Firms move away from external arrangements: Includes chart

Of the almost $800 million invested in Portus’s family of alternative investment products, more than $500 million came via referrals from Manulife. Advisors at the latter firm — who racked up the lion’s share of $22 million in commissions — thought they were benefiting from their firm’s cozy relationship with the high-flying alternative investment firm that offered “absolute returns.” But it turned out to be too good to be true. And, in the end, they felt the sting from Portus more than anyone else.

“Referral” is somewhat of a catch-all term that can point to a relationship between two Investment Dealers Association of Canada firms, two Mutual Fund Dealers Association firms, or an IDA and an MFDA firm for all sorts of products. As a result, the scrutiny of the entire referral relationship is somewhat of a red herring. As one executive puts it: “You can be referring GICs that are totally guaranteed or you can be referring Arabian horses, you know? So the question about referrals, itself, needs to refer to the product continuum.”

In the case of securities, financial planning firms that have sister IDA firms or that own securities arms solve a fundamental problem because they no longer have to worry about performing due diligence on new securities-based products, such as the latest linked notes. As Robert Frances, president of Montreal-based Peak Investment Services Inc. , says, it’s one division trusting the other division, with both ultimately reporting to the parent. “That’s part of the reason we set up an IDA firm,” he says. “So it would be easier to get answers when we needed them. So we would have the authority to act.”

It’s the outside referrals that are complicated. In cases such as Portus or “convoluted insurance schemes,” these referrals don’t pass the smell test because they aren’t straightforward and can’t be easily monitored.

Frances notes that Portus wasn’t on Peak’s buy list. “As a result, we did not have to change our procedures,” he says. “We still have some outside referrals with reputable firms, including some mutual fund companies [for managed products]. But we have evidently become more cautious in our review.”

Similarly, Joe Canavan, chairman and CEO of Toronto-based Assante Corp. , praises the chartered accountants and certified financial analysts who make up Assante’s investment committee for simply doing their due diligence on all the the products the firm offers. “They have been very successful, protecting us from many of those types of scandals, including Portus,” he says.

Burlington, Ont.-based Berkshire Investment Group Inc. subscribes to the “all in the family” approach to referrals with its IDA sister firm, Berkshire Securities Inc. “We have five CFAs on staff now at Berkshire, which, compared with many firms, is pretty common,” says Craig Henshaw, vice president of operations and information technology.

Winnipeg-based financial planning firm Investors Group Inc. also sticks solely with its IDA sister firm, Investors Group Securities Inc. , for securities; as for the fund products it offers, Investors Group stays in-house or with the select fund companies it deals with. “It helps make our task simpler, in this regard,” says Kevin Regan, executive vice president of financial services.

As a result of the scandal, mutual fund dealers are questioning referrals they have with outside firms, while a joint committee consisting of the Canadian Securities Administrators, the MFDA and the IDA is attempting to come to an agreement on where the legal responsibility for these relationships lies. (The committee is still discussing some issues, but it’s at the point at which it wants to develop some guidance for the industry, with the objective of delivering a discussion paper open to public comment by September.)

The ambiguity of responsibility in other possible referral situations also illustrates the Byzantine regulatory structure in Canada. When a rep sends a client to an investment counsellor/portfolio manager, regulatory responsibility is transferred from the MFDA to the provincial regulator — which oversees the portfolio manager — and then back to the IDA, the level at which the portfolio manager ultimately completes the trade.

@page_break@Toronto-based Laurentian Financial Services, which currently has a stock-buying arrangement with MRS Securities Services Inc. , may, in the future, lean more heavily on IDA sister firm Desjardins Securities Inc. , a full-service brokerage firm in the family of Laurentian’s parent, Desjardins Sécurité Financier, says Steve Cole, Laurentian’s regional vice president of sales and recruiting: “That’s the way the industry is moving.”

In the end, all product approval decisions go back to Desjardins Sécurité Financier. “We just don’t believe we can do our due diligence in a referral arrangement. And we probably have as stringent a due diligence process for bringing on new product as anyone in Canada,” says Cole. “It has to go back to our legal department at Desjardins [the parent], and it is very stringent because it has the entire organization’s reputation to think about.”

Insurance is one way to mitigate the risk of referral arrangements for firms and their clients. Regina-based Partners in Planning Financial Services Ltd. maintains a referral relationship with firms such as National Bank Securities Inc. , but for a handful of more complex products that it sells to clients who ask for them, Partners in Planning has covered the risk with an extra rider on the firm’s errors and omissions insurance, says CEO Mike Wolfond, who is also an advisor.

“The insurance carrier still needs to know from us that we have done our due diligence,” says Wolfond. “The only referral products we approve have to be eligible to be covered under our E&O insurance rider.”

The extra insurance, he adds, has been developed over the past couple of years: “Not every carrier wants to be involved, because not enough reps are selling these products and the insurers can’t generate enough money to deal with the potential claim.”

Mississauga, Ont.-based PFSL Investments Canada Ltd. has never offered securities through referrals of any sort. But president and chief marketing officer Jeff Dumanski says that firms with outside referral arrangements are probably leaning on old relationships with firms carrying products that already meet current “know your client” requirements.

“Those that don’t have referrals are a bit gun-shy,” he says. Even with tight MFDA guidelines, “there’s a lot to read between the lines.” IE