Preventing investor abuse and fraud: a key role for regulators

March , 2016

Preventing fraud: a key role for regulators

Regulators have a huge role to play in preventing investor fraud and abuse . The Investment Industry Regulatory Organization of Canada ( "IIROC” ) asserts that : Protecting Investors and Fostering Fair and Efficient Capital Markets across Canada" is their role yet when victims complain they are too often met with a dismissive response : “ We have determined that the matter does not currently meet our threshold for initiating disciplinary action. IIROC does not provide a substantive report to any party involved in our review process."

Here's a prime example where prompt and firm regulatory action can help prevent or at least reduce investor abuse and fraud . The know-your-client (KYC) suitability obligation is among the most fundamental obligations owed by dealers to their clients and is a cornerstone of the investor protection regime. Yet far too often we hear complaints about the subversion of the KYC process .Examples:

1 Rep do not properly apply investor information in completing the KYC / NAAF forms.

2. Rep improperly apply risk tolerance as medium/high on instead of low on the KYC forms.

3 Reps misstate the client's investing experience elevating it beyond reality

4. Rep ask clients to sign blank forms or change them after they are signed

5 Reps downplay the KYC by saying it is just administrative paper from the investment firm.

6. Reps do not provide clients with a final signed and dated copy. to read

7. Reps mislead clients as to the meaning of terms on the NAAF and the importance of the form in determining suitability.

The inevitable result is the sale of unsuitable investments and losses for investors.

Complaints about the KYC process should give rise to a full investigation by IIROC. By summarily dismissing the complaint , the IIROC is in effect downplaying the value of KYC especially for an industry that now promotes itself as trusted wealth managers. It is no wonder that year after year we see the same complaints arise. The general deterrent value of inaction is zero. Instead ,we recommend IIROC adopt a "Broken windows " approach to regulatory enforcement. A zero tolerance approach would cut down on blank signed forms, signature forgery , “papered” KYC's and adulterated NAAF's. This approach would quickly grab the attention of dealers and lead to changed behaviours resulting in improved investor assessment , risk profiling practices and portfolio outcomes

Further ,the dismissive response to investor complaints is not neutral. There are several downsides to IIROC's prevailing practices that can actually harm retail investors . These include but are not limited to:

(a) It wastes victim's time in filing a complaint
(b)The IIROC response is used by IIROC member dealers to deny victim restitution claims
(c) It may affect OBSI's efforts to effect a facilitated settlement

(d) It unduly discourages investors from proceeding with the complaint
(e) It creates a false impression that the IIROC decision is robust and fair
(f) It sets a bad role model example for dealers in their handling of retail investor complaints
(g) It restrains the industry from moving from a low suitability framework to advice that is professional
It also reflects poorly on IIROC and the investment industry leading to investor cynicism .

Kenmar have also provided a detailed report to IIROC that its dealer complaint handling rules are inadequate to protect retail investors. For example , dealers continued use of so-called " internal ombudsman" have had the adverse effect of reducing client claims and subverting OBSI .Action to date: NIL.

There is clear and convincing evidence that IIROC 's idea of investor protection is far from that expected and needed by investors .We urge IIROC to review its policies and practices with a view to making its claim to protecting investors credible by diligently preventing and reducing investor abuse and fraud.

With its Recognition Order as a Self-Regulating Organization , the CSA has given IIROC not only the right but the obligation to protect investors. In effect, IIROC has been given the privilege and honour to be the national regulator for Retail investors. We do not believe this obligation is being adequately fulfilled starting from governance and investor engagement right through to enforcement and complaint investigation.Reforms are urgently required.

In the interim , it's CAVEAT EMPTOR for retail investors .

Kenmar Associates