The blowback from the collapse of Portus Alternative Asset Management Inc. has industry players and regulators puzzling over how to deal with the supervisory gaps the case reveals.

Portus accumulated about $800 million in assets over a relatively short period, and largely under the regulators’ radar. Most of that money came via referrals from mutual fund dealers and, as a result, regulators are taking a hard look at some of the issues that practice raises. Earlier this year, the Ontario Securities Commission cut a deal with the fund dealers that referred clients to Portus, which saw the firms agree to return the $22 million in commissions they earned from these referrals. But, beyond that, the case raises policy issues for regulators to consider.

One of the core issues is whether the reps who sent clients to Portus were acting in furtherance of a trade by making referrals, thereby effectively acting beyond their registration. Although reps may not have overtly given clients advice on these products, by referring them to a firm that sells only one product, it could be argued that they were effectively advising them to buy. Moreover, it is not clear who is responsible for ensuring suitability — the fund dealer rep who is managing the rest of a client’s portfolio or the product manufacturer that sells the client a single component of that portfolio.

Clarifying the distinction between a pure referral and pure advice is one of the subjects being tackled by a working group made up of representatives from Canadian Securities Administrators, the Mutual Fund Dealers Association and the Investment Dealers Association of Canada.

“The CSA is examining the practice of paying referral fees and the accountability to clients of those dealers or advisors who pay or receive these fees,” says Langley Evans, director of capital markets regulation at the B.C. Securities Commission.

Wendy Dey, the OSC’s director of communications, says that the OSC is considering issues beyond referral compensation, such as disclosure to clients of referral arrangements and compensation, and distinguishing between making referrals and giving advice. “After considering these issues, the working group will determine the appropriate form of guidance,” she says.

Evans notes that any recommendations will be published for public comment, but cannot say when that might be or what recommendations the group may make.

As much as the industry might complain about the volume of rules with which it must comply, this is one area in which guidance can’t come soon enough. Apart from the referral/advice question, there is also confusion about the separate self-regulatory regimes for fund dealers and investment dealers.

For example, the question of responsibility gets complicated when a fund-dealer rep refers a client to an investment counsellor/portfolio manager who, in turn, clears trades through an IDA member. The rep is under MFDA oversight, the ICPM answers directly to the securities commission and the trading firm is accountable to the IDA. All the regulators are administering the same system, but the number of organizations creates confusion.

An institutional brokerage firm sent out a letter in early February outlining some of its concerns and asking its ICPM clients to notify it about any referral arrangements they might have with fund dealers.

One ICPM suggests the lack of regulatory guidance may be pushing such firms to adopt defensive approaches to any arrangement that involves referrals. These defensive positions and the persistent ambiguity in this area, notes the ICPM, “coincidently happen to put up significant barriers to entry, particularly for any innovative new wealth-management platforms that are able to reduce costs and fees to clients.”

Some investment dealers are also troubled by the fact that their transactions are highly regulated, yet fund dealers can refer clients to a firm selling a complex product such as a principal-protected note — which, because of the exemption for banking products, is subject to none of the requirements that mainstream securities trades attract. As a result, there may be little disclosure about these often complicated products.

Although upstart firms that rely on referrals may detect a wilful obscurity and dealers may marvel at the heavily tilted playing field that different types of products face, the regulators insist they are keen to bring clarity to it.

“The goal of the project is a harmonized approach to referral arrangements,” says Larry Boyce, the IDA’s vice president of sales compliance and registration.

@page_break@This is not the first time referral arrangements have posed a concern for regulators. The IDA last attempted to pass a bylaw on the issue in 2002, but the CSA rejected it. And the CSA’s distribution structures committee looked at the issue well before that, in 1999. IE