Proprietary mutual fund distributor, Quadrus Investment Services Ltd., has accepted a settlement agreement with the Mutual Fund Dealers Association of Canada (MFDA), admitting that its internal dealer incentive and sales practices excluding the sale of third-party mutual funds from bonus structures did not comply with securities legislation.
A mutual fund dealer in all provinces and territories in Canada and a member of the MFDA since 2002, the firm was reviewed by the MFDA as part of a project known as the Targeted Review of Member Compensation and Incentive Programs, orchestrated in conjunction with the Ontario Securities Commission (OSC), other provincial regulators and the Investment Industry Regulatory Organization of Canada (IIROC). “The review was part of a larger initiative to coordinate compliance efforts on common issues such as sales incentives and related conflicts of interest,” the settlement agreement states.
A second issue – the MFDA identified that some aspects of Quadrus’ operations were not in compliance with an exemption order granted to the dealer – was also discussed in the settlement agreement. This conduct was identified after an investigation was made in response to a client complaint.
At the material time, Quadrus had two general classes of approved persons, those who were authorized to sell only proprietary funds and those who could also sell third party mutual funds.
Three incentive programs
From 2002 until December 2016 the firm’s approved persons participated in three incentive programs, including the Gold Key Recognition Credits, the LL (London Life Insurance Company) Recognition Program and the LL Sales Commission Bonus. In the settlement agreement, the MFDA says each of the programs created incentives that may have encouraged approved persons to recommend proprietary mutual funds over mutual funds offered by a third party: Program credits were calculated only on the net sales and assets under administration of proprietary mutual and segregated funds, creating an incentive for those sales representatives to favour the recommendation and sale of proprietary mutual funds over third-party mutual funds. Third party fund commissions were also excluded when calculating the bonus.
The MFDA says between 2008 and 2017 the approved persons in question sold substantially more third-party mutual funds than proprietary mutual funds. “The availability of the programs described had no bearing on the fees charged to clients for any of the funds. As such, no evidence of direct financial harm to clients from any specific trades was identified,” they write.
As for the operational issues, in 2009 the OSC granted Quadrus an exemption which allowed third party funds to be held in accounts serviced by the approved persons who were typically only allowed to sell proprietary products on an accommodation basis where no sales commissions would be paid. The adjustment process put in place to comply and prevent sales commission from being paid to these advisors for the purchase of a third-party fund failed, resulting in trades affecting 1,700 clients not being adjusted.
“The respondent received approximately $219,000 in DSC (deferred sales charge) or low load sales commissions in respect of third-party mutual fund trades in accounts serviced by category 1 advisors that could not be reversed and rebooked in accordance with the respondent’s process and as a result was not remitted to the mutual fund companies,” they write. “In approximately 525 instances a client incurred a DSC or low load charge.”
Engaged in remediation measures
The MFDA notes that Quadrus engaged in remediation measures and has fully cooperated with its review.
“The respondent admits that from 2002 to 2018 it failed to establish, implement and maintain adequate policies and procedures and an adequate system of controls and supervision to ensure that it complied with securities legislation including requirements relating to internal dealer incentives and sales practices,” they conclude before fining Quadrus $600,000 plus costs in the amount of $25,000.
