Compliance and Investment Licensing – Jason’s Corner

I have had several questions and conversations of late about what licensing is required to transact in securities. This article is a summary of those conversations but is not a thorough examination of securities laws. If you have questions about your own situation, you are encouraged to engage a securities lawyer or your internal compliance department.

Keep in mind that your internal compliance department is primary concerned with the firm’s outcomes and not your personal outcomes. That said, keeping the firm out of trouble usually also means keeping the advisor out of trouble. No criticism is intended of compliance departments. Most compliance professionals that I have worked with over the years are top-notch and are genuinely interested in arriving at helpful solutions to challenging problems.

The specific question that comes across my desk on a regular basis is: “Do I need an investment license?” or “Can I drop my MFDA license?” There are several versions of this, and I know many advisors who have deliberately made this decision. I believe the heart of the problem is what are seen as onerous compliance requirements from MFDA firms. My hope is that you speak to your compliance department about anything you find onerous, and you don’t just start making plans to leave at the first sign of trouble. I find, when asked, compliance officers usually have excellent reasons for the policies they enforce.

If you want to continue delivering financial advice, but you don’t want to have an ongoing relationship with the MFDA, what are your alternatives?

1. Exit the securities business altogether. One can simply stop selling any securities products and only deliver other forms of advice. This might mean selling insurance under an insurance license and/or offering financial planning advice for a fee. My biggest concern with this model is that the regulatory restrictions on offering securities advice are not subject to a bright-line test. It’s probably okay to offer broad commentary, such as “You should be in a 60/40 portfolio.” But anything that might be interpreted as a specific securities recommendation is likely offside. So if I tell my client, “You should be using VBAL” that might be considered offside by securities regulators, who have very little sense of humour in such matters.
2. Offer only segregated funds and annuities. Absent a securities license, it is possible (though prohibited by some firms) to sell segregated funds and annuities to clients who have assets to invest. I have some concerns with this model:
   • While it’s not always the case, seg funds tend to have higher fees than mutual funds or ETFs. The advisor selling on a seg fund-only platform must have a reasonable explanation for any additional fees their client might be paying. We don’t want to prove Questrade right, after all. And if you’re using the guarantees as the justification for higher fees, be very careful. The mathematical justification simply isn’t there, unless your client is ‘lucky’ enough to die in the first 5 or so years at the same time as there is a bear market.
   • Lack of Indexing Products. The evidence continues to mount in favour of index investing. There are very few seg fund products that feature a fully indexed option for investors.
   • Lack of Compliance Oversight. There is a benefit to a second set of eyes reviewing transactions and asset allocations. With seg funds, this is not as likely to happen. This can expose the client to potential unnecessary losses (or missed opportunities) and the advisor to additional risk.
3. Work in a referral model. There are many third-party portfolio managers (PMs) that operate on a referral basis. It is possible to have those asset managers take on all investment-related matters, including compliance, asset allocation, and responsibility for transactions and pay a referral fee, such as .5% of assets under management, to the advisor. I do like this model, and I might operate this way if I were going into the advisory business today. A variation on this model would see a small advisory team where one person is ‘the insurance person’ and another is ’the investments person.’

To nobody’s surprise, I have some concerns:

1. Relationship ownership. Who owns the client relationship? What if you become unhappy with the service offered by your chosen PM? How easy is it to move the client? Alternately, as happened with a high-profile digital asset manager, what happens when the service in question is no longer offered due to a shift in strategy or a cost-cutting measure?
2. Path of liability. If the client ends up in a loss situation, who gets sued? Does the advisor’s E&O insurance step in for an activity the advisor isn’t licensed for? As many advisors have warned me, ‘if you’re in this business long enough, eventually there will be a lawsuit.’
3. Regulatory change. I have heard from more than one trustworthy source that regulators are sniffing around these arrangements, perhaps concerned that advisors are delivering investment advice inappropriately, or that advisors should have some degree of liability, but are skirting that with these arrangements. I don’t think this is a reason not to change, but I do think that advisors should not be surprised if at some point, regulators clamp down.

Of course, there are also options to license through IIROC, or to switch to an exempt markets license, or to license as a discretionary manager directly through the provincial securities commission. I would suggest that none of those models result in a substantially lower compliance burden than MFDA licensing, though an argument can be made for the exempt markets license. That is an issue that I may explore in a future post.

What have you seen? What are your thoughts about the different models? What have I missed? Thanks so much for reading, and enjoy your continued studies!