Referral Arrangement Rules (Part 1): What You Need to Know
Earlier this year, when the Canadian Securities Administrators (CSA) delivered their long-awaited proposals regarding embedded commissions, they also published a proposed set of rule changes aimed at enhancing advisor and dealer obligations toward their clients (Client Focused Reforms). These Client Focused Reforms will no doubt significantly impact the economics of advisors’ business models and how they address key issues such as KYC, KYP, suitability and conflicts of interest, all of which we discussed in a previous article.
An area of particular interest and concern to many of our clients, however, were the proposed rule changes dealing with referral arrangements. Many advisors have arrangements with third parties either as a means of client acquisition or to provide their clients with services that they are not authorized to perform. For example, it’s very common for an MFDA advisor to have an arrangement with another professional services firm (i.e. an accounting firm) for purposes of client acquisition. They may also have arrangements with either an investment counsel or brokerage firm for certain high net worth clients who want either products or services that the MFDA advisor is not licensed to provide. The Client Focused Reforms will impact each of these relationships.
The Big Picture: Regulators are proposing major changes to rules governing how financial advisors and dealers deal with referral arrangements. Referral arrangements will be permitted but only if advisors comply with specific requirements.
Here are five key takeaways from the CSA’s proposals:
1. A Referral Fee must not:
- Continue for longer than 36 months;
- Constitute a series of payments that together exceed 25% of the fees or commissions collected from the client;
- Increase the amount of fees or commissions that a client would otherwise pay for the same product or service.
2. Advisors cannot pay a Referral Fee unless:
- The recipient of the fee is a registered individual or firm;
- The terms of the referral arrangement have been set out in writing between the registered firm (i.e. dealer) and the other party. The advisor may (but need not) be a party to the agreement.
- The dealer keeps a record of all referral fees; and
- The client receives in writing and understands the terms of the referral agreement.
3. The definition of what constitutes a referral arrangement goes beyond that of providing financial products and services. It also includes client names and information.
4. The regulators view all referral arrangements as a conflict of interest that must be resolved in favor of the client.
5. The rules governing referral relationships will come into effect immediately once the Client Focused Reforms come into force. Advisors will have 3 years to bring pre-existing arrangements into conformity.
Why This Matters: The new requirements will significantly increase the risk, cost and administrative complexity of referral arrangements for both advisors and dealers. They will certainly alter how advisors process, administer, and evaluate any current and future referral relationship.
Check out Part 2 of our article to learn more about what you can do to get ahead of these changes to ensure that your referral arrangements comply with regulatory requirements.
Please contact us if you have any questions.
Afsar Shah, BA, LLB.
Business & Regulatory Coach
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