Fine collection, IIROC and Best interests

Fine collection, IIROC and Best interests

In a recent paper released by the Small Investor Protection Association (SIPA) , it was determined that there is more than $899,216,448.32 in fines owing to Canadian regulators. A huge number by any standard.

The paper, “Unpaid fines: a national disgrace” was released by SIPA to raise awareness of the issue of unpaid fines for breaches of financial services regulation levied by regulators against individuals or firms.The report breaks down fines based on provincial commissions as well as Canada’s mutual fund and securities regulators.

“Unpaid fines contribute to a breakdown of trust in the system and reduced investor protection,” writes Debra McFadden, who authored the report for SIPA. “Better collection of fines is needed but a legislated fiduciary standard for advice giving would reduce the number of complaints and lead to better financial outcomes for retail investors.”

While the biggest amount owing isn't related to The Investment Industry Regulatory Organization of Canada ( IIROC ) we want to emphasize IIROC as it is in effect Canada's national regulator for retail investors. The comments we make here apply also to the Mutual Fund Dealer Association (MFDA) . The IIROC figure is $27,941,793.00 and the MFDA total is $56,793,709.71 (includes costs imposed).To stay in the business, both firms and individuals are required to pay the fines that are levied.

The fines relate to a myriad of investor abuses , including misappropriating client funds; providing fictitious account documents to the client; forging signatures; unauthorized trading; outside business activities , off book transactions and engaging in personal financial dealings with a client . It is not known the extent to which employers compensated the clients for such activities.The large amount of fines whether collected or not are a sign of a far deeper issue with advice giving in Canada.

According to the SRO's, somewhere between 80 and 90 % of fines imposed on individuals are never collected.This is the main issue. Unpaid fines on such a scale make a mockery of the enforcement system and the general deterrence value of fines. This needs to be changed.The core issue is that dealers are not held accountable for the actions and inactions of their staff/ agents. If they were ,there would be a small collection problem.If a carpet cleaner ruins your rug , the firm , not the individual is held accountable. The financial services industry immunized themselves by having regulators chase the small fry who often can't pay or go bankrupt.This has zero deterrent value and reflects poorly on the industry and its regulation. Still, until the system is fixed, better fine collection is needed .

In two provinces, Alberta and Quebec, IIROC can pursue individuals after they leave the investment industry - a power it said it has used on occasions.In Alberta, the collection rate between 2008 and 2014 was 35.75%, compared to 17.6% nationwide.In Quebec, the collection rate for personal fines was 59% in 2014 (the first full year that the court enforcement power existed), compared to 17.3% nationwide. It wants Ontario regulators to have the same power. Andrew Kriegler, chief executive officer of the Investment Industry Regulatory Organization of Canada, asked the Ontario government’s standing committee on finance and economic affairs for legislative reform – stating the regulator’s unpaid fines in Ontario was largely due to the organization’s lack of power to enforce collection.We certainly agree with this as it will improve deterrence at least on the margin. We would expect to see that (a) any fines uncollected after one year will be to the account of the dealer and (b) the proceeds be used for investor education , outreach, research.,formation of an investor advisory Panel or restitution.

Over the years investor advocates have provided regulators with many ideas to imprive fine collection :

Improve supervisory controls over Reps -prevent problems

Require firms / staff to have appropriate insurance coverage
Link to insurance and banking regulators to deal with dual -licensed Reps
Incentivize collection staff with a bonus program
Use dedicated ,well trained specialist staff for collections
Use outside professional collection agencies whwn required

Prohibit use of personal corporations
Withhold x weeks pay as collateral
Make fine collection a defined annual executive compensation objective of each commission chairman and SRO president

Require dealers to automatically rebate profit they made as a result of the sanctioned activity in satisfaction of fine( unless they too are prosecuted)

Allow a certain percentage of collected fines to be go into an unrestricted fund

Increase dues/ fees for dealers with above average rate of rule breakers
Seize termination payouts and post employment benefits if and as applicable
Require all  securities commissions to publish detailed unpaid fines information
Check to see if EI , CPP et al  benefits can be seized;Use wage garnishment
Strengthen "advisor" recruitment screening processes and hiring criteria
Introduce an effective internal whistleblowing program at dealer level
Get more aggressive on fraud prosecutions - work with law enforcement
Notify professional Associations which the Rep is licensed with eg FPSC ( CFP designation)

SRO's often take too long to investigate and discipline, so by the time the fines are levied, years have passed and there is no money left. We therefore welcome IIROC's recent initiative to use mediation to help speed up the process.

So what else can be done? One possible approach to collection would be to work with FSCO ( and other provincial insurance regulators) in establishing a reciprocal agreement so that dual licensed salespersons were not immunized form paying fines. This would help in collections from dual licensed “advisors”. It appears that IIROC is taking steps in that direction after years of cajoling from SIPA and others . We welcome the new approach.

Given the large amount of unpaid fines, it is difficult to argue the current system is functioning. Given that working in the financial business is a privilege, a reasonable starting point would be to make it more difficult for people to enter the industry in the first place by requiring higher standards - academic, professional and ethics.

And once the individual is part of the system, make the advisors work to an even higher standard, namely fiduciary duty which means that they act solely in the client’s best interests. Although IIROC has not provided leadership in that area , the CSA /OSC appears to be ready to introduce such a standard. That should reduce the amount of abuse and by extension the need for sanctions and fines.

By making it harder to get into the business, by insisting that they the act to a higher standard, there’s a good chance that there will be better outcomes for investors.

Another way is for the regulators to insist employers are responsible for the behavior of the employees they take on — even if the employees regard themselves as independent contractors.In our opinion, such a change would result in an immediate improvement in dealer behaviour and supervisory practices. In the majority of cases cases it is the policies, practices, sales quotas , commission grids . compensation arrangements and other non-financial incentives of dealers that incent “advisors” to push the envelope of compliance. We have also encountered cases where supervision share in branch commissions earned!

Actually, fine collection is far less important to investors than recouping their money and that's what we'd like to see the IIROC really focus on. Fairer dealer complaint handling and an OBSI with binding decision powers are regulatory protections needed by retail investors .



Caveat Emptor !

Surviving a Complaint investigator interview

We have recently received a growing number of questions and complaints about the complaint resolution system itself. The investigator’s interview is a part of the analysis process. Interviews are voluntary but not participating could be harmful to your case. Readers increasingly report feeling uncomfortable with this stage of the process.

Here are a few cautionary tips we’ve received from lawyers and professional dispute resolvers, should you have occasion to interact with the MFDA/IIROC, a Firm’s complaint department/"ombudsman" or OBSI regarding an interview with an investigator:

Before the interview takes place the claimant must confirm that the interview is without prejudice. Thereafter and before the interview, the claimant must send an e-mail confirming the date and time of the interview and once again recording, in writing now, that the interview is without prejudice. Written confirmation of the without prejudice aspect, is of vital importance.

• Avoid  participating in an interview without being prepped

• Make a list of everything you want to say and make sure you say it whether you are asked about it or not.

• Ensure you have your key documents and files with you.

• Ask for a list of questions the investigator intends to ask so you are properly prepared. If they refuse, ask why. If you have an Intervenor (someone who’s familiar with the complaint process and willing to provide support), consult with them before participating in an interview.

• Have a friend participate with you to take notes and act as a witness. Ask if you can record the interview.

• Don't allow the investigator to put words in your mouth.-ask if conversation is being recorded. If so, ask for a copy of the recording.

• Don't let them cross-examine you. Being a victim of financial assault is enough pain. After you have provided an honest response, it’s best to remain silent.

• Don't think that they are your friend, and get lulled into a false sense of security –investor advocates have provided lots of evidence that the system is biased against you

• Do not answer questions you do not believe are relevant to your case. Try to clarify why the question is being asked. Assume anything you say, can and will be used against you.

• If you have provided documents or information to the investigator, ask if they have been provided to the Firm. If they have, you may have the right of reciprocity- obtaining internal documents the Firm has provided to the investigator.

• You do not have to answer every question asked. If you don’t recall something, say so. If you want to check your files before responding, say you will get back to the investigator after you’ve checked the facts.

• If inconvenient, impossible (e.g. hospitalized, infirm) or too expensive for you to travel (travel costs, lost time at work), ask for a conference call or a meeting location suitable to you. 

• If you feel like your undergoing an interrogation, you feel your integrity is being challenged or the investigator is disrespectful, report this to senior management of the Firm.

• If the Firm has been unable or unwilling provide you with personal documents [NOTE 1] ask the regulator or OBSI to assist you in obtaining them. These documents may be of great importance to you to help you make an informed decision as to whether to accept or reject any recommendation the Firm may make to you, with regard to a possible settlement of your complaint. Without them, you could be placed in a disadvantageous position.

• Resist paying any fees for these documents. If you are forced to pay, ask the investigator to include these expenses in any Decision so you can be reimbursed if your complaint is validated.

• Watch out for trick questions. For example in one case, the investigator asked if the complainant had taken any courses in investing. She said “Yes”. This was used against her in a subsequent trial. It turns out the course was in fact a 2-hour seminar on RRIF’s, eight years earlier. In another case, the  investigator was able to extract information about the growth in assessed  value of a complainant’s home  over time, thus increasing his Net Worth ; a figure that can be used ( or abused)  to demonstrate suitability.

NOTE 1:  These include but are not limited to your NAAF, KYC, transaction slips, client statements, copies of all KYC updates, any Investment Policy Statements, all agreements including margin, option and shorting Agreements, Powers of Attorney, discretionary and/or managed account Agreements, and annual renewals of discretionary accounts. Copies of all notes from the financial advisor or somebody else acting on his or her behalf, including entries in any diary or calendar relating to the claimants account in question. Recordings and/or notes of all telephone calls or conversations. Copies of all daily and monthly internal reviews carried out by the compliance department or other designated party relating to the financial advisors handling of the claimants account with particular emphasis to suitability and other issues, The dates and times when such internal reviews were carried out, and by whom. Records of any disciplinary action taken against the financial advisor, whilst at the current  Firm and whilst at any previous Firms. Copies of any and all correspondence, e-mails between the compliance department and the financial advisor, or any other e-mails sent by anyone else in the Firm with relation to the claimants account to anyone else. The investigator or the Firm may refuse to provide requested documents- take note of the refusal and the reason provided for the refusal.

We continue working with regulators and OBSI to make the interview process less intimidating and fairer and to accommodate the special needs of seniors and vulnerable clients.

Contact kenkiv@gmail.com for a copy of the Investors Guide to Effective Complaints. It may save you a lot of time, trouble and money. 

Kenmar review of “A Major Setback for Retirement Savings: Changing how Financial Advisers are Compensated could Hurt Less-Than-Wealthy Investors Most “

                                                                                                           April 12 , 2016

Kenmar review of “A Major Setback for Retirement Savings: Changing how Financial Advisers are Compensated could Hurt Less-Than-Wealthy Investors Most “
http://policyschool.ucalgary.ca/sites/default/files/research/financial-advice-lortie.pdf
Except for the title , a few unsubstantiated assertions and conclusion ,there's a lot to like about this paper. The University of Calgary school of Public Policy must've woken up one day and decided it's time to write about embedded commissions. A report of this depth must have cost it at least $100,000 to produce -the timing couldn't have been better – mostly for industry participants.

On page 1 we are presented with this paragraph “ We find that critics of current embedded compensation practices tend to base their policy prescriptions on a truncated analysis of the likely consequences that would unfold if implemented.3 These consequences are much broader and pervasive than investment outcomes. From a public-policy point of view, the “outcome” that truly matters is the impact of financial advice on households’ accumulation of financial wealth and, therefore, how it is affected under different remuneration models. We make the case that voluntary personal savings are unlikely to deliver adequate retirement income unless individual investors have access to expert advice from competent and well-regulated professional advisers and asset managers on terms that are reasonable and conform to their expressed preferences, regardless of whether advice is delivered using commission- or fee-based advice models.”

This essentially critiques the CSA research for undue emphasis on performance , arguably the main reason for investing in the first place. Even if “ outcomes” were defined as accumulation of financial wealth it's not obvious that advisors impact that much of that wealth accumulation ( eg home ownership ) for small investors. Of course for some , putting a child through university might be the goal rather than wealth accumulation. The other built in assumption is that today's mutual fund salespersons are in fact experts , competent and well regulated is an unsubstantiated assumption . A correspondence course and multiple choice exam is hardly proof of proficiency.In fact, investor advocates would argue that it is nothing more than industry hype , an illusion achieved via sharp marketing programs to mask the true nature of the role of the “advisor” as a saleperson .

The Report does contain some solid facts , statistics and excellent reference research materials in an attempt to support the argument that conflicted advice is better than no advice at all. If we didn't know better we might be swayed.

So where do we take issue with the report? First off , it refers to those providing advice as advisers as opposed to their actual registration as sales persons or dealing representatives. It also assumes that the advice is actually delivered but does admit that it could indeed be conflicted. Given the low qualification requirements for mutual fund “ advisors” even if advice is provided , it isn't based on a high standard of proficiency.

The Report doesn't deal with the issue that larger mutual fund investors are unknowingly, and likely unwillingly, subsidizing smaller investors. It also ignores the fact that funds sold by discount brokers collect embedded trailer commissions but don't provide a dime of advice.

As is well known , different advisors do different things (some more; some less) for their clients. In the real professions (law, accounting, etc.) those who do more charge more - and clients willingly pay it. Under the embedded commission model, there's a 'one compensation model fits all' approach - regardless of how much (or how little) the "advisor" does . This could mean that some investors are being overcharged under the embedded commission model.

The report labels investments in mutual funds as savings when in fact they are investments. They are naturally higher for advised accounts than for non-advised accounts. This is to be expected since the advisor is incentivized to sell more funds even if it may be better for the client to reduce ,say , 18% credit card debt or increase life insurance coverage. Without knowing the debt level it is meaningless to refer to account amounts as “savings “ and an advantage of an advised account. Focus should be on income adequacy in retirement rather than savings.

Too many advisors recommend leverage which in most cases is a wholly unsuitable investment strategy for the small investor. The cost impact of bad advice is not reflected in the report but for those who have ever experienced conflicted advice, it can be life altering.

It's easy to think that value of the service you’re getting is implicit, particularly when various pro-embedder Reports like this one routinely reference a 2012 report by the Centre for Interuniversity Research and Analysis on Organizations (CIRANO) which states that investors who have used a financial advisor for 15 years or longer had 2.73 times the level of assets as investors who don’t use an advisor. Sounds great, right? Well, not quite. If you dive a little deeper into the methodology of CIRANO’s research, you’ll find that someone who has fired their advisor—presumably for poor performance—is counted as a non-advised household (even if they used an advisor for more than 15 years!).

The report provides some rationale that a certain fraction of retail investors will refuse to pay for advice if charged separately. [ A study involving retail investors from eight European countries found that between 26 to 30 per cent of respondents were unwilling to pay upfront for advice.87 ] This means that 70-74 % would be willing to pay . In Canada , investors have been told for so long that advice ( such as it is) is free, that the figures will undoubtedly be higher. If a prohibition is applied, the industry, Regulators and governments will need strategies and programs to demonstrate the cost-effective value of professional advice and help make it affordable via productivity improvements , use of technology and creative tax and other strategies .

If the report had reported on studies about the integrity of advice they want ,they would have found that the overwhelming majority of investors want to be provided advice that is in their best interests. A U.S. Study by Financial Engines https://corp.financialengines.com/docs/Financial-Engines-Best-Interest-Report-040416.pdf found that over nine in ten (93 percent) said it is important that all financial advisors be legally required to put their clients’ best interest first when providing advice on retirement savings. We expect Canadian results would be similar especially since most Canadians assume , incorrectly, that this is the prevailing case.

There is no consideration of the pain and anguish caused each year by hundreds of these "advisors' through unsuitable investments, excessive leveraging, account churning , unduly expensive fund choices , early redemption charges and even fraud. These behaviors can be traced to the lack of a Best interests standard, a standard incompatible with embedded commissions.

The argument goes that if they refuse to pay for advice and go it alone they will suffer much worse than the estimated 2 1/2% annual penalty for investing with conflicted advisors. We don't understand why that would be the case .If a fee-based account was set up ,clients would still pay the 1% charged monthly but then would have a clear idea of cost/ services provided and the advisor would be free to recommend lower cost funds , inexpensive index fund's or tax-efficient ETFs. The net result would be increased retirement savings and improved retirement income security.

The report counters this by pointing to research that fee-based accounts are no panacea either. That is true where regulatory enforcement to counter reverse churning is absent which does appear to be the case in Canada. Regulators need to face up to that challenge.

To say that “ .., although studies that investigate adviser behaviour have found surprisingly little evidence that advisers provide unsuitable advice as a matter of course and that other structures of remuneration lead advisers to adopt practices that are better aligned with their clients’ interests ” is plain wrong .The suitability standard along with conflicted advice has caused harm to Canadian retirement income security. The fiduciary/ Best interests structure has demonstrated far better performance and client satisfaction. As an aside , as this report was issued, the US Dept. of Labour decided to proceed with a Best interests duty for retirement accounts.

The report does not suggest imposing a cap on commissions or doing away with DSC funds ( the word deferred doesn't even appear in the report). In essence, the Report strongly recommends the status quo.

The report states “ The existence of a regulatory body that provides oversight to a profession is a signal to consumers that they need not spend resources on costly monitoring in order to reduce self-serving behaviour by the adviser and that there is a mechanism for redress if that behaviour were to occur. “ We totally disagree that mutual fund salespersons constitute a profession ,that CAVEAT EMPTOR is not required and that redress in Canada is robust. There is not a shred of evidence to support that statement.

We also disagree with “ A compelling body of empirical research demonstrates that regardless of their level of financial education and wealth, left to their own devices, individuals’ investment and savings decisions are, as a rule, sub-optimal compared to the results obtained by “advised” investors. “ In fact there are many studies that show quite the opposite. Given that Canada's fund fees are the highest in the world , it is not obvious that unadvised folks would do worse . In fact if they just bought a low cost balanced fund , a life cycle fund or used a robo advisor they could well be far better off. Since the average hold period for funds is about 5 years , it's not even evident that advisors are able to claim they are able to control investor behavioural biases.

Given the emphasis on the financial illiteracy of Canadians one would have thought the solution would involve a Best interests advice standard as investor protection . Of course that would make it hard to justify an embedded commission  model which is the apparent goal of the paper.

We do agree that trust in the financial advice industry would certainly be enhanced if there were more discipline and standardization on the use of titles, which, in addition, would facilitate compliance with proficiency requirements. Problem is regulators refuse to tackle the issue. In a 2015 OSC mystery shopping experiment ,a total of 48 different titles emerged. The Report does not actually say that it is necessary to support its conclusion.

We also agree that active consideration should also be given to the benefits that would accrue from the establishment of a professional designation for financial advisers, which, as for other professions, would entail formal training with an agreed curriculum and more extensive continuing education requirements than what presently exists. Again , industry lobbyists continue to fight such an initiative. It's not clear whether this is a firm recommendation or merely a nice to have with a conflicted advice regime.

The paper does make a case that the UK RDR initiative led to less Britains receiving conflicted advice or any advice. “ Testifying before the U.K. House of Commons work and pension committee, the chief executive of the FCA admitted that the “advice gap” and the number of people being orphaned by their advisers was a “concern.” Since then a separate report has been issued that provides many examples as to how to close the so-called “ advice gap: https://www.fca.org.uk/static/fca/documents/famr-final-report.pdf . It should be noted that the FCA has not reverted back to a commission oriented advice system or backed off on increased advisor proficiency standards. Conversely, the FCA Consumer Panel which represents the voice of investors says : “We have not seen any evidence to show the existence of a gap in the supply of professional advice, apart from in the provision of compulsory pension advice, e.g. on defined benefit to defined contribution transfers. Consumers do not always seek professional advice, even when they could benefit from it: some are not aware of what is available; they do not want to pay for advice because they do not understand the price or value of it; they cannot afford it; or they prefer to take decisions themselves. .” https://fs-cp.org.uk/sites/default/files/financial_services_consumer_panels_response_to_famr_24122015.pdf

Nevertheless, the potential for a "advice gap"  should be addressed by regulators as part of its implementation strategy and learnings from the UK experience ( which includes anticipating the countermeasures the industry may employ to undermine the initiative) applied to tactics.

We think the paper underestimates the positive impact robo advice will have . [ “Drawing on the experience of the discount brokerage industry, it is unlikely that automated digital wealth-management platforms will close the “advice gap” that would be created by a regulatory regime prohibiting the bundling of advice with financial products.” ] We believe technology- based advice at the competitive pricing levels and payment approaches being offered in Canada will be especially attractive to small investors, younger Canadians and millennial If the US is any guide, many Canadians will sign up thereby closing or greatly narrowing the postulated gap. The advice provided will be more client focused and should easily beat mutual fund based advice returns simply by using cheaper products and charging lower fees. The fees may also be tax deductible adding to their competitive advantage.

We vehemently disagree that “ The evidence presented in this paper suggests that the operation of the Canadian market for financial advice has, heretofore, been successful in producing beneficial outcomes for households that obtain the service, and for society as a whole. “ . If it was so successful there wouldn't be a pension crisis, a record debt to income ratio for Canadians , thousands of investor complaints each year and pleas from investors/investor advocates for the introduction of a Best interests standard.

Furthermore , most investors have no idea how their account has performed. It was only due to the relentless efforts of investor advocates , against fierce industry opposition , that mandatory performance reporting will be required under CRM2. How advice was provided without knowing returns should have alerted the author of the Report that something ain't right.

Recent regulatory sweeps on DSC sold funds raised many issues. A OSC IAP supported research project on risk profiling found just 16.7% of questionnaires reviewed would be considered ‘fit for purpose’. A recent IIROC Bulletin noted that that its recent compliance reviews have found that most of the firms it reviewed "lacked a meaningful process to identify, deal with, monitor and supervise compensation-related conflicts." The 2015 MFDA Enforcement report listed blank unsigned forms as issue #1.This is a snapshot of what passes as advice , the type of advice that Canadians would lose if embedded sales commissions were prohibited .

The report raises a number of valid points while omitting others. Compared to some other reports , this one is more analytical and evidence based.Overall , despite its shortfalls, we believe this Report constructively adds to the debate on the impact of embedded sales commissions on retirement income security. We remain convinced that a Best interests standard is required for all financial advice givers and planners.