Introduction Arrangements

Louis P. Piergeti VP, IIROCMarch 29, 2011

NI 31-103 Requirements

NI 31-103 internal control requirement

ICB compliance

1. Functions outsourced by a securities registrant must be set out in a written legally binding contract

YesPrescribed type 1-4 written introduction agreements required to be executed and subject to IIROC approval.

2. Registrants remain responsible and accountable for all functions outsourced to a service provider

Yes Introducer contractually retains the services of the carrying broker.

No provision in the prescribed agreement permitting introducer to subrogate compliance with its regulatory responsibilities to customers.

Agreement provides for indemnities for errors or omissions by either party.

Dispute resolution mechanism referenced in the prescribed agreement to resolve commercial disputes.

NI 31-103 Requirements

NI 31-103 internal control requirement

ICB compliance

3. Arrangement must define all activities outsourced and responsibilities of the parties

YesResponsibilities differentiated by specific type 1-4 introduction agreements and ancillary services by supplementary schedules.

4. Registrant must conduct ongoing reviews of the quality of outsourced services

YesAnnual section 5970 audit report provided by carrying broker provides introducing broker with an assessment of adequacy of internal controls over services outsourced.

5. Arrangement must establish precise service and performance levels and how they will be monitored

Yes.Defined in the terms and conditions of the prescribed type 1-4 agreements. All carrying brokers agree to comply with IIROC rule requirements on record keeping, settlement, margining, segregation of securities, insurance etc.

NI31-103 requirements (cont’d)

NI 31-103 internal control requirement

ICB compliance

6. Registrants must have the same access to the work product of the third-party service provider as they would if the Dealer Member itself performed the activities.

YesProvision in the prescribed agreements require access to work product information to both the registrant and IIROC including by way of access to electronic databases.

Supplementary schedule to the prescribed introduction agreement references the work product information.

As both the Introducer and Carrying broker must be Dealer Members of IIROC - IIROC retains full jurisdiction over both entities and to access records as required.

7. Auditor of the registrant must have the same access to the work product of the third-party service provider.

YesIIROC Rule 300 set out specific audit requirements that include introduction arrangements.

8. Service provider must develop and test a business continuity plan

YesAs a rule requirement - all IIROC Dealer Members must have in place and test BCP.

NI31-103 requirements (cont’d)

NI 31-103 internal control requirement

ICB compliance

9. Agreement must cover termination and exit process to allow for transfer of the service to another service provider.

Yes.Agreement includes provision for terminations subject to IIROC approval.

10. Arrangement must consider other legal requirements such as privacy laws

YesSupplementary schedules to prescribed introduction agreement address PIPEDA requirements.

11. Service provider must have safeguards in place to keep information confidential

YesUndertaking provided by the Carrying Broker in the agreement to refrain from using any information for the purpose of solicitation of business from clients of the Introducing Broker.

Considerations in the event of a EW, CD or insolvency event of an introducer

• Type 1 and 2 carrying broker lien on an introducer’s comfort deposit is limited to customer credit risk exposure resulting from margin requirements, including unsecured debits. In the event of an insolvency of an introducer, the credit loss to the carrying broker may exceed the introducer’s comfort deposit.

• Type 3 and 4 introduction arrangements should include a clause in the supplementary schedules to the prescribed agreement requiring the introducer to promptly notify the carrying broker of material changes in the financial status of the firm such as early warning and capital deficiency occurrences.

• IIROC will notify all type 1 and 2 carrying brokers of early warning and capital deficiency occurrences and provide details of sanctions and business restrictions imposed on the introducer.

• IIROC will promptly notify all carrying brokers of membership suspensions and appointment of trustee for insolvency.

• The termination of all introduction agreements is subject to IIROC approval. All carrying brokers must co-operate with suspension or court orders that require continued service to introduced customer accounts. This may include instructions to close inventory and customer open contract positions, assign investment advisor to process customer orders to liquidate positions or cover short positions, carrying out customer instructions to transfer out.

• Customer protection priority for IIROC and CIPF is to work towards a successful bulk transfer of all customer accounts to another dealer as expeditiously as possible in the event of an insolvency or permanent suspension of an introducer.

Common deficiencies - Introducers

• Failure to reclassify comfort deposit as non-allowable asset for amounts representing margin lien by carrying broker to cover customer margin requirements.

• Failure to reclassify comfort deposit as non-allowable asset for amounts unsecured customer debit balances.

• Failure to provide inventory margin on securities processed through average price inventory accounts assigned by carrying broker for “all or none” customer trade orders.

• Inadequate credit risk management policies and procedures and/or failure to apply policies of the carrying broker to its customers.

• Failure to perform independent price verification on inventory holdings.

• Lack of procedures in place to monitor performance of certain outsourced functions such as monitoring of segregation of customer fully paid and excess margin securities.

• Failure to margin, report and/or reconcile trades jitnied with other brokers.

• Failure to report customer complaints on Comset.

Common deficiencies - Carriers

• Differing standards of due diligence work and risk assessment of prospective introducing clients.

• Inadequate policies and procedures to monitor and/or restrict introducer (type 1-3) customer and inventory funding requirements.

• Inadequate credit risk policies and procedures applied to type 1 and introducing customers.

• Failure to promptly notify introducer - in writing - of lien on comfort deposit taken to offset introducer customer margin requirements (including unsecured balances).

• Failure to provide appropriate customer margin for guaranteed fill customer trade orders processed though inventory accounts assigned to introducer for average price accumulation and client trade ticketing.

• Failure to provide annual section 5970 report to introducer and its auditors.

• Failure by auditors of carrying broker to include type 1 and 2 customer accounts in year-end confirmation process.