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Bulletin #0624-C

For further information, please contact:

Caroline Ou
Manager, Financial Compliance
Compliance
For Distribution to Relevant Parties within your Firm

Cost-sharing Arrangements

During the year, the Financial Compliance department commenced a review of existing cost-sharing agreements between Members and related parties.

Approximately 95 Members had some form of cost sharing agreement in place with related parties.  Some Members had executed agreements for normal course operations (e.g. software, payroll, and statement printing), but other Members had agreements with a broader scope and were subject to a further review as part of this project.    The form of the agreements ranged from single-page documents to extensive multi-page agreements with many terms and conditions. 

While the nature of an agreement is understandably tailored to the transactions and entities themselves, certain concepts and principles should be considered in drafting cost sharing agreements.  For example, the agreement should provide sufficient clarity of the basis for which costs are allocated to the Member.   This MFDA Bulletin is intended to provide guidance to Members on the use and implementation of cost-sharing arrangements with affiliated and possible non-affiliated entities.  The next round of compliance examinations will include a more thorough analysis of any cost-sharing agreements and Members are advised to review their existing arrangements and update their agreements accordingly.

1. Outsourcing

Cost-sharing arrangements with affiliates are a form of outsourcing of services to another party.  Pursuant to MFDA Rule 1.1.3, Members that engage outside service providers are reminded to ensure that the outsourced services meet all applicable regulatory requirements.  Members must exercise due care, skill and diligence in the selection of any service provider to ensure that the service provider has the ability and capacity to effectively undertake the outsourced services.  In addition, procedures for monitoring the performance of the service provider on an ongoing basis should be established to ensure that services continue to be performed in compliance with all applicable regulatory requirements.

Members are allowed to delegate certain tasks and duties to other entities, but not the ultimate responsibility for compliance with MFDA By-laws, Rules, Policies, and Forms.  This requirement remains applicable for all service arrangements, regardless of whether they are with a related party.  Certain tasks cannot be outsourced or delegated.  For example, Members are required to keep adequate books and records for recording business transactions under Rule 5.1.   

2. Form 1 Reporting

The Form 1 is a set of regulatory financial statements and schedules prepared in a prescribed format containing a Member’s financial information.  The Form 1 is an integral tool for enabling the MFDA to monitor the financial status of its Members and ensure that Members’ financial processes and internal controls are in adherence with MFDA By-laws, Rules, Policies and Forms.  Members are required to submit monthly unaudited and annual audited Form 1 filings to the MFDA.

A Member’s reporting on its monthly and annual Form 1s should be done on a gross basis.  More specifically, the reporting should reflect the Member’s true operating activity and financial condition before any distributions or reimbursements relating to cost-sharing arrangements.  All revenues earned and expenses incurred by the Member in the normal course of operations should initially be reported on the Form 1.  Expenses include, but are not limited to, the following:

  • salaries
  • rent
  • audit and accounting
  • legal
  • MFDA fees
  • MFDA Investor Protection Corporation fees
  • financial institution bond insurance
  • back-office system
  • bank charges
  • office supplies

Any distribution of revenue or reimbursement of expenses under an agreement with another entity should be recorded independent of the initial transaction and not in lieu of it.

3. Transaction Terms

The services covered under the arrangement should be outlined in the agreement, along with a detailed calculation of the exchange amount, where possible.  The terms of settlement should also be specified (e.g. monthly, semi-annually, or annually).  Where balances are to be net-settled between entities, the intention should be included in the agreement.  In addition, the criteria for netting under International Financial Reporting Standards should be met.  According to International Accounting Standard 32, Financial Instruments:  Presentation:

  1. A financial asset and a financial liability shall be offset and the net amount presented in the statement of financial position when, and only when, an entity:
    1. currently has a legally enforceable right to set off the recognised amounts; and
    2. intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

4. Legal Terms

Contracts and agreements should be signed by signatories with the authority to legally bind the entities, and renewal and/or termination criteria should be outlined in the agreement.  Where an agreement contains multiple clauses, Members should be aware of clauses that could negate other terms of the agreement, especially MFDA requirements.  In addition, Members subject to a reorganization should consider the need to create successor agreements under the new corporate organizational structure.

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