Of the many elements included in the Canadian Securities Administrators’ client-focused reforms, proposed rules around referral arrangements have garnered some of the strongest reaction.
In comment letters responding to the CSA’s proposals, which were released in June, industry organizations and advisors are arguing against changes to rules governing referrals between advisors and third-party experts, such as portfolio managers.
In addition to referral arrangements, the CSA proposed amendments to rules around KYP, KYC, suitability, conflicts of interest and relationship disclosure information. The deadline for submissions is Oct. 19.
The regulator wants to ensure that registrants only refer registered firms and individuals, and that they provide adequate written disclosure to clients. More importantly, the CSA’s proposals would limit referral arrangements to a three-year period, and any associated fees paid by or to a referrer couldn’t “exceed 25% of the fees or commissions collected from the client by the party who received the referral.”
Several commenters said the impact of the rules could be harsh.
The Institute of Advanced Financial Planners (IAFP) says in its submission that many of its Registered Financial Planner (RFP) members provide advice “in tandem” with a referral to portfolio managers, and that disclosure requirements for RFPs identify the compensation paid to each party.
“From our experience, clients benefit from this arrangement in that they receive both expert financial planning advice and separate investment management services for one low and clearly defined fee,” the letter from IAFP board chair Melanie Twietmeyer and president Jeff Wachman says.
Limiting the amount and duration of referral payments could mean clients receive financial planning advice for a limited time before finding “other portfolio arrangements that carry higher costs, and in doing so relinquish established, trusted relationships and a formula that not only works for them but that they understand,” the letter says.
The organization says its position on referral fees does not affect its stance on ongoing embedded commissions, noting that “some advisors or salespeople may be receiving compensation for services they are not providing, and we agree that this is not in the clients’ best interest.”
The OSC’s Investor Advisory Panel also raised concerns about the referral proposals. Chair Neil Gross’s letter said that limiting the duration of referral fee payments could lead advisors to retain clients better served by a referral to a portfolio manager or full-service dealer.
“This could also pose a problem if fees in general must increase to make 25% sufficient, in dollar terms, to maintain current levels of referrals,” the letter says.
The panel also said more guidance is required to distinguish referrals from shared-client service arrangements to know what counts under the three-year, 25% limits.
Concerns from practitioners
One MFDA advisor, Jamie Robb of Fiducia Wealth Management in Mississauga, Ont., writes that two-thirds of his revenue comes from a referral arrangement with an investment counsel/portfolio manager (ICPM), who’s able to offer more than just a regular mutual fund portfolio.
Under the arrangement, clients benefit from lower costs (which he outlines in an average breakdown), customized management, tax management and a long-term collaborative relationship between him and the managers he chooses.
“I attend every meeting with my clients and their portfolio manager,” he says.
Better risk management is also a benefit, he says, given the “discretionary nature of the ICPM referral structure provides a significant advantage over an advisor-traded/managed mutual fund portfolio.” Robb notes he’s a CFP and offers clients an engagement letter that clearly states his portion of their referral fees, alongside his fees for comprehensive planning.
While the CSA’s proposals don’t ban referral arrangements, Robb argues it “eliminates them as a legitimate business arrangement.” If the rules go through, he predicts he’ll lose clients: since he wouldn’t be comfortable telling his clients that a regular mutual fund portfolio is now better for them, he says the ICPM would retain their business. Robb says he could revamp his billing infrastructure, but the costs to the client would be higher.
Another commenter, advisor Chad Viminitz from RTR Advisory Group in Edmonton, is also concerned about maintaining relationships with clients who are dually served by portfolio managers. Setting a three-year time limit on referral arrangements will only result in “the client los[ing] their financial team, often the advisor/team they started with and want to continue with,” he writes.
“Some advisors will keep their clients in a higher, longer paying mutual fund portfolio, even though there is a better, lower cost option available” via referral arrangements, he says. Others may choose to “move clients between portfolio managers every 36 months to encourage payment, hence putting the clients[‘] portfolio at risk.”
Long time coming?
Issues with referral arrangements have been on regulators’ radar for years, said Debra Foubert, the OSC’s director of compliance and registrant regulation, during a regulatory panel at the 2018 IFIC Annual Leadership Conference in September.
She cited the OSC’s 2011 and 2013 annual reports for dealers, advisors and investment fund managers, both of which said referrals weren’t being done properly. The 2017 report said inadequate disclosure of arrangements is a repeat common deficiency.
The CSA’s referral fee proposals “were a surprise,” she said, even though efforts so far to review referral arrangements and remind registrants of the rules have done little to address regulators’ concerns.
The biggest issue that needs to be addressed, she said, is professionals can choose to continue working under long-term referral arrangements and “outside of the regulatory purview,” even after their registration lapses.