OSC whistleblower program released

01 CSA publishes more research on mutual fund fees

On October 22, CSA published new, independent research on how commissions affect mutual fund sales. The research follows a CSA literature review published in June.

The research finds that positive past performance drives mutual fund flows; however, past performance affects flows differently, depending on fee structure:

• Past performance has less influence on fund sales when those funds have sales and trailing commissions, or are sold through affiliated dealers. The lack of influence in turn reduces future fund performance.
• Past performance highly affects flows in fee-based accounts. This influence improves future fund performance.
• Funds with trailers increase flows, regardless of performance. “Generally, the greater the trailer fee, the greater the level of net flows that has no relationship to past performance,” says the report.
• An increase in trailers corresponds to a decrease in performance, and a decrease in trailers corresponds to an increase in performance.

This research “makes the case for fee-based funds, to make sure you’re getting objective advice,” says Bernard Pinsky, partner at Clark Wilson LLP in Vancouver. “[The research says] those advisors who are not committed to any particular product will look at past performance as their major indicator” when choosing funds, as they logically should, he says.

Does research like this mean Canada could ban embedded sales commissions? Potentially: “It gives the commission the ability to move forward,” says Simon Romano, partner at Stikeman Elliott in Toronto.

Says Pinsky, “But I don’t know that everyone wants to go to fee-based, because it can be more expensive.” Romano agrees, saying there’s concern small investors won’t be served. That concern highlights the need for a measured approach, suggests Lynn McGrade, partner at Borden Ladner Gervais in Toronto. She says this research is only one piece of the policy puzzle. “The bottom line is, I still view that the regulators are in research mode, and [this] research is just one of a variety of inputs that’s going to be looked at both by industry and by the regulators.”

Those inputs include past research and comments, the result of CRM2 disclosure requirements on fee transparency and the experiences in countries that have restructured their fee models.

“Historically, the CSA has taken the approach of not regulating fees, but they have relied on disclosure,” she says, citing POS initiatives and CRM2 as examples. (An exception would be NI 81-105, enacted in 1998 to regulate mutual fund sales practices). The CSA plans to communicate a policy direction on mutual fund fees by the first half of 2016.

McGrade speculates a more detailed paper on CSA’s proposed changes may be published at that time, or “the regulators may be very bold and just come up with draft proposed rules.” For now, she says, “we’re applauding this research-based approach.”

02 OSC whistleblower program

On October 28, the OSC published OSC Policy 15-601–Whistleblower Program. The program details:

• the procedure for submitting whistleblower information,
• whistleblower protections,
• award eligibility and
• award amounts.

Howard Wetston, then CEO and chair of the OSC, said in a release, “We are providing strong incentives for [whistleblowers] to come forward. Our whistleblower program is well-considered, and we believe it will result in real-time tips on complex securities law matters that may otherwise be difficult for us to detect.”

But Pinsky says the program has weaknesses. For example, there are limitations to maintaining whistleblower confidentiality, including “to permit a respondent to make a full answer and defence.”

This may render whistleblower protection less ironclad in many instances, says Pinsky.

“[Exceptions to confidentiality] will be one of the first battles,” says Romano, and will influence future whistleblowers. “You may not want to be the first whistleblower; you may want to see how it pans out.”

The program’s statement on retaliation is even weaker, says Pinsky. The commission “expects” employers will not retaliate against a whistleblower. “I have never seen anything that tepid in a policy,” he says. However, the Notice and Request for Comment states OSC staff will recommend legislative amendments to the Securities Act that would protect whistleblowers against retaliation.

Also according to the notice, says Romano, “until they get legislative amendment, they will still prosecute in the public’s interest,” under section 127 of the Act. “That kind of statement suggests they’ll prosecute whether or not they get the power” to protect whistleblowers.

Another concern is the limit on awards, says Bill Singer, a New York-based attorney and former regulatory lawyer. (Section 18 of the proposed policy caps a whistleblower award at 15% of total monetary sanctions, up to a maximum of $5 million when the commission collects at least $10 million. The SEC awards a maximum of 30% with no limit.)

“Any threshold on a whistleblower award is misguided and myopic because, if you can afford to stop a $100-million fraud, and the cost of stopping that fraud is $10 million to the tipper, certainly that would be money well-spent.” Awards are made only after the appeal process, so, Romano says, “it could in fact be a very long time until you get paid.”

Pinsky notes Canadian awards are typically smaller than those in the U.S., so a cap doesn’t concern him. In fact, he questions whether awards matter at all, because the typical employee who would be privy to sensitive information—a director or an officer—is ineligible for an award.

“I think that [ineligibility] is probably a mistake,” says Pinsky, because it potentially eliminates the main pool of whistleblowers. Some directors, he explains, might not have the authority themselves to stop misconduct, but they would have access to the required information.

Further, there’s no immunity for a complicit whistleblower. Will potential whistleblowers take the chance they won’t be prosecuted, wonders Romano, or will they instead keep silent?

Ultimately, he says, “we’ll have to see how [the program] unfolds in practice.” The comment period ends January 12, 2016, and the OSC plans to enact the program by spring 2016.

03 SEC enforcement report for fiscal year 2015

In fiscal year 2015, which ended September 30, the SEC filed 807 enforcement actions and obtained orders of $4.19 billion in disgorgement and penalties. This is up from 755 enforcement actions and orders of $4.16 billion in fiscal year 2014.

Of the 807 actions, a record 507 were independent actions for violations of federal securities laws, up from 413 in fiscal year 2014. The rest were either administrative proceedings or actions for delinquent filings.

Andrew J. Ceresney, director of the SEC’s Division of Enforcement, credited the division’s hard work and efficiency for “a significant number of high-impact, first-of-their-kind actions,” such as those involving a private equity advisor for misallocating broken deal expenses, and an underwriter for pricing-related fraud in the primary market for municipal securities. Singer isn’t impressed by the increase in numbers. “Some of the U.S. attorneys are now going over recent cases where they got settlements or convictions, and they’re now throwing them out because [the cases] won’t survive” a retrial or appeal.

He sees the report as an attempt at positive public relations. “We shouldn’t be considering it an achievement that we’re announcing the largest fines imposed in the history of the organization when, in the prior year, we announced the same thing.”

If the SEC wants to show how successful it is, he suggests the numbers should actually decrease to show systems and legislation are in place to reduce misconduct.

Instead, numerous scandals continue. “There’s no prescription in here. There’s nothing in this report that is suggesting they’ve found a way to avoid any of this. What they found is a way to catch people engaged in misconduct and fine them, but that’s nothing.”