Conflicts of Interest Remain a Regulatory Focus

Regulators continue to focus on real and perceived conflicts of interest, whether as between individual advisers and their clients, or as between registered portfolio managers and affiliates.

Key Facts

Questrade Wealth Management Inc. is a registered investment fund manager, exempt market dealer and portfolio manager. It had discretionary authority over $60 million in client accounts. These accounts were sub-advised by a U.S.-based registered sub-advisor. Questrade also acted as the trustee, manager and portfolio manager of eight exchange-traded funds (ETFs).

In July 2017, Questrade entered into a variety of strategic agreements with WisdomTree, a registered investment fund manager and exempt market dealer. As part of the series of agreements, WisdomTree became the IFM and manager of Questrade’s eight ETFs. Prior to the execution of the agreements, both parties agreed WisdomTree would discuss with the sub-advisor the potential purchase of the new WisdomTree ETFs in Questrade’s managed accounts. WisdomTree insisted the sub-advisor confirm that its ETFs would be purchased in the managed accounts prior to the agreements being signed.

Shortly before agreements were executed, the sub-advisor confirmed it would invest 94% of the managed accounts’ fixed income assets and 70–75% of the managed accounts’ equity assets in WisdomTree ETFs. An order was placed for the fixed income ETFs, but Questrade’s regular compliance process was not followed in processing these trades, as no diligence documents or documented rationale for the trade were received in advance of orders being placed.

The Questrade portfolio manager had telephone calls with the sub-advisor regarding the suitability and rationale for the trade and the sub-advisor confirmed a research note was prepared in respect of the trade but was not provided to Questrade after the trade was placed. Senior management also had discussions with the sub-advisor in which it confirmed that the decision to purchase the WisdomTree ETFs was independent of the agreements being executed with WisdomTree, and that the trade was in the best interests of the managed account clients. The trade was approved, but a subsequent trade to invest the managed accounts’ equity assets in WisdomTree ETFs was withdrawn.

Settlement Agreement

Staff and Questrade agreed that Questrade’s review of the purchase of the WisdomTree ETFs failed to meet the high standard of conduct expected of a registrant in taking appropriate steps to ensure it did not create a conflict of interest (as required by s. 13.4 of National Instrument 31-103) and that its conduct was contrary to the public interest.

However, the parties agreed there was no dishonest or wilful misconduct by Questrade or its senior management, and the trading prices for the WisdomTree ETFs and those they had replaced were very similar. Questrade agreed to retain an independent consultant to review the suitability of model portfolios containing the WisdomTree ETFs, and to review and update its compliance systems. Questrade also agreed to a voluntary payment of $2.9 million, that it be reprimanded under the OSC’s public interest jurisdiction, and that it pay costs of $100,000.

What You Need to Know

Conflicts of interest—whether real or perceived—remain a hot topic for regulators. In this case, Questrade and the sub-advisor both concluded the trade in fixed income WisdomTree ETFs was in the best interests of Questrade’s managed account clients, and was not recommended as a result of the WisdomTree agreements. However, these conclusions were formally documented after the trade was placed. The significant size of the voluntary payment may reflect Staff’s concern that conflicts of interest be clearly addressed and documented before client funds are invested.

We expect regulators will continue to focus on conflicts of interest in the coming year, especially given the prominence of the issue in the CSA’s proposed client focused reforms. Market participants should ensure that standard conflict of interest procedures are sufficient to contemplate special circumstances, such as unique strategic transactions.

To discuss these issues, please contact the author(s).

This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

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