Investors Scrutinizing the Regulators

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Securities Regulation In CanadA


Fox Guarding the Hen House

   

January 2005
Since audit, IDA has tackled problems
The SRO says internal mistakes have all been corrected, but its critics aren’t all satisfied


By James Langton

The Ontario securities Commission has released a damning, albeit somewhat stale audit of the Investment Dealers Association of Canada. The question that lingers for both investors and advisors is whether the problems it details are history, as the IDA insists, or whether they still dog investment industry self-regulation.

The OSC recently decided to abandon its court challenge of an order of the provincial Information and Privacy Commissioner requiring it to release the report of its audit of the IDA, carried out in 1999-2000. The IPC ordered the release in response to a request from an unnamed individual investor under the Freedom of Information Act. The OSC twice refused to release the report, but it lost two appeals to the IPC and decided to take its opposition to court for judicial review before abandoning that tack.

The OSC’s submissions to the privacy commissioner say one of its chief reasons for wanting to maintain the confidentiality of the audit was to preserve its ability to carry out future audits. If the audit reports were published, it suggested, OSC staff couldn’t be candid in their assessments of the IDA, and the self-regulatory organizations under its oversight might not be candid with it.

Yet the OSC ultimately decided to drop its opposition — due to the “passage of time and the resources required to continue with this file,” says Eric Pelletier, the OSC’s manager of media relations. The report was disclosed to the investor, and a copy was later posted on the Web site of self-styled investor advocate Robert Kyle (http://www.investorvoice.ca).

In the future, the OSC will routinely disclose results of its IDA audits, Pelletier says: “We are trying to balance the value of transparency with the work involved in conducting an oversight review.” However, given the OSC’s argument that the spectre of public scrutiny may chill its staff’s candour in the audits, the reports may have diminished value.

Still, public availability of the audits is important because the examination carried out in 2000 — and only now released, thanks to the efforts of an aggrieved investor — reveals the IDA wasn’t doing its job properly. The report concluded that the IDA did not have “sufficient resources allocated to its member regulation to ensure that it meets its obligations as an SRO.”

The report found several IDA departments didn’t follow formal policies; the staff suffered from low morale and the IDA had trouble retaining staff; it didn’t have a formal strategic-planning process; it couldn’t evaluate the effectiveness of its committees, and mandates were vague; there was no formal process to evaluate the effectiveness of the board nor its regulation department; management decisions weren’t reported to the board in an effective way; it didn’t have an IT strategy; and it was not complying with the terms of its recognition order in several respects. The report also made several recommendations for dealing with conflicts of interest that arise from the IDA’s dual roles as both regulator and trade association.

The enforcement side of the IDA came in for particular criticism. Among its conclusions, the OSC found a growing backlog of enforcement cases; no screening process for complaints and a bloated case review process; and a “significant number of changes to penalty recommendations” by the former senior vice president of member regulation. The OSC called for an emergency resources allocation to help clear the backlog and an overhaul of the department’s other processes.

In response to the audit, the IDA commissioned Robert Chambers of Toronto’s Asset Risk Advisory Inc. to conduct a further review. The Chambers report delivered 48 recommendations for improvement. Paul Bourque, the new IDA senior vice president of member regulation, says the association has implemented changes in all the areas criticized in the audit, and adopted all 48 recommendations in the Chambers report.

“We have implemented significant changes to our policies and procedures in every area, and we are certainly prepared to be judged on our track record to date and on our current results,” Bourque says.

The most recent results are detailed in an internal report to be released in late January, which shows that in 2004, the IDA had a blowout year in terms of total monetary penalties levied and disgorgements imposed against brokerage firms — almost $42 million, largely due to the mutual fund market-timing settlement with three firms.

Even looking at the penalties assessed to individuals, the IDA had a productive year.
Total fines, costs and disgorgements reached $5.5 million, up from $3.3 million in 2003. Nineteen permanent industry bans were handed out, up from nine the previous year. The IDA also rendered a total of 65 decisions, up from 41 in 2003.

The IDA has also continued to lighten its backlog of active investigations and prosecutions. For the first time in the past four years, it no longer has investigations that have been open for more than two years, a significant change from 16 cases that had been dragging on in 2001.

Similarly, there are no longer any two-year-old prosecutions lingering, down from 12 that had lasted that long in 2001.  Undoubtedly, progress has been made, but it’s cold comfort to those who believe the IDA mishandled their cases back when the candid, highly critical audit was carried out.

 

One disgruntled investor, who asked not to be named, says, “Do I think everything’s fine there now? No, I don’t.”

Dogged IDA critic Kyle says if the problems are ancient history, then there wouldn’t have been so many aggrieved investors eager to turn up at hearings held last August by the Ontario government’s standing committee on finance and economic affairs to criticize the regulator.

Indeed, after considering the testimony, the committee recommended that the government review the role of self-regulation in the securities industry, as some investors clearly don’t have faith in its integrity. If and when a review of self-regulation takes place, mechanisms of oversight — such as having the securities commissions audit their proxies, particularly when their own accountability is being severely questioned — should surely be on the agenda.

The issue also isn’t history for Kyle, who is engaged in a legal fight with the IDA over its attempts to discipline him in 2000, when he ran his own derivatives brokerage.

One of the central issues in his fight is whether the IDA operates as an agent of the government or as a purely private body and, therefore, what the limits of its authority are.
Some IDA power flows from the OSC’s recognition order, granted in 1995. However, Kyle says, the now public report reveals the IDA wasn’t complying with all terms of that order when the audit was carried out in 1999-2000.

His case was heard last fall, and the court has yet to hand down its judgment.

Bourque says investors and industry members who were dissatisfied with their IDA dealings back then should “look at our track record, look at our current results, and judge us on that.” He says regulators do so in their ongoing scrutiny of the IDA, which has had substantial improvement in its performance.

The IDA’s new annual report on enforcement says it was subject to three reviews of enforcement performance by provincial regulators in 2004. The results have not yet been released.

The most recent public results are from follow-up audits carried out in 2002-2003.  The Alberta and British Columbia securities commissions have released their reports, which came out of their portions of the effort. At press time, however, the OSC had not responded to Investment Executive’s informal request that it release its report from any follow-up audits conducted since 2000.

In their follow-up reports, both the Alberta Securities Commission and the B.C. Securities Commission found that the IDA had made significant improvements since the 2000 audit. However, they also reported continued problems with different parts of its operations in their particular regions.

The ASC’s audit, in late 2003, had some concerns with aspects of sales compliance, financial compliance and registration. However, it noted that the quality of the IDA’s fundamental enforcement activities — investigation, prosecution and file management — were improved due to stepped-up staffing and training.

The BCSC’s follow-up in December 2002 focused solely on enforcement. It, too, found the IDA had implemented many of the recommendations it received from the regulators and the Chambers report. However, IDA enforcement results still needed work.

“Significant change has been accomplished with the implementation of new systems and the development of better processes for handling complaints and managing priorities. However, enforcement results have still lagged below historical levels, particularly in corporate actions brought against firms,” the BCSC report said.

Ultimately, enforcement results are what regulators are largely judged upon. The regulators should take note: if investors and advisors are to have continued confidence in SROs, those SROs need credible, independent oversight and verification. IE

 

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