A significant source of in-come in the past for some professionals in private practices, including accountants and lawyers, has been referring clients to sellers of securities and other investments. Many securities dealers and salespersons have actively solicited these “centres of influence” for referrals and offer compensation for referrals that lead to sales. Many of these private professionals, in addition to making such referrals to salespersons, have taken active roles in selling securities, thus enhancing their income.

In some cases, these amounts can exceed the earnings from their primary occupation. While there seems to have been a significant reduction in these activities over the past several years, it is not clear whether this is due to a decline in the interest of potential investors, increased scrutiny by the Canada Revenue Agency and securities regulators, or increased sensitivity regarding questionable investment and tax-planning schemes.

Referral and sales activities in the context of a professional relationship, even if appropriately disclosed to clients, raises a number of legal, ethical and professional conduct issues. Many people who have augmented their income through these activities are seemingly unaware of recent changes to the law that will have a dramatic impact on their income from this source, whether their activities are limited to referrals or involve “selling.”

Outside of Ontario and Newfoundland and Labrador, persons were, until recently, entitled to rely on exemptions from being licensed (“registered,” in securities law parlance) to sell a host of securities or to sell to investors who met certain requirements — provided that such securities were not offered pursuant to a prospectus. Such securities include the ever-popular real estate limited partnerships, as well as oil and gas ventures.

In Ontario and Newfoundland and Lab-rador, these exemptions have not been available for many years to “market intermediaries” — generally, people or companies in the business of selling securities. While finding that a person is in the “business of selling securities” requires an assessment of the particular facts, receiving compensation for selling or referral activities is often seen by securities regulators as an almost conclusive indication of being in the business of selling securities. As a result, such payments are often cloaked or characterized as fees for professional or consulting services in an attempt to avoid being captured by securities laws or in order to fall within an exemption, available to certain professionals (lawyers, accountants and engineers), that deals with the provision of incidental advice.

The interpretation and application of these exemptions have often been stretched to the point of absurdity. The Nova Scotia Securities Commission took disciplinary action against an accountant several years ago: in that situation, the consulting fee charged was a constant percentage of the price of the securities sold to his clients who had received consulting services.

If it looks and smells like a commission, then the securities regulators will treat it as a commission, unless convinced otherwise.

While registration as an advisor is not required by certain specified professionals, “where the performance of the service as an advisor is solely incidental to their principal business or occupation,” this particular exemption has been both misapplied and misinterpreted. First, an “advisor” for securities law purposes is a person or company engaged in or holding out as engaged in the business of advising another as to investing in, buying or selling securities. Note: there is no mention of actually “selling” securities or receiving compensation based on the completion of a sale. The word “incidental” has been misinterpreted as taking only a portion of one’s time or attention, or resulting in only a small portion of one’s income. The actual definition of “incidental” is: to have a minor role in relation to a more important thing or event. Taking an active role in the sale of securities is not “incidental” to being an advisor or having a minor role in relation to the distribution or sale of the securities.

Changes in the law, which came into effect in September 2009, have resulted in the removal of these exemptions from registration for most prospectus-exempt securities in most provinces, and will be in full effect across Canada in the not so distant future. Professionals or others who wish to continue to receive compensation for their activities related to the actual sale of prospectus-exempt securities will, in most cases, have to either become registered as dealers (or as salespersons of a dealer) or enter into formal referral arrangements with registered dealers.

@page_break@It is unlikely that many persons and entities who have participated in the distribution of securities on an ad hoc basis, either as selling or as referring parties, will choose to become registered as dealers or as salespersons, given the initial and ongoing cost of being registered, initial proficiency requirements, potential liability and the ongoing compliance requirements.

Referral arrangements with dealers, while conceptually straightforward, need to be appropriately documented. And disclosure requirements to clients will have to be strictly complied with in order to ensure compliance with applicable legal requirements and any applicable professional conduct rules. IE

Richard E. Austin is counsel to Borden Ladner Gervais LLP.