The gradual evolution of securities regulators to investor advocates from seemingly uncaring bystanders is taking another small step forward with a modest proposal to dealers that referred clients to ill-fated Portus Alternative Asset Management Inc.

The Ontario Securities Commission is offering the 55 dealers that directed some of their clients toward Portus a sort of plea bargain: return the commissions you received for the referrals to the clients and you won’t face supervisory violations.

The proposal puts the regulators’ seal of approval on a step that some firms had already contemplated on their own. Last year, a number of firms that referred clients to Portus agreed among themselves to collect the commissions for possible return to investors. Now, if they do so, they’ll get a break from regulators.

The total dollar value of the initiative is rather small in the context of the Portus fiasco. About $800 million of Portus notes were sold, and the OSC estimates that about $22 million in referral commissions were generated. Of that, Manulife Financial Corp. has already made its clients whole for their entire Portus investments, including the $10 million in referral fees that its reps generated. If the other dealers agree to the proposal, a further $12 million could be sent back to investors. So far, the OSC says, 28 firms, representing about 80% of the total value, have indicated that they will accept the deal.

Although the amount of money isn’t huge, it has great symbolic significance. It shows regulators — which have long avoided getting back the money of people wronged in the capital markets — are now doing so. Traditionally, regulators have insisted that it’s not their role to help out injured clients. In Canada, they have been reluctant to get involved in the sort of regulatory actions that are common in the U.S., in which ill-gotten gains are disgorged into restitution funds and then redistributed to harmed investors.

Their view has changed, however, in the wake of widespread consumer complaints about the lack of effective consumer redress mechanisms in the capital markets. A legislative committee report has also called for the government and regulators to develop a more efficient system.

“It’s a small step, but we think it’s an important one, in terms of getting money back into the pockets of investors right away,” says Wendy Dey, the OSC’s director of communications. She notes that the regulators decided the approach would be the most efficient and effective way to get that money returned.

The OSC proposal is also interesting in that it will use firms’ registrations to seal the deal. The regulators propose that dealers agree to have terms and conditions placed on their registration. Conditions include repaying referral fees to investors by May 31; agreeing to participate in studies of the referral fee arrangements by regulators; and agreeing to implement any recommended policy changes that come out of such research. Dealers have until Jan. 24 to decide whether they are going to accept the deal. (Although Manulife has already voluntarily repaid the fees, it is being invited to accept the other conditions.)

Compliance will be overseen by the self-regulatory organizations. Of the 55 dealers affected, just five belong to the Investment Dealers Association of Canada. The rest are the responsibility of the Mutual Fund Dealers Association of Canada. Firms that go along with the deal must have a repayment plan in place by March 1. By June 30, they will be required to certify to their SRO that the payments have been made. Shaun Devlin, MFDA vice president of enforcement, says that evidence of the payments will show up in firms’ monthly financial reports.

Submit referral policies

As for the policy and procedure changes that might be required as a result of accepting the proposal, Devlin says firms will have until the end of April to submit their referral policies to the MFDA. They’ll be required to make any changes determined by the SRO.

In exchange for accepting conditions on their registration, the OSC indicates that dealers will not face regulatory action in Ontario for any failures of due diligence or supervision that may have occurred in the case. They will also get credit for co-operation if there are any other actions related to Portus. However, the deal doesn’t necessarily put the firms or their reps in the clear.

@page_break@In the past, regulators indicated that they are looking at whether the referrals constitute acts in furtherance of a trade and, if so, whether reps were effectively trading beyond their registration. This would raise the spectre of suitability, among other sales practices concerns.

Notwithstanding the terms of the offer, regulators note that investigations into other issues are continuing, and may result in enforcement action. Nor will the repayment of referral fees thwart investors’ attempts to get redress through the courts, or through the ongoing insolvency proceedings. So far, Portus’s receiver, KPMG Inc. has recovered $133 million in assets, US$36 million in cash, as well as notes of an indeterminate value that were purchased for $529 million, with a maturity value of $611 million.

For the Portus investors, there’s a long way to go before it’s clear just how much they’ll recover of their original investment. “There’s no question that investors have miles to go before they have answers to all their questions,” Dey says. “But this proactive step is the fair way to proceed. It’s only fair that these referral fees be returned to investors.”

Certainly, the OSC’s initiative is a welcome step, not just in this case, but for investors generally. Not only are regulators making some effort to get money back to investors, but they are doing so in a rather clever way, by making dealers’ registration the linchpin of a voluntary restitution deal.

Registration suspended

Registration has often been criticized as simply a fee-collection exercise and, while this initiative doesn’t make it a more meaningful indicator of competence, it does highlight its potential utility as a regulatory tool. Firms that accept the OSC’s proposal, but then fail to follow through, would face having their registration suspended. Dey calls the novel approach “a tailor-made solution to one aspect of the Portus problem.”

The importance of effective restitution is getting some consideration from the regulators’ umbrella group, the Joint Forum of Financial Market Regulators. The joint forum has engaged Harold MacKay, counsel with Regina-based MacPherson Leslie and Tyerman LLP, to conduct a review of the industry complaints-adjudication system, the Financial Services OmbudsNetwork.

David Wild, chairman of both the joint forum and the Saskatchewan Financial Services Commission, says that the review isn’t being conducted in response to consumer complaints or industry suggestions that the system should be streamlined, but rather because the network has been in operation for several years. Regulators thought it was time to see if it was achieving its objective.

“Now that the FSON has been operating for three years, the joint forum decided that it would review the operations of the FSON to ensure that the conceptual design is being fully realized,” he says.

MacKay is reviewing the system in terms of whether it’s meeting its original objective; he’s not looking to reinvent it.

MacKay is expected to deliver his findings sometime in the spring.

Regardless of whether the industry ombudsman service is improved, or ultimately replaced by a new system, securities regulators are at least demonstrating a new willingness to come to the defence of wronged investors. IE