The illusion of independent supervision

“It's best that the king's food taster reporst to the king rather than the chef” – Machiavelli , the Prince

For years we’ve been complaining about lax supervision of Dealing Reps (aka “advisors”, salespersons). It has been a mystery how so much wrong-doing was effected in plain sight of supervisors and branch managers for extended periods of time.  A number of White Hat Reps have gotten the courage to clue us in. Here is what they tell us:

·         Branch managers may obtain over-rides of sales commissions received by those they supervise. 

·         Branch managers may receive a bonus  based solely on the revenue/profitability of the branch

·         Some Branch managers also double as Reps so in effect they are part time managers. Some Branch managers have actually purchased the client “book “from those they are supposed to supervise.

·         Branch managers may be rewarded based on the number of new Reps brought on and on AUM growth  

·         Branch managers are tolerant of signature forgery, document adulteration and pre-signed blank forms

·         Titles such as VP can be awarded solely on the basis of sales production 

·         Dealers provide greater incentives for fee-based accounts  

We’ve also been told that at some firms when a Rep under a manager quits or is fired ,the Branch manager hand picks the largest accounts for himself and passes on the small ones to other registered Reps.

The conflicts -of-interest here are enormous so it should come as no surprise that supervisory controls are lax. In effect, we have conflicted Reps overseen by conflicted supervisors (gatekeepers).
Branch Manager duties typically include the review and approval of new client application forms (NCAF’s) and client account updates, as well as the review of daily and monthly trading summary reports. They are there to ensure that Reps under their supervision do not engage in improper or unlawful behaviour e.g. suitability, discretionary trading,  leveraging, excessive trading (churning) violations or fraud.

In a 2017 Guidance NOTE http://www.iiroc.ca/Documents/2017/5365cb5b-e384-477f-8fc0-8c2b9450424a_en.pdf  IIROC noted that in most Dealers .reviewed, they saw supervisors compensated partly (to varying degrees) on revenue generated by registrants subject to the supervisor’s oversight.

IIROC Dealer Member Rule 2500 III.A.3 requires that:

“A Dealer Member should ensure independent supervision of all retail accounts.”  IIROC  adds "While this rule is more frequently cited to ensure a producing supervisor does not have supervisory oversight over his or her own accounts, the spirit of the rule speaks to the need for genuinely independent supervision. It is understandable that the compensation of a supervisor who is also a branch manager is based partly on the overall profitability of his or her branch. However, the Dealer should consider other factors in determining supervisor compensation that would offset any undue bias towards branch profitability at the expense of client best interest.”.

IIROC finds it acceptable that Branch Managers can be partly compensated based on branch profits and can also be dealing Reps, supposedly supervised by someone else. More importantly, IIROC  believes that the non--independence can be negated by other, albeit unspecified, factors. IIROC’s guidance is pretty vague and leaves it entirely up to dealers to resolve the conflict-of-interest- the very dealers who have created the conflict-of-interests. Apparently independent doesn’t really mean independent in the commonly understood use of the word. There really is a good reason why external auditors report to the Board and not management- independence.

For example, without a rule regarding fee -based accounts, we do not see how, except in the most abusive cases, IIROC can give operational meaning to its guidance on independent supervision. IIROC have not created criteria that would enable them to robustly enforce certain issues e.g. wrong account type.

We think these conflicts must and can be avoided. There are numerous ways to measure how well a manager is supervising staff. Dealers should be required to prove to regulators that managers’ performance is evaluated based on many factors so that branch profitability isn’t a factor. This can be done by investment dealers just as it is done in retail, manufacturing, etc. companies.

Here are some ideas for rewarding Branch managers/ supervisors:

·         The manager/branch office supervisor should be evaluated on her/his performance in implementing corporate standards of behaviour. This assumes, of course, that the firm expects employees to behave as well trained professionals compliant with regulatory requirements.

·         Measuring the number of client complaints at the branch 

·         How well the manager is supervising his staff’s compliance with the regulations. There should be a review of supervisor’s performance from the firm’s compliance department certifying how many regulatory violations the supervisor’s advisers have had.  So a branch manager’s performance includes how well he is managing staff from a regulatory perspective. If dealers are required to explicitly approve a supervisor’s performance, this will raise the bar, putting Compliance staff on the line... Example: if a Branch manager has many staff faking client signatures or if he allows big producers to get away with discretionary trades... compliance department will be aware of this.

·       His/her Reps are fully compliant and up to date with professional training and CE. Supervisor gets rewarded if Reps are seeking more product knowledge  training, more professional upgrading, improving their professionalism 

We appreciate that the conversion from a sales culture to a client focus will be challenging but the journey must begin.IIROC as a Public interest regulator must address these fundamental conflicts-of-interest in the supervision of Reps.