In a recent decision of the BC Securities Commission (BCSC), the BCSC provides helpful guidance concerning when referral arrangements cross the line and become trading for which registration is required.
Chien-Hua Liu (Liu) and two affiliated corporations referred BC and Hong Kong investors to two issuers, leading to the purchase of over $6.5 million in securities, and earning nearly $450,000 in commissions.
In Re Liu, 2018 BCSECCOM 372, the BCSC scrutinized the details of the referral arrangements and determined that Liu and the corporate respondents had contravened section 34(a) of the BC Securities Act (the Act) by acting in furtherance of trades while not registered under the Act.
Liu is a registered insurance agent and former registrant under the Act for selling mutual fund securities. This registration lapsed in March 2013. During the material time, he was the sole shareholder and a director of NuWealth Financial Group (NuWealth), and the sole director and officer of CPFS Professional Financial Services Inc. (CPFS, together with NuWealth and Liu, the Respondents). CPFS was an insurance company which sold segregated funds and employed approximately 20 insurance agents, including Liu.
The Respondents entered into formal referral agreements with two companies: W, a registered exempt market dealer which sold only proprietary products; and GB, an issuer whose principal business was an early stage real estate development project.
Pursuant to these referral agreements, during the period between April 2013 and January 2016, NuWealth referred investors to W and GB, resulting in 160 trades of securities totaling $4,826,504.52 and CPFS referred investors to W and GB, resulting in 54 trades of securities totalling $1,696.878. Liu was personally involved in referrals which resulted in 48 trades totaling $1,713,070.80.
In the absence of direct evidence to the contrary, the BCSC accepted Liu’s evidence about the referral arrangements:
- he provided general promotional brochures about W and GB […] to investors, without any discussion of specific investments;
- he referred the investors to representatives of W and GB and, on occasion, assisted in setting up those meetings;
- he and other representatives of the corporate respondents attended seminars put on by W and GB. but none of the investors were ever at these sessions;
- he, NuWealth and individual brokers of CPFS received commissions from W and GB, as the case may be, for these referrals; and
- he believed that NuWealth, CPFS and their representatives also did what he testified that he had done himself.
The referral arrangements were terminated in late 2016.
The BCSC considered whether the Respondents were in breach of section 34(1), which provides that “A person must not…trade in a security… unless the person is registered in accordance with the regulations…”. The BCSC observed that the definitions of “trade” and “acts in furtherance” of a trade are intentionally broad in order to support the Act’s purpose of investor protection. These broad definitions include both direct and indirect conduct.
The BCSC rejected the notion that an introduction or referral was, in and of itself, an “act in furtherance” of a trade. Referrals occur on a spectrum and vary from uncompensated introduction to full service registrants offering a range of securities, to highly compensated introductions to issuers who offer limited securities. The context and circumstances will determine where a referral is on this spectrum and whether it is an act in furtherance of a trade within the meaning of the Act.
The BCSC set out a non-exhaustive list of factors that are material for determining where a referral falls on the spectrum:
- was there material (relative to the amount invested in securities) compensation paid for the referral?
- was that compensation tied to specific trades in securities? If so, this suggests that the referrer played a material role in causing the trade.
- what is the range of securities offered by the person to whom the investor is referred? If there is only one product, this suggests that the referrer anticipated a trade in that product as the likely outcome of the referral.
- was the investor receiving financial services from the referrer prior to the referral? An existing financial services relationship indicates a level of trust and that a referral would be more likely to be interpreted as a recommendation.
Each of these factors in this case supported a finding that the Respondents, in making referrals to W and GB, were engaged in acts in furtherance of trades and were therefore “trading” for the purposes of s. 34(a) of the Act.
The BCSC rejected the Respondents’ submission that since there was no evidence of investor harm there was no need to consider their referral activities to be “trades”. Investor protection concerns are raised in the circumstances regardless of whether any harm is established: the investors here could not benefit from the Respondents satisfying “know your product” and “know your client” obligations required of registrants.
The BCSC also rejected the Respondents’ reliance on the guidance set out in the Companion Policy to NI 31-103 regarding permissible referrals by registrants. Not only is the Companion Policy not binding on the BCSC, but also on a technical basis this only applies where registrants made referrals, which the Respondents were not.
The Respondents further submitted that they were entitled to an exemption as they were “not in the business of trading”. The BCSC disagreed, finding that by finding and soliciting a large number of investors, and connecting them with issuers over many months and in exchange for significant compensation, the Respondents were “in the business of trading”.
The Respondents made a number of submissions urging the BCSC to find that sanctions are not necessary and not in the public interest. The BCSC distinguished this case from others where such a finding was made at an early stage, and deferred these submissions to a later sanctions hearing. Written submissions on sanctions are scheduled for January 2019.