The Canadian Securities Administrators (“CSA”) have published for comment amendments and changes to the principal distributor model in the distribution of mutual fund securities (collectively, the “Proposed Amendments”). The Proposed Amendments would: (i) clarify that a principal distributor cannot act as a principal distributor for multiple mutual funds unless they are mutual funds in the same mutual fund family;[1] (ii) require disclosure of principal distributor arrangements and compensation; and (iii) ensure that the DSC option (as defined below) is not available to investors purchasing mutual fund securities distributed by principal distributors. While comments were initially due by February 27, 2025, the submission deadline has been extended to April 28, 2025.
Background
Mutual fund securities are distributed by participating dealers and principal distributors. Principal distributors have an exclusive right to distribute, or benefit from a feature that provides a material competitive advantage over others in the distribution of, mutual fund securities of an investment fund manager (“IFM”) with which the principal distributor is typically affiliated.
Principal distributor model
National Instrument 81-105 Mutual Fund Sales Practices (“NI 81-105”) established minimum standards of conduct in the distribution of mutual fund securities to minimize conflicts of interest between investors and industry participants. Principal distributors are carved out of the provisions of NI 81-105 that are applicable to participating dealers, based on the premise that principal distributors only distribute mutual fund securities of the same mutual fund family, and the conflicts of interest raised by such arrangements are less acute than those raised by participating dealers that distribute mutual fund securities of multiple IFMs. This premise is not, however, reflected under NI 81-105, which does not restrict principal distributors to distributing only mutual fund securities of a single mutual fund family.
Disclosure of principal distributor compensation
A fundamental obligation of industry participants is to provide their investor clients with full, true and plain disclosure of all material facts concerning a mutual fund, including the compensation paid and other sales practices followed in connection with the distribution of mutual fund securities, to ensure that investors understand the nature of their investments and the impact of fees and charges. This obligation extends to the disclosure of the compensation paid to principal distributors and their representatives.
DSC option
Previously, under the deferred sales charge option (“DSC option”), an investor did not pay a sales charge for mutual fund securities upon purchase but paid a redemption fee to the IFM if the securities were redeemed before a predetermined time, according to a redemption fee schedule (i.e., a deferred sales charge). While the investor did not pay a sales charge to the participating dealer, the IFM paid the participating dealer a commission upfront. This created a conflict of interest, as the commission could incentivize participating dealers and their representatives to make self-interested investment recommendations adverse to investor interests.
In June 2022, the CSA adopted amendments (the “DSC Ban Amendments”) that were intended to result in the discontinuation of all forms of the DSC option, as we had discussed in a previous post. As principal distributors are, however, carved out of the provisions of NI 81-105 that are applicable to participating dealers, the DSC Ban Amendments do not technically apply to principal distributors.
Proposed Amendments
The modernization of mutual fund sales practices was contemplated when the CSA proposed the DSC Ban Amendments in September 2018. This initiative has since been reflected in the 2022-2025 CSA Business Plan, to further the CSA’s strategic goal of improving investor protection by enhancing investors’ ability to obtain redress and strengthen the advisor-client relationship. To this end, the Proposed Amendments include:
- Principal distributor model: The CSA would clarify that a dealer cannot have multiple principal distributor relationships except where it acts as a principal distributor for mutual funds in the same mutual fund family. The Proposed Amendments would not, however, affect a principal distributor’s ability to also distribute mutual fund securities as a participating dealer to multiple IFMs. In addition, affiliated IFMs would not be required to have the same principal distributor, and an IFM may have more than one principal distributor for the distribution of its mutual fund securities;
- Principal distributor practices: The Proposed Amendments would prohibit a principal distributor from providing incentives to representatives to recommend one mutual fund over another, effectively extending a similar prohibition that is currently applicable to participating dealers in respect of mutual fund families;
- Disclosure of principal distributor compensation: The Proposed Amendments would require that the Simplified Prospectus, Fund Facts document and Annual Report on Charges and Other Compensation disclose: (i) that the principal distributor has the exclusive right to distribute funds; and (ii) if the principal distributor receives a payment, other than trailing commissions, in connection with services provided to the IFM and the funds as a principal distributor, the maximum percentage of the management fee paid by the IFM to the principal distributor for its services; and
- Prohibition on fees for redemptions (i.e., deferred sales charges): While the CSA do not observe the DSC option being made available by principal distributors, the Proposed Amendments would prohibit IFMs from charging a fee to investors upon the redemption of mutual fund securities to ensure that the DSC option is not available to investors purchasing mutual fund securities from participating dealers or principal distributors. An exception would be included for mutual fund securities purchased prior to June 1, 2022, for so long as such securities remain subject to a redemption fee schedule. The Proposed Amendments would not impact fees charged by a mutual fund (as opposed to an IFM) in connection with the redemption of mutual fund securities that are not based on the DSC option (e.g., fees for short-term trading and large redemption orders), provided that such fees are retained by the mutual fund for the benefit of remaining securityholders. A housekeeping amendment would also repeal a provision relating to commission rebates, as this provision is no longer required.
What’s Next?
The Proposed Amendments would impact National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”), National Instrument 81-101 Mutual Fund Prospectus Disclosure, National Instrument 81-102 Investment Funds, NI 81-105 and certain corresponding companion policies. The Proposed Amendments are expected to come into force three months after their final publication date, with the exception of those in:
- NI 31-103 and its companion policy: These amendments would come into force on January 1, 2026, and coincide with the coming into force of final amendments and changes relating to total cost reporting for investment funds and segregated funds, which we also discussed in a previous post; and
- NI 81-105: These amendments would come into force 18 months after the final publication date of the Proposed Amendments, to provide time for principal distributors that act as a principal distributor for more than one unaffiliated IFM to transition their practice, operational model and compensation arrangements. Any impacted IFMs would also need to make alternate distribution arrangements for their mutual fund securities prior to the effective date.
The CSA recognize that some existing or new business models might not fit within the parameters of the Proposed Amendments. They encourage commenters whose existing business model might be uniquely impacted to provide feedback regarding alternative transition measures that might ease any burden for that particular business model as it aligns with the Proposed Amendments.
[1] As noted below, a principal distributor may continue to also act as a participating dealer to multiple IFMs (as defined below).
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