CSA Notice: CSA Notice - 33-304 - CSA Distribution Structures Committee Position Paper

CSA Notice Concept Proposal

le 6 août 1999

CANADIAN SECURITIES ADMINISTRATORS' NOTICE 33-304

CSA Distribution Structures
Committee Position Paper

The Canadian Securities Administrators ("CSA") are publishing the Position Paper of theCSA Distribution Structures Committee (the "Committee"). The CSA established the Committee in1997 to develop policy positions to address the regulatory issues that have arisen due to changes thatare occurring in the manner in which securities firms structure their businesses to facilitate thecommercial provision of securities trading and advising services to the public. The Committee iscomprised of representatives of the securities commissions of British Columbia, Alberta,Saskatchewan, Ontario, Québec and Nova Scotia.

An important underlying principle of the Paper is that the positions put forward are intendedto apply, subject to the observations below regarding Québec, to members of all existing andproposed self-regulatory organizations ("SROs"). The positions set out in the Paper are expected toform an integral part of the rules proposed by the new Mutual Fund Dealers Association ("MFDA").The CSA intend to work closely with the MFDA and other SROs to implement the positions set outin the Paper.

In Québec, the introduction of the regulatory regime in Bill 188 provides for a sharing ofresponsibility between the Commission des valeurs mobilières du Québec ("CVMQ") and the Bureaudes services financiers. Consequently, the CVMQ must apply the positions discussed in the Paperby taking into consideration current practices related to the distribution of financial products otherthan securities, as well as existing legislative provisions.

For further information, please contact the following members of the CSA DistributionStructures Committee:

Wayne Alford (Chair)
Legal Counsel
Alberta Securities Commission
(403) 297-2092
[email protected]

Simon Millner
Senior Legal Counsel
British Columbia Securities Commission
(604) 899-6642 or (800) 373-6393 (in B.C.)[email protected]

Jennifer Elliott
Legal Counsel
Ontario Securities Commission
(416) 593-8109
[email protected]

Renée Piette
Conseillère à la réglementation
Commission des valeurs mobilières du Québec
(514) 940-2199 ext. 4558
[email protected]

Terry Ford
Deputy Director, Registration
Saskatchewan Securities Commission
(306) 787-5876
[email protected]

August 27, 1999

CSA Distribution Structures Committee:
Position Paper, August 1999

Table of Contents

Executive Summary

Background
Short Term Goals
Long Term Goals

Discussion and Positions

Introduction
The Committee
Commission des valeurs mobilières du Québec
Distribution Structures
Committee Deliberations

Background

Principles for Distribution of Securities
Short term goals
Long Term Goals

Discussion and Positions
Dual Employment
Position #1
Securities Sold Under Exemptions
Regulatory concerns
Position #2
Trade Names
Regulatory concerns
Position #3
Referral Arrangements and Commission Splitting
Regulatory concerns
Position #4
Financial Planning Activities by Registrants
Regulatory concerns
Position #5
Legal Relationships and Business Structures
Dealer as employer and salesperson as employee
Regulatory Concerns
Position #6
Dealer as principal and salesperson as agent
Regulatory concerns
Position #7
Salesperson acting as independent contractor
Regulatory concerns
Position #8
Incorporation without registration
Regulatory concerns
Position #9

Proposed Business Structures
Dealer as employer and salesperson as employee, or dealer as principal and salesperson as agent
The service provider business structure
Position #10
The introducing and carrying dealer model
Position #11

Implementation

Executive Summary

Introduction

The Distribution Structures Committee (the "Committee") was established in 1997 by the Chairs ofthe Canadian Securities Administrators (the "CSA"). The Committee's mandate is to develop policypositions for the CSA. Those positions are to address the regulatory issues that have arisen due tochanges that are occurring in the manner in which securities firms structure their businesses tofacilitate the commercial provision of securities trading and advising services to the public. Animportant underlying principle of the Position Paper is that the positions put forward areintended to apply, subject to the observations below regarding Québec, to all securitiesregulatory systems including all existing and proposed self-regulatory organizations("SROs").

The term "distribution structures" refers, in part, to how securities firms organize theirbusinesses. Under the traditional structure, a securities firm markets and delivers itsservices through its partners, officers, or employees. Under this structure, the dealer'sliability for the actions of its salespersons and its duty to supervise the actions of thosesalespersons is clear. There is, however, pressure from the securities industry to allowthe use of non-traditional structures. In some cases firms have already implemented thesestructures. These non-traditional structures do not always honour the regulatory principlesof effective supervision, legal responsibility to the client, access to books and records, etc.and, therefore, regulatory concerns arise.

The Committee has limited the scope of its policy positions by the use of the expression"financial services, not subject to another regulatory regime". The Committee recognizesbanking, insurance, and, in Québec, deposit taking activities, mortgage brokerage, realestate brokerage and financial planning activities, as financial services that are subject toanother regulatory regime.

Commission des valeurs mobilières du Québec

In Québec, the introduction of the regulatory regime in Bill 188, An Act respecting thedistribution of financial products and services, provides for a sharing of responsibility withregard to regulating the distribution of mutual funds, insurance products and financialplanning services between the Commission des valeurs mobilières du Québec (CVMQ)and the Bureau des services financiers (BSF). Bill 188 entrusts the supervision of mutualfund dealers, insurance brokers and agents, and financial planners to the BSF, andpermits all of these activities to be carried out at the same firm. Bill 188 imposesresponsibility for the activities it covers on the dealer through registration and, on therepresentative, through certification.

Consequently, the CVMQ must apply the positions discussed in this report by taking intoconsideration practices currently in use related to the distribution of financial productsother than securities and existing legislative provisions.

Background

The Canadian securities regulatory regimes assume that the relationship between asecurities firm and its sales staff is that of employer and employee. The regimes deal withregulatory and accountability issues on the basis of this assumption. Regulatory issuesarise from certain proposed non-traditional structures that are not based on therelationship of employer and employee.

Principles for Distribution of Securities

In considering whether non-traditional structures should be allowed, the Committeeconsidered whether those structures are consistent with the following principles: the dealermust be legally responsible for the acts of its salespersons; the dealer must exercise anappropriate level of supervision over its salespersons; all conflicts of interest must bedisclosed to the client and the client must be aware of all of the types of investor protectionthat are available to the client; the dealer must ensure that its salespersons are andremain competent; the dealer and regulators must be able to perform their oversightfunction; and the range of allowable structures must not unduly limit the options availableto securities firms.

Short Term Goals

The following are the Committee's short term goals and are fundamental to theCommittee's deliberations: all financial services, not subject to another regulatory regime,are to be conducted through the dealer; the dealer must be liable for all financial serviceactivities, not subject to another regulatory regime, conducted by its salespersons; and thebooks and records of the dealer and all salespersons must be available for inspection atall times by the dealer and regulators.

Long Term Goals

The following are the long term goals identified by the Committee that are to be achievedin consultation with other regulators: all financial service activities conducted by a dealer'ssalespersons must be conducted through, and appear on the books of the dealer, or otherappropriately registered or licensed and regulated entity; and the dealer must be liable forall financial service activities between the dealer's salespersons and its clients.

Discussion and Positions

The Committee reviewed six specific subjects: dual employment, securities sold underexemptions, trade names, referral arrangements and commission splitting, financialplanning activities by registrants, and the legal relationships that exist between dealersand their salespersons.

A summary of the Committee's position on each of these subjects follows. For a fulldiscussion of the issues and positions please refer to the Position Paper.

Dual Employment: Dual employment will be allowed, provided that thesalespersons' other employment does not interfere with their duties andresponsibilities as salespersons and provided that the dealer is responsible andliable for all of the financial service activities of the salespersons that are notsubject to another regulatory regime.

Securities Sold Under Exemptions: Restricted dealers and salespersons will bepermitted to sell only those securities for which they are expressly registered, aswell as deposit instruments and government debt instruments.

Trade Names: Trade names and trademarks will be permitted to accompany, butnot replace, the full legal name of the dealer on materials that are used tocommunicate with the public, provided that the following condition, and othersspecified in the Position Paper, are met: all trade names and trademarks throughwhich a salesperson conducts registerable activities and financial service activitiesthat are not subject to another regulatory regime must be registered to the dealer.

Referral Arrangements and Commission Splitting: Referral arrangements will bepermitted only between dealers or between dealers and entities that are licensedor registered under some other regulatory system that is acceptable for the purposeof referral arrangements ("acceptable entity"), and then only if certain conditionsspecified in the Position Paper are satisfied. These conditions include therequirement that there be a written agreement governing the payment of referralfees between the dealers, or the dealer and the acceptable entity. The agreementcannot be between the salespersons themselves.

Financial Planning Activities by Registrants: Salespersons who provide financialplanning services must do so through the dealer that sponsors their securitiesregistrations. They must also comply with certain other requirements that aredetailed in the Position Paper, including the requirement that salespersons mustsatisfy minimum proficiency standards.

Legal Relationships and Business Structures

The following items deal with legal relationships between dealers and salespersons andwhether business structures based on those relationships are acceptable, having regardfor the regulatory principles on which the Position Paper is based.

Dealer as employer and salesperson as employee: A relationship between a dealerand its salesperson that is properly characterized as that of employer and employeeis acceptable to the Committee. The Committee, however, also takes the positionthat the liability of a dealer for the acts of its salesperson should be governed by aregime of comprehensive statutory liability. This regime will require legislativeamendments.

Dealer as principal and salesperson as agent: A principal and agent relationshipbetween a dealer and a salesperson is acceptable provided that the following, andother conditions discussed in the Position Paper, are met: the dealer must beresponsible for and supervise all of the activities of its salespersons that relate tothe delivery of financial services, other than financial service activities subject toanother regulatory regime.

Independent contractor: Salespersons will not be permitted to carry out theirfinancial service activities on behalf of a dealer where they are acting asindependent contractors.

Incorporation without registration: Subject to the discussion that follows concerningintroducing and carrying dealer structures and service provider structures,salespersons will not be allowed to incorporate in order to conduct registerableactivities and financial service activities that are not subject to another regulatoryregime.

Acceptable Business Structures

It is the position of the Committee that the following are acceptable business structures:

Dealer as employer and salespersons as employees, or dealer as principal andsalespersons as agents: A structure wherein the dealer is the employer and thesales force is composed of employees is acceptable. Where the dealer is theprincipal and the salespersons are agents, the structure will also be acceptable, butonly if the conditions set out in the Position Paper's discussion of salespersons asagents are satisfied.

Service provider business structure: Unregistered corporations may provide certainservices to a dealer and its salespersons, provided that the conditions discussedin the Position Paper are satisfied. Those conditions include the requirement thatthe dealer's ultimate responsibility and liability to clients must not be affected bythese arrangements.

Introducing and carrying dealer model: Dealers may only enter into arrangementsinvolving multiple corporations when all of those corporations are registered in anappropriate category of dealer or the arrangement is in accordance with the serviceprovider model.

Implementation

Some of the Committee's positions are expected to be implemented by policy and someby rule and certain requirements may require legislative amendments. Much of the detailwill be left to the SROs to determine and implement by way of by-laws or regulations. Itis clear that the positions may have a significant impact on the manner in which registrantsorganize and conduct their business operations. The Committee believes that its concernsare well-founded, and its positions flow from those concerns.

CSA Distribution Structures Committee: Position Paper, August 1999

INTRODUCTION

The Committee

The Distribution Structures Committee (the "Committee") was established in 1997 by theChairs of the Canadian Securities Administrators (the "CSA"). The Committee consists ofstaff members from several Commissions, including the Chair of the Nova ScotiaSecurities Commission, and it is chaired by Renée Piette of the Commission des valeursmobilières du Québec ("CVMQ").

Securities firms adopt business structures to facilitate the commercial provision ofsecurities trading and advising services to the public. There are changes occurring inthose structures. The Committee's mandate was to develop policy positions for the CSAthat will address the regulatory issues that have arisen due to these changes.Consideration was, therefore, given to whether the evolution of these structures hascreated concerns about the integrity and efficacy of the existing regulatory system, and ifso, to determine how those concerns could be addressed. This Position Paper containsthe Committee's response to that mandate. The positions set out in this Position Paperapply to all existing and proposed self-regulatory organizations ("SROs").

It was the Committee's overall goal to harmonize the relevant regulatory requirements inCanada. Nonetheless, there are now, and may continue to be, particular requirements inparticular jurisdictions that will govern. Many, but not all, of those requirements are notedin footnotes to this Position Paper. The Committee believes that most of the positionscontained in this Position Paper reflect existing regulatory provisions and do not representchanges to the basic legislative regimes that are in place in Canada. This position shouldnot, however, be interpreted to mean that the Committee believes that all the structurescurrently in use by securities firms comply with the requirements of the existing regulatoryprovisions.

Commission des valeurs mobilières du Québec

In Québec, the introduction of the regulatory regime in Bill 188, An Act respecting thedistribution of financial products and services, provides for a sharing of responsibility withregard to regulating the distribution of mutual funds, insurance products and financialplanning services between the CVMQ and the Bureau des services financiers (BSF). Bill188 entrusts the supervision of mutual fund dealers, insurance brokers and agents, andfinancial planners to the BSF, and permits all of these activities to be carried out at thesame firm. Bill 188 imposes responsibility for the activities it covers on the dealer throughregistration and, on the representative, through certification.

Distribution Structures

The term "distribution structures" covers a number of subjects. It refers, in part, to howfirms that sell securities to the investing public organize their business. For example, a firmmay arrange its business as an employer (the firm) and employees (the salespersons).⁽¹⁾The term also refers to arrangements between securities firms and others. For example,an arrangement whereby a securities firm pays to another organization or person a referralfee for client referrals is a part of the securities firm's distribution structure. The term alsorefers to arrangements whereby a securities firm contracts out to other organizations theperformance of various functions associated with the conduct of the firm's business.

Historically, a securities firm marketed and delivered its services through its partners,officers, or employees. This is the traditional distribution structure. Under this structure,the firm is conducting the business; it is doing so through its employees or "servants", and,accordingly, all of those employees are appropriately registered. That is, individuals areregistered as salespersons and the entity that employs them is registered as a dealer. Thefirm is responsible and liable for the acts of those employees performed in the dischargeof their employment with the firm.

There is pressure from the securities industry to allow the use of non-traditional structures.In some cases firms have already implemented these structures. The desire to use non-traditional structures is driven, in part, by perceived, and actual, tax and operationalefficiencies for dealers and salespersons and an appetite for a higher degree of autonomyand independence for salespersons. This desire has been evidenced over the pastnumber of years by the appearance of new structures such as independent contractorsand franchises, and arrangements such as referral fees. Securities regulation places greatimportance on principles such as effective supervision, legal responsibility to the client,access to books and records, etc. These new structures do not always honour thoseprinciples and, therefore, regulatory concerns arise.

The liability of the dealer for the acts of its salespersons is an important part of investorprotection under Canadian securities law. Where that liability is clouded, investorprotection may be compromised. For example, the responsibility of a dealer for the actsof its franchisees or independent contractors may not be clear and regulatory concerns,therefore, will arise. Another important component of the Canadian investor protectionprogramme is the requirement that all persons or companies that are acting in furtheranceof trades in securities be registered with the appropriate securities regulatory authority.When securities firms accept referrals from non-registered persons or companies, orpersons and companies that, while registered, are not registered for trading or advisingin the securities in question, concerns arise about persons and companies that are notappropriately registered acting in furtherance of trades and about the quality of advice theinvestor is receiving.

The Canadian securities legislative regimes classify firms that trade in securities for theinvesting public into several different categories. These are the categories of dealers, andthey include: full service securities firms that are members of a self-regulatory organization("SRO"), securities firms that are not members of an SRO, and mutual fund dealers.Individuals are, subject to proficiency requirements, registered as representatives of thesefirms. Every registered representative must be sponsored by an appropriately registereddealer. The current registration regime for individuals and businesses that distributesecurities to the investing public in Canadian jurisdictions assumes that the traditionalmaster and servant relationship exists between the firm and its salespersons.⁽²⁾ With sucha relationship in place, the reporting lines are clear; it is clear who is supervising whom;it is clear to whom the books and records belong; it is clear who is liable for the acts of thesalesperson; and so on. The Committee is aware that distribution structures exist in theCanadian securities industry that may not be based on the legal relationship between thedealer and its salespersons of employer and employee. The Committee consideredwhether these structures replicate the clear lines of responsibility etc. outlined above, and,if they did not, what regulatory accommodation would be required to balance the industry'sdesire for non-traditional structures and the Committee's concerns for investor protection.As will be discussed, the Committee has determined that certain of these structures cannotbe reconciled with the existing regimes. Further, some structures cannot beaccommodated even when modifications are made to the regimes, where thosemodifications are consistent with the regulatory principles that are articulated in thisPosition Paper.

Committee Deliberations

In this Position Paper, the Committee limits its policy positions by the use of the expression"financial services, not subject to another regulatory regime". The Committee's positionsare not intended to disrupt existing regulatory relationships. Rather, the Committee'sintention is to ensure that the regulatory regime is complete. The Committee recognizesbanking, insurance, and, in Québec, deposit taking activities, mortgage brokerage, realestate brokerage and financial planning activities as financial services that are subject toanother regulatory regime. The Committee is looking forward to working with theinsurance industry's regulators, and others, to ensure harmonization and cooperation inthe regulation of dually-licensed registrants.

The Committee began its deliberations by defining the structures that exist in the securitiesindustry, including the traditional structure of firm employer and salesperson employee andthe non-traditional structures. The non-traditional structures considered included: non-registrants sharing in registrants' commissions; registrants who are not qualified to dealin specific products referring clients to registrants who are registered to deal in thoseproducts and then sharing in the second registrant's commission; registrants conductingother financial businesses through unregistered corporations; registrants using tradenames other than the name of the securities firm through which they are registered;independent contractors; franchises; and service providers.

The Committee focussed its attention on the implications that the use of these structureshas on the proper supervision of salespersons by dealers; on dealer capital and bondingrequirements; on record keeping functions; and on dealer liability. The Committee thenconsidered how, if at all, the regulatory system should be altered.

During its deliberations the Committee met with several industry and regulatoryorganizations, including the Canadian Investor Protection Fund, the Investment DealersAssociation of Canada, the Investment Funds Institute of Canada, and the Mutual FundDealers Association of Canada. The Committee thanks all of these organizations for theirinput.

BACKGROUND

The Canadian securities regulatory regimes assume that the relationship between thesecurities firm and its sales staff is that of employer and employee. The regimes deal withregulatory and accountability issues on the basis of this assumption. There are, however,pressures being exerted by the securities industry to allow firms to operate with non-traditional structures. The IDA's introducing and carrying dealer models are examples ofregulatory responses to this desire for change.

The use of non-traditional structures is driven by business concerns, including competitivepressures and the desire to reduce costs. These structures have arisen in the mutual fundindustry due, in part, to the historic relationship between insurance sales and mutual fundsales. Many mutual fund salespersons began as insurance salespersons whosubsequently became registered to sell mutual funds. Insurance products were soldthrough the registrant's own corporation, and, due to dual licensing, the registrant foundit desirable to also conduct the sale of mutual fund securities through this corporation. Taxsavings, business expansion without large additional costs, and the desire of individualsto have their own business are often cited as reasons for the use of non-traditionalstructures.

PRINCIPLES FOR DISTRIBUTION OF SECURITIES

The Committee determined that the following principles must be adhered to in any regimeof permissible distribution structures:

(a) Legal responsibility: the dealer must be liable to the clients and tosecurities regulators for all financial service activities of its salespersons thatare not subject to another regulatory regime.

(b) Bonding: The bonding and insurance carried by the dealer must cover theactivities of the dealer's salespersons regardless of the relationships thatexist between the dealer and the salespersons.

(c) Supervision: appropriate supervision is required to ensure thatsalespersons' dealings with clients comply with securities legislationand requirements. The supervisor must have the ability, and theauthority, to carry out his supervisory function.

(d) Client awareness: clients should be able to identify easily the dealerwith which they are dealing and the types of investor protection thatare available to the clients.

(e) Conflicts: before entering into a transaction, clients should be awareof the compensation arrangements and any relationships that existbetween the registrant and any other party that may affect the advicegiven.

(f) Competence: a dealer is responsible for ensuring its staff maintainsan appropriate level of competence.

(g) Oversight: regulators must ensure that they are able to carry out theiroversight responsibilities in accordance with their respectivelegislation. The Committee places great value on the transparencyof an organization. In the absence of demonstrated advantages toclients, the Committee will reject structures that are more complexand therefore less easily monitored than the traditional distributionstructure.

(h) Market structure: securities legislation and requirements must not bea barrier to market competition and development where no regulatoryconcern has been identified.

Short Term Goals

The Committee has identified certain principles that are fundamental to its deliberationsand to the formulation of its positions. Ensuring adherence to these principles is the shortterm goal of the Committee. The principles are:

(a) all financial service activities, that are not subject to another regulatoryregime, that are pursued by a dealer's salespersons must be conductedthrough the dealer;

(b) the dealer must be liable for all financial service activities, that are notsubject to another regulatory regime, conducted by its salespersons; and

(c) regardless of the nature of the relationship that exists between thesalesperson and the dealer, the books and records of the dealer and allsalespersons that relate to financial activities, not subject to anotherregulatory regime that the salesperson conducts must be available forinspection at all times by the dealer and regulators.

The Committee believes that these principles are fundamental components of investorprotection. Without these requirements the client may be misled as to the entity with whichshe is dealing. The client may not have access to the dealer's bonding and regulatorycapital in the event of a compensable loss, and the duty of the dealer and the salespersonto ensure suitability may not be properly executed.

Long Term Goals

The Committee has concluded that the following are appropriate long term goals that areto be achieved in consultation with other regulators:

(a) all financial service activities conducted by a dealer's salespersons must beconducted through, and appear on the books of, an appropriately registeredor licensed and acceptable entity; and

(b) the dealer must be liable for all financial service activities between thedealer's salespersons and it clients. Towards this end the Committee isrecommending the imposition of enhanced, statutory liability on dealers.This subject is discussed under Position #6 below.

The ultimate objective is to achieve uniform levels of investor protection through regulationof financial services, regardless of the regulatory regime through which the services aredelivered. For example, uniform levels of regulation of financial planning would berequired under both the insurance and securities regulatory regimes.

DISCUSSION AND POSITIONS

The Committee was asked to review six specific subjects. Those subjects are: dualemployment, securities sold under exemptions, trade names, referral arrangements andcommission splitting, financial planning activities by registrants, and the legal relationshipsthat exist between dealers and their salespersons. The following is the Committee'sdiscussion of those subjects in the context of the principles enumerated above and theCommittee's regulatory responses.

The Committee intends that the positions in this Position Paper are to be interpreted asminimum standards. SROs and regulators charged with implementation may choose tosupplement them.

Dual Employment

Many salespersons are employed by more than one entity and pursue more than one lineof business. For example, they may be employed as insurance agents and as mutual fundsalespersons. The CSA's "Principles of Regulation" specify certain rules that apply to dualemployment by mutual fund salespersons who are employed by financial institutions.Further, most jurisdictions have rules that preclude, with some exceptions, dualemployment. Accordingly, employment in more than one financial capacity may berestricted. The Committee is advised that persons who are dually employed frequentlystyle themselves as "independent contractors".

The Committee identified the following regulatory concerns that arise from this situation:

(a) legal responsibility and liability for the acts of salespersons may notbe clearly defined;

(b) clients may be confused as to the entity they are dealing with;

(d) the books and records of the salesperson's operation may not bereadily accessible for review by the dealer or regulator;

(e) the dealer's ability to supervise a salesperson's registerable activitiesadequately may be compromised unless the dealer can supervise allof the financial service activities of the salespersons that are notsubject to another regulatory regime; and

(f) part-time salespersons may not be able to maintain their proficiencyat as high a level as is required to ensure the proper performance oftheir duties.

The Committee is supportive of continuing education programs for all salespersons toensure that their level of proficiency and competence is maintained.

Position #1

Dual employment should be allowed, provided that the salespersons' other employmentor other activities do not interfere with their duties and responsibilities as salespersons⁽³⁾and provided that the dealer is responsible and liable for all of the financial serviceactivities of the salespersons that are not subject to another regulatory regime.⁽⁴⁾

Implementation of this position would require the adoption of regulations to ensure that:

(a) the dealer supervises all financial service activities, that are notsubject to another regulatory regime, carried on by its salespersons;

(b) salespersons may not receive revenue from financial service activitiesthat are not subject to another regulatory regime, except through thedealer;

(c) all financial services, that are not subject to another regulatoryregime, must be performed on behalf of and through the dealer. Thedealer must be aware of and give prior approval for all such activitiescarried on by each of its salespersons;

(d) conflicts of interest that arise due to dual employment are disclosedto the client prior to the execution of any transactions;

(e) the full legal name of the dealer is disclosed in all dealings betweenthe salesperson and clients; and

(f) the dealer and regulators have access to all books and recordsregarding the salesperson's financial service activities.

Securities Sold Under Exemptions

The Committee is advised that many mutual fund dealers sell securities under exemptionsto clients who normally invest in mutual funds, clients who may not be familiar with thecharacteristics of these other products. These products sold under exemptions include,for example, limited partnership units sold under the seed capital or sophisticated investorexemptions. The Committee understands that salespersons often sell these investments"away" from the dealer, and the transactions do not appear on the books of the dealer.

Regulatory concerns

The Committee has identified the following as regulatory concerns that arise from thispractice:

(a) salespersons with restricted registrations are frequently sellingexempt securities through distribution channels that normally attractclients seeking relatively safe investments where those safeinvestments are subject to a comprehensive regulatory regime;

(b) the proficiency of the salesperson that is advising on the exemptsecurities may not be adequate in circumstances where the clients,due to previous dealings with the salesperson and the salesperson'sregistration, are expecting a higher level of proficiency than theywould from a stranger;

(d) there may be no access to the books and records that relate to salesthat are not made on the books of the dealer or there may be norecords at all of the sales;

(e) the dealer may not be able to supervise the salesperson effectively;

(f) the ability of regulators to perform effective oversight may beimpaired; and

(g) the liability of the dealer for the acts of the salesperson may not becertain.

Position #2

Restricted dealers and salespersons will be permitted to sell only those securities forwhich they are expressly registered, deposit instruments and government debtinstruments.⁽⁵⁾^, ⁽⁶⁾

Restricted dealers that wish to sell other exempt securities⁽⁷⁾ may apply to the appropriatesecurities regulatory authority for permission to do so. Some securities regulatoryauthorities may require a separate application for each offering the restricted dealerwishes to sell. Other securities regulatory authorities will consider the matter whenimposing conditions on the dealer's registration. It may also be that some securitiesregulatory authorities will not be prepared to grant this relief.

Trade Names

Trade names are used within the securities industry in a number of ways. Some dealersoperate under names that are different from the name of the registered corporation, whilesome salespersons use trade names associated with their own business and not with thedealer's corporate or trade name. The Committee understands that these salespersonsoften conduct their registerable activities through the dealer, while other financial serviceactivities are conducted through the salesperson's company. The Committee alsounderstands that several businesses may share a common trade name.

In the Committee's view, the proper use of trade names could, in fact, remove somepotential for client confusion. Proper use is to be guided, in part, by the principle that alltrade names are to be registered⁽⁸⁾ to the dealer where those trade names are used in theconduct of activities related to trading or advising on securities and financial serviceactivities that are not subject to another regulatory regime.⁽⁹⁾ The trade name may be usedby the dealer's salespersons as long as the dealer's name is also disclosed to the clients.⁽¹⁰⁾

It has been suggested that a contractual relationship could be created between the dealerand its representatives regarding the use of a trade name belonging to the salespersons.Such a contractual relationship would, it is suggested, provide the client with an adequatelevel of protection. The Committee rejects any suggestion that relationships that arecreated by laws of general application can be re-created through the use of contractualrelationships between the dealer and its salespersons. On this specific issue, theCommittee points out that rules of privity of contract will not permit a stranger to thecontract to enforce its provisions, even where those provisions are for the benefit of thatstranger. Laws of general application, on the other hand, do grant standing to parties thatare harmed by the actions of persons using a trade name to seek compensation from theregistered user of the trade name.

Regulatory concerns

The Committee has identified the following as regulatory concerns that arise from thesepractices:

(a) the dealer may not be legally responsible for all financial service activitiescarried on by the salesperson under a trade name not registered to thedealer; and

(b) clients may be confused about which entity they are dealing with.

Position #3

Trade names and trademarks will be permitted to accompany, but not replace, the full legalname of the dealer on materials that are used to communicate with the public, providedthat the following conditions are met:⁽¹¹⁾

(a) all trade names and trademarks, through which a salespersonconducts activities related to trading or advising on securities andfinancial service activities that are not subject to another regulatoryregime, are registered to the dealer;

(b) each dealer is aware of and gives prior approval to the trade namesand trademarks that are used by any of its salespersons for theconduct of financial service activities that are not subject to anotherregulatory regime;

(c) the dealer gives notification to and receives approval from therelevant securities regulatory authorities of every trade name andtrademark registered to it prior to its use. The relevant securitiesregulatory authority must also approve any transfer of trade names ortrademarks prior to their use by the transferee dealer;

(d) a trade name can be used by only one dealer at a time, although thisprinciple may have to be altered in the context of the introducing andcarrying dealer model; and

(e) all written agreements with clients are entered into in the dealer's fulllegal name.

Referral Arrangements and Commission Splitting

A referral arrangement is an agreement whereby a registrant earns or pays a fee for thereferral of a client to or from a non-registered party or a party registered in a differentcategory. The fee may be a flat fee; it may be contingent and based on commissions orfees earned; it may be based on the value of assets transferred. The Committee does notdistinguish between referral fees that are based on a flat fee and those based oncommissions (fees based on commissions are sometimes referred to as "commissionsplitting"). The Committee does not believe that the manner by which the quantum of thefee is calculated raises any incremental regulatory concerns. It will be up to those whoseek to take advantage of an acceptable referral fee arrangement to ensure that theactivities of the party making the referral do not constitute acts in furtherance of a trade insecurities or advising on securities. The Committee has excluded from its definition ofreferral arrangements any arrangement whereby payment based on the level of sales ismade to a third party service provider where the services provided are clearlyadministrative and the service provider has no direct contact with clients or their assets.Arrangements of this type and the regulatory concerns they raise are dealt with belowunder the discussion of the service provider business structures.

Regulatory concerns

The Committee is concerned about the following regulatory issues:

(a) persons that lack the appropriate proficiency or registration may beacting in furtherance of trades in securities or may be giving adviceregarding securities;

(b) conflicts of interest may not be disclosed adequately to clients prior toentering into transactions; and

The Committee is concerned that referral fee arrangements are unregulated in manyjurisdictions. The Committee believes that some arrangements may be acceptable, butthat the arrangements will require monitoring and supervision to address the Committee'sconcerns. Clients may not know who is responsible for certain registerable activities.Disclosure of the fee and the identity of the recipient will assist in this regard. Thisdisclosure will also be effective in bringing potential conflicts of interest to the attention ofthe client. Disclosure will not, however, alleviate the concern about parties without theappropriate registration or proficiency acting in furtherance of trades in securities or givingadvice regarding securities.

Position #4

Referral arrangements will be permitted only between dealers or between dealers andentities that are licensed or registered under some other regulatory system that isacceptable for the purpose of referral fee arrangements ("acceptable entity").⁽¹²⁾ For thesepurposes Canadian financial institutions,⁽¹³⁾

insurance agents, insurance brokers and, inQuébec, mortgage brokers, real estate brokers and financial planners, are acceptable.Therefore, referral arrangements will be allowed, provided that:⁽¹⁴⁾

(a) there is a written agreement governing the payment of referral feesbetween the dealers, or the dealer and the acceptable entity, andnot between the salespersons themselves. The written agreementmust be filed with the relevant securities regulatory authority. Theagreement must describe the means by which the dealer will ensurecompliance with applicable securities regulation, and the agreementmust be filed prior to the execution of the first transaction that willlead to the payment or the receipt of fees as provided for in theagreement;

(b) all fees received are paid to the dealer by the other dealer or theacceptable entity named in the agreement, and the receipt of the feesis recorded on the books of the dealer;

(c) all fees paid are paid by the dealer to the other dealer or acceptable entity,and the payment of those fees is recorded on the books of the dealer;

(d) written disclosure is made to clients of any referral fees prior to atransaction taking place. This disclosure must include the amount ormeans by which the fee is calculated, the reason for the payment, thename of the party to or from whom the fee will be paid or received,and a statement that it is illegal for the recipient of the fee to giveadvice regarding a transaction if he is not licensed or registered togive that advice;

(e) a signed acknowledgement of consent is obtained from each clientregarding the above disclosure prior to the execution of the firsttransaction that will lead to the payment or the receipt of fees asprovided for in the agreement; and

(f) the party receiving the fee is not engaged in trading or advisingactivities that it is not licensed or registered to perform.

Financial Planning Activities by Registrants

Financial planning and its regulation are attracting a great deal of attention. Participantsin the securities industry and other financial industries often offer financial planningservices, whether for a fee or not, as an adjunct to the other services they offer. There areseveral organizations that provide training and certification for financial planners. InQuébec, the CVMQ regulates registrants acting as financial planners. When it comes intoforce, Bill 188 will regulate financial planning activities. However, in the other jurisdictionsthere is a lack of consistency in the proficiency requirements and attributes of people whoact as financial planners.

The CSA⁽¹⁵⁾ have undertaken an initiative on financial planning. Staff are lookingspecifically at the regulation of financial planning and, generally, at advising on securities.The Distribution Structures Committee will, to the extent possible, rely on the work that isbeing done in this area by the committee on the regulation of financial planning. TheDistribution Structures Committee's concern is that activities that may lead to a trade insecurities, or that involve advice on securities, should be regulated.

The Committee's regulatory concerns and the general framework for dealing with theseconcerns are discussed below. These concerns and the Committee's positions wereconsidered only in the context of registrants provide that provide financial planningservices. The Committee has not looked at these issues in relation to financial plannersthat are not registered under the securities regulatory regime.

Regulatory concerns

The Committee identified the following as regulatory concerns in CSA jurisdictions otherthan Québec, where these concerns have been addressed by regulation:⁽¹⁶⁾

(a) the lack of minimum proficiency requirements for persons providingfinancial planning services;

(b) the confusion of clients as to who is providing the service;

(d) the risks to dealers whose salespersons are providing financial planningservices where there is no supervision or errors and omissions insurance inplace; and

(e) the conflicts of interest that may exist when financial planners earntheir income from the subsequent sale of products.

The large number of financial planning designations that have been established leaves theconsumer in the position that she must make her own judgement as to whether or not theindividual offering the advice is qualified. Consumers may have a great deal of difficultymaking an appropriate decision. Codifying proficiency standards and limiting the abilityof organizations to grant certifications or charters is a way to reduce the magnitude of thisproblem.

The Committee is also concerned that the advice received by investors will not be free ofinfluence from conflicts of interest. Disclosure of compensation for product sales wouldassist consumers in determining the value of the advice they have been given.

The Committee is advised that salespersons often conduct their financial planningactivities through companies other than the dealer that sponsors the salespersons'securities registration. Clients may not understand that the service is not being offered bythe dealer or that the dealer may not be liable for any losses that result from following theadvice given. This situation leads to concerns about the lack of dealer supervision of thesalesperson's financial planning activities, the risks faced by dealers who are not insuredfor this activity, and the conflicts of interest that may arise.

Position #5

Salespersons who provide financial planning services, must provide these servicesthrough the dealer that sponsors their securities registrations. The Committee issupportive of all dealers having comprehensive errors and omissions insurance coverage.In addition, a salesperson who provides financial planning services must meet thefollowing requirements:

(a) the salesperson must satisfy minimum proficiency requirements thatare set for registrants who provide financial planning services;

(b) the salesperson must deliver a disclosure statement to the client thatinforms the client of the means by which the salesperson generateshis income; that informs the client that the client need not implementthe plan through the financial planner that prepared it, that is, at theoption of the client, the plan can be executed through anyappropriately registered entity; that informs the client of the fact thatcommissions are received for transactions to implement the plan; andthat advises the client of the various licenses and registrations heldby the salesperson, including those for securities, insurance, and realestate;

(d) all fees earned from financial planning activities are to be paid to andrecorded on the books of the dealer;

(e) the financial planning activities conducted by the salesperson are subjectedto the same level of supervision by the dealer as are securitiestransactions;⁽¹⁷⁾ and

(f) an adequate level of insurance is in place.

Legal Relationships and Business Structures

The Committee analysed the following legal relationships that may exist between a dealerand its salespersons:

	Dealer	Salesperson
	Employer	Employee
	Principal	Agent
	Independent Contractor	Independent Contractor

In addition to these relationships, the Committee considered the regulatory issues thatarise when corporations enter into relationships with the dealer. The Committee'sconclusions regarding the acceptability of these relationships are discussed in this section.

(a) Dealer as employer and salesperson as employee

The existing regulatory system is premised on the existence of an employer and employeerelationship between a dealer and its salespersons. Therefore, a relationship between adealer and its salespersons that is properly characterized as employer and employee isacceptable to the Committee.

Regulatory Concerns

Committee members have expressed concern, however, over whether even the traditionalemployer and employee relationship provides sufficiently comprehensive protection forinvestors. This concern arises from the fact that salespersons may offer services, suchas financial planning, or they may sell products, such as securities sold under exemptions,which the dealer does not consider to be part of its business. It is not clear in thesesituations whether the dealer would be held liable for compensable losses suffered byclients as a result of these activities, despite the employer and employee relationship.Further, even with the requirements of Position #1 fully satisfied so that all financial serviceactivities of salespersons are conducted through the dealer, where a salesperson causesa client loss, the courts may find that the dealer is not liable if the salesperson was actingon a "frolic of her own". The Committee believes that adequate supervision and internalcontrols at the dealer level would reduce the potential for such losses to occur and thatfailure to meet this regulatory standard ought to give rise to liability to clients. Concernsabout supervision and internal controls are considered in the discussions on otherbusiness structures that follow.

Position #6

The Committee believes that the best long term approach to ensure comprehensiveinvestor protection is to amend legislation to impose statutory civil liability on dealers forall the financial service activities of their salespersons, regardless of the businessstructure used to deliver those services. This position is intended to prevent dealers fromavoiding liability by defining the scope of the representative's employment so narrowly thatit does not include the activity that caused the client losses.⁽¹⁸⁾

(b) Dealer as principal and salesperson as agent

Many dealers and their salespersons have entered into arrangements that characterizethe salespersons as independent contractors. Despite this characterization, theCommittee is of the view that many of these relationships are more likely, in law, that ofprincipal and agent. The Committee also notes that, when examined closely, manyrelationships between dealers and their salespersons that are characterized as that ofprincipal and agent are, in substance, that of employer and employee. The dealer's liabilitydepends upon the legal relationship which exists between the dealer and the salesperson,and it is, therefore, important to characterize those relationships properly.

In the relationship of principal and agent, a salesperson operates with a very high degreeof autonomy. Salespersons that conduct business as agents do so in an effort to achievetax advantages while dealers use this relationship, for example, to expand theirbusinesses without incurring increased salary costs. The salesperson can, and does, bindthe dealer in contracts for the sale of securities. The dealer, as principal, is liable for theacts and torts committed by the salesperson, as agent, in the course of the business theagent was authorized, or was held out by the principal as authorized, to conduct.

Regulatory concerns

The Committee believes that the following regulatory concerns arise from the legalrelationship of principal and agent:

(a) the dealer's ability to supervise its salespersons properly may becompromised;

(b) the ability of regulators to perform effective oversight may be compromised;

(d) issues may arise concerning bonding and insurance coverage of agents.⁽¹⁹⁾

The Committee has concerns about the ability of the dealer to supervise effectivelysalespersons who are agents and not employees and about the dealer's ability to maintainthe level of control over the activities of the agent that is required under securitieslegislation. Supervision of an agent is more difficult because of the autonomy that isinherent in the relationship. It follows that the oversight role of regulators is also mademore difficult.

The Committee is concerned as to whether or not the agent will maintain adequate booksand records and whether the dealer will have sufficient proprietary interest in those booksand records to ensure that it can, in the event of disputes, obtain access to them. Thedealer and regulators must have access to those books and records at all times.

The Committee also wants to ensure that the protections offered under the minimumbonding or insurance coverage required to be maintained by dealers on behalf of theirsalespersons do, in fact, cover agents.

It should be noted that in some jurisdictions legislation requires that a salesperson mustbe an employee of the dealer. Where this is the case, the Committee is of the opinion that,from a policy point of view, relationships characterized as that of principal and agent maynonetheless be acceptable if, through the adoption of the conditions listed below, theyapproximate to a high degree the relationship of employer and employee. Prior toimplementation, however, those jurisdictions will require legislative amendments to permitsalespersons to operate as agents of the dealer.

Position #7

The Committee believes that a relationship between dealer and salesperson that ischaracterized as that of principal and agent may be structured in such a manner as toreplicate the attributes of liability, supervision, etc., that exist in the relationship ofemployer and employee. A principal and agent relationship between a dealer and asalesperson is, therefore, acceptable provided that the following conditions are met:

(a) the dealer is responsible for and supervises all of the activities of itssalespersons that relate to the delivery of financial services and products toits clients, other than financial service activities subject to another regulatoryregime;

(b) the liability of a dealer to clients for acts of the salesperson is the same asthat which would apply in an employer and employee relationship. Thisliability may be reinforced through the use of appropriate conditions ofregistration;

(d) the salespersons maintain appropriate books and records to which thedealer and regulators have access even in the event of disputes between thedealer and the salespersons.

The Committee is concerned about the existence today of relationships between dealersand their salespersons that are characterized as that of independent contractor. Whetheror not these relationships are such at law, there is little question that their existence hasthe potential to erode investor protection because the relationships are used, in part, torestrict the circumstances in which the dealer will be liable for the actions of itssalespersons. The discussion in this section concerns those relationships in which thesalesperson is a true independent contractor.⁽²⁰⁾

True independent contractors represent a low level of risk to dealers and a high level ofrisk to investors. True vicarious liability does not exist. In the context of trading insecurities, an independent contractor cannot bind the dealer to a contract with a thirdparty. The structures that the Committee considers acceptable are those which containa legal relationship between the dealer and the salesperson that provides for anappropriate level of liability on the part of the dealer for the actions of the salesperson.The Committee is of the opinion that the relationship of independent contractor does notprovide an appropriate level of liability.

Regulatory concerns

The Committee has the following concerns about this relationship:

(a) the reduced scope of liability imposed on the dealer for the actions ofindependent contractors;

(b) the possible impairment of the dealer's ability to supervise the independentcontractors effectively;

(d) the possible impairment of the dealer's and regulator's ability to access thebooks and records of the independent contractor; and

(e) the dealer's bonding and insurance coverage may not extend to independentcontractors.

Position #8

Salespersons will not be permitted to carry out their financial service activities on behalfof a dealer where the relationship between the dealer and the salesperson is that of anindependent contractor.⁽²¹⁾

(d) Incorporation without registration

The Committee is aware of the existence today of non-registered corporations whichprovide services to dealers and their salespersons and which receive commissions fromthe sale of securities. These corporations are not registered with the relevant securitiesauthorities and, as a consequence, are prohibited from carrying on the business of sellingor advising in securities. The Committee refers to these types of situations as multi-levelselling structures.

For example, a salesperson may establish a personal corporation and direct thatcommissions earned by the salesperson from the sale of securities be paid to thatcorporation. The salesperson may also conduct other activities, such as the sale ofinsurance products and financial planning activities, through the corporation. The insertionof the salesperson's corporation into the business structure may lead to beneficial taxrates, but it may also limit the salesperson's personal liability.

In other cases, the non-registered corporation has the responsibility of running a branchof a dealer, and it may employ one or more salespersons sponsored by the same dealer.The payment of commissions earned by each salesperson operating out of the branch isoften directed to the corporation. The corporation retains some portion to cover branchexpenses and remits the balance to the salesperson. In other cases each salespersonreceives the commission directly from the dealer and then pays a portion to thecorporation to cover overhead costs. Normally, one of the owners of the corporation isappointed as branch manager and, as such, is responsible for approving new accountsand the supervision of trades. The salespersons employed by the branch may not havean employment relationship with the dealer, notwithstanding that because they areregistered as salespersons of the dealer they must trade on behalf of the dealer. Inaddition, the salespersons operating out of these branches may themselves incorporateand receive their commissions through their own personal corporations.

In still other cases, these corporations have entered into franchise arrangements in whichthe dealer, as franchiser, grants certain rights and entitlements to one or moresalespersons to operate a business as franchisee in connection with the commercialprovision of securities trading and advising services pursuant to the dealer's registration.The franchisee is not registered as a dealer and operates a branch in a manner similar tothat described above.

Regulatory concerns

The Committee is concerned about the following issues arising from the insertion of asalesperson's non-registered corporation between the dealer and the salesperson:

(a) the non-registered corporation may be performing acts in furtherance oftrades in securities or may be giving advice regarding securities;⁽²²⁾

(b) investor protection may be reduced if a salesperson's personal liability forclient losses is limited by the insertion of a non-registered corporation;

(c) clients may be confused about the identity of the entity with which they aredealing and who is responsible for the advice they are receiving, particularlyif salespersons provide other services or sell other products through a non-registered corporation and not through the dealer;

(d) dealers may attempt to avoid liability for client losses on the basis that theclient only has a legal relationship with the non-registered corporation;

(e) the dealer's ability to supervise a multi-level selling structure effectively maynot be adequate;

(f) the ability of regulators to perform effective oversight of activities in a multi-level selling structure may be impaired; and

(g) access by the dealer and regulators to the books and records of non-registered corporations may be impaired.

Position #9

Subject to the discussion that follows concerning introducing and carrying dealerstructures and service provider structures,⁽²³⁾ and in the absence of legislation that allowsa salesperson to render registerable services through a corporation while preserving thatsalesperson's, and the dealer's, liability to clients for the salesperson's actions,salespersons will not be allowed to incorporate in order to conduct registerable activitiesand financial service activities that are not subject to another regulatory regime.

Proposed Business Structures

The Committee prepared an analysis of three business structures that the Committeeconsiders acceptable for use as distribution structures in the securities industry:

(a) dealer as employer and salesperson as employee, or dealer as principal andsalesperson as agent;

(b) the service provider business structure; and

These business structures are illustrated in the diagrams that are attached as Appendix"A" to this Position Paper. These business structures could be used either in isolation orin combination to create acceptable business arrangements.

The Committee considers it important to remind readers of the very significant differencesbetween dealers and registered representatives. All entities performing acts in furtheranceof a trade in securities or advising in regard to securities must be registered. To beregistered, representatives must be employed by a registered dealer, and only registereddealers can employ representatives. Only individuals can be registered as salespersons,and representatives cannot employ other representatives. It follows that any entity thatpurports to employ representatives must be registered as a dealer. Registration as adealer entails satisfaction of all the capital, supervisory, and other requirements of adealer. The Committee is, therefore, of the opinion that, for example, any businessstructure wherein representatives purport to conduct registerable activities throughunregistered corporations is contrary to the provisions of securities legislation. Neithersalespersons nor dealers can deliver registerable services through unregistered entities.

(a) Dealer as employer and salesperson as employee, or dealer as principal andsalesperson as agent

The first diagram portrays a business structure involving one corporation which isregistered in a dealer category. It includes more than the traditional relationship ofemployer and employee as it contemplates salespersons functioning as agents as analternative to salespersons being employees of the dealer.

Where the dealer is the employer and the sales force is composed of employees, thisstructure is acceptable. Where the dealer is the principal, and the sales force consists ofagents, the structure will be acceptable only as long as the conditions set out in Position#7 are satisfied.

(b) The service provider business structure

The second diagram portrays a service provider relationship. The structure assumes thatan acceptable relationship exists between the dealer and its salespersons. In the serviceprovider relationship, an arrangement exists whereby the dealer contracts some of its non-trading functions to a separate, non-registered corporation which charges a fee to performthose functions. The services provided by the non-registered corporation must be limitedto those which do not raise regulatory concerns. The non-registered corporation will notbe permitted to provide back office services which have a direct impact on client assets.Permitted services are those that are clearly administrative, such as the provision ofpremises, computers, phones, and so on. The payments directed to these entities fromthe dealer, or salespersons, are directly related to the services provided. The Committeebelieves that there are regulatory concerns associated with the provision of services bya non-registered corporation, such as:

(a) attempts may be made to transfer dealer liability to the service provider;

(b) attempts may be made to transfer the performance of supervision dutiesaway from the officers and employees of an appropriately registered entity;

(c) bonding issues may arise when responsibility for certain functions istransferred from the dealer to the service provider;

(d) where the service provider provides services to more than one dealer,concerns may arise over the commingling of funds; and

(e) the dealer's and regulator's access to all books and records maintained bythe service provider may be impaired.

Position #10

Unregistered corporations may provide certain services to a dealer and its salespersons,provided that:

(a) the dealer's ultimate responsibility and liability to clients is not affected bythese arrangements;

(b) the dealer is prohibited from contracting out supervision of trading and othercompliance functions to any service providers;⁽²⁴⁾

(c) commissions earned for the performance of registerable activities orfinancial services not subject to another regulatory regime must be paiddirectly to the salesperson; commissions cannot be paid to the salespersonthrough a service provider;

(d) the dealer must disclose in its application for registration which services arebeing contracted out and to whom;

(e) the dealer must file any new arrangements, or changes to existingarrangements, with the securities regulatory authorities; and

(f) for the purposes of carrying out their supervisory obligations, the dealer andregulator must at all times have access to the premises from whichsalespersons operate.

The third diagram presents an introducing and carrying dealer business structure. It isbased on structures that are available under SRO introducing and carrying dealer rules.Both the introducing dealer and carrying dealer are registered as dealers. The Committeeencourages the SROs to continue developing new variants of the introducing and carryingdealer models.

According to the IDA's Compliance Interpretation Bulletin C-111, "Introducing and CarryingBroker Arrangements", the purpose of the introducing and carrying arrangement is to allowa member of an SRO to utilize the back office facilities of another SRO member. Theservices provided by the carrier may include order execution, clearing and settlement,custody of funds and securities, and maintenance of books and records. The arrangementallows the introducing dealer to rationalize its own operations while retaining its tradingrelationship with customers.

The Committee is aware of the existence of non-registered corporations that do not limitthe services provided to dealers and their salespersons to those considered acceptableby the Committee, as described under the service provider business structure. As statedin Position #9, the Committee believes these structures are unacceptable. However, withall participants belonging to a fully operational SRO, such structures might be permissibleprovided that the previously non-registered corporation becomes registered as anintroducing dealer with the SRO. In the interim, however, the Committee doubts that anyamount of regulation, no matter how intricate, can overcome the added risks andimpediments to supervision and dealer liability presented by these structures.

Position #11

Dealers may only enter into arrangements involving multiple corporations when all thosecorporations are registered in an appropriate category of dealer or the arrangement is inaccordance with the service provider model.

IMPLEMENTATION

The Committee has stated a large number of positions as a means of achieving its shortand long term goals. Some can be implemented by policy, others by rule, and others willrequire legislative amendments. Much of the detail will be left to the SROs to determineand implement by way of SRO by-laws or regulations. It is clear that the positions mayhave a significant impact on the manner in which registrants organize and conduct theirbusiness operations. The Committee believes that its concerns are well founded, and itspositions flow from those concerns.

1. The terms "salespersons" and "salesperson" are used throughout this Position Paper. It is the Committee's intention that these terms be interpretedto include all personnel that interact with clients for the purpose of trading or advising in securities.

2. The expression "master and servant" has a precise legal definition but it is not an expression in common use. To facilitate ease of reference, the morecommon expression "employer and employee" will be used in this Position Paper.

3. In Québec, the introduction of the new regulatory regime in Bill 188, An Act respecting the distribution of financial products and services, may giveregistered firms the capacity to conduct mutual fund sales, life insurance sales and financial planning activities. Bill 188 activities must be conductedthrough the dealer (the firm). With the implementation of Bill 188, a representative would be allowed to perform different activities through differentfirms. Firms will be liable only for the activities performed through it. The books and records of a specific firm will contain transactions related onlyto a specific activity of its representative. Mutual fund activities should be performed under only one firm. But other financial activities can beperformed by a representative through different firms. Supervision of all firms in the financial activities prescribed by Bill 188 will be performed bythe Bureau des services financiers ("BSF").

The activities pursued by the representative that are governed by Bill 188 must be the representative's principal activity. Non-financial activities maybe performed if, as provided in the regulations under Bill 188, those activities are not incompatible with the duties imposed on the representative byBill 188.

4. In Québec, with respect to Bill 188 activities, dealers and their representatives, financial planners, insurance agents, and brokers will be supervisedby the BSF. Further, restricted dealers and their representatives must disclose their registration category along with the full name of the dealer in allcommunications with clients.

5. Exempt securities in Québec are deposits and government debt instruments. The distribution of those securities is, amongst other things, part ofan insurance agent's function, and the distribution of the products, record keeping, and supervision will be performed by the firm that is responsiblefor the insurance activities of the representative. In the case of an independent representative, the supervision will be performed by the BSF.

6. In Saskatchewan, agents who sell guaranteed investment certificates ("GICs")are subject to reporting requirements and to business practice rules.

7. In Ontario, GICs are not securities. However, limited market dealers ("LMDs") that are licensed to sell only NP 39 mutual funds pursuant to NP 36simplified prospectuses cannot, without express permission, sell GICs. It follows that in Ontario, notwithstanding the status of GICs, the Committee'sposition on securities sold under exemptions will apply to LMDs whose registration is restricted to the sale of NP 39 mutual funds.

8. By "registered" the Committee intends that the trade name be registered for purposes of the general law of the relevant jurisdiction. For example, insome jurisdictions this involves filing of a declaration of trade name with the appropriate authority.

9. The Committee's position will not require the registration, etc. of trade or corporate names used by registrants to conduct financial services that aresubject to another regulatory regime. For instance, where a registrant is dually licensed to sell insurance products and does so through his owncorporation, that corporation's name will not be affected by this requirement as long as the registrant does not conduct registerable activities, orfinancial services not subject to another regulatory regime, through that corporation.

10. The CVMQ requires restricted dealers and their representatives to disclose their registration category along with the dealer's full legal name. Tradenames must also comply with the Regulation respecting titles similar to the title of a Financial Planner. In British Columbia, the dealer's name, asregistered, must be at least equal in size and prominence as any trade name or trademark used in communications with the public.

11. In Québec, under Bill 188, representatives will not be permitted to use trade names or trademarks.

12. In this position, "acceptable entity" means an entity that is regulated in the context of financial regulation. It does not include, for example, lawyersor accountants.

13. National Instrument 14-101 Definitions s.1.1(3):

"Canadian financial institution" means a bank, loan corporation, trust company, insurance company, treasury branch, credit union or caisse populairethat, in each case, is authorized to carry on business in Canada or a jurisdiction, or the Confédération des caisses populaires et d'économie Desjardinsdu Québec

14. In Québec, registrants are not permitted to enter into referral fee arrangements with unregulated entities. All agreements must be filed with the CVMQ.The first agreement is approved by the CVMQ, and all subsequent agreements, that are the same as the first, need only be filed. At the time of writing,the regulations that will govern these activities under Bill 188 have not been drafted.

15. Québec has established a regulatory regime for financial planners. Accordingly, this initiative is being conducted without the participation of theCVMQ.

16. In Québec, financial planning activities will be performed by a representative through the appropriately registered firm. These financial planningactivities will be regulated by the BSF, which will, for mutual funds, insurance, and financial planning, act as an SRO.

17. The Committee recognizes and accepts that supervision of financial planning activities will involve processes that are different from those involvedin supervising securities trading. However, the Committee expects that dealers will achieve the same level of supervision, through the adoption ofappropriate processes. In particular, the Committee contends that supervision must include the review of financial plans by persons who are qualifiedto perform financial planning activities.

18. See for example: Druiven v. Warrington [1998] O.J. No. 679 (Ont. Ct. Gen. Div.) This case raises uncertainties as to the extent that a client willbe protected by a dealer's vicarious liability for the actions of its salespersons.

In Québec, Bill 188 creates a connection of responsibility between the firm (the dealer) and its representatives, whatever the relationship that existsbetween the representative and the firm. Bill 188, section 80 makes the firm responsible for any loss suffered by the client due to the fault of the firm'srepresentative in the performance of his functions. The representative's function is not linked to the nature of the relationship that exists between therepresentative and the firm.

19. In Québec, Bill 188 requires that, when registering, the firms must demonstrate that every non-employee representative acting on its behalf has liabilityinsurance that satisfies the requirements of the regulations made under Bill 188.

20. Independence of action is, perhaps, the most striking attribute that distinguishes between the relationship of independent contractor and that ofprincipal and agent. An independent contractor works in accordance with his own methods. The principal does not control these methods. This isnot, however, the only distinguishing feature of an independent contractor.

21. In Québec, under section 13 of Bill 188, securities representatives are not permitted to pursue their activities as an independent representatives, orpartners or employees of an independent partnership. Securities representatives must act for a registered firm; financial planners and insuranceagents may act for a registered firm or as an independent representative or as a partner or employee of an independent partnership.

22. In Québec, the receipt of commissions is considered conclusive evidence that the person receiving the commission has been performing acts infurtherance of trades in securities.

23. In Québec, the possibility of creating new categories of registrants is not reflected in Bill 188.

24. It has been suggested that compliance can be contracted out. The Committee rejects this suggestion. The Committee views the compliance functionas integral to the daily operations of a dealer. The introducing and carrying model disclosed below may require amelioration of this prohibition, butthis would occur only in circumstances where the CSA is satisfied that the proposed compliance regime is appropriate.