To incorporate or not?

(February 2008) The long-standing debate on whether registered salespersons should be permitted to incorporate has been recently recharged.

In October 2007, the Manitoba Securities Commission exempted Canadian corporations from the dealer registration requirement under the Manitoba Securities Act solely to allow them to receive commissions and fees from dealers, provided certain conditions are met. To take advantage of the exemption, all of the directors, officers and shareholders of the corporation must be registered salespersons of the same dealer and the corporation and the dealer must have a written contract under which the dealer will be liable for the acts or omissions of the corporation that relate to the securities business. The corporation also must make its books and records available for inspection by the Manitoba Securities Commission.

The issue of “incorporated” salespersons in the investment industry has been under review for well over 10 years. The then newly established Mutual Fund Dealers Association of Canada (MFDA) initially passed a rule in 1999 that would have, in effect, prohibited the incorporated salesperson structure, since dealers were not to pay commissions to anyone other than a registered salesperson (an individual) who earned that commission. Once the MFDA became operational in 2001, this rule was suspended, largely in recognition that corporate business structures had been customary for mutual fund salespersons for some time. Notwithstanding this suspension (which continues today), several provincial securities commissions indicated that they did not permit commissions to be paid by dealers to anyone other than a registered salesperson, although the regulators in British Columbia, and now Manitoba, later crafted exemptions to permit these payments.

Many believe that an incorporated business structure provides flexibility for the Canadian investment industry and recognizes the evolving organizational structures in the provision of financial services in Canada. In recent years, the relationship between a dealer firm and an individual advisor has been changing into a relationship that is entered into between the dealer firm and groups of independent advisors. These groups function within existing firms with operations that are increasingly independent — independent in terms of controls over operating expenses and revenues, product lines and branding — while still under the umbrella of the dealer’s regulatory compliance and investor protection systems. Proponents of the incorporated salesperson model believe that a corporate structure will offer advisor groups the most tax-efficient structure to manage expenses and cash flow.

Related articles:

Advisor Inc.(Advisor’s Edge, August 2006) Follow this step-by-step process to incorporate your business.

Advisor incorporation rule delayed… again (Advisor.ca, December 7, 2006)

IDA moves on advisor incorporation (Advisor’s Edge Report, March 2006)

Incorporation toolkit: Advice for your professional clients

The pros and cons of Client Inc.

The Canadian Securities Administrators (CSA) has reiterated its concerns with incorporated salespersons, which centre on a perceived lack of a public interest policy for the model and concerns over maintaining an adequate level of investor protection. The CSA believe that in the absence of a requirement for the salesperson’s corporation to be registered, investor protection could be compromised as the salesperson’s corporation would not have the statutory obligations that a registrant has under Canadian securities legislation. Moreover, the CSA have stated that regulators would be more limited in their ability to deal with issues related to improper trading, among other things, since one link in the chain — the salesperson’s corporation — would, in the view of some CSA members, be outside the regulatory regime.

The industry, however, has voiced many arguments in favour of allowing incorporated salespersons. This business structure would level the playing field among investment professionals and other professionals who are allowed to incorporate, including insurance agents, lawyers, doctors, accountants, architects, engineers, etc. It would also support current investment industry harmonization and uniformity initiatives.

The Investment Industry Association of Canada (IIAC) has indicated that allowing advisors to incorporate would remove an obstacle to advisor migration from the MFDA to an Investment Dealers Association of Canada (IDA) platform, which would result in the IDA-regulated advisor being subject to increased proficiency and continuing education standards and having the ability to offer a greater selection of products to clients.

One has to wonder whether the level of legal and regulatory risk that would exist if incorporated salespersons were permitted would be materially greater than the risks that arise from the current permitted model used by dealer firms of engaging individuals either as employees or agents (independent contractors). An adequate legal and regulatory framework could be constructed for a corporate model, which would include contractual liability of the dealer firm and a salesperson’s corporation to customers, protection of customer assets, confidentiality, insolvency protection, supervision and preservation of regulatory oversight through books and records access. The investment industry recognizes that in order to allow this business structure to be implemented, the integrity of investor protection must be preserved.

The solid business case in favour of incorporated salespersons has been acknowledged, in part, by the CSA. In releasing the draft registration reform rule — National Instrument 31-103 — in February 2007, the CSA conceded that the incorporated salesperson issue was not dealt with by the proposals, but indicated that they intend to address this issue. Let’s hope that the second draft of National Instrument 31-103, which is to be issued in the coming weeks, provides a framework for this business structure, which can then be made effective on a parallel time-frame to the implementation of the registration reform proposals.

This article first appeared in the January 2008 issue of Advisor’s Edge Report.

Rebecca Cowdery and Prema Thiele are securities lawyers focusing on legal matters associated with the securities, investment management and insurance industries. They are partners in the Toronto office of Borden Ladner Gervais LLP. Their column appears regularly and deals with compliance and regulatory issues. The views expressed in their columns are their own and are not necessarily the views of other lawyers at BLG, the firm or its clients. No person should act or refrain from acting in reliance on any information found in these columns without first obtaining appropriate professional advice.

What do you think? Let us know by sending your letters to feedback@advisor.ca.

(02/22/08)