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Jul 2, 2020

Understanding “Investor Protection” – Spotlight On Regulation

by Ken Kivenko

Ken Kivenko“The scandal isn’t what’s illegal, the scandal is what’s legal”

Most Canadian retail investors trust and rely on financial regulators to protect them. This trust and reliance seem based on the legislated mandates of the provincial securities regulators: To provide protection to investors from unfair, improper or fraudulent practices, to foster fair and efficient capital markets and confidence in capital markets, and to contribute to the stability of the financial system and the reduction of systemic risk. The goal of an administrative tribunal is protecting the vaguely defined “public interest,” which means to protect the public in general rather than specific investors. Restitution is usually the job of the courts, not administrative tribunals. Disgorgement is primarily a power that is designed to deprive the rogue of his or her illegal profits; it doesn’t necessarily imply that the money will be returned to investors.

Most investors first learn of the shortcomings of securities regulation when they have an investment complaint. For too many, it is a life-altering event. It is the purpose of this article to provide investors with a more realistic view of investor protection in Canada.

In Morningstar’s 2019 Global Investor Experience (GIE) Study, the Fees and Expenses grade for Canada improved, from dead last in the 2017 study, to “Below Average” this time around. Investor advocates postulate that this poor relative ranking is due to weak regulation. Canadians are not permitted to buy cheaper U.S. mutual funds.

The regulatory and tax framework for Canada’s fund industry also continues to rank “Below Average” for investors, according to the Regulation and Taxation chapter of Morningstar’s 2020 biannual GIE report. The report notes that, while the investor experience can still be good in the “below average” markets, “they fall short of the standard set by other markets that govern conflicts-of-interest and incentivize investing.” The report also notes that the pace of reform in Canada has not kept up with the rest of the world, explaining why Canada continued to receive a below average grade for regulation and taxation.

On the positive side, there are investor protection funds, designed to provide compensation up to $1 million per eligible account to clients if investment firms become insolvent. This protects investors from dealer bankruptcy. However, Portfolio Managers and Exempt Market Dealers who are not members of IIROC and the MFDA are not covered.

Regulators provide online access to a registration database. This allows investors to check if an advisor is registered, her/his registration category and disciplinary history. That can help prevent investor harm. This is a valuable investor protection service that is well promoted by regulators. Regulators are working on making the system more investor friendly.

Regulators can make rules regarding disclosure, prospectuses, corporate and fund governance, insider trading reporting, financial reporting, and auditing.

Regulators can make rules about which investors can buy a product (an example is the “accredited investor” rules), the types of products that can be sold, how investors pay for them (trailers, upfront payments, Deferred Sales Charges (DSC) and rules regarding certain types of products (mutual funds) etc. They can establish rules that relate to advisor conduct, conflicts of interest, disclosure, Know-Your-Client, suitability, reporting, and client complaint handling. Regulators conduct financial compliance reviews and set minimum capital requirements to ensure that investment dealers have enough capital for the specific nature and volume of their business.

While protecting investors, provincial securities commissions need to balance out their mandate to avoid adversely affecting the capital markets. This can create a conflict of interest, and in turn, a need to make trade-offs. The financial services industry can leverage a well-resourced lobbying capacity to influence how regulators make the trade-offs. Countering these lobbyists are a small contingent of dedicated individuals and underfunded advocacy groups. In this lopsided debate, the loudest voice in the room often prevails.

Not only that, but there is an interchange of personnel between the regulators and the regulated financial services industry or law firms that represent the industry. This “revolving door” could lead to the temptation that, while working at a regulator waiting for a more rewarding career in the industry, individuals may consciously or subconsciously adjust the zeal with which they pursue their regulatory responsibilities.

The effectiveness and perceived fairness of securities regulation can be further jeopardized when the statutory regulators subcontract the regulation of investment dealers to industry self-regulating organizations (SROs): the Mutual Fund Dealers Association of Canada (MFDA) and the Investment Industry Regulatory Organization of Canada (IIROC). The “members” of these SROs are restricted to industry firms. In addition, their advisory committees are comprised almost exclusively of industry participants. There is limited opportunity for input by investors and their advocates. After decades of overlooking this imbalance, an upcoming consultation will examine the pros and cons of self-regulation and a new framework.

Canada’s security regulations have elements that aim to protect retail investors. These regulations can address the worst types of financial assault, albeit they are certainly not best-in-class. Provisions even exist for regulators to grant exemptions to published rules and regulations. The real problem arises with how these regulations are interpreted, administered and enforced.

Advisors are required to provide trustworthy advice to clients, but they are allowed to do so under conditions of conflicts of interest, conflicts of interest that impact the dealer’s profit and advisor’s take-home pay. Do regulators really believe that it is reasonable or even possible for investment dealers to mitigate the conflicts of interest they have designed? This is not an objectively reasonable process and degrades the standards of investment advice.

After more than a decade of consultations and roundtables, regulators finally made it mandatory for an annual report on account costs and expenses incurred to be sent to investors. Turns out the disclosure requirement report leaves out the fees paid to the mutual fund companies, fees that could account for up to 50% of the cost. Regulators are working on correcting this deficiency.

When the rules are broken, regulators can take enforcement action that includes fines, suspensions, permanent bans and other sanctions. Some dramatic failures have occurred including Bre-X, YBM Magnex, Livent, Sino-Forest and mutual fund market timing scandals that have cost investors billions of dollars. In the case of the non-bank ABCP fiasco, it was investor advocates, not the regulators, who ultimately helped retail investors secure redress. As currently structured, securities regulators lack the power and resources to provide effective investor redress.

More recently it was revealed that virtually all investment dealers had been double-billing clients for over 10 years. That debacle cost investors over $350 million which was returned to clients after numerous regulatory settlement hearings. The question is: how did such abusive behaviour go undetected and unaddressed for so long? A related question is why are these abuses permitted to continue for years after investor advocates bring specific wrongdoings to the attention of regulators?

Those who break the rules should be held to account. When enforcement intensity is light and sanctions are small, investor protection is compromised. A number of independent research studies show that Canada’s enforcement regime lacks the robustness of other jurisdictions.

Ombudsman for Banking Services and Investments (OBSI)’s potential effectiveness has been undercut by the unwillingness of regulators to give the Ombudsman the power to make a binding decision. The lack of a binding decision mandate has seriously jeopardized the ability of harmed investors to receive fair compensation and investor confidence in public markets. Multiple independent reviews of OBSI have recommended a binding decision mandate for years—recommendations that have fallen on the deaf ears of regulators who oversee OBSI.

It is outside the scope of securities regulators to immunize investors against risk or against loss. And, it is not the job of securities regulators to ban speculation or risk-taking. It is not the role of securities regulators to approve or disapprove the merits of securities being offered to the public. In principle, a questionable investment product could be sold to retail investors as long as the issuer, dealer and advisor provided full and plain language disclosure about the product including its risks and complied with other investor protection rules. In the decision involving the recently approved Bitcoin fund, the Ontario Securities Commission “bluntly stated” Some novel asset classes and securities products fail. They become tulip bulbs or dot.coms. Others succeed and become gold or the next great technology. Securities regulators are not mandated to try to pick winners and losers.”

In the case of Bitcoin, we have seen pronouncements by Warren Buffet that Bitcoin is “rat poison squared”. Respected industry commentator Dan Hallett has said “Cryptocurrencies—including Bitcoin—have no place in investment portfolios. We design client portfolios to achieve a specific goal—a specific long-term return target. I can take each component of the portfolio and give you a very good ballpark estimate of how each piece will contribute to achieving that long-term goal. I have no idea how anyone can do this with bitcoin or any cryptocurrency. It can’t be done.” Yet, a closed-end Bitcoin fund is now available to retail investors for purchase in RRSPs, RRIFs and TFSAs. What steps will regulators take to warn and protect investors about these seemingly risky products?

The Deferred Sales Charge (DSC) sold mutual fund has been identified as a toxic product by empirical research, investor advocates and regulators. Regulatory Commissions, after at least 20 years of review and discussion, did, in fact, approve a rule that would effectively ban such funds by not permitting mutual funds to make upfront payments. Unfortunately, the government of Ontario rejected the ban and has proposed different rules that would allow DSC funds to be sold in Ontario, subject to certain limitations.

It seems obvious that a discount broker, who is not permitted to provide advice, would be sanctioned for pocketing trailing commissions intended to finance personalized advice, yet that is not the case. There has not been a single enforcement action by any regulator. Recently, the regulators have proposed a rule that requires any dealer who collects trailing commissions to make a suitability determination. In principle, that could stop this insidious practice—no date for implementation has been set. Because of SROs’ and securities commissions’ inaction, investors’ only option is to wait for years for the outcome of a number of class action lawsuits which have been filed to recoup payments made for services not provided. Over the years, more than a billion dollars of investor savings have paid for advice that was neither wanted nor received. Would this abuse have occurred had SRO boards, executives and senior staff been less influenced by industry?

COVID-19 has created additional investor protection challenges. Within days of the pandemic’s affirmation, the regulators granted industry relief, regulatory exemptions, eliminated or reduced dealer fees and extended reporting /filing due dates. In April, regulators delivered a blow to agreed-upon investor protection reform when they issued a pair of orders that granted relief to firms, pushing back adoption of the new conflict of interest provisions by six months to June 30, 2021, and delaying the Client Focussed Reform’s new disclosure requirements by a full year to Dec. 31, 2021. Investors most need these reforms during times of crisis, but regulators favoured action to protect the industry at the expense of investors. While most actions placed investor protection reform initiatives on hold, regulators’ have said they will consider moving ahead with efforts designed to reduce regulatory “burdens” if they will provide immediate relief.

When it comes to improving investor protection, the reforms are stalled and deferred but when the investment dealers need support, regulators can move at light speed. The odds are stacked against the retail investor at every turn.

Bottom Line

Based on empirical data and observations, there is little question that regulators are under the influence of industry participants. Investor advocates reluctantly accept this reality, so have lobbied for financial support for an independent investor advocacy group or a separate agency dedicated to investor protection and a binding decision mandate for OBSI. Without regulatory reforms, Canadian retail investors will remain disadvantaged.

While securities regulators are mandated to protect investors, it is important for retail investors to understand the scope, nature and limitations of the protections provided. It is best to assume a Caveat Emptor approach. No one cares more about your money than you do.


Ken Kivenko, PEng, President, Kenmar Associates,,