Investors Scrutinizing the Regulators

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Securities Regulation In CanadA

Fox Guarding the Hen House


Sep. 21, 2002

Listen up, Bay Street

Individual investors must help push for the major reforms needed in the investment marketplace, says a former member of the Ontario Securities Commission

Public must demand change, everyone else has interests to protect

Glorianne Stromberg

Special to The Star

There is an eerie silence in the marketplace as Canadians come to grips with a frightening reality - the disappearance into thin air over the last two years of a substantial portion of the value of their invested savings.

The hope that this is a temporary blip is fading. Each day brings new revelations of corporate and individual wrongdoing, of greed, fraud and bankruptcies, and of widespread market manipulation fueled by endemic conflicts of interest.

The revelations have exposed fundamental problems with the way things are done. It is obvious that all of the gatekeeping mechanisms designed to protect investors and to ensure a fair and efficient marketplace have either failed or shown serious shortcomings. Auditors, boards of directors, individual directors, lawyers, investment bankers, rating agencies, standard setters, analysts, regulators and lawmakers have each in their own way failed the public. Their failures have produced what many are referring to as a crisis of faith in the entire market system.

The lack of trust in Wall Street (and by extension Bay Street) is said to be unparalleled since the 1930s. Polls indicate that a growing number of people believe the stock market is no longer a fair and open way to invest one's money and that the market is rigged by and for insiders. A recent New York Times article bluntly stated that the hidden hands of speculators profiting from bad-news rumourmongering, good-news insidership, and no-news accounting has made markets unsafe for ordinary investors.

Arthur Levitt, the former chair of the U.S. Securities and Exchange Commission, refers to the failures that the corporate scandals have revealed as "societal." These failures, he says, reflect a deterioration of values and the recognition that many people have no standards or values, which is something we should all be gravely concerned about.

And individual investors are concerned. But they don't know what to do about it. Many are shell-shocked. They have suffered enormous economic and psychological losses. There are stones of people in their late 50s and early 60s postponing or abandoning retirement. Those who are retired are terrified by the decline in the value of their retirement savings, the likelihood of a diminished standard of living and of outliving their retirement income. These concerns are real and will inevitably result in huge social problems that will require the allocation of substantial public resources to fund the shortfall in private resources.

For the present, individual investors have quietly moved to the sidelines. Some have taken their money out of the stock market in an attempt to stop their losses and preserve their capital Many are not reinvesting this money in new securities. This is unsettling for financial services providers. The withdrawal of the individual investor from the stock market is an unforeseen and very serious development for these providers It has a negative effect on market liquidity. And it significantly reduces the income they earn while their fixed expenses remain high.

The silence of individual investors may well be the calm before the storm. As the reality of what has happened to them sinks in, it is likely that their discontent will grow. They will want answers. They will want to know how their capital could be wiped out when they followed the advice of financial advisors who assured them that the investments they were recommending were suitable to meet their investment objectives and tolerance for risk. It is likely that the confidence of individual investors in their financial advisors will be undermined. They are likely to be looking closely at the advice they were given and questioning how appropriate it was. And then they will start thinking about whether they have any right of recourse against these financial advisors, against the regulators and possibly against governments.

The actions of securities regulators (such as the Ontario Securities Commission) and of the self-regulatory organizations (such as the Investment Dealers Association) have already come under close scrutiny. There are lawsuits in progress that raise serious allegations about how these bodies carry out their investor protection mandate. The actions raise fundamental issues about regulatory structure, accountability, due process, transparency and timeliness. These issues cannot continue to be ignored by regulators and governments and those who advise them.

This is a gloomy situation. What can be done to turn it around? Lots. But it will involve the concerted effort of everyone involved in the capital markets - investors, regulators, the other so-called gatekeepers, government, and industry. Each group (including the public) needs to focus on the improvements it can make.

The Public:

The most important thing the public can do is to improve its ability to make sound economic and other decisions. Individual investors should take responsibility for their own economic and financial well-being by using every opportunity to enhance their education, improve their life skills and increase their knowledge and awareness of issues that will help them make these decisions. A growing number of employers, as part of their employee benefit plans, are offering programs designed for this purpose. It's important to take advantage of them.

Auditors, boards of directors, individual

 directors, lawyers, investment bankers,

rating agencies, standard setters, analysts,

regulators and lawmakers have each in

their own way failed the public.

One of the first steps in taking control of your economic and financial well-being is to develop an action plan. Start by identifying what matters most to you and what your personal and family goals are. Then make a plan to achieve these. Don't assume you have to buy something like mutual funds, segregated funds or other investments. Sometimes, the best plan is to pay off your debt or cut your spending. Your financial plan should centre on your needs, not your advisor's. You may find it helpful to use some of the new dynamic life-planning software that has been developed such as VisionWorks Life Planner ( ).

Don't expect a financial advisor to do your thinking for you about what matters to you. Although a good financial advisor is an invaluable resource and can help you, a bad one can hurt you Sometimes it is hard to tell if you've got a good or a bad advisor before the harm is done.

It's almost impossible to find out whether a financial advisor or the affiliated firm has a history of complaints or has been the subject of regulatory or legal actions. Ask these questions before you get involved and make a note of the answers. Beware of bad apples.

It's also important to understand what your financial advisor specializes in. Despite their title, some do not provide over-all planning advice. Their advice is only incidental to selling you mutual funds or insurance products and tied to what they sell.

You will find information about choosing a financial advisor on Web sites such as those of the Ontario Securities Commission ( and the Financial Planners Standards Council ( Some fund companies and other financial services providers have helpful information available on their Web sites.

Don't be lulled into thinking your needs will be met by filling in dots on a questionnaire. This method often results in high-cost products being sold to you that generate initial and ongoing commission revenues for the financial advisor and fees and charges for the fund or other product manager, which is affiliated, or has business relationships, with the financial advisor.

When someone tries to sell you financial products, ask lots of questions about them. They are not all created equal Comparison shop. Look for low costs, consistent returns, freedom from conflicts of interest, and sound governance procedures. Find out whether there are restrictions on transfer, redemption fees, surrender fees or transfer fees.

Your refusal to buy is the only way that financial services providers will be induced to lower costs, remove restrictions, implement better governance procedures, and eliminate conflicts of interest Be sure to make your concerns known. Speak loudly and speak often. It's easy for financial services providers to ignore individual customers but as the number of dissatisfied customers increases, so will the pressure to change. No one is going to reduce costs or take other action unless the marketplace - which means you, the consumer - forces them to do so by refusing to deal with them It is an opportune time to do this when financial services providers are already feeling the pressures of investors moving to the sidelines.

As your next step, set realistic goals centred on what you can control. You can't control rates of return Nor can you control taxes. Do not be mesmerized by the prospect of high rates of return. They usually involve substantial risk, high costs and unexpected tax consequences.

Think carefully before chasing after the projected returns offered by hot products such as income trusts, hedge funds and private investments that are being promoted by financial services providers. Ask yourself whether you can withstand the loss of your total investment and the possibility that you may be called upon to pay taxes and/or make other expenditures to protect your position.

Financial Services Providers:

remedial steps need to be taken to

restore investor confidence and ensure

that the stock market becomes a fair and

open way to invest one's money rather

 than one that is rigged by and for insiders.

The most pressing issue for financial services providers is the irreconcilable conflicts of interest created by the deregulation of the financial services industry These conflicts have not received much public attention. But this is changing as people learn the details of the widespread conflicts that underlie the investment banking and corporate transactions that are the subject of federal and state investigations in the United States as well as lawsuits launched by investors. Similar conflicts exist in Canada but somehow they have not received sustained public, regulatory or governmental attention. Eliminating conflicts will be an important part of regaining the confidence of the public. This will involve the restructuring of your business, eliminating some business activities and developing new business strategies It will involve recognizing and dealing with the major problems presented by many (if not all) of the industry's compensation systems. These create huge conflicts that are inconsistent with advisory and trust relationships and the promoting of ethical conduct.

In designing products and services, it's important to recognize that costs matter to your clients. Costs are a major deterrent to capital accumulation. The reality is that many people would be better off in the long term (or at least no worse off) if they confined their investments to Government of Canada bonds and bank deposit certificates rather than expose themselves to the increased risks and expenses embedded in many of the products and services offered by financial services providers.

Governments, Regulators:

They have a tough job. If they provide too much oversight and regulation they are criticized. If they provide too little they are criticized. Their problem is to find the right balance. They haven't found it yet and this has contributed to the current crisis of confidence.

Part of the problem is that governments and regulators are slow to act. When they do act their actions reflect what the financial services industry wants or is prepared to accept. Seemingly little regard is given to the needs of consumer/investors or fairness despite the fact that everything is said to be done "in the public interest."

Where individuals turn to the regulatory system for help when they encounter problems with financial advisors, they often run into a stone wall. Very little information is made available to them. The actions taken to resolve the complaint often seem inadequate or are too late to prevent further harm occurring to others.

There is seldom a public record of complaints and dispositions that might serve as an early warning to other investors. When private actions are settled, there is usually provision included that prevents disclosure of the settlement. This needs to be remedied. There ought to be reporting requirements and a national data base that the public can access that contains this information.

The industry has fought this for years. It's time to strike a better balance between the legitimate industry concern respecting the potential misuse of this information, the benefit the industry enjoys by requiring settlements to be kept secret, and the benefits the public would derive by being alerted to problems with dealers and their representatives.

Another of the many areas that needs attention is the issue of regulatory accountability. It is virtually impossible to hold regulators accountable for their actions or inactions no matter how deficient they were or how extensive the resulting harm was. While statutory immunity may be necessary, its existence demands that the legislatures exercise oversight over what their regulatory agents are doing or not doing. Such overview is virtually non-existent today.

These and other remedial steps need to be taken to restore investor confidence and ensure that the stock market becomes a fair and open way to invest one's money rather than one that is rigged by and for insiders.

Individual investors - the public - will have to play a crucial role in bringing about change if there is to be any hope of change. Everyone else has vested interests to protect. However, their common interest is that their respective survival depends on meeting the needs of the public. The public must speak up and demand change. They must make their voices heard by governments, regulators and industry. This is not easy to do but it can be done, one voice at a time growing into a chorus that cannot be ignored.

Glorianne Stromberg is a securities lawyer, a former Commissioner of the Ontario Securities Commission and a frequent commentator on the financial services industry.