On July 19, 2019, the Ontario Securities Commission (OSC) approved a settlement with Caldwell Investment Management Ltd. (CIM) over failures to comply with the best execution obligation applicable to investment advisers. The best execution obligation requires advisers to ensure that they execute trades for their clients on terms that are as advantageous to the client as reasonably available. The OSC’s settlement with CIM marks the first ever enforcement proceeding brought before the OSC based on the best execution obligation and so provides insight into the standard that the OSC staff will apply to advisers going forward.
CIM is a registered adviser in Ontario that serves as a portfolio manager and investment fund manager. Between January 2013 and November 2016, CIM directed most of its clients' equity and bond trades to a related investment dealer named Caldwell Securities Ltd. ("CSL"). The client trades that CIM directed to CSL often resulted in equity commission rates and bond spreads that were less favourable than CIM could have obtained at an unaffiliated dealer. In some instances, CIM directed client trades to CSL at commission rates that were over ten times higher than the rates that were available at unaffiliated dealers.
During this time period, CIM had an independent review committee (IRC) that was responsible for reviewing potential conflicts of interest, including the conflict associated with CIM's direction of mutual fund trades to CSL. The IRC had issued a standing instruction requiring that trades directed to CSL be executed on terms at least as favourable as those offered by unaffiliated dealers. CIM certified to the IRC semi-annually that it had complied with the instruction. CIM also represented to its mutual fund investors that it would direct trades to CSL only "on terms as favourable or more favourable" than offered by other dealers. However, CIM had never "systematically" compared the rates offered by CSL to rates offered by unaffiliated dealers.
OSC Compliance staff first noticed CIM's best execution issues during a compliance review conducted between July and December 2015. The OSC Enforcement staff later opened an investigation into the matter that culminated in the settlement approved by the OSC last week.
In the settlement agreement, the OSC staff concluded that CIM had failed to comply with the best execution obligation under section 4.2 of National Instrument 23-101. As part of CIM's failure to comply with the obligation, the staff found that CIM had not maintained written policies and procedures regarding best execution and had provided inaccurate information about its compliance to the IRC. The staff also found that CIM had made misleading representations to its mutual fund investors about its compliance.
To resolve the allegations, CIM agreed to pay an administrative penalty of $1.8 million and the cost of the Enforcement staff's investigation. CIM also agreed to the imposition of an independent monitor that is charged with supervising CIM's implementation of, and compliance with, new best execution policies and procedures. The OSC staff noted as mitigating factors CIM's cooperation with Enforcement staff during their investigation and previous hire of an independent consultant to assist with remediation.
As the first OSC case on best execution, the CIM settlement provides important guidance for advisers on how the OSC staff will assess an adviser's compliance with the obligation going forward. In light of the settlement, advisers should:
- Ensure that they have written policies and procedures in place that explain their process for obtaining best execution, including how they undertake selection of dealers and analyze trade terms for competitiveness and favourability;
- Direct trades to an affiliated dealer only after conducting a systematic comparison of terms offered by the affiliated dealer to terms offered by other dealers; and
- Document efforts to comply with best execution in the normal course of business so that contemporaneous records are available to OSC Compliance staff in the event of a compliance review.