The Mutual Fund Dealers Association has issued a notice to members that aims to clarify the responsibilities of dealer firms to manage conflicts and make disclosure to clients when entering referral arrangements.
The notice says that only firms can enter referral arrangements for securities business, whereas individual reps can make referral deals for others sorts of business.
The MFDA notes that there is a potential conflict of interest in all paid referral arrangements, because the individual that makes the referral has a financial interest in introducing the client to the other service provider.
The notice states that firms must ensure that this potential conflict is addressed through the “exercise of responsible business judgment influenced only by the best interests of the client. Clients must be given sufficient information to appreciate the extent of the conflict before the referral takes place. In addition, controls must be put in place to ensure that clients are not mislead as to the nature of the relationship between the referring parties, or as to any licensing limitations of the parties to the arrangements.”
To address these concerns, MFDA rules require that referral arrangements may only be entered into on the following basis:
- the referral arrangement is only between MFDA member firms, or between an MFDA member and licensed investment dealers, Canadian financial institutions, insurance agents or brokers;
- there is a written agreement governing the referral arrangement prior to implementation;
- all fees or other forms of compensation paid as part of the referral arrangement must be recorded on the books and records of the firm; and
- written disclosure of referral arrangements must be made to clients prior to any transactions taking place. The disclosure document must include an explanation or an example of how the referral fee is calculated, the name of the parties receiving and paying the fee, and a statement that it is illegal for the party receiving the fee to trade or advise in securities if it is not licensed or registered to do so.
For securities-related business, the MFDA says referral arrangements involving other securities registrants, or that are otherwise connected to securities related business, will only be permitted where a written agreement has been made between them.
For example, a referral arrangement may be established with an Investment Counsel/ Portfolio Manager (“IC/PM”), but only if an agreement is in place between the IC/PM and the firm. The agreement cannot be entered into directly between the IC/PM and a rep, or between the IC/PM and another entity, such as an insurance agency or a personal service corporation.
The MFDA firm is required to monitor and account for referral payments and ensure that clients are given sufficient information regarding potential conflicts of interest and the fees that will be paid under the arrangements. The firm must also satisfy itself that the recommendations that have been made are in the best interests of the client and are not inappropriate in the circumstances; and to put in place controls to prevent situations where unlicensed individuals may be acting in furtherance of trades, or individuals may be providing advice beyond the limits of their registration contrary to securities legislation.
Referral arrangements that do not involve securities related business may be entered into directly between reps and other entities, assuming that conflicts are managed and disclosure is made.