The lowdown on paying for referrals

Whether a dealer or registered representative can receive or pay compensation for referrals of clients and prospective clients has, for many years, been subject to debate. Some have argued the receipt of compensation is indicative of “acting in furtherance of a trade” and registration obligations apply. Well, at long last, the debate has been settled.

While registration reform has added to registrants’ compliance burden, it has also clarified that referral arrangements (or finder’s fee arrangements) are permitted, as long as certain requirements are met. Understanding these requirements is key for those who wish to keep compliance at bay when entering into referral arrangements with centres of influence.

Applications

Referral arrangements apply to investment products, financial services or services requiring registration, but they also apply to referrals to people and businesses in any kind of service or industry, even if completely unrelated to the financial industry.

As well, referrals aren’t limited to a registrant’s personal recommendation that clients or prospective clients invest in a particular product or seek the services offered by another individual or company. Providing a client’s name and contact information to another person or firm is seen as a referral arrangement if a referral fee is paid.

Registrants also need to be aware that colleagues working at the same firm aren’t exempt from the rules on referral arrangements either. So, an advisor who, say, refers a client to an insurance broker working down the hall for a fee is caught. Even though it’s common — and in many cases expected and welcomed by the client — registrants who refer or have clients referred to them by people within the same organization for a fee are still considered to be party to referral arrangements.

This broad definition has already led some industry groups to seek clarification. For example, would a registrant need to comply with the rules when acting in a different capacity, such as an insurance broker? The answer is probably yes, where the registrant also provides a registerable service to the person being referred.

Referral fees?

Referral fees are any kind of compensation paid for the referral of a client. One of the areas where this definition could be a concern for registrants is gifts of appreciation or tokens of gratitude received or given to business contacts.

A referral fee doesn’t necessarily have to be paid in cash. It can be anything of value, including gift certificates, sports tickets or services. And there’s no lower threshold with respect to value: A bottle of wine is as much a referral fee as a flight to Europe.

It’s common practice for registrants to split or share a commission resulting from the purchase or sale of a security or other investment product. This can also be seen as a referral arrangement, so registrants must take the appropriate compliance measures.

In practice, registrants should exercise caution before giving or receiving, or agreeing to give and receive, any gifts from someone to whom they have in the past referred — or may in the future refer — clients. While the regulator may not look too closely at a box of cookies at Christmas, any fee or gift given where there’s an expectation of referrals could land an advisor in hot water.

Registrant obligations

That said, referrals can be paid for, provided a number of requirements are met.

For starters, a written disclosure regarding each referral arrangement must be provided to the client at the earlier of the opening of the client’s account or the provision of any services to him or her. Although many clients and prospects know and expect that registrants receive compensation for referrals with regard to the purchase of investment products or financial services, the law imposes specific disclosure requirements. Among other things, the written disclosure must set out the value or the method for calculating the referral fee and, if possible, the amount, disclosed in writing, of the material terms of the referral agreement and conflicts of interest arising, or that could potentially arise.

But advisors beware: Disclosure requirements don’t end after the referral. The registrant (or the person appointed in the referral agreement) has an ongoing duty to promptly inform affected clients every time there’s a change in the disclosed information.

Firms also need to be a party to any referral agreement entered into by one of their registered representatives, and they must keep the associated records.

While this requirement isn’t intended to prevent advisors from entering into agreements and receiving referral fees directly, it does ensure the firm can properly supervise its representatives and monitor compliance with the referral agreements. Of particular note is the registrant’s responsibility to ensure the person to whom their client or prospective client is being referred is appropriately qualified to provide the services.

So how does one determine this on an ongoing basis? If a lawyer claims he or she is a specialist in wills and estates, can the registrant refer clients to the lawyer for wills and receive payment? Is the lawyer actually qualified? What, if any, due diligence is required with regard to the lawyer’s claim? The answers are far from clear at this point.

Conclusion

Recent changes in the law mean registrants now have a clear set of rules for referring and receiving referrals in exchange for compensation. But these rules cover more than just conventional referral schemes, such as one-time fees for the referral of a managed account, or commissions from the sale of a security. Sending someone sports tickets after receiving the contact information of a potential client may constitute a referral arrangement, though one would hope regulators would exercise discretion where there’s no true pattern.

There are strict requirements surrounding the duty to disclose, the content of referral agreements, and a registrant’s obligations to clients and prospective clients. And a violation of these rules can result in serious penalties, including revocation of a registration.

So, before entering into any agreement to pay or receive payment for referrals, registrants should make sure they’re well advised and have appropriate documentation, policies and procedures in place.

Richard E. Austin is Toronto-based lawyer.