A decade of regulation

But more significant than that early penury was the level of anger that greeted them. Waite remembers meeting rooms full of irate mutual fund reps, who didn’t understand why this supposedly “self”-regulatory organization was being foisted upon them by the OSC. “Initially,” he says, “we were extremely shocked at the hostility.”

Some fund dealers and reps suspected that it was a plot by the big banks. As one letter — addressed to “Hitler and the SS” — read: “Years ago, when the big banks didn’t want to sell mutual funds, there weren’t any ‘rape and pillage the private person committees’ telling us what we could and could not do with our money.”

The outbursts of anger and threats of physical harm culminated in a bomb threat before a meeting in Victoria. The RCMP was called in, the meeting went ahead and no one was blown up.

“We were walking into a very angry, hostile and scared group of people,” Waite recalls. “And, to a large extent, it was justified because they knew their world was going to change. All they knew was that they had these three people — Mark, Karen and myself — who [had formerly worked in] the enforcement branch of the OSC, and they didn’t know where we were coming from.”

In retrospect, Waite understands why dealers were frightened and angry about the prospect of increased regulation. But, their worst fears have not been realized. While some of the industry’s bad apples may have been weeded out, the MFDA has not driven fund dealers out of business en masse.

The MFDA began admitting members in mid-2001, and by 2003, it had more than 200 dealers on board, with an aggregate $182 billion in assets under administration. The number of members has declined every year since then, and currently sits at 159 firms. But that smaller group of firms is sharing a larger pie, as collective AUA has risen to more than $300 billion. On a simple average basis, then, AUA per dealer has more than doubled to $1.9 billion in 2008 from $900 million in 2003.

Although few fund dealers were happy about the launch of the MFDA, most have survived and, better than that, have grown their assets. Over the past decade, the bank-owned fund companies may have taken the lead in mutual fund sales, but fund dealers are still taking their share of the spoils, despite intense competition from other sales channels and rival products.

But the MFDA was not set up to build business for the dealers. Its primary goal was to bolster investor protection by bringing some oversight to an area that had had virtually none. Fund dealers, at the time, were under the direct regulation of the securities commissions, and with the commissions’ limited resources (the OSC did not have self-funding status), the dealers received almost no regulatory attention.

It was acting OSC chairman Jack Geller who had pushed for the creation of the MFDA. He insisted that the existing system just wasn’t good enough, and that the creation of a new SRO was preferable to the securities commissions trying to do the job properly themselves, which would have involved overhauling their rules and significantly beefing up their staff.

Neither option was particularly appealing to the fund dealers; but for investors, all that mattered was that someone took the job. At the time, the OSC had said it was capable of reviewing only a couple of dealers a year. Since 2003, the MFDA has carried out almost 700 sales compliance reviews (318 head office reviews and 360 branch reviews). It has also completed 121 financial compliance reviews.

That work is at the heart of how the MFDA has changed the fund dealer world. “To be an effective regulator, the meat and potatoes, your core competency, has to be compliance,” says Gordon. “Active compliance is the key to effective regulation. Focusing only on enforcement, that’s reactive; that’s waiting for there to be blood on the floor.”

Through compliance work, he adds, “You can prevent the violation from happening.”

It’s difficult to quantify what introducing this ongoing oversight has meant to investors, in terms of harm that has been avoided or deterred, but the development is certainly positive for clients. Perhaps just as important, it has also created a compliance culture at the dealers that didn’t previously exist.

“One of our challenges,” Gordon says, “was to change the whole mindset of the industry. Ten years ago, the [reps] all thought of the dealers as working for them, and many of the dealers didn’t understand that they were responsible for the conduct of those [reps].”

So, not only did some reps not want closer oversight from a regulator, they also didn’t want the regulator pushing the dealer to take closer account of their businesses. “I don’t think they understood that they were already under these obligations [as securities registrants],” McGuinness suggests. “We were just providing some clarification of what they were.”

“Our approach was not to go in and find fault,” Gordon explains, “but to go in and educate and work with the dealers in terms of what’s expected and how they could meet their compliance obligations.”

That effort has helped to change the old-school mindset. Originally, the reaction the MFDA got from dealers and advisors was “Go away,” Waite says. “Now, they want our help complying with the rules.”

The rules were essentially created from scratch, too — modelled on the rules of what was then the Investment Dealers Association of Canada (now the Investment Industry Regulatory Organization of Canada). As a result of the imposition of those detailed rules and the compliance work that followed, Gordon says, dealers have better books and records, better supervision, better policies and procedures, and are better capitalized.

In addition, the MFDA set up the industry contingency fund, providing clients with coverage that’s comparable to what they receive from investment dealers. And the MFDA joined with the IDA to establish the Ombudsman for Banking Services and Investments, which offers a dispute resolution mechanism.

The MFDA has also brought an enforcement process to the fund dealer world. Since 2003, the MFDA has handled almost 5,000 calls to its enforcement department, opened more than 2,000 cases and carried out more than 500 investigations. Of those, 86 files have been escalated to litigation, and 60 hearings have been brought forward.

The biggest dollar win for the MFDA, as is the case for several Canadian regulators, was the mutual fund market-timing settlement in 2004. There are a couple of large blemishes on the MFDA’s record, too: for example, the fact that fund dealers were the source of much of the buying in failed hedge fund firm Portus Alternative Asset Management Inc.; and the Ian Thow case in Vancouver, which saw Thow’s firm sanctioned for supervisory failures, while millions in client money has disappeared, as has Thow.

Notwithstanding those very public setbacks, Waite and his team have tried to run the MFDA differently. The enforcement, compliance and policy branches are not separate silos; each department has to be at the table when the MFDA issues a notice of hearing, Waite says, which ensures that they are all on the same page.

“We recognized from Day 1,” Gordon says, “that policy isn’t driven by a couple of policy wonks working away. We realized that policy is really driven by your compliance and your enforcement folks. They are the ones who identify issues around which you need to wrap a policy.”

That has led to some policy innovations, too, including the MFDA’s current pet project, a new suitability policy. To keep policy relevant, the MFDA has also initiated a rule review to ensure that its rules are working as intended, to eliminate obsolete rules and add new ones when needed. And it pioneered a co-operative approach to regulating dealers in Quebec.

Today, co-operating with other regulators and navigating the byzantine provincial regulatory structure is one of the MFDA’s biggest ongoing tasks. “We knew it would be a challenge dealing with members,” Gordon says. “We didn’t know what sort of challenge it would be dealing with all of the securities regulators.”

Looking ahead to the next 10 years, regulatory consolidation remains a possibility, although Waite doesn’t see it in the immediate future, given IIROC’s prolonged gestation. In the meantime, Gordon says, the focus is on improving — doing the job better and doing it faster. The regulator no one wanted might even have another 10 years in it.