Rules, referrals and registration reform

(April 2008) Many financial advisors have chosen, consciously or not, to avoid or abandon sales and other activities that require them to be registered under securities laws. At the same time, though, many have not been monitoring proposed changes to securities legislation that will have a broad impact on marketing, sales activities and revenues for those who wish to participate in the sale of exempt securities in the future.

Currently, these securities — including limited partnerships, mortgage syndications, some principal-protected notes and hedge funds — can be sold by anyone in jurisdictions other than Ontario and Newfoundland and Labrador, without getting a licence. Under proposed securities laws expected to come into force in spring, 2009, however, registration will be required in almost all cases.

Advisors who have, or plan to steer clear of selling so-called exempt securities to avoid certain regulatory requirements, will need to consider the new legislative requirements, as will those who rely on referral arrangements to provide access to securities, portfolio managers or investment counsel services.

The time to consider the forthcoming changes, often referred to collectively as “Registration Reform,” and its impact on your business model, is now.

Before deciding to get registered to continue in the business of selling exempt securities, you should know, understand and accept from a business perspective what the initial and ongoing capital, reporting, audit and compliance requirements are, not to mention the power securities regulators have, and the penalties they can impose.

Even those already registered under securities laws in an existing “dealer” category will need to apply to augment their current registration to include an “Exempt Market Dealer” qualification, unless they are already a member of the Investment Dealers Association of Canada or registered as an approved person.

Other reasons to consider your business model now concern the time needed to meet application requirements. In order to file an application for registration as an Exempt Market Dealer, would-be registrants will need to file:

• A five-year business plan that includes specific information about products, services and fees;

• a copy of the dealer’s policies and procedures manual;

• proposed marketing materials;

• a standard employment or agent agreement between the registrant and registered individuals, specifically outlining compensation arrangements; and

• client-related documents, such as financial plans and investment policy statements.

If you fail to obtain registration as required under securities laws, but earn commissions or other compensation from the sale of exempt securities, the promoters and principal distributors of the securities could refuse to pay you on the basis that you are acting illegally.

Given the initial and ongoing requirements associated with becoming an Exempt Market Dealer, you may choose to limit your involvement with exempt securities to referrals to parties who are registered. Even if you only provide referrals to appropriately registered entities or persons in the business of selling securities, including prospectus-exempt securities, you’ll have disclosure and fiduciary obligations to many of your clients.

These fiduciary duties are not limited to instances where clients are referred strictly for the purchase of securities; they should also be considered for any referral for which you are compensated.

Persons registered under securities legislation who wish to enter into any referral arrangement will be required to enter into written referral agreements with parties providing the referrals, and provide written disclosure of the arrangement to clients. The agreements will need to set out the roles of both parties in some detail. Both advisors and their sponsoring companies will need to take steps to ensure the other parties in any referral arrangement have the appropriate qualifications to provide services. Everyone receiving referrals from registered advisors and dealers should expect to receive requests for documents outlining their qualifications.

You will need to establish policies and procedures to appropriately respond to these types of requests. You will also need to request this type of information and consider the responses you receive from those you refer clients to. Members of the Mutual Fund Dealers Association who choose to use a referral model will need to consider the MFDA requirements regarding outside business activities.

Many advisors will need assistance from legal counsel with experience in the securities industry and in dealing with regulators, to help assess the business impact of Registration Reform and for help drafting policies and procedures and filing the necessary documentation to get registered.

Richard E. Austin is counsel with Borden Ladner Gervais LLP in Toronto, and specializes in financial services, with a particular emphasis on registration and compliance matters. RAustin@blgcanada.com

(04/14/08)