Are outside business activities worth the risk?

Outside business activites are regulated to protect consumers.

But the MFDA is also concerned with the reputation of advisors and their dealers, said Shaun Devlin, vice president of enforcement of the MFDA, at the IFB Toronto Fall Summit yesterday in Toronto.

He concedes heavy regulation can interrupt the flow of business, but also warns advisors to “avoid becoming the next statistic” by refusing to cut corners.

Read: IIROC eyes outside business activity

And in a session on how to make errors and omissions claims, George Georgiadis and Warren P. Cooney of AXIS Reinsurance echoed his advice:

“Your clients will appreciate your attention to detail, and will see you as a reliable source of advice and information if you ensure they’re always informed and protected. It may take extra time to follow rules by the book,” they say, but it’s better than getting fined.

Read: Limit liability with detailed processes

Definition of outside activities

In general, the MFDA says all outside activities advisors get paid for—whether they involve investing and financial advice or not—must satisfy these basic principles:

• They can’t create conflicts of interest. If you receive high commission and earn more than your clients, that’s a red flag.
• They can’t cause servicing issues, such as limiting the time and resources you spend on your job.
• They can’t give you more influence over your clients. Devlin says if you’re a minister on the side, this might give you a unfair advantage since you’ll develop a deeper personal relationship with clients.

You also have to ensure customers are clear on any agreements and sales, and if someone complains, you must report that to the MFDA.

The MFDA performs audits every three years to confirm you’re working within these guidelines.

During an audit, they’ll review your branch and practice, your outside activities and profits, and your online advertising and websites for hints of rogue behaviour. They’ll also look at your dealer’s recruitment and training standards, as well as all commission reports for any discrepancies or fluctuations.

Client complaints can also trigger reviews. They’ll track your activities and expect complete cooperation, with fines for withholding information running as high as $50,000.

To find out what not to do, click through below.

What not to do

So, what outside activities should you get approved to avoid an audit?

Common risky outside business activities include:

• selling and renting real estate
• offering small business financing
• referrals to products you aren’t licensed to sell like exempt issuers and charitable programs

Common forbidden outside business activities include:

• acting as a trustee for a client
• cooperating in stealth advising—where one unregistered or differently registered (e.g., IIROC) rep offers services through you

Devlin says purely personal activities like acting as a trustee for a parent, being on a charitable board, or renting out your basement are exempt, but advisors have to be aware of where to draw the line. He says one man was fined $15,000 for acting as officer of three companies against his dealer’s wishes. Though the fine is minimal, he also faces a ban — more damaging to his reputation.

Read: Reputation at risk

Another offered advice and charged an extra fee for it, on top of his normal commission. He was permanently banned for acting in his own interests rather than his clients’.

While these were obvious breaches, making the distinction can be difficult. One audience member sells insurance and said her contract allows her to collect commission on a specific non-insurance product, for instance. While the insurer agreed to this, Devlin says she should still run it by her dealer to avoid possible legal tangles.

Beware provincial regulators

Specifically, advisors face tough guidelines regarding referral programs and leveraging stratgies. And while the MFDA does govern these areas, Devlin says provincial regulators have strict rules.

For instance, many provincial regulators say when an advisor refers a client to a product specialist, the most she should do is hand over a name and contact. If she spices up the referral with “recommendations or product reviews to ensure sure the referral goes through,” Devlin says, she runs the risk of offering advice she’s not authorized to give.

Those who borrow from clients, allow clients to borrow from them, or who get involved in investment schemes with customers have created a major conflict of interest, which will likely trigger an audit.

More E&O claims emerging

Georgiadis and Cooney revealed the number of leveraging claims has risen dramatically, accounting for a quarter of their firm’s claims in the past year despite only accounting for 3% of business activity overall.

They say a mutual fund dealer and two of its reps are now facing a class-action lawsuit worth tens of millions due to their use of leveraging strategies. Clients who engage in this activity are usually older people with high debt levels, they say, and entering into leveraging deals leaves you exposed as suitability and fiduciary standards are becoming issues of hot debate.

Additionally, more advisors are being targeted for making administrative and filing errors when dealing with suitability forms and blank-signed documents. In some cases, advisors have pre-filled forms ahead of meetings and then miss the chance to get the form signed when a meeting is cancelled. When something goes awry with the client’s investment, this means you won’t have the paperwork to back up your actions if get sidetracked and forget about the unsigned agreement.

Read: CSA paper examines fiduciary duty

In general, Devlin says to avoid customer complaints, keep all forms updated—KYC forms only need to be updated every three-to-four years, but you have the option of doing so each year—bring up any concerns with your dealer, and don’t skip any training. You should also keep documentation (digital or hard copies) for as long as possible since claims can include data from several years back, especially if someone has invested for decades.

And remember: While documentation is a good defence, the best form is setting realistic expectations, says Cooney. Returns are generally 2.5%-to-5% in today’s market, so don’t promise more. And, if you have clients for whom you did risk tolerance profiles 15 years ago, make sure they’re aware of today’s rates.

Read: Buffer your business with sound insurance

Georgiadis also reminds advisors that asking for quotes on E&O insurance in advance of possible claims won’t negatively impact your premiums. If you’re constantly asking for coverage due to suitability claims, that’s when there’ll be an issue.