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MSN-0003

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Paige Ward

General Counsel, Corporate Secretary and Vice President, Policy

(416) 943-5838

pward@mfda.ca

MSN - 0003

Mar 16, 2001

(Updated Mar 4, 2013)

Introducing/Carrying Dealer Arrangements

MFDA Staff Notices are intended to assist Members and their Approved Persons in the interpretation, application of and compliance with requirements under MFDA By-laws and Rules. Notices make reference to these requirements and 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 non- registered 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 1998. 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, 1999.

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; and
  • 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, and 4 dealers, as defined in MFDA Rule 3.1.1 (Capital – Minimum Levels), to use the services of a carrying dealer. Accordingly, Levels 2, 3 and 4 dealers have the option of either using a carrying dealer or operating on a stand alone basis. A Level 1 dealer does not have such option and is required to use the services of a carrying dealer.

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 2.4.1 (Remuneration, Commissions and Fees – Payable by Member Only), except for Members operating in British Columbia and Alberta.

Rule 2.4.1 requires that remuneration be paid directly to the salesperson rather than the non- registered corporation of the salesperson. Accordingly, such arrangements can continue in the relevant jurisdictions, subject to the terms and 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 3.1.1 categorizes dealers into four different levels for capital purposes:

  • Level 1 – A dealer that does not hold client cash, securities or other property; and is required to introduce all of its accounts to a carrying dealer and is not otherwise registered in any other category of registration under securities legislation.
  • Level 2 – A dealer that does not hold client cash, securities or other property.
  • Level 3 – A dealer that holds client cash in a trust account but does not hold client 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 client securities or other property).

MFDA Rule 1.1.6 (Introducing and Carrying Arrangement) also refers to these dealer levels in setting out the permitted arrangements and the terms of those arrangements. For example, a Level 1 dealer is required to introduce all of its accounts to a single carrying dealer. Level 2, 3, and 4 dealers, however, have the option of introducing registered accounts to more than one carrying dealer.

Permitted Arrangements

A Member may enter into an introducing/carrying dealer arrangement provided:

  • A Member may only introduce accounts to an entity that is also a Member of the MFDA;
  • A Member may not introduce accounts to more than one Member (except for Level 2, 3, and 4 dealers who are permitted to introduce registered accounts to more than one Member. Please refer to paragraph 3 herein entitled “Registered Accounts” for more information);
  • The introducing and carrying dealer must enter into a written agreement in accordance with the provisions of Rule 1.1.6; and
  • The arrangement (including the form of agreement) and any amendment to or termination of the arrangement or agreement must be approved by the MFDA before it is to be effective.

Terms of the Arrangement

Minimum Capital

All carrying dealers must be Level 4 dealers, regardless of the activities they perform. Rule 3.1.1 requires Level 4 dealers to maintain $200,000 in minimum capital.

Introducing 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 account (but does not hold client securities or other property) and uses another Member to carry registered accounts on behalf of its clients, 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 client assets for an introducing dealer’s clients, the carrying dealer must report such client balances in its financial filings. For example, if a carrying dealer holds funds in trust for clients of its introducing dealers, the carrying dealer will, and the introducing dealer will not, report the funds held in trust on its annual audited Form 1 and 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 and held in trust for each introducing dealer. The comfort deposit may be reported by the introducing dealer as an allowable asset on its financial filings.

Segregation of Client Cash and Securities

Carrying Dealers

If a carrying dealer holds client cash or securities on behalf of its introducing dealer’s clients, the carrying dealer shall be responsible for holding and segregating such assets in accordance with the MFDA Rules.

Introducing Dealers

Level 1 and 2 dealers are prohibited from holding client cash and 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 client cash however, and Level 4 dealers may hold client cash as well as client securities. Accordingly, Level 3 and 4 dealers that are also introducing dealers are required to segregate such assets they hold on behalf of clients in accordance with the MFDA Rules.

Trust Accounts

If a carrying dealer holds cash on behalf of an introducing dealer’s clients, such cash must be held in a trust account maintained by the carrying dealer. It should be noted however, that introducing dealers that are either Level 3 or Level 4 dealers may operate their own trust accounts under the MFDA Rules.

Insurance

The introducing and carrying dealer are each individually responsible for maintaining insurance in accordance with the MFDA Rules. If a carrying dealer holds cash or securities on behalf of its introducing dealer’s clients, the amount of such client cash and 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 and holds client assets, such assets are to be included in the introducing dealer’s calculation of its “base amount” under the MFDA Rules.

Disclosure and Acknowledgement on Account Opening

At the time of opening each client account, the introducing dealer must obtain an acknowledgement in writing from the client that the introducing dealer has advised the client of the relationship between the introducing dealer and the carrying dealer and the relationship between the client and the carrying dealer.

Contracts, Account Statements, Confirmations, and Client Communications

The name and role of the carrying dealer must be shown on all contracts, account statements and confirmations for those accounts introduced to the carrying dealer by the introducing dealer.

In the case of introducing dealers that are Level 1 dealers, the name and the role of the carrying dealer must also be shown on all client communications, as defined in Rule 2.8.1 (Client Communications – Definition), advertisements and sales communications, as defined in Rule 2.7.1 (Advertising and Sales Communications – Definitions). The name and 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 dealer. Introducing dealers that are not either Level 2, 3 or 4 dealers need not disclose the name and role of the carrying dealer on any such documents relating to those accounts that it does not introduce to the carrying dealer.

Clients Introduced to the Carrying Dealer

A client that is introduced to a carrying dealer by an introducing dealer is considered to be a client of the carrying dealer for the purposes of complying with the MFDA Rules and By-laws with respect to the services it provides to the introducing dealer. For example, if a carrying dealer executes and settles a trade for a client of the introducing dealer, MFDA staff will consider that client to be a client of the carrying dealer for the purpose of ensuring the trade was executed and settled in compliance with the MFDA Rules.

Responsibility for Compliance

An important distinction between an introducing /carrying dealer arrangement involving an introducing dealer in Level 1 and 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 and the carrying dealer are jointly and severally responsible 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 account but can enter into an arrangement with a carrying dealer that operates a trust account. In such a case, only the carrying dealer is in a position to ensure the trust account is being operated in compliance with the MFDA Rules. It will be up to the introducing dealer and the carrying dealer to determine which entity will perform the compliance functions that are not directly related to the services provided by the carrying dealer. However, regardless of who actually performs the compliance functions, both the Level 1 introducing dealer and carrying dealer are responsible for compliance with all MFDA By-laws and Rules.

Unlike carrying dealers for Level 1 introducing dealers, carrying dealers for Levels 2, 3 and 4 dealers will be responsible for compliance only for those 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 client accounts to more than one carrying dealer for registered accounts 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 dealer. However, a carrying dealer for an introducing dealer that is in Level 1 may introduce registered accounts to another carrier. Accordingly, there may be instances where a carrying dealer may also be an introducing dealer.

For example, ABC Co. is a mutual fund dealer and 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. and decides to become an introducing dealer to ABC Co. ABC Co. uses two other organizations, RRSP Services Inc. and Registered Accounts Inc., to carry and administer registered accounts. In this case, ABC Co. would be a carrying dealer for XYZ Co. and would be a Level 4 dealer with the MFDA under Rule 3.1.1. ABC Co. would also be an introducing dealer of RRSP Services Inc. and Registered Accounts Inc. RRSP Services Inc. and Registered Accounts Inc. would also be Level 4 dealers with the MFDA since they carry the registered accounts for another Member, XYZ Co.


SUMMARY OF REQUIREMENTS

Required Standards Introducer
Level 1
Introducer
Level 2
Introducer
Level 3
Introducer
Level 4
  1. Must introducing and carrying dealers (including organizations that provide registered account services) be Members of the MFDA?
Yes Yes Yes Yes
  1. Can an employee of an affiliated financial institution, mutual fund company or investment dealer handle securities clearance, settlement and record keeping on behalf of the Member?
Yes. However, the Member remains responsible for those activities. Yes Yes Yes
  1. Can an introducing dealer introduce clients to more than one carrying dealer?
No Yes but only for registered accounts. Yes but only for registered accounts. Yes but only for registered accounts.
  1. What is the minimum capital requirement?
$25,000 $50,000 $75,000 $200,000
  1. Can an introducing dealer operate a trust account?
No No Yes Yes
  1. Who is responsible for insurance, the introducing dealer or the carrying dealer?
Each dealer is responsible for insurance. Each dealer is responsible for insurance. Each dealer is responsible for insurance. Each dealer is responsible for insurance.
  1. Does the introducing dealer have to disclose its relationship with the carrying dealer and the client’s relationship with the carrying dealer at account opening and
    receive written acknowledgement from the client?
Yes. Where the carrying dealer uses another carrying dealer for registered accounts, the name and role of both carrying dealers must be disclosed. Yes. Yes. Yes.
  1. Does the introducing dealer have to disclose the name and role of the carrying dealer to clients on all documents?
Yes. On all contracts, account statements, confirmations, client communications and advertisements and sales communications. Only on contracts, account statements and
confirmations.
Only on contracts, account statements and
confirmations.
Only on contracts, account statements and
confirmations.
  1. Does the introducing dealer have to disclose the name and role of the carrying dealer on contracts, statements and confirmations for all of its client accounts?
Yes. All accounts of the introducing dealer are carried. Only for those client accounts that are carried. Only for those client accounts that are carried. Only for those client accounts that are carried.
  1. Who is responsible for supervision and compliance?
Both the introducing
dealer and carrying dealer.
Introducing dealer, subject to carrying dealer also being responsible for those
functions it performs.
Introducing dealer, subject to carrying dealer also being responsible for those
functions it performs.
Introducing dealer, subject to carrying dealer also being responsible for those
functions it performs.
  1. Who is responsible for sending client statements?
Carrying dealer Introducing dealer. Carrying dealer is responsible for those accounts it carries. Introducing dealer. Carrying dealer is responsible for those accounts it carries. Introducing dealer. Carrying dealer is responsible for those accounts it carries.
  1. Who is responsible for maintaining client files and client documents (such as new account application forms, etc.)?
Both Introducing
dealer
Introducing
dealer
Introducing
dealer

DM #329305