Outside Activity

Members must comply with the requirements of both MFDA Rule 1.3 and NI 33-109 when determining what activities constitute an outside activity. In accordance with MFDA Rule 1.3.1 (Outside Activity - Definitions), “outside activity” is defined as any activity conducted by an Approved Person outside of the Member:

for which direct or indirect payment, compensation, consideration or other benefit is received or expected;
involving any officer or director position and any other equivalent positions; or
involving any position of influence.

An outside activity includes an activity for which the Approved Person does not receive, or expect to receive, payment, compensation, consideration, as set out above in clauses (b) and (c) and an activity for which the Approved Person receives, or is expecting to receive, payment, compensation, consideration, as set out above in clause (a) of Rule 1.3.1.

In addition to the activities included in Rule 1.3.1, Members are encouraged to review NI 33-109 respecting the categories of reportable outside activities, as discussed in section 2 of this Notice.

An outside activity can include a single transaction or event and does not have to occur with repetition, regularity or continuity.

In addition, the requirements relating to an outside activity cannot be avoided by structuring transactions so that the benefit does not flow directly to the Approved Person. For example, an activity carried on by an Approved Person that could or does result in a benefit to the Approved Person’s spouse, or to a corporation in which the Approved Person has an interest or exercises control, would fall within the definition of outside activity as an indirect benefit.

Positions of Influence

As noted above, pursuant to MFDA Rule 1.3, an activity that involves a position of influence is an outside activity. NI 31-103 further defines a position of influence as “a position, other than a position with a sponsoring firm, if, due to the nature of the position or the training or specialized knowledge required for the position, an individual in that position would be considered by a reasonable person to have influence over another individual.”

For greater certainty, NI 31-103 also provides that a position of influence includes, but is not limited to, the following:

a leader in a religious or similar organization
a medical doctor
a nurse
a professor, instructor or teacher at a degree or diploma granting institution
a lawyer
a notary

Despite these specifics with respect to the definition of a position of influence, in certain cases, the determination of whether a position is in fact a position of influence depends on the circumstances. Members and Approved Persons should consider the following factors when assessing whether a position is a position of influence given the specific situation:

the degree of influence that the Approved Person has through that position due to the functions of the position, the prestige or the training or specialized knowledge required for the position
the degree to which a person may be confused as to whether the Approved Person is acting in the capacity as a registrant or in another capacity, and
the degree of susceptibility that another person has to the Approved Person in that position due to the other person’s reliance on or perception of the Approved Person’s specialized expertise or trustworthiness associated with the role

2. Reporting of Outside Activities

Members and Approved Persons must comply with securities legislation, which requires full disclosure to the applicable securities regulatory authority of reportable outside activities. This disclosure is required whether or not the Approved Person receives compensation and whether or not any such position is business related.

NI 33-109 establishes a framework for the reporting of outside activities to the securities regulatory authorities. Under Form 33-109F4 Registration of Individuals and Review of Permitted Individuals, Part 10 (Reportable Activities), reporting in relation to outside activities must be provided in respect of the following categories:

Activities with another registered firm
Activities with an entity that receives compensation from a registered firm
Other securities-related activities
Provision of financial or finance-related services, and
Positions of influence

Guidance in respect of required reporting under each of these categories is set out under 33-109CP.

In addition to the reporting required under Form 33-109F4, Members and Approved Persons are reminded that they must meet reporting requirements set out under MFDA Policy No. 6 Information Reporting Requirements, which include specific requirements for the reporting of outside activities.

3. Activities of the Member

MFDA Rule 1.1.1 (Members) requires that all “securities related business” must be conducted through the Member, with exceptions for the sale of deposit instruments not on account of the Member and the activities of bank employees conducted in accordance with the Bank Act (Canada). “Securities related business” is defined in MFDA By-law No. 1 to mean any business or activity which constitutes trading or advising in securities for the purposes of applicable securities legislation in any jurisdiction in Canada. This includes securities sold pursuant to exemptions under applicable securities legislation. Apart from the specific exceptions noted in Rule 1.1.1, Approved Persons are prohibited from personally engaging in the sale of any investments that would be considered securities under applicable legislation, or selling or advising on such investments through any entity other than their MFDA Member dealer (often referred to as “selling away” or “off book trading”.)

4. Activities Permitted Outside of the Member

Pursuant to MFDA Rule 1.3.2 (Requirements for Outside Activity), an Approved Person may have, and continue in, an outside activity provided that:

The MFDA and the securities regulatory authority in the jurisdiction in which the Approved Person carries on, or proposes to carry on, the outside activity do not prohibit the Approved Person from engaging in such outside activity;
The Approved Person discloses the outside activity to the Member;
The Approved Person obtains written Member approval of the outside activity prior to engaging in such outside activity;
The outside activity of the Approved Person must not be such as to bring the MFDA, its Members or the mutual fund industry into disrepute; and
To the extent that the outside activity could be confused with Member business, clear written disclosure is provided to clients that any activities related to the outside activity are not the business of the Member and are not the responsibility of the Member.

5. Obligation to Disclose Outside Activity

(a) Disclosure to Member

Approved Persons are required to disclose all outside activities to their Member and obtain written Member approval prior to engaging in the activity

(b) Disclosure to Client

Pursuant to Rule 1.3.2(e), clear written disclosure must be provided to clients that the outside activity is not the business of the Member and not the responsibility of the Member. With respect to new clients, Approved Persons are expected to provide such disclosure at the time the client relationship is established. Where the Approved Person has an existing relationship with a client and the outside activity is a new activity or there is a change to an existing outside activity, written disclosure to the client is required at the time when the Approved Person first engages in the outside activity with the client.

Members and their Approved Persons are required to provide written disclosure to the client in respect of any outside activity where the outside activity could be confused with Member business. For example, where the outside activity deals with financial services such as financial planning, insurance, mortgages, real estate, and tax and estate planning, the outside activity must be disclosed. Where there is uncertainty as to whether an outside activity should be disclosed to a client, Members and their Approved Persons should provide the required disclosure.

In addition, the nature of the outside activity and the name of the legal entity through which the activity is conducted should be disclosed to the client.

6. Member Approval of Outside Activities

Members that allow Approved Persons to engage in outside activities should perform reasonable due diligence and have a process in place that allows for the assessment and prior approval of any such activities. This process should ensure that Approved Persons are not involved in the approval of their own outside activities. As a preliminary step in the approval process, the Member must obtain from the Approved Person basic information about the activity, including the business name, the location where the activity will take place and the nature of the activity, the title or position of the Approved Person, the number of hours to be devoted to the activity and a description of any potential for confusion or conflicts of interest. Members should assess if the activity should be considered to be an outside activity based on the specific facts of the Approved Person’s activity and circumstances.

For approval of a position of influence as an outside activity, Members should review Section 9 of this Notice which discusses the specific considerations for the approval of positions of influence.

In addition, Members must maintain records of the process under which the outside activity was approved and specific details on the nature of the outside activity approved. The approval process should require the Approved Person to notify the Member of a material change and require the Member to approve that change. A material change could include the expansion of the activity initially approved by the Member or the offer of new services or products.

The issues that Members should consider before approving outside activities include:

(c) Conflicts of Interest

Members are required to take reasonable steps to identify and address material conflicts of interest and risks arising from all outside activities in which their Approved Persons participate. This assessment should not be limited to only reportable outside activities. In particular, MFDA Members and their Approved Persons must determine whether an outside activity is a conflict of interest and determine whether the conflict of interest is material in the circumstances. . This assessment should include consideration of the compensation to be paid under the outside activity arrangement, the nature of the relationship between the Approved Person and the outside entity, and any other potential conflicts that are identified. If any such conflict cannot be addressed in the best interest of the client, the outside activity must not be permitted.

(d) Potential Client Servicing Issues

Members must ensure that the outside activity does not impair the ability of the Member or Approved Person to provide continuous service to clients. This includes the inability to place trades in a timely manner and remaining current on securities law and product knowledge.

(e) Standards of Conduct

The Member must be satisfied that the outside activity will be consistent with the general standards of conduct to deal fairly, honestly and in good faith with clients as provided in MFDA Rule 2.1.1 (Standard of Conduct) and will not bring the MFDA, its Members, or the mutual fund industry into disrepute. Accordingly, the background, history and experience of the others involved with the outside activity should be considered.

(f) Nature of the Activity and Related Proficiency

The standard of review in considering whether to approve outside activity will depend on the nature of the activity. The review process regarding the investment of client funds or financial services provided outside of the Member should be more stringent than that applied with respect to outside activities that are clearly unrelated to the Member’s business. As a best practice, such review should include consideration of educational, experience or other relevant competency thresholds that may reasonably be expected as a prerequisite to allowing certain financial service activities.

(g) Risk Management Issues

Members should determine the extent to which there is the potential for the client to be confused between Member business and the Approved Person’s outside activity. The Member should recognize the potential exposure to complaints and litigation against the Member in the event that the outside activity is permitted.

(h) Ability to Supervise

The Member should evaluate its ability to satisfy supervisory requirements regarding the outside activity and consider the effect such requirements will have on resources.

7. Ongoing Member Supervisory Obligations

While Members do not have specific obligations under the Rules to supervise the approved outside activity itself on an ongoing basis, Members must monitor the activities of their Approved Persons in relation to compliance with MFDA Rules and applicable securities legislation. Accordingly, Members should take reasonable measures to ensure that there is no change in the outside activity that was approved.

Approved Person and Member obligations also include ensuring that the distinction between Member business and outside activity is properly disclosed to clients. Such disclosure should clarify that the outside activity is not the responsibility of the Member. In addition, Members must monitor for conflicts of interest and must follow up on all client complaints that relate to the outside activity.

Members should take measures to detect and look for evidence of undisclosed outside activities of their Approved Persons. The Member should assess whether its knowledge of the Approved Person’s lifestyle is commensurate with its knowledge of the Approved Person’s activities and stay alert to other indicators of possible fraudulent activity. For example, if the Approved Person’s lifestyle is not commensurate with their compensation by the firm, the Member is expected to make further inquiries to assess the situation.

In addition, Members are expected to provide training or education on outside activities (including the need to report on changes in outside activities) and, as discussed in section 8 of this Notice, the restrictions on an Approved Person who is in a position of influence as to the clients they can deal with or advise.

Effective processes to detect undisclosed outside activity can be implemented using many of the Member’s existing review procedures including:

Advertising, website and other social media reviews - MFDA Rule 2.7.3 (Review Requirements)
Approval of trade names - MFDA Rule 1.1.7 (Business Names, Styles, Etc.)
Branch reviews - MFDA Policy No. 5 Branch Review Requirements
Trend analysis and trade reviews - MFDA Policy 2 Minimum Standards for Account Supervision
Due diligence in recruitment
Complaint handling, and
Annual Approved Person questionnaires

8. Member Response to Supervisory Issues

Where a Member becomes aware of an Approved Person’s undisclosed outside activity, it would generally be expected that the Member conduct a reasonable investigation to ensure that the issues noted above have been properly addressed.

In order to meet their supervisory obligations under MFDA Rules, Members must ensure that they have access to any files necessary to complete the investigation into the nature and extent of any undisclosed or unauthorized outside activity. Members must be aware of potential client privacy issues since information that clients disclose to the Approved Person as part of an outside activity may be deemed to be confidential. For more information on the collection, use and disclosure of personal client information, Members should review MFDA Staff Notice Joint Regulatory Notice on Federal and Provincial Privacy Legislation, issued in December 2003.

The Member must take steps appropriate for the type of activity identified, being particularly alert to potential client concerns. Members must take action to resolve any issues, such as by providing disclosure to clients, consideration of discipline, or other suitable measures.

Any information received by a Member that would suggest that the outside activities of an Approved Person may bring the Member or the mutual fund industry into disrepute must be followed up. Any client complaints received by the Member that relate to outside activities must be dealt with in accordance with the provisions of MFDA Policy No. 3 Complaint Handling, Supervisory Investigations and Internal Discipline. As required under Policy No. 3, complaints involving allegations of theft or misappropriation of funds or securities or of forgery must be promptly reported to the MFDA.

9. Positions of Influence

The processes by which positions of influence are approved and supervised as outside activities include all the requirements and best practices discussed throughout this Notice. However, as discussed below, there are several unique considerations with respect to approving and supervising positions of influence.

If both the degree of influence by the registered individual in the position of influence and the confusion or susceptibility of a person subject to that influence are considered significant, a registered firm is expected to consider the outside activity to be a position of influence.

As discussed in Section 1 of this Staff Notice, NI 31-103 defines and provides examples of positions of influence. Further guidance in respect of assessing whether a registered individual’s outside activity puts the registered individual in a position of influence is set out in the Companion Policy to NI 31-103.

Restrictions on the Client Base of an Approved Person in a Position of Influence

Members and Approved Persons must comply with the requirements respecting restrictions on the client base of an Approved Person in a position of influence. Specifically, NI 31-103 prohibits a registered individual in a position of influence from purchasing or selling securities or recommending the purchase, sale or holding of securities to:

an individual who:
1. has a relationship with the registered individual arising from the position of influence, and
2. to a reasonable person, would be considered to be susceptible to the registered individual’s influence, or
a spouse, parent, sibling, grandparent or child of the individual referred to in paragraph (a).

Members should have adequate procedures to supervise compliance with these restrictions, including, for example, obtaining acknowledgement from clients at account opening that they are not restricted clients.

10. Member Policies and Procedures

Members are required to establish, maintain and implement policies and procedures designed to approve outside activities and to ensure subsequent compliance with MFDA Rules, Policies and By-laws as these relate to the activities.

Members should ensure that they implement policies and procedures respecting outside activities that address matters that include:

identifying material conflicts of interest and addressing them in the best interest of clients
the requirement for Approved Persons to disclose to the Member all outside activities, obtain pre-approval of the outside activity and the process by which Approved Persons may seek such pre-approval
the Member’s criteria for the approval of an outside activity
having Approved Persons provide annual certifications for attesting compliance with policies relating to outside activities
using standard forms and/or questionnaires to collect and assess the outside activities of their Approved Persons
measures for detecting undisclosed outside activity, such as performing internet searches or branch reviews to identify non-disclosed outside activities
the requirement to communicate to the Branch Manager or supervisor the details of the Member’s approval of, and any refusal to approve, the Approved Person’s outside activity
the requirement for the Approved Person to notify the Member in the event of any material changes to significant aspects or termination of an outside activity
disclosing outside activities to clients using a standard form that is tailored for each outside activity
obtaining acknowledgement from clients that they do not fall within the class of individuals that a registered individual who is in a position of influence may not trade for or advise
taking action when firms identify non-compliance with policies and procedures relating to outside activities, and
the requirement for records to include complete supporting evidence regarding the Member’s handling and supervision of all outside activity approval requests, including any special conditions, policies, procedures and controls that have been imposed and how compliance will be monitored.

May 20, 2005

MSN-0040

Type:

Guidance Note

Rulebook connection

MFDA Rules

Outside Activity

Purpose

Table of Contents

1. Definition of “Outside Activity” and “Position of Influence”