What’s a regulator good for? In Canada, not much

By Harper Fraze | March 1, 2011 | Last updated on March 1, 2011
5 min read

In my last column, I assailed the bad behaviour I see — and tragically, continue to see — from financial advisors. As seen in several news articles in the past few months, poor conduct is not limited to advisors: regulators are guilty, too.

Like most Canadians, I have a strong belief in law, order and good government. Duty and responsibility are not just marketing phrases: they are the basic foundation of our society.

It is reasonable to expect our securities regulators to ensure that our markets work efficiently, investors are protected from fraudsters and high standards are kept. Given our history and national character — our most recognizable national feature is our federal police force — our securities markets should be the standard for the world to follow.

Yet, consider just a few of the items in the news recently:

  • The head of the CFA Institute wants the RCMP’s Market Enforcement Team reinvented, as it has had only five convictions after spending over $100 million in the past seven years.
  • The BC Securities Commission has found the Mutual Fund Dealers Association acted improperly in a proxy solicitation, with actions that are just short of vote rigging. “Proxygate” has destroyed the trust MFDA members have in their governing body.
  • The 9,200 Norbourg investors will get their money back, but only after a judge forced the regulator to repay the victims. The regulator argued mutual funds were not under its purview.
  • The three men behind the massive Norshield hedge fund fraud have finally been found guilty by the securities commissions in Ontario and Quebec. Fines and penalties have been assessed, but only the regulators will collect. There is no compensation for the 1,900 retail investors who collectively lost $159 million. Indeed, it was their money that paid for the forensic investigation. There is no word yet on a criminal investigation.
  • BMO Nesbitt Burns was fined $3 million for its role in the FMF Capital saga. Again, the victims will see none of this money, as it will all be paid to the Ontario Securities Commission.
  • Boaz Manor, one of the two masterminds behind Portus, is finally back in Canada. After fleeing to Israel and allegedly hiding over $17 million in cash and jewels, he has yet to stand trial for his part in the multimillion-dollar fraud that used the retail hedge fund industry as part of its con.
  • Poor Ian Rankin is back before the courts, as he continues to deal with the 2005 insider trading charge of which he was ultimately cleared. To me, his only error was in picking his friends. In this, its most famous case, the OSC can’t seem to tell the bad guys from the bystanders. Leave the guy alone already.
  • I could go on, but the point is clear: The market regulators are an abysmal failure. In case after case, there is lax enforcement, minor penalties and/or no protection or remedy for investors. And when they do finally go after someone, they target the wrong person (Rankin instead of Daniel Duic) or fail to deal with them harshly enough (John Xanthoudakis or BMO Nesbitt Burns).

Compare how U.S. regulators have handled problems in their securities industry. When Portus, Norshield and Norbourg were failing, Bernie Madoff was still in business. The Madoff fraud was larger than all the Canadian scandals combined. And while our stories are still being played out, he was investigated, charged and convicted. He sits in jail, while Manor, Xanthoudakis and other Canuck crooks are still walking around. Manor’s partner, Michael Mendelson, has already served his time and is out of prison.

The Fair Dealing failure

These failures result in part because Canadian investors face a patchwork of regulatory bodies that is utterly nonsensical. A decade ago, the OSC attempted to introduce the Fair Dealing Model, which had the goal of clear roles and responsibilities for investors and representatives, enhanced transparency for investors, and clarity with respect to any conflicts of interest.

One of the key parts of the model was that the level of advice an investor sought and received would determine regulation. There would be three paradigms: a managed approach, with the investment manager taking full responsibility; an approach in which both the advisor and the investor share responsibility; and a self-managed approach in which the investor takes full responsibility for his or her choices.

Of course, such a logical and clear framework was doomed from the start. The entire project failed about five years ago. Today, both the MFDA and IIROC are putting the finishing touches on their own respective client-dealing models. Each, in its own way, will attempt to improve the transparency and suitability of client-advisor relationships.

Even when implemented, investors will still be stuck with a mismash of regulations and a labyrinthine, ineffective regulatory regime: in essence, a two-tiered investment advice model. What Canadians won’t tolerate in their health care, they will accept in their finances.

Most investors do not know the difference in educational requirements, licensing standards, order processing capability, product availability and other key areas between MFDA-licensed representatives and IIROC-licensed advisors. Both platforms provide advice to clients. Yet, the regulatory framework that surrounds the advisor is structurally different, and clients simply do not know or appreciate that difference.

Full disclosure: I am an IIROC advisor. I appreciate there are differences in the business models and culture between IIROC and MFDA channels. Each group mistrusts the other. To move forward and create a better environment for everyone — where the client is at the centre of what we do — a more rational conversation is needed.

I propose we continue with a two-tiered regulatory structure, with the distinction being clearly labelled as “Restricted Advice” and “Full Advice.” The discount brokers and branch bankers would be on the “Restricted Advice” side; full-service investment advisors, investment counsellors and financial planners would be on the “Full Advice” side.

The minimum educational requirements to be a “Full Advice” advisor would include the Canadian Securities Course along with the Certified Financial Planner and Canadian Investment Manager designations. “Full Advice” advisors would be considered fiduciaries and have a period of time, say five years, to move to a fee-based model. Only “Restricted Advice” representatives would be permitted to charge transaction commissions, similar to what discount brokers charge now. The Exempt Market Dealer category should be eliminated altogether. These cowboys would have to decide what business they are actually in.

Canadians still trust in their securities markets. This trust is in jeopardy when they see case after case of bad behaviour going undiscovered or lightly punished. Justice delayed is justice denied.

Moreover, Canadian investors need a simpler, stronger and more suitable system for governing their advisors. Moving to a regulatory scheme governed by level of advice, rather than by products sold, is a step in the right direction.

  • Harper Fraze is a pseudonym. He is an investment advisor with a large, Canadian-based financial services firm he cannot name.

    Harper Fraze