Rep incorporation proposals prove to be sticky wicket

With the investment industry divided on the best approach to enabling advisors to use corporate structures that allow them to curb their tax bills, investor advocates have a proposed solution for regulators: Don’t allow these structures at all.

In late January, the Canadian Investment Regulatory Organization (CIRO) launched a consultation on possible options for resolving a long-standing disparity between the fund dealer industry and the investment dealer industry — the ability for reps to direct revenues through corporations that face lower tax rates.

Historically, fund dealers had been able to use corporate structures, which were generally outlawed on the investment dealer side. Now that self-regulation has been consolidated and the new combined self-regulatory organization (SRO) is working to harmonize the rules for fund dealers and investment dealers, it began tackling this thorny issue.

In its consultation, CIRO proposed three basic policy options; yet, the consultation revealed a lack of industry agreement on the approach regulators should pursue.

While there’s generally support for giving reps the ability to adopt corporate structures that allow them to benefit from preferential tax rates, along with other potential advantages in areas such as succession planning and approaches to employee compensation, there’s less consensus on the best way to get there.

Some of the feedback to CIRO’s consultation calls for regulators to adopt the approach that can be implemented most quickly and easily. Others favour one of the comprehensive solutions proposed by the SRO, despite the likely complications.

Given the lack of consensus, the Investment Industry Association of Canada suggested that regulators look at allowing more than one type of rep incorporation.

“We ask CIRO to consider whether only one incorporation model is necessary and encourage availability of incorporation options so that dealers and advisors may better adjust to their operational, business and client concerns,” it said in its submission.

Industry voices raised a variety of concerns with the proposed reforms.

Among other things, they cited the need for comprehensive provincial government buy in for certain solutions, which is difficult to achieve, particularly given long-standing concerns with rep incorporation in provinces such as Alberta.

There’s also the risk that the solutions allow certain inconsistencies to persist, such as a disparity between dealers’ employees and independent contractors, and the fact that SRO reps and non-SRO reps (such as reps at exempt market dealers and portfolio managers) would continue to face an unlevel playing field.

Commenters also pointed to the difficulty of requiring reps to distinguish between activities that require registration and those that don’t (under a model that would require that determination).

There’s also concern over the uncertainty with which the Canada Revenue Agency (CRA) would view these different models; if the CRA doesn’t like the type of structure that securities regulators decide to allow, then there’s little point in pursuing it, some commenters suggested.

To all of these concerns, investor advocates have a clear retort: Maybe don’t allow them at all.

“CIRO could achieve regulatory consistency by prohibiting [directed commission] arrangements for all [dealers],” said FAIR Canada in its submission to the SRO.

“We are concerned that the position paper did not present this as a possible option,” it said.

FAIR noted that, while it supports the SRO harmonizing the rules for fund dealers and investment dealers, “CIRO has not demonstrated why harmonizing compensation vehicles for [reps] should be among its top priorities.”

Instead, CIRO should be focusing on harmonizing areas such as proficiency requirements, FAIR suggested.

“Addressing these types of inconsistencies would have a more significant impact on investors, particularly retail investors,” it said, and it urged CIRO to “reconsider the prioritization of this policy issue and focus instead on closing regulatory gaps that raise investor risks.”

The Canadian Advocacy Council of CFA Societies had similar concerns in its submission to the consultation, which warned that the proposed reforms “have the potential to generate unfair outcomes for investors seeking redress, with the prevalence of such outcomes increasing over time.”

It also questioned the wisdom of pursuing regulatory reforms that are driven primarily by reps’ finances.

“We are concerned that tax benefits to [reps] are being placed paramount to investor protection as an impetus for regulatory change, and that any perceived benefits may not outweigh the cost to industry in compliance measures,” it said in its submission.