Investors Scrutinizing the Regulators

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Fox Guarding the Hen House

   

 

 

The IDA's Guidelines to Investigation of Supervisory ractices

 

The Investment Dealers Association of Canada has been in breach of an ORDER of the Ontario Securities Commission for over 11 years.

OSC overrides "Public Interest" in favor of the IDA's interests.

On July 27, 2001 the Ontario Information and Privacy Commission ("OIPC") upheld an Ontario Securities Commission's decision NOT to release the IDA's "Guidelines to Investigation of Supervisory Practices" ("Guidelines").

The initial request for access to the "Guidelines" was refused by both the IDA and the OSC. Upon appeal to the OIPC, the OSC made the following representations.

The reasons why it is necessary to have this document made public is explained within the appellant's representations.  Also included is a letter from The Small Investor Protection Association (SIPA) and Mr. Jim Roache - strong advocates for investor protection.

A major concern is that the IDA is not abiding by an ORDER of the OSC.   This ORDER sets out the criteria that the IDA must follow.

To be clear, the Recognition Order- issued by the OSC -is an improper delegation of authority. If the IDA was properly delegated authority through legislation they would be classified as an agency of the government (as is the OSC).  By not empowering the the IDA through legislation, the IDA can operate on a different set of rules than government.  This allows the IDA perform a function, which would otherwise be performed by the government agency (the OSC), without the necessary checks and balances, and protections, that one would normally expect when dealing with government.

Why does the public NOT have a right to know what guidelines are used by the IDA to investigate supervisory lapses by our brokerage firms?

Without guidelines, investigators are left to their own devices - some of which have no experience within the securities industry!

Without knowing what the guidelines are, the public has no benchmark to judge whether the IDA is doing its job. This decision means there is no public accountability. 

The OSC Audit of the IDA illustrates this very point.

This ORDER demands that the

""Guidelines for Investigations of Supervisory Practices", are followed and updated as necessary…."

The IDA denies access to this document to both IDA members and the public.   The IDA's legal counsel issued a letter stating:

"We have decided not to release the "Guidelines" because the document is not current, nor has it been applied by staff of the Division in any investigation…"

The OSC claims to perform "oversight" upon the IDA as described in their public release below.  The OSC has also stated publicly (1, 2, 3 ), as has the British Columbia Securities Commission ( 1, 2, 3, BC Audit Report, Ontario Audit), that the IDA is NOT doing their job. Why then be part of an attempt to hide that fact from the public - those guidelines are critical to any such determination!

Operating under a veil of "secrecy" does not benefit the public in any regard.

The Information Privacy Commission held that under Section 153 of the Securities Act, information received from a self-regulatory organization (the IDA) is deemed to be confidential.  It is not subject to scrutiny by anyone other than the OSC.

Further, that since the OSC has not acted and still "recognizes" the IDA, the Privacy Commissioner is powerless.

The Guidelines are not available to the public. The IDA can blatantly breach an ORDER of the OSC. The OSC continues to advocate their "oversight".  The Information Privacy Commission has no jurisdiction.

Welcome to DENMARK!

 

 

The provincial securities commissions depend on a Mutual Reliance Reporting System

 

'Mutual Reliance' :  If we all ignore it, then we won't have to do anything about it.

 

 

On October 03 & 04, 2001 all the provincial securities commissions were notified of this breach.  Letters were issued to all the commissions asking for an explanation as how this could happen and who was responsible.  Some of the statements made by the various commissions were alarming. My responses are below on the right.  Their written responses are available here.


Responses from Commissions

My Response

Is the OSC aware of this breach?

The OSC claims to perform oversight on the IDA every year and describes the process as being critically important and in depth. (See below)


How does a breach of an Order issued under the Ontario Securities Act affect my province? 

The IDA has NO investigative GUIDELINES, as required under the Securities Act, and operates nationally.


Perhaps the IDA & OSC made an agreement that since the Guidelines were outdated that they would no longer be required to follow them.

An Order can only be changed with another Order - there are no subsequent Orders of Recognition in Ontario. The existing order states that the Guidelines must be updated and followed.

So what guidelines are they following?


"It's an administrative technicality."

It is an Order made under the Ontario Securities Act.


I'm very busy, send a letter, and we will get back to you if we feel it is necessary.

In the meantime, all Canadians residing in a province which has recognized the IDA, are subject to improper regulation.


"...our recognition order for our regional office of the IDA does not have requirements in it and is only 1 paragraph long."

Handing over authority to the IDA, with a very limited number of checks and balances, and no requirement to follow them, is why we have so many problems in the securities industry.

 

Each of the provincial securities commissions has an Order "recognizing" the IDA.  Each Order is worded to place the onus of reporting such a breach to another securities commission. Since it is an Ontario problem, as suggested by the ASC, there is no requirement for the ASC to report it; and until the OSC does acknowledge the breach, no commission will do anything." 

Investors are on their own. In fact, you now not only need to cope with price risk, execution risk and broker risk, you can now add regulatory oversight risk to your portfolio.

Bon chance!


 

In early March 2000 a consulting firm was hired to audit the IDA's investigation and enforcement department. The resulting report, known as the "Chamber's Report", as reported by the Financial Post (who obtained a copy in a brown paper envelope) was most damning.  The OSC and IDA again refused access to this document to the public.

 


The following is a description of the oversight 

that the OSC claims to administer over the IDA.


 

 

 

Oversight of Self-Regulatory Organizations

 

OSC Dialogue

 

November 3, 1998

 

by Toni Ferrari

 

Introduction

 

One of the Ontario Securities Commission's ("OSC") strategic directions is to push down direct regulation of registrants to self-regulatory organizations ( "SROs"). This is because SROs can help regulators to achieve regulatory objectives more efficiently and effectively. Because the regulator remains ultimately responsible for the regulation of market intermediaries, it is important that we develop an effective oversight programme for SROs. Accordingly, one of the OSC's priorities for fiscal 1999, as published, is "to develop and implement an effective programme of oversight for SROs, including the new SRO for mutual fund dealers".

Today's Topics

Today, I will be speaking to you about how the OSC conducts SRO oversight. I will start by reviewing the definition of an SRO and the powers of the Commission under the Securities Act (Ontario) (the "Act"). I will state some of the objectives of SRO oversight and I will describe the different mechanisms we use for effective oversight, including the recognition process; regular reporting and ongoing communication; the by-law review and approval process; and compliance examinations of the SRO. Finally, I will talk a bit about how the OSC can rely on the work of others to make SRO oversight more efficient and effective.

Definition and Powers of the Commission

The Act defines an SRO as a company that represents registrants and is organized for the purpose of regulating its members and their representatives, with a view to promoting the protection of investors and the public interest. Section 21.1 of the Act gives the Commission the power to recognize an SRO, and to impose terms and conditions on that recognition. The section also gives the Commission broad powers to oversee the SRO. Specifically, the Commission is able to make any decision with respect to any by-law, rule, regulation, policy, procedure, interpretation or practice of a recognized SRO.

Objectives of SRO Oversight

The objectives of SRO oversight are to identify deficient SRO operational performance at an early stage and ensure that corrective measures are implemented; to ensure effective communication between SROs and the OSC; and to periodically review the SRO's member compliance monitoring, and the handling of complaints, investigations and settlements of disciplinary matters. SRO oversight should not interfere with or attempt to micro-manage the work of the SRO. Rather, the objective is to validate reliance on the SRO for the functions which we have delegated to it. An outcome of effective oversight should be clear communication of the regulator's expectations. This will place the SRO in a better position to meet those expectations.

Mechanisms for Effective Oversight

The Recognition Process

The Investment Dealers Association of Canada ("IDA") is the only recognized SRO in Ontario. It is anticipated that the Mutual Fund Dealers Association will apply for formal recognition once it is up and running. For today, I will limit my discussions to the supervision of the IDA.

For years the IDA was treated informally as an SRO. The IDA was formally recognized as an SRO on October 31, 1995 pursuant to section 21.1 of the Act. The recognition process is an important one. It helps set clear standards which must be met by the SRO prior to exercising its delegated authority. The recognition process for the IDA was quite rigorous and included an examination of the IDA's compliance and enforcement capacities and operations to ensure it had effective resources; and a review of the IDA rules, including its constitution, by-laws, regulations and policies, to ensure that the rules were justified according to the recognition criteria.

Through the recognition process, the Commission was able to impose terms and conditions on the recognition of the IDA. The terms and conditions imposed on the IDA require that:

  • the IDA maintain adequate staff resources and an appropriate internal reporting structure to be able to perform compliance and enforcement functions;

  • the IDA obtain Commission approval prior to making any fundamental changes to its organizational structure which affect its self-regulatory functions;

  • the IDA cooperate generally with the Canadian Investor Protection Fund ("CIPF"), the Commission and other regulators, and that the IDA advise other self-regulatory organizations to which a member is subject of any breach of the rules;

  • public disclosure be made of disciplinary and settlement hearings; and

  • the IDA keep any trade association or lobbying activities structurally separated from its self-regulatory operations. Examples of these activities include any representations made to governments regarding such issues as industry fee structures, ownership and foreign participation in the securities industry.

Where staff had concerns with some of the IDA's procedures, the recognition process resulted in the IDA undertaking corrective action.

Ongoing Reporting and Communication

Once the recognition process is complete, the regulator should perform oversight of the SRO on an ongoing basis. One of the mechanisms for ongoing supervision is regular reporting and communication. This mechanism is important so that the regulator can ensure that the SRO continues to meet the recognition criteria.

The IDA's conditions of recognition set out many items which the IDA must report on to the Commission. For example, there is a requirement that the IDA report to the Commission certain situations where its members are non-compliant. There is also a requirement to report to the Commission regularly on investigations and complaints. The IDA must report any material changes in financial or operational compliance programmes or enforcement programmes. Notices to members and interpretations of rules must be copied to the Commission. On an annual basis, the IDA must report on its staff complement by function; it must provide its budget and audited financial statements and a copy of its annual report; and it must submit a self-assessment of the IDA's performance of its self-regulatory responsibilities. This self-assessment is a very useful document as the IDA must make recommendations for improvement in areas which they themselves have identified as weaknesses.

In addition to regular reporting, OSC staff must ensure that the lines of communication remain open with the SRO. To this end, staff meet regularly with IDA staff.

By-law Review Process

Another mechanism for supervision of an SRO is the by-law review process. The IDA's conditions of recognition set out a formal process for development of new rules. Generally speaking, all new rules or rule amendments must be:

  • approved by the Commission prior to implementation;

  • published for comment;

  • accompanied by statements outlining the rule's nature, purpose and effect;

  • accompanied by a statement that it is in the public interest to make such rules; and

  • justified by reference to the permitted purposes set out in the recognition criteria.

According to the recognition criteria, the IDA can only make rules for specific permitted purposes such as:

  • to ensure compliance with Ontario Securities Law;

  • to promote investor protection;

  • to facilitate an efficient capital-raising process;

  • to facilitate free and open competition in the securities industry;

  • to provide for the administration of the affairs of the IDA;

  • and other permitted purposes.

The recognition criteria states that rules shall not permit unfair discrimination among customers, issuers, dealers or others. Also, rules should not impose any burden on competition that is not necessary or appropriate. When the IDA submits a proposal for a new rule or rule amendment, it is OSC staff's job to ensure the proposal meets the permitted purposes of rules under the recognition criteria. OSC staff submit a recommendation to the Commission as to whether the rule should be approved. If the ongoing communication process I spoke about earlier is working well, then OSC staff should be aware of new rules that are under development at the IDA, and any significant issues staff has with the rule should be addressed early on.

Oversight Through Compliance Examinations

A very important tool for effective oversight is performing compliance examinations of the SRO and its members. Section 20 of the Act gives the Commission the powers to perform compliance reviews of market participants, which includes SROs. Compliance reviews include inquiry into and examination of the books, records and documents of the market participant. To date, the OSC has performed compliance reviews of the IDA's enforcement and compliance functions as part of the recognition process. However, no comprehensive compliance examination has ever been performed. We are planning to change this, and have allocated significant resources in 1999 to do just this. Ongoing monitoring through compliance reviews was contemplated as part of the recognition process. In fact, one of the IDA's conditions of recognition is the requirement to cooperate and assist with any review of the self-regulatory functions conducted by the Commission, or by a party appointed by the Commission.

The objectives of a compliance review of the IDA include:

  • to determine compliance with the terms and conditions of the IDA's recognition, and the undertakings signed in connection thereto;

  • to ensure that the IDA continues to have appropriate procedures and resources to do the job;

  • to ensure that the IDA's core regulatory functions, such as Registration, Compliance, Enforcement and Policy, are being performed in a manner that results in appropriate and consistent enforcement of Ontario Securities Law and IDA rules;

  • to identify any weaknesses in the above; and

  • to report weaknesses to the IDA and the Commission, including a plan for action and follow up.

Some examples of the work that would be done include:

  • reviewing IDA examination programmes to ensure that they are designed to test compliance by members with all relevant IDA and OSC rules;

  • reviewing a sample of IDA compliance and enforcement files to assess whether all issues have been identified, and whether appropriate action was taken by the IDA; and

  • reviewing applications for exemptions from IDA rules to ensure that the discretion used by the IDA was appropriate and consistent.

There are many more steps, but in the interest of time, I won't list them all. There is however, one procedure that's worth mentioning. The OSC plans to conduct examinations of IDA member firms on a very selective basis as part of its SRO oversight programme. The objective of this would be to compare the regulator's results to those of the SRO as a means of assessing the effectiveness of the SRO's compliance reviews. In the U.S., the Securities and Exchange Commission includes as part of its supervision programme for the National Association of Securities Dealers ("NASD") the performance of joint examinations of NASD member firms. This is certainly an alternative we are considering.

Relying on the Work of Others

CIPF

Finally, I want to talk about how the OSC can and does rely on other organizations to assist in the oversight of the IDA. One of these organizations is the CIPF. In July of 1991, the Canadian Securities Administrators ("CSA") signed an agreement with CIPF in an effort to reduce the burden of oversight. In the agreement, CIPF agreed to perform oversight procedures on member's financial compliance activities. As part of this, CIPF agreed to establish minimum standards. These minimum standards were presented to and approved by the Commission in March, 1995, and include standards imposed on dealers, such as capital, insurance, books and records and segregation requirements; and standards imposed on SROs, such as field examinations and reporting obligations to CIPF. In addition, CIPF agreed to perform financial examinations of SRO member firms on a rotational basis to ensure member firms and SROs are complying with the minimum standards. CIPF currently completes examinations of anywhere from 5 to 10% of members each year. Such examinations include a review of the SRO's working paper files. CIPF also reviews all monthly, quarterly and annual financial reporting of member firms. Finally, CIPF reviews all deficiency letters issued by SROs to member firms, and member responses, to ensure that all deficiencies have been addressed appropriately, and to ensure consistency among SROs in dealing with deficiencies.

In the agreement with the CSA, CIPF agreed to report to the CSA on the results of the above oversight activities. In Ontario, this reporting has been mainly informal. As part of our efforts to develop effective oversight procedures, we will be looking to formalize such reporting so that we can establish greater reliance on the work of CIPF in the area of SRO oversight.

CSA

Our other partners in the area of SRO oversight are the other Canadian securities regulatory authorities, or the "CSA". To further improve the efficiency and effectiveness of SRO oversight, the CSA should develop a consistent approach to supervision of SROs, and should rely on each other's work wherever possible. In the case of a national organization like the IDA, mutual reliance amongst the CSA can make the process much more efficient. In recognition of this fact, we are in the process of setting up a CSA committee to coordinate IDA oversight. The committee has not yet had its first meeting, but some of the things the committee might be doing include developing a consistent approach to the approval of new rules and rule amendments; developing a consistent approach to the examination of IDA functions; ensuring consistency in the type of information required to be reported by the IDA to each regulator; and developing a mechanism for relying on each other's work. If successful, the work of this committee would not only make oversight of the IDA more efficient, but would also assist the IDA in dealing with regulators through the implementation of consistent procedures.

Conclusion

In conclusion, I just want to reiterate that an effective SRO oversight programme is essential as the regulator is ultimately responsible for the regulation of market intermediaries. Again, the objective of SRO oversight should not be to interfere with or micro-manage the work of the SRO. Rather, the objective is to validate reliance on the SRO for the functions which we have delegated to it. Finally, an important outcome of SRO oversight should be to foster a good working relationship with the SRO, which includes clear communication of our expectations as regulators.

 

 

"Its like putting General Motors in charge of road safety!"