MFDA STAFF NOTICE INTRODUCING/CARRYING DEALER ARRANGEMENTS

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1 Contact: Paige Ward General Counsel Vice-President, Policy Phone: (416) MSN-0003 March 16, 2001 (Updated March 4, 2013) MFDA STAFF NOTICE INTRODUCING/CARRYING DEALER ARRANGEMENTS MFDA Staff Notices are intended to assist Members their Approved Persons in the interpretation, application of compliance with requirements under MFDA By-laws Rules. Notices make reference to these requirements set out MFDA staff's interpretation of how to comply with these requirements. Notices may also include best practices or guidance. Background The MFDA Distribution Structures Industry Committee (the "Committee") was established to provide recommendations to the MFDA regarding acceptable industry structures, including nonregistered incorporated salesperson structures. The Canadian Securities Administrators ("CSA") found such structures to be unacceptable as stated in their Distribution Structures Position Paper published in August Accordingly, the Committee developed recommendations that attempted to accommodate existing structures but which also complied with the CSA's Position Paper. The Committee recommended an introducing/carrying dealer model as a potential solution to existing non-registered incorporated salesperson structures. This model was included in the MFDA draft Rules that were submitted to the securities commissions on December 22, In June 2000, the MFDA draft Rules were published for a 90-day public comment period. The MFDA received comments with respect to the introducing/carrying dealer model to the effect that: the introducing/carrying dealer model reflected in the MFDA draft Rules did not adequately accommodate all of the existing industry arrangements; carrying dealer arrangements should be permitted for all dealer levels. In response to the public comments, the MFDA amended its introducing/carrying dealer rules to also allow Level 2, 3, 4 dealers, as defined in MFDA Rule (Capital Minimum Levels), to use the services of a carrying Accordingly, Levels 2, 3 4 dealers have the option of either using a carrying dealer or operating on a st alone basis. A Level 1 dealer does not have such option is required to use the services of a carrying Page 1 of 7

2 In addition, as set out in MFDA Staff Notice MSN-0001 Payment of Commissions to Non- Registered Entities, there was a 3-year transition period for MFDA Rule (Remuneration, Commissions Fees Payable by Member Only), except for Members operating in British Columbia Alberta. Rule requires that remuneration be paid directly to the salesperson rather than the nonregistered corporation of the salesperson. Accordingly, such arrangements can continue in the relevant jurisdictions, subject to the terms conditions set out in the above MFDA Notice. Affected parties will therefore not have to become introducing dealers in order to continue with such remuneration structures for the duration of the transition period. Rule categorizes dealers into four different levels for capital purposes: Level 1 A dealer that does not hold cash, securities or other property; is required to introduce all of its s to a carrying dealer is not otherwise registered in any other category of registration under securities legislation. Level 2 A dealer that does not hold cash, securities or other property. Level 3 A dealer that holds cash in a trust but does not hold securities or other property. Level 4 A dealer that acts as a carrying dealer, or any other dealer not covered by Level 1, 2 or 3 (i.e. a dealer that holds securities or other property). MFDA Rule ( Carrying Arrangement) also refers to these dealer levels in setting out the permitted arrangements the terms of those arrangements. For example, a Level 1 dealer is required to introduce all of its s to a single carrying Level 2, 3, 4 dealers, however, have the option of introducing registered s to more than one carrying Permitted Arrangements A Member may enter into an introducing/carrying dealer arrangement provided: A Member may only introduce s to an entity that is also a Member of the MFDA; A Member may not introduce s to more than one Member (except for Level 2, 3, 4 dealers who are permitted to introduce registered s to more than one Member. Please refer to paragraph 3 herein entitled "Registered Accounts" for more information); The introducing carrying dealer must enter into a written agreement in accordance with the provisions of Rule 1.1.6; The arrangement (including the form of agreement) any amendment to or termination of the arrangement or agreement must be approved by the MFDA before it is to be effective. Page 2 of 7

3 Terms of the Arrangement Minimum Capital All carrying dealers must be Level 4 dealers, regardless of the activities they perform. Rule requires Level 4 dealers to maintain $200,000 in minimum capital. dealers may fall within any of the various dealer levels. They are therefore required to maintain capital in accordance with the various levels established in Rule 3.1.1, like any other dealer in that particular dealer level. For example, an introducing dealer which operates a trust (but does not hold securities or other property) uses another Member to carry registered s on behalf of its s, would be considered a Level 3 dealer for the purpose of capital requirements. As a Level 3 dealer, it would be required to maintain $75,000 minimum capital. Reporting Client Balances If a carrying dealer holds assets for an introducing dealer's s, the carrying dealer must report such balances in its financial filings. For example, if a carrying dealer holds funds in trust for s of its introducing dealers, the carrying dealer will, the introducing dealer will not, report the funds held in trust on its annual audited Form 1 on its monthly Financial Report. Comfort Deposit The MFDA does not require an introducing dealer to provide the carrying dealer with a comfort deposit. However, where a carrying dealer does obtain a comfort deposit from an introducing dealer, such deposit must be segregated held in trust for each introducing The comfort deposit may be reported by the introducing dealer as an allowable asset on its financial filings. Segregation of Client Cash Securities Carrying Dealers If a carrying dealer holds cash or securities on behalf of its introducing dealer's s, the carrying dealer shall be for holding segregating such assets in accordance with the MFDA Rules. Dealers Level 1 2 dealers are prohibited from holding cash securities under the MFDA Rules. Therefore for introducing dealers in either of these capital levels, the segregation requirements are not relevant. Level 3 dealers may hold cash however, Level 4 dealers may hold cash as well as securities. Accordingly, Level 3 4 dealers that are also introducing dealers are required to segregate such assets they hold on behalf of s in accordance with the MFDA Rules. Page 3 of 7

4 Trust Accounts If a carrying dealer holds cash on behalf of an introducing dealer s s, such cash must be held in a trust maintained by the carrying It should be noted however, that introducing dealers that are either Level 3 or Level 4 dealers may operate their own trust s under the MFDA Rules. Insurance The introducing carrying dealer are each individually for maintaining insurance in accordance with the MFDA Rules. If a carrying dealer holds cash or securities on behalf of its introducing dealer s s, the amount of such cash securities held are to be included in the calculation of the carrying dealer s base amount for the purpose of calculating insurance coverage requirements under the MFDA Rules. If, however, an introducing dealer is a Level 3 or 4 dealer holds assets, such assets are to be included in the introducing dealer s calculation of its base amount under the MFDA Rules. Disclosure Acknowledgement on Account Opening At the time of opening each, the introducing dealer must obtain an acknowledgement in writing from the that the introducing dealer has advised the of the relationship between the introducing dealer the carrying dealer the relationship between the the carrying Contracts, Account Statements, Confirmations, Client Communications The name role of the carrying dealer must be shown on all statements confirmations s introduced to the carrying dealer by the introducing In the case of introducing dealers that are Level 1 dealers, the name the role of the carrying dealer must also be shown on all communications, as defined in Rule (Client Communications Definition), advertisements sales communications, as defined in Rule (Advertising Sales Communications Definitions). The name role of the introducing dealer may also be shown on such documents provided it is in equal or lesser size to that of the carrying dealers that are not either Level 2, 3 or 4 dealers need not disclose the name role of the carrying dealer on any such documents relating to those s that it does not introduce to the carrying Clients Introduced to the Carrying Dealer A that is introduced to a carrying dealer by an introducing dealer is considered to be a of the carrying dealer for the purposes of complying with the MFDA Rules By-laws with respect to the services it provides to the introducing For example, if a carrying dealer executes settles a trade for a of the introducing dealer, MFDA staff will consider that to be a of the carrying dealer for the purpose of ensuring the trade was executed settled in compliance with the MFDA Rules. Page 4 of 7

5 Responsibility for Compliance An important distinction between an introducing /carrying dealer arrangement involving an introducing dealer in Level 1 introducing/carrying dealer arrangements involving introducing dealers in Levels 2, 3, or 4 is that, in an arrangement with a Level 1 dealer, both the introducing dealer the carrying dealer are jointly severally for compliance. However, from a practical perspective, certain compliance functions must remain with the carrying dealer based upon the nature of the services the carrying dealer is providing. For example, a Level 1 dealer is prohibited from operating a trust but can enter into an arrangement with a carrying dealer that operates a trust. In such a case, only the carrying dealer is in a position to ensure the trust is being operated in compliance with the MFDA Rules. It will be up to the introducing dealer the carrying dealer to determine which entity will perform the compliance functions that are not directly related to the services provided by the carrying However, regardless of who actually performs the compliance functions, both the Level 1 introducing dealer carrying dealer are for compliance with all MFDA By-laws Rules. Unlike carrying dealers for Level 1 introducing dealers, carrying dealers for Levels 2, 3 4 dealers will be for compliance only specific functions they agree to perform for their introducers. Registered Accounts An introducing dealer that is also either a Level 2, 3, or 4 dealer may introduce s to more than one carrying dealer s only. An introducing dealer that is a Level 1 dealer may enter into only one introducing/carrying dealer arrangement under the MFDA Rules. That is to say they are limited to using the services of only one carrying However, a carrying dealer for an introducing dealer that is in Level 1 may introduce registered s to another carrier. Accordingly, there may be instances where a carrying dealer may also be an introducing For example, ABC Co. is a mutual fund dealer some of ABC Co's salespeople start their own mutual fund dealer called XYZ Co. XYZ Co. wants to retain its relationship with ABC Co. decides to become an introducing dealer to ABC Co. ABC Co. uses two other organizations, RRSP Services Inc. Registered Accounts Inc., to carry administer registered s. In this case, ABC Co. would be a carrying dealer for XYZ Co. would be a Level 4 dealer with the MFDA under Rule ABC Co. would also be an introducing dealer of RRSP Services Inc. Registered Accounts Inc. RRSP Services Inc. Registered Accounts Inc. would also be Level 4 dealers with the MFDA since they carry the registered s for another Member, XYZ Co. DM# Page 5 of 7

6 SUMMARY OF REQUIREMENTS Required Stards 1. Must introducing carrying dealers (including organizations that provide registered services) be Members of the MFDA? 2. Can an employee of an affiliated financial institution, mutual fund company or investment dealer hle securities clearance, settlement record keeping on behalf of the Member? 3. Can an introducing dealer introduce s to more than one carrying dealer? 4. What is the minimum capital requirement? 5. Can an introducing dealer operate a trust? 6. Who is for insurance, the introducing dealer or the carrying dealer? 7. Does the introducing dealer have to disclose its relationship with the carrying dealer the 's relationship with the carrying dealer at opening receive written acknowledgement from the? 8. Does the introducing dealer have to disclose the name role of the carrying dealer to s on all documents? Introducer Introducer Introducer Introducer Level 1 Level 2 Level 3 Level 4 Yes Yes Yes Yes However, the Member for those activities. No. However, the Member activities. Yes but only s. However, the Member activities. Yes but only s. However, the Member activities. Yes but only s. $25,000 $50,000 $75,000 $200,000 No. No. for insurance. Where the carrying dealer uses another carrying dealer s, the name role of both carrying dealers must be disclosed. On all statements, confirmations, communications for insurance. for insurance. Only on statements confirmations. Only on statements confirmations. for insurance. Only on statements confirmations. Page 6 of 7

7 9. Does the introducing dealer have to disclose the name role of the carrying dealer on statements confirmations for all of its s? 10. Who is for supervision compliance? 11. Who is for sending statements? 12. Who is for maintaining files documents (such as new application forms, etc.)? advertisements sales communications. All s of the introducing dealer are carried. Both the introducing dealer carrying Carrying Both. Only s that are carried. dealer, subject to carrying dealer also being functions it performs. Carrying dealer is s it carries. Only s that are carried. dealer, subject to carrying dealer also being functions it performs. Carrying dealer is s it carries. Only s that are carried. dealer, subject to carrying dealer also being functions it performs. Carrying dealer is s it carries. Page 7 of 7