Investor restitution tops list of demands

In early April, the OSC published its latest draft statement of priorities, which sets out the regulator’s agenda for the coming year. The OSC must finalize that agenda by the end of June, after seeking public input on its plans. This year, that feedback features calls for the OSC to take on a series of policy challenges not on its itinerary.

For example, several comments suggest that the OSC wade into the consultations that are underway to consider the regulation of financial planning. The Canadian Advocacy Council for Canadian CFA Institute Societies’ comment notes that the OSC is in an “excellent position” to assist with the provincial government’s efforts, and it urges the OSC to get involved. This suggestion is backed by investor advocates, such as the OSC’s independent Investor Advisory Panel (IAP).

“It is simply unacceptable that anyone in Ontario today can call themselves a financial planner (or advisor, or seniors specialist, for that matter) with no formal training or proficiency requirements. This is unfair, both to industry professionals and investors,” the IAP argues in its comment, which calls on the OSC to take regulatory action both to deal with titles that advisors can use and to bolster advisor proficiency. “Ontario investors ought to be able to count on an investor protection regime that ensures competent, well-trained advice givers whose use of business titles is properly regulated and controlled. This is not the case today, and the commission should make this a priority.”

Investor advocacy groups are unified in calling for the OSC to put investor restitution back on the policy agenda. In 2004, a legislative committee in Ontario urged the OSC to look at ways of improving investor access to restitution. Yet, seemingly little has been done to tackle the issue.

In fact, the situation has deteriorated in recent years, as the one accessible venue for restitution – the Ombudsman for Banking Services and Investments (OBSI) – has faced industry resistance, with a handful of firms routinely rebuffing OBSI’s compensation recommendations in the past several years. Recently, OBSI reported that investors are facing lowball settlement offers in the wake of this demonstrated willingness to ignore OBSI’s recommendations.

The comment from the Canadian Foundation for Advancement of Investor Rights says that the rise in refusals and the emergence of lowball deals represent inherent weaknesses in the OBSI system, which the OSC must address.

The IAP’s comment echoes this suggestion, saying that fixing these problems must be a priority.

Absent that, the OSC should consider establishing an investor restitution fund, similar to the one the Autorité des marchés financiers operates in Québec, the Small Investor Protection Association’s comment suggests.

In addition, the IAP’s comment recommends that the OSC consider giving the Mutual Fund Dealers Association of Canada and the Investment Industry Regulatory Organization of Canada the power to collect fines from rule-breakers who leave the industry without paying the monetary sanctions levelled against them.

Investor advocates aren’t the only ones calling for tougher enforcement, though. The Investment Funds Institute of Canada (IFIC) also has some ideas. Principally, IFIC’s comment calls for more harmonization in enforcement, both among the provincial regulators and between the provinces and the self-regulatory organizations.

For example, IFIC’s comment recommends that market bans handed down in one province should automatically apply throughout Canada: “IFIC believes that if an advisor is banned for misconduct within one provincial jurisdiction, then this ban should apply nationwide.”

In addition, IFIC’s comment recommends that regulators create a national registry of securities law offenders to bolster investor protection and enhance confidence in the capital markets.

Comments from the Independent Financial Brokers of Canada (IFB) and the IAP also advocate co-ordination among regulators in the securities sector and the insurance sector. For example, the IFB’s comment suggests that regulators build a database that would provide consumers with access to registration and disciplinary information for both insurance- and securities-licensed advisors.

The IAP’s comment also calls upon the OSC to address the risks of regulatory arbitrage between the insurance and securities sectors. That comment warns that the risks of this arbitrage may rise as securities regulators adopt more stringent rules and consider even more fundamental measures – such as banning trailer fees – which may drive some advisors to favour segregated funds over mutual funds to avoid the stricter regulatory regime for securities.

“The plan should involve recommendations to the Ontario government that it reform financial regulation in Ontario so it reflects the realities of the marketplace, eliminating regulatory silos and creating a single, consumer-centric investor protection regime for Ontario consumers,” the IAP recommends in its comment.

Furthermore, that comment suggests that the OSC participate in the province’s recently convened expert panel that is studying insurance regulation, noting that this panel would be a convenient venue for launching these deliberations.

Corporate governance and climate change are two other topics attracting demands for OSC action. The Vancouver-based Shareholder Association for Research and Education’s (SHARE) comment calls upon the OSC to introduce mandatory “say for pay” votes for all issuers.

SHARE’s comment argues that the latest proxy season – which saw investors reject compensation plans at a handful major Canadian companies – proves the value of these sorts of votes.

In addition, SHARE’s comment suggests the OSC push companies to face up to climate change, which”may pose a broader market-level risk, as well as risks to individual issuers and investors.” Thus, SHARE’s comment calls for introducing greenhouse-gas emissions disclosure requirements for issuers.

 

Progress on Commissions

Although the Ontario Securities Commission (OSC) has not yet finalized its regulatory agenda for the coming year, the regulator is halfway to achieving one of its goals – completing independent research on the effects of mutual fund compensation models on financial advisors’ behaviour.

The OSC’s draft statement of priorities for 2015-16 includes completing third-party research on mutual fund fee structures and reviewing those results with the Canadian Securities Administrators (CSA) as a key objective. In mid-June, the CSA published the first component of that research – a review of the academic literature carried out by research firm Brondesbury Group.

The Brondesbury report indicates that research shows that commissions-based compensation structures create regulatory concerns because: mutual funds that pay commissions tend to underperform; commissions can bias advisor recommendations; and higher embedded commissions can drive sales. The report concludes that these problems are significant enough to justify regulatory action.

That said, it’s not clear just what that action should be. The report states that while fee-based compensation structures probably are better than commissions, it’s not certain that investor results would be improved by simply outlawing commissions.

Although banning commissions appears to result in advisors recommending lower-cost funds that generate higher returns, the research also found that firms may compensate for this in various ways, such as raising advisory fees, hiking administrative fees, increasing the cost of margin accounts and/or decreasing the rates paid on cash balances.

The Brondesbury report says that more research could help regulators craft an approach to minimize the negative, unintended consequences that could flow from an abrupt decision to ban trailer fees.

Yet, such a ban is what investor advocates are advocating. In comments on the Ontario Securities Commission’s draft priorities, groups such as the OSC’s independent Investor Advisory Panel reiterate their positions in favour of a decisive ban on trailer fees.

However, the Investment Funds Institute of Canada’s comment maintains that banning trailers would needlessly disrupt client/advisor relationships and limit clients’ access to advice for smaller accounts.

This oft-repeated criticism of banning trailers is addressed in the Brondesbury report, as the research confirms that less affluent investors do have a harder time getting advice in markets that utilize fee-based compensation models. But the report also notes that it’s not clear whether banning commissions causes advice to become less available or if that situation existed before a ban was imposed.

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