A careful reading of the pronouncements of the Canadian Securities Administrators (“CSA”) discloses that in all likelihood, Stage 2 of the point of sale (“POS”) initiative will become reality during 2013. POS is, broadly speaking, an investor-focused project intended to “provide investors with the opportunity to make more informed investment decisions by giving them access to key information about a mutual fund, in language they can easily understand, and at a time that is relevant to their investment decision.” Substituting a shorter, more investor-friendly Fund Facts document (“FF”) for the prospectus is central to achieving this objective.
Stage 1 of POS (completed January 1, 2011) required mutual funds subject to National Instrument 81-101 Mutual Fund Prospectus Disclosure (“NI 81-101”) to file the FF with regulators, and post it on the mutual fund’s or the mutual fund manager’s website.
The implementation of POS Stage 2 will be an important turning point for all dealers who distribute mutual funds in Canada. Once Stage 2 of POS is in effect, dealers will be required to deliver the FF to purchasers of mutual funds within two days of purchase. Failure to comply may expose dealers to regulatory sanction and civil liability.
Dealers Delivery Obligation
Currently, subsection 71(1) of the Securities Act (Ontario) requires a dealer to send a purchaser of securities the latest prospectus and any amendments within two days of the trade date. When POS Stage 2 takes effect, the dealer will be required to send a FF to meet the prospectus delivery requirement.
While delivery of the simplified prospectus will no longer be required, the simplified prospectus will continue to be available at the request of investors. As such, a dealer may send a simplified prospectus at the same time as a FF. The dealer, however, does not have the option of not delivering the FF.
Failure by market participants to comply with securities legislation may result in any of a reprimand, fines, penalties or loss of registration.
Section 11.1 of National Instrument 31-103, Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”) provides that a dealer must establish a compliance system of internal controls and monitoring systems to identify non-compliance with securities legislation, as well as supervisory systems to correct non-compliance.
Few things are more fundamental to our securities regulatory regime than the principle that a purchaser of securities is entitled to a prospectus providing “full true and plain” disclosure about securities to be purchased. It follows then, that dealers have an obligation to establish compliance systems capable of ensuring prospectus delivery is carried out consistently and that omissions are identified and rectified.
This obligation will carry over to the FF delivery once dealers are required to send the FF in lieu of the prospectus. Dealers will be required to demonstrate that the correct, most up-to-date FF was sent to the purchaser within the allowable time period. Dealers will thus require systems for FF delivery that are consistent, controlled and auditable.
Dealers may also face civil liability for non-delivery of the FF.
For purposes of securities laws, there is only “good delivery” and “non-delivery”. It is one or the other: there are not points for trying hard. Good delivery will require delivery of the most recent version of the FF for the particular class or series purchased by the investor (in general, each class or series of the fund has its own FF). The regulations permit the dealer to send only the FF for the class or series of the fund purchased. If the dealer sends FFs for securities of the mutual funds that the investor is not purchasing, (i.e. as marketing material), in a way that is “attached to or bound with” the FF for the fund purchased, it will not constitute compliant delivery.
Civil liability for non-delivery of the FF will be the same as for non-delivery of a prospectus. Upon implementation of POS Stage 2, the new section 133 of the Ontario Securities Act will provide purchasers of mutual funds with a right of action for rescission or damages against dealers who fail to deliver the correct FF.
Outsourcing the Delivery
Outsourcing FF delivery to a third party will not relieve dealers of their obligations and legal liability.
Dealers and advisors doing “client name” business may have an expectation that fund companies will send out the FF along with the trade confirmation. There is no specific regulatory framework under which this is contemplated.
However, should a fund manager agree to deliver the FF for dealers doing client name business, this would likely constitute an “outsourcing” arrangement under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”). The dealer would be required to have a separate outsourcing agreement with every fund company with whom it is doing business. The dealer would also be responsible for monitoring the fund company to ensure it had the necessary internal controls and ability to deliver the FF.
The implementation of POS Stage 2 is fast approaching, bringing with it new obligations and potential liability for dealers.
The good news is that POS Stage 2 provides dealers with an opportunity to re-imagine how documents are delivered. It is the perfect time for dealers to consider moving to electronic delivery of documents (see National Instrument 11-201 Electronic Delivery of Documents).
A longer and more detailed version of this article is available by contacting firstname.lastname@example.org.