December , 2014
Supervision
on vacation , compliance out of sight
The Hearing Panel’s decision dated November 21, 2014, is available at: http://docs.iiroc.ca/DisplayDocument.aspx?DocumentID=E3CCCA84688043EBB50218E0C0801C75&Language=en .
Specifically, the Hearing Panel found that Mr. Matthews committed the following violations:
a) Between approximately January 2009 and May 2012, Mr. Matthews failed to use due diligence to ensure that recommendations were suitable for four clients, based on factors including the client’s financial situation, investment knowledge, investment objectives and risk tolerance, contrary to IIROC Dealer Member Rule 1300.1(q);
b) Between approximately June 2010 and May 2012, Mr. Matthews engaged in discretionary trading with respect to the accounts of one client, without being authorized and approved as having discretionary authority, contrary to Dealer Member Rule 1300.4;IIROC Notice 14-0289 Enforcement Notice/News Release – In the Matter of Grant Patrick Matthews – Discipline decision - Liability
c) In December 2008, Mr. Matthews engaged in discretionary trading with respect to the accounts of one client, without being authorized and approved as having discretionary authority, contrary to Dealer Member Rule 1300.4; and
d) Between January 2009 and March 2011, Mr. Matthews engaged in improper practices by excessively trading in (churning) the accounts of three clients, for the sole purpose of generating additional commissions, contrary to Dealer Member Rules
These are fine regulator-speak words but let's take a closer look at what really happened to one of the clients in more detail , client EF. Source : http://www.iiroc.ca/Documents/2014/5e35ee7b-0a06-4618-a4f3-b90971a9ef33_en.pdf
Know your Client (KYC): Client -
EF is a 69 year old retired widow. She has a high school education,
and was a homemaker for much of her working life. She also worked at
one time as a franchisee operator of a lottery booth. Her late
husband, RF, worked as a custodian at a local high school before he
retired. Prior to that, he managed a gas stationer generally left the
household financial affairs and investment decisions to her
husband.11. A March 2004 New Client Account Form (“NCAF”) for
EF’s RRSP account stated that EF earned $40,000 per year from the
lottery booth, and RF earned $32,000 per year as a custodian. Their
stated liquid assets were $100,000, and their fixed assets were
listed as $300,000. The stated
[
emphasis ours] investment objectives
[ emphasis ours] were 50% long term growth, 50%
short term speculative, [ are these are
clear and proper objectives for a retiree?]
and her stated risk tolerance parameters were 50% medium and
50% high. At the
time, EF was 60 years old and her investment knowledge was listed as
“fair” [ whatever that means but we can be confident she didn't
understand the leveraged ETF's mechanics] . Her husband died in May
2010. Following her husband’s death, in June 2010, EF, met with
Matthews to sign estate documentation and discuss his future handling
of her accounts. She was then 67 years old. Do you think this is a well defined set of “objectives” for a person in this
financial situation? Do you think this is robust KYC or a setup for a
fee grab?
She completed an NCAF to open her TFSA
account, which stated that she was retired,
with a modest income of $32,000 per
year. The investment objectives were 25% income/50%
long term growth/25%
short term speculative, and the risk tolerance parameters were
changed to 33% low/33% medium/33%
high [ whatever that means].
The stated assets remained the same, as did the description of her
investment knowledge as “fair”.
Given the available information, her risk capacity , the
ability to absorb losses, was low . Losses in a TFSA cannot be offset
against capital gains. The word “ fair” is meaningless and it
appears to be a slick way to justify the risky trading strategy in
her TFSA account by portraying her as more knowledgeable than she
really is..
Following her husband’s death, EF
completed an NCAF for the TFSA, but not for her other accounts. There
are no account updates between June, 2010, and
EF’s transfer of her accounts to another firm in May, 2012 [
for us, this suggests a compliance systems problem] IIROC
notes that for the period of June 2010 onward, the stated investment
objectives and risk tolerance parameters were too aggressive for EF,
who was then a retired and recently widowed senior, with limited
assets and income. IIROC says Matthews failed
to learn and remain informed of the essential facts relative to EF
as the stated investment objectives and risk tolerance parameters
in her accounts were inconsistent with her true financial situation,
investment knowledge, investment objectives and risk tolerance. In
our view that is being disingenuous. We say Mathews deliberately set
it up so he would have a paper trail to show his actions were
consistent with a knowingly defective KYC document. He didn't fail,
he succeeded at deception.We also ask, where the heck was the
supervisor or Branch manager to prevent this obvious information
travesty? And why does the IIROC investigation report play word
games?
Suitability :EF's
investing knowledge was very limited so naturally IIROC has
concluded EF relied upon and followed Matthews’ recommendations for
the investments in her accounts. “This was particularly evident
during the time period of June 2010 onward, following her
husband’s death” IIROC notes. Did the Branch manager not notice
the change in pattern? In general, the nature of the trading in the
RRSP account [ her retirement fund] was focused
on frequent trades in medium to high risk securities. The medium risk
securities were primarily resource issuers trading on the TSX, and
the high risk securities were primarily commodity-based leveraged
exchanged traded funds (“LETF”) , a complex speculative product
that works on the basis of daily returns. There
were no low risk holdings according to IIROC yet the dealer's
systems did not detect this wholly unsuitable portfolio
construction.. From May 2010 to April 2012, the average hold period
for all securities was approximately 5 months. The
average hold period was just 38 days for positions in which
gains or losses were actually realized. In addition, although there
were some purchases made in the accounts of dividend-paying
securities, in many cases the securities were not held long enough
to be eligible to actually receive the dividends. By
now, you'd think someone at the dealer would have woken up to
the fact this poor retiree was being gamed. No such luck.
Between Jan. 2009 and Oct. 2010, there
were an incredible 66 LETF transactions, which resulted in
losses of $14,999
(including $7,805 in commissions).
The majority of the LETF positions were held for short time periods,
on average 2.74 days. However, there were 5 LETF trades which
were held for a much longer period, an average of 178 days, and
resulted in losses of $17,485. Between
June 2010 and May 2012, the total value of EF’s accounts declined
from $115,478 to $106,159, reflecting a loss of 8%. This
included the payment of commissions of $13,378. During the
same time period, the S&P TSX Composite Index increased by
5.29% for a differential of 13.5 %. During this time period, the
performance of her holdings was very volatile in comparison to the
overall market performance. The total value of her accounts ranged
between approximately $160,000 to $100,000. Such volatility is a sure
sign that account risk was high The dealer Reps recommendations were
not suitable for this client in light of her age, employment status,
investment knowledge , experience and true circumstances but
inexplicably they continued for a considerable time without dealer
intervention except to cash brokerage commission cheques.
Discretionary Trading : The
nasty “advisor” behaviour doesn't stop with unsuitable
investments. . During the period from June 2010 (after
her husband’s death) to May 2012, Matthews
made 113 trades ( about 1 trade per week!) in EF’s
retirement and savings accouterments tells us that EF says that she
instructed Matthews to “take care of her”, and that she “left
everything up to him”. She wanted him to continue the type of
trading activity that he had carried out with RF, as she had limited
investment knowledge. Gimme a break . During the material time, Mr.
Matthews executed many trades in EF’s accounts without confirming
the details of the trades with EF prior to their execution. The
hapless widow's retirement account savings were not designated as
discretionary by Leede but they happened anyways. Leede’s
supervision and systems failed to pick up on this in your face
financial assault.
What do we learn form this case ?
Clearly
, Risk tolerance does not match the trading patterns. It should have
been 100% speculative risk. Anything else is a compliance breach.
Investment knowledge is “fair”. An attentive supervisor should
not ever set up a speculative account for an investor with “fair”
investment knowledge. And of course Objectives did not match risk .
Despite the obvious, this exploitation carried on in plain view for a
prolonged period of time.
The
first lesson learned is therefore quite clear. The most basic systems
and processes were not in place at Leede . Nearly everything that
could be wrong , was wrong. The real culprit here is Leede Financial
. We do know the abusive practices by this individual impacted 4
other investors possibly many more at that Branch. IIROC tell us
it is standard practice for IIROC Investigation teams to consider the
issue of supervision whenever they are conducting an investigation of
a dealer Rep, and to investigate where there are indications of a
failure to supervise. However, given the confidential nature of their
investigations, they cannot confirm whether or not they have or had
an active investigation ongoing, unless and until any such matter
proceeds to disciplinary action, in which case it then becomes public
record when a Notice of hearing is issued. They assert that it is
general practice to prosecute cases involving a failure to supervise
by way of a separate Notice of Hearing before a separate Hearing
panel.
Here's some 2013 IIROC Enforcement statistics for 2013 that we think speak for themselves.:
There were 1690 complaints of which 280 originated from the public
There were 203 complaints involving unsuitable investments and 88 involving unauthorized trading
There were just 63 prosecutions of individuals by IIROC of which 19 involved suitability ,1 involved discretionary trading and just 4 involved supervision
There were only 12 prosecutions of dealers of which a mere 5 involved supervision ( this is for the entire year for all of Canada)
Fines imposed on individuals amounted to $4,382,500; only 10.5% of the penalties assessed against individual registrants were collected.
Fines imposed on dealers amounted to $2,220,000 ,about half that imposed on individuals; 98.1% of the penalties assessed against dealers were collected
What do these numbers suggest to you?
In the Mathews case we say that management was asleep or willfully blind at such horrific and highly visible and prolonged financial assault. This cannot and should not ever happen in the wealth management industry especially to multiple victims over such a extended period of time. The advocacy community, including a number of former and current Reps, is of the firm conviction that SRO's are spending too much time on disciplining Reps ( and not collecting fines) and not going after the root cause : Deficient supervision / compliance systems and a broken KYC system. The great Quality Control expert Edward Deming coined the rule: 85-97% of problems are the responsibility of management. We are convinced this is correct .This is why for every Rep prosecution we expect at least one corresponding supervisory prosecution and with much higher penalties and sanctions. A few strong high profile examples would change dealer behaviour real fast.
We argue that suspected supervisory breakdowns should have at least as high investigation priority than Rep prosecutions and should carry larger fines. This is further supported by the fact that Reps are usually fired but Branch managers often remain on to be negligent again in the future.
Hopefully, 2015 will see a lot more timely prosecutions of dealers for breakdowns in supervision , compliance and KYC deficiencies/adulteration.
The other BIG lesson . CAVEAT EMPTOR ! You are not dealing with “advisors” that are required to act in your Best interests.
Kenmar SRO surveillance Team
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