Financial advisors hoping for a solution to the long-standing regulatory dilemma over the use of personal corporations may be disappointed yet again if investor advocates have anything to say about it.

Late last year, Alberta’s Ministry of Finance and Enterprise published a consultation paper proposing several ways in which regulators could allow advisors to adopt business structures that utilize personal corporations. Doing so would allow advi-sors to structure their businesses to reduce taxes, along with providing other advantages, especially in terms of administrative efficiency and succession planning.

Yet the idea is receiving some scathing reviews from those who worry that such a step could hinder investor protection if unaccountable corporations are allowed to stand between dealers and their advisors. (This concern has kept regulators from embracing the idea as well.)

Says the Markham, Ont.-based Small Investor Protection Association’s comment on the proposal: “To accept representatives incorporating is tantamount to throwing inves-tors to the wolves if this in fact limits advisors’ exposure to accountability.”

Indeed, several of the comments that aim to deliver the retail investors’ perspective suggest that policy-makers are moving in precisely the wrong direction by trying to accommodate advisor incorporation. These comments argue that regulators should be focusing on reforms to improve retail investor protection before expending any energy changing rules on business structures.

Notes Toronto-based Weigh House Investors Services Inc. ’s comment: “We feel the focus should be on removing the inequities between the public and their advisors before worrying about inequities between different groups of salespeople.”

The lack of a level playing field among different types of advi-sors is one of the issues policy-makers aim to correct by addressing the personal incorporation issue. The question of whether advisors should be allowed to incorporate stretches back at least to 1998, when the securities regulators decided to herd mutual fund dealers into a self-regulatory organization, the Toronto-based Mutual Fund Dealers Association of Canada.

ISSUE DEFERRED

At that time, it became evident that mutual fund dealer reps were using personal corporations, something that investment dealer reps had not been able to do under their SRO, the Investment Dealers Association of Canada, now known as the Investment Industry Regulatory Organization of Canada. The MFDA initially proposed to do away with personal incorporation by mutual fund dealer reps, but as it became evident such a move would require many advisors to restructure their businesses for no urgent regulatory reason, the issue has been deferred repeatedly.

In the meantime, the MFDA has tried to come up with a way to satisfy regulatory concerns with personal incorporation — chiefly, that the presence of a corporation between advisors and their dealers could interfere with the flow of liability from advisors to dealers or disrupt a dealer’s ability to oversee an advisor — without causing major upheaval of existing business structures. Finally, last year, the MFDA managed to come up with a model that has been accepted by several provincial securities commissions — but not Alberta’s.

At the same time, IIROC has been loosening the constraints on business structures that reps can use — first by allowing them to move from strict employer/employee relationships into principal/agent structures; then, by proposing its own rules to allow individual reps to use personal corporations, a move that the provincial securities commissions declined to approve.

The result is that many, but not all, mutual fund reps can incorporate, but no investment dealer reps can. This wonky situation was allowed to persist until Alberta’s Ministry of Finance and Enterprise tried to tackle it once again last year in its consultation paper. That paper notes that governments and regulators haven’t necessarily signed on to the idea of allowing reps to incorporate, but that it was looking to stimulate discussion on the subject.






@page_break@On that count, the paper has certainly succeeded — at least, among those aiming to defend the interests of retail investors. One longtime investor advocate, Ken Kivenko, raises a number of concerns with the proposal regarding investor protection: he worries that courts may not uphold the expected chain of liability from advisors to dealers and that it could become tougher to recover assets or collect fines as a result of an enforcement decision.

“Left unchecked,” says Kivenko’s comment, “we believe we are seeing the wedge that will eventually allow total shielding of sales reps from personal liability for inves-tor fraud or misrepresentation.”

Moreover, Kivenko suggests, allowing incorporation will further entrench commissions-based compensation, which some industry-watchers see as a significant source of problems between clients and advisors.

Indeed, sales commissions are under siege in several countries, including Britain, Australia and, to a lesser extent, the U.S. Regulators in these jurisdictions have decided that certain forms of commissions-based compensation carry unacceptable conflicts of interest.

“Rather than enhancing a demonstrably flawed compensation system (from a retail inves-tor perspective),” Kivenko’s comment says, “we recommend a move toward a fiduciary model.”

He argues that securities regulators should be looking to impose fiduciary duties on advisors and raising their proficiency requirements instead of introducing the incorporation option, which, he adds, will only make the shift to fiduciary client/advisor relationships more difficult.

ENSURING ACCOUNTABILITY

SIPA’s comment also indicates that the idea of allowing all reps to incorporate raises investor protection concerns: “Incorporation normally reduces personal liability, which is not what is needed. What is needed are measures to ensure accountability.”

Although investor advocates are unanimous in their disdain for Alberta’s proposal, the financial services industry is united in its support for the idea. However, the industry is less unified in its opinion on which of the three models proposed in the paper should be adopted.

There’s relatively little support for the idea of having IIROC follow the same approach as the MFDA and allow reps to have their commissions paid to an unregistered corporation. As Alberta’s paper notes, this model preserves the flow of liability between reps and their dealers, but isn’t as definitive from a tax perspective as the other two alternatives.

In general, reps appear to prefer the other two proposals, which would require legislative changes be enacted. However, their support is somewhat divided between the two alternatives.

The proposal developed by the Alberta Securities Commission involves setting up a permit system and requiring a rep’s corporation to secure a permit authorizing it to provide trading or advisory services — although the corporation would not have to register.

The third proposal, developed by Advocis, would set out the requirements for incorporation largely based on the ones that already exist in the life insurance sector.

Of the responses submitted on Alberta’s paper, there appears to be somewhat greater support for the ASC proposal. Although some of the comments favour the Advocis proposal, saying that it would be more flexible, others prefer the certainty that the ASC model might offer.

One comment says the ASC proposal is preferable because it would give advisors’ corporations the same status as other kinds of professional corporations — such as those used in the legal, medical and accounting professions — and “is much less likely to be challenged by [the Canada Revenue Agency] than either of the other two options.”

Another comment suggests the ASC model would be the least disruptive to existing business models, as it would represent a natural extension of the principal/agent structure that’s already in use and is similar to the regime IIROC had proposed several years ago. IE