Mutual fund reps have at least two more years to continue funnelling commissions through their personal corporations. The question is why brokers don’t enjoy the same freedom.
In mid-November, the Ontario Securities Commission issued an order that essentially gives fund dealer reps another two years to use their personal corporations. Such freedom was slated to expire at the end of the year, but it has been extended to the end of 2008.
When the Mutual Fund Dealers Association of Canada was founded, it adopted a rule outlawing use of personal corporations, which was in line with the practices of the Investment Dealers Association of Canada. The structures, however, were already widely used in the fund dealer world.
Before the MFDA, these dealers were under direct supervision of the securities commissions, which allowed the structures to develop on their watch, but the IDA did not. That means the brokerage industry and the fund dealer industry have not been allowed to use the same structures, and the fund industry’s treatment has not been uniform across Canada.
As the MFDA was being pressed into service, the personal incorporation issue was one of the biggest irritants for reps who already faced a slew of dramatic changes to their business. To help ease its implementation, the rule was temporarily suspended in a number of jurisdictions.
For fund dealers, the rule was suspended in 2001 in British Columbia, Saskatchewan, Ontario and Nova Scotia as part of the terms of its recognition as a self-regulatory organization, says Mark Stechishin, MFDA senior legal and policy counsel. Alberta did not suspend the rule as a term of recognition, Stechishin notes, and has not changed its position to this day.
Elsewhere in Canada, the MFDA is still seeking SRO recognition. The New Brunswick Securities Commission recently published for comment a draft recognition order, and it is specifically seeking comments on the incorporation issue, Stechishin notes.
It also has applications for recognition pending in Manitoba and Newfoundland. “As far as treatment of payments to corporations in each of these jurisdictions, it is essentially status quo,” he adds.
Although regional differences beleaguer the fund dealer industry, the brokerage business has had to make do without the structures. The IDA prohibited them in the belief that they aren’t permitted under securities law.
In the past few years, however, the IDA has began moving toward allowing its members some of the flexibility that fund dealers already enjoy. It used to require that brokers be considered employees of their firm, but in 2003 it introduced the principal-agent model, and it’s now proposing to allow the use of personal corporations. It developed a bylaw that would introduce an incorporated agent structure late last year, and its board passed the bylaw last January. It is currently awaiting approval from the securities commissions.
In the meantime, allowing MFDA reps to use personal corporations, but not IDA reps, is problematic for various reasons. For one, it’s unfair, as it creates an unlevel playing field between the two parts of the business. It’s difficult to see why fund dealer reps should treated one way and brokerage reps another.
There are a number of advantages to being incorporated: reps enjoy some tax benefits (having income assessed at the lower corporate rate rather than the personal rate); they can avail themselves of other perks governments offer to encourage small businesses; and it makes it easier to transition out of the business when it’s time to retire. So, it’s difficult to see why the benefits should be based solely on registration category. Fund dealers aren’t the only ones using the structures. Other professionals such as accountants, lawyers and insurance agents are allowed to incorporate.
Moreover, different treatments may be distorting the evolution of the financial services business. In a presentation to a conference hosted by the Investment Industry Association of Canada in early November, Daniella Dimitrov, of Raymond James Ltd. in Toronto, pointed out the inability of brokers to incorporate discourages top producing fund dealer reps from migrating to the IDA platform. Reps who have built large books in the fund business are understandably reluctant to upgrade their licences and proficiency if it means dismantling a corporation and moving to a less efficient structure, she said.
The ability to use more flexible business models is particularly important to the independent side of the brokerage industry, which faces powerful competition from the bank-owned dealers. The incorporated agent model would give them one more arrow in their quiver against the big dealers, although Dimitrov noted there’s no reason why the bank-owned dealers couldn’t offer the option, too.
@page_break@Regulators’ reluctance to permit the incorporated rep structure in the IDA world appears to be based on liability concerns. They want to ensure that the firms aren’t insulated from liability to the client, and that reps aren’t shielded from their responsibilities to their firm, and regulators, if a corporate structure is allowed to stand between the firm and the rep. There are also other issues, such as the potential for confusion among clients about whom they are dealing with if another corporation is added between the firm and the rep, and whether the corporation is acting in a way that requires registration. Currently, only individuals can be registered.
Paul Bourque, IDA senior vice president, member regulation, says although the issues are complex, the primary concern when introducing an incorporated rep structure is ensuring that clients still have recourse to hold the firm responsible if the rep does something offside. At the same time, it ensured that reps can’t hide behind a corporate veil preventing the firm from properly supervising them.
Bourque says the IDA’s board approved its bylaw allowing the introduction of incorporated reps because it believes the structure properly preserves the flow of liability in both directions.
“We are comfortable that [the proposed bylaw] does that, and we are still discussing the merits of our approach, and we are still trying to convince the [Canadian Securities Administrators] to approve the amendments we put forward.”
He maintains the amendments to allow reps to incorporate essentially mirror the principal-agent structure, which the CSA eventually approved after a great deal of deliberation. The principal-agent model preserves liability in the IDA world, so he believes adding the incorporated agent model shouldn’t be a big leap.
Nevertheless, allowing brokers to adopt an incorporated agent structure would require changes to Canadian securities laws, which doesn’t happen easily.
The issue is also being considered as part of the CSA’s Registration Reform Project, which provides some hope that a nationally consistent solution can be achieved, although complexities abound.
Regulators are caught in a dilemma. They are reluctant to tinker with currently allowable business structures in the IDA world for fear of unintended consequences, yet they probably won’t be able to outlaw incorporated reps in the MFDA world without a huge outcry.
Regulators probably wish they’d paid more attention when they were supervising fund dealers directly. It’s too bad they weren’t, but they need to put that mistake behind them and begin treating all reps equally. IE
Fund reps get two more years to use personal corporations
These structures, which were scheduled to end this month, will remain until the end of 2008, but brokers still can’t use them
- By: James Langton
- December 5, 2006 December 5, 2006
- 11:04