have taken steps to address the concerns raised and note that this project will provide a more complete solution. Staff will monitor the progress of this project.

T&C #6 of the RO requires that MFDA rules permit all properly registered mutual fund dealers who satisfy the membership criteria to become members. The criteria and processes for approving or denying membership must be fair, consistent, and reasonable. The Membership Services Department is responsible for reviewing and approving membership requests, member reorganizations, membership resignations, and membership suspensions or terminations for disciplinary reasons.

The objective of this part of the oversight review was to determine whether the MFDA has fair and consistent processes for reviewing and approving membership applications and requests for member resignations and reorganizations, and for membership suspensions and terminations.

Staff assessed whether the MFDA obtained and reviewed all the relevant facts necessary to support membership decisions and the analysis performed by the MFDA to determine whether the decisions were properly supported. Staff considered the fairness and reasonability of terms and conditions imposed on applicants. Staff also verified that MFDA staff followed adequate internal policies and procedures to ensure the protection of client assets transferred because of member resignations or reorganizations.

Staff interviewed the Vice-President of Compliance, the Director of Financial Compliance, the Director of Membership Services, and other MFDA managers and staff to assess the adequacy of MFDA Membership Services’ internal procedures. Staff also reviewed a sample of five member reorganization files and two membership suspensions and terminations.

Staff found that the MFDA’s policies and procedures for reviewing and approving requests for membership, membership resignations, and member reorganizations are adequate and were adhered to by MFDA staff during the review period. The policies and procedures for membership suspensions or terminations for disciplinary reasons were adequate.

Quality and consistency of working paper documentation
Staff noted instances where documentation could be improved:

• There were inconsistent working paper documentation in 2 of 19 Level 2 and 3 examination files reviewed. Staff noted that the adjustments in the Form 1 Financial Questionnaire and Reports Adjustment Summary and the Risk Adjusted Capital (RAC) Adjustment Summary were not consistent with the adjustments in the examination program or the deficiency forms in the file. However, all adjustments in the final report to the member were supported by the tests of details and the analytic procedures in the file.
• There was a lack of supporting documentation in 1 of 19 Level 2 and 3 examination files reviewed. In that file, a RAC adjustment, in the deficiency form and the RAC Adjustment Summary, was not supported by tests of details and analytic procedures. The adjustment in the file was accurate, but due to clerical error, an incorrect amount was recorded on the RAC Adjustment Summary and deficiency form, and subsequently cited in the report to the member.
• Not all documentation standards outlined in the MFDA Compliance Officer Reference Manual were met in 1 of 19 Level 2 and 3 Financial Compliance examination files reviewed. In that file, not all working papers contained adequate referencing and information necessary to re-perform the executed procedures.

• The MFDA should ensure the adjustments in the Adjustment Summaries are consistent with the other working papers in the file to reduce the risk of inaccurately or incompletely reporting deficiencies in the final report to the member.
• The MFDA should check the adjustments in the Adjustment Summaries and deficiency forms for accuracy as part of the manager review of each file prior to finalizing the file to ensure that the working paper file records all RAC adjustments as accurate and complete, and that the final report to the member accurately reflects the findings.
• The MFDA should ensure that their documentation standards are adhered to and consistently applied in all Level 2 and 3 Financial Compliance examination files.

With respect to the first two findings, the MFDA has the recommended procedures in place to review working papers for accuracy.

With respect to the third finding, while we believe that in the particular case noted there was sufficient information in the file to re-perform the test procedures, going forward we will ensure that the documentation standards are adhered to and consistently applied.