Cultural fit is a
basic issue for corporations contemplating a merger. It should also be fundamental to self-regulatory organizations that consider combining.

The Investment Dealers Association of Canada has proposed consolidating the SROs — merging with both the Mutual Fund Dealers Association and Market Regulation Services Inc. There are no active talks underway, but if and when they begin, it’s worth considering whether there is a genuine match in cultures.

Superficially, the idea is a no- brainer. The IDA and the MFDA both regulate dealers, and the MFDA’s rules were modelled on the IDA rule book. So, the two organizations share philosophical roots. Similarly, RS polices market integrity, and IDA members are the ones dealing in those markets. But this operational overlap doesn’t guarantee cultural synergy.

The IDA is the big dog in the SRO world. It had a hand in spawning both RS and the MFDA. But the parent and its offspring sometimes seem to view each other as rivals rather than comrades. They compete for headlines, and their styles frequently clash.

While the MFDA is still a fairly new organization that has yet to establish fully its identity, it has displayed a different personality than the IDA in terms of transparency.
The MFDA has adopted a more independent governance structure. And it seems to be more open in alerting both its members and the public to the types of problems it uncovers during routine compliance reviews. It frequently issues bulletins warning about practices that could constitute dubious conduct or flat-out violations of its rules.

However, SROs’ reputations tend to be forged primarily by their enforcement records.
So far, the MFDA has brought a number of cases forward, and has levied some harsh penalties. But, many of these cases represent the low-hanging fruit — obvious cases of severe misconduct that are relatively easy to prosecute. The MFDA has yet to prove itself in less clear-cut cases.

Not only is the MFDA’s enforcement personality still being formed, but also the current turmoil in the mutual fund world could yet alter its mandate. Recent fund industry scandals are highlighting the danger of minimal oversight of fund managers. The market-timing case revealed that regulators failed to detect a widespread industry issue until prodded by U.S. authorities. Also problematic are a couple of recent cases in Quebec in which fund managers are accused of misusing unitholders’ funds.

These problems reveal a huge gap in an otherwise highly regulated securities industry.
Technically, the provincial securities commissions have responsibility for overseeing fund managers, as they did for fund dealers before the MFDA was formed. However, these scandals suggest the intensity of direct oversight from the commissions may be unacceptably low. If the securities commissions still believe in the value of self-regulation, it’s not hard to see that an SRO for fund managers could make sense.

This idea has been floated in the past, but never got off the ground. The IDA once kicked around the idea of taking over manager regulation itself. However, IDA president and CEO Joe Oliver says, that’s not in its plans right now. With possible SRO mergers, its push for prudential regulation powers and ombudservice reform, the IDA has its hands full, he notes.

Oliver recalls that when the IDA was setting up the MFDA, there was some
consideration of whether the new organization should also regulate managers. At that time, it was rejected because fund companies are issuers, and regulating them would be different from supervising fund dealers.

Back then, there had been few incidents of fund manager misconduct. The question today is whether the recent regulatory troubles involving fund managers are severe enough to necessitate a move to more intrusive regulation.

Indeed, it is possible the MFDA itself will soon contemplate whether to seek that role. The MFDA hinted as much in its submission to the standing Senate committee on banking, trade and commerce earlier this year. In that submission, the MFDA cited the relative paucity of regulatory oversight of fund managers as a significant gap. It called for the establishment of a contingency fund to cover the entire fund industry, not just the dealers. And it recommended that fund managers be subjected to oversight by an independent regulator.

The MFDA is in the midst of its strategic planning process, which could see it deciding to seek responsibility for fund manager regulation. That process isn’t due to conclude until the spring, however. In the meantime, MFDA president and CEO Larry Waite declines to comment on speculation that its mandate could expand.

@page_break@As for an industry-wide contingency fund, MFDA Investor Protection Corp. has struck a working group to review various aspects of a protection fund, as required by the regulators. The group is chaired by Tanis MacLaren, former head of the Ontario Securities Commission’s office of international affairs. The group is stocked with industry representatives. It will presumably consider the issue of an industry-wide fund as part of its deliberations.

It may make sense to let all this jockeying for jurisdiction play out before the various SROs seriously contemplate a merger. Given the divergent paths that the IDA and MFDA appear to be taking, however, the best chance for an effective merger may be sooner rather than later — in another couple of years, they could be significantly further apart, culturally and operationally. IE