Kenmar Associates Investor protection and education
Bay Street vs OBSI
OBSI's hands are tied
“I think we've got a lot of work to do on the culture of complaint handling and dispute resolution in financial services,There are some firms that have worked hard at it, but we also see some behaviour that really suggests to me they don't get it. It's the tactics of delay, it's the automatic no, it's the attitude of, ‘Get this into the hands of legal and start the formal letters.'“ - former Ombudsman for Banking Services and Investments, David Agnew on his departure in 2009 . [ see June , 2009 Research Paper by Dr. P. Reeve FLAWED PROCESS, FAULTY PRODUCT for a discussion of industry complaint handling rules and process weaknesses at
http://www.pjreeve.com/pjr/blog/Entries ... ULATION.ht ml ]
August 9, 2011
1
Kenmar Associates Investor protection and education
Introduction
Per Wikipedia, “ The modern use of the term [ ombudsman] began in Sweden, with the Swedish Parliamentary Ombudsman instituted by the Instrument of Government of 1809, to safeguard the rights of citizens by establishing a supervisory agency independent of the executive branch. ”. Today, an Ombudsman, such as OBSI, is used to provide fair, unbiased resolutions of financial consumer complaints . By design,their services are non-legalistic and participation does not require legal representation. Findings are not admissible in any subsequent litigation or arbitration. There is no charge to complainants for the use of OBSI's dispute resolution services. OBSI can also serve as a bulwark of financial consumer democracy in troubled times, protecting citizens and helping industry, regulators and government to improve in the face of a tough economy and fiscal constraint. But it is under attack by a group of investment dealers.
Major Investment dealers are rejecting 15 OBSI recommendations for compensation This has only happened once before in OBSI's history, with a small mutual fund firm. Problems with industry participants have been brewing for some time- see Feb. 23, 2011 OBSI Board meeting minutes.
http://www.obsi.ca/images/document/High ... D_s_Mtg_EN.pdf In this paper we offer the retail investor's perspective on this unnecessary fiasco .
Background
Per the OBSI 2010 Annual Report ,the average and median compensation for in- vestment cases were modest - $19,121 and $8,205 respectively. OBSI recom- mended compensation in 78 banking case files and in 177 investment case files, with 100 % of recommendations being accepted by the firms involved. Complain- ants received compensation from their financial institution in just 20% of banking cases and 38% (177 of 468) of investment cases, representing a total of only $3,788,896 for all of Canada ( of this amount $3,346,138 was related to invest- ment cases) . Thus , almost two thirds of investment case complainants received NIL compensation. Just five cases were settled for an amount greater than $100,000 . Per the chart on pg 49 there appears to be one case that paid out $200,000 , the highest amount of the year. Frankly, we are surprised at how low these numbers are and puzzled why so much static has been generated on the is- sue of loss calculations.
Of the major investment issues in 2010 ,Investment suitability was cited in 227 cases (48 %) , the most frequent cause of investment complaints out of a total of 468.Misrepresentation, fees, transaction errors , unauthorized trading and fraud make up the difference and are not affected by the issues raised by dealers.
2
Kenmar Associates Investor protection and education
National Instrument 31-103 , a regulation investor advocates feel was an organized industry attempt to hijack the OSC's Fair Dealing Model, is the statutory basis on which suitability is founded. Section 13.3 of NI 31-103 provides that:
Suitability (1) A registrant must take reasonable steps to ensure that, before it makes a recommendation to or accepts an instruction from a client to buy or sell a security, or makes a purchase or sale of a security for a client’s managed account, the purchase or sale is suitable for the client. (2) If a client instructs a registrant to buy, sell or hold a security and in the registrant’s reasonable opinion following the instruction would not be suitable for the client, the registrant must inform the client of the registrant’s opinion and must not buy or sell the security unless the client instructs the registrant to proceed nonetheless. NI 31-103 also states that the “registered representative is responsible for the advice given. In providing this advice, the registered representative must meet an appropriate standard of care, provide suitable investment recommendations and provide unbiased investment advice”.
From this Instrument we see that each recommendation (transaction) must be suitable for the account . This is important because it is establishes a principle upon which OBSI bases its loss calculations and restitution recommendations.
The OBSI Consultation
http://www.obsi.ca/UI/Resources/WhatsNew.aspx? csid1=77 resulted from complaints from a several investment dealers. They assert OBSI is being unfair in their investigation methodology and loss calculations . Specifically they assert:
1. As regards suitability ,OBSI should take at face value documents relevant to the case. These include but are not limited to NAAF, KYC , transaction slips, loan agreements, account statements and the like. It is felt that OBSI should not exercise discretion and judgment in weighing issues of credibility but instead should rely on legal and regulatory principles.
2. OBSI should assess suitability in the context of a portfolio, not as a stand- alone investment ; additionally, that OBSI is not consistent in its approach
3. OBSI client interviews may unduly influence the results especially as regards risk tolerance.
4. The adviser makes recommendations but the final investment decision is that of the investor who receives regular disclosure and account statements
5. OBSI should not award compensation greater than actual losses incurred on the basis that opportunity losses are akin to a performance guarantee
3
put forward ; #24 stated “
That OBSI continue with and expand its one-to-one
liaison activity with participating firms, with a view to continuously improving
cooperation and complaint handling between the two parties.”
] In our opinion ,
all of the key recommendations have been satisfactorily resolved The next report
is due out next month. No doubt, it will be closely read and analyzed.
Kenmar Associates Investor protection and education
6. OBSI should not use benchmarks for notional portfolios on the basis that Index funds are rarely the basis for a complaint and Index funds are not generally held for long terms
The 78 page September 2007 Report of the Independent Reviewer concluded “ In the course of our review, we looked closely at OBSI’s written complaints handling procedures and how they are implemented in practice. Our conclusions were that the OBSI does provide a fair and balanced opportunity for both the participating firm and the consumer to provide documents and other information in support of their positions and that OBSI achieves the right balance as between the participating firm and the consumer”.
http://obsi.ca/images/document/up- 7Independent_Review_of_OBSI.pdf [ 24 recommendations for improvement were
In our view, OBSI staff conduct an independent fact-based assessment of suitability, the risk of investments and the sophistication and responsibility of the investor. This assessment is done with the benefit of information provided by the dealer and also from the complainant. Compensation recommendations based on such research are not now being accepted by some firms . The resulting impasse has led to undue delays for complainants in receiving compensation has created a growing backlog of long standing cases. Restitution is being with-held while this very public battle rages with no end date in sight.
The financial and emotional pain of these delays on complainants has been severe and impaired the reputation of the dealers and OBSI . Investor confidence in the complaint handling system, which was intended to be a fair alternative to the longer and expensive litigation process is now in peril. OBSI has been unduly patient and not exercised its right to publicize the names and details of complaint cases where dealers have rejected OBSI's recommendations. Industry suggestions that this one power that OBSI has should be replaced with mediation makes a farce of the very concept of an Ombudsman. Industry participants assert that this is all about principles. We think it's more about a demonstration of power and influence. As Mammy Yokum says “ Sometimes you have to rise above principles” .
[Ironically ,while this nonsense is going on in Canada, the UK's securities regulator, the Financial services Authority , fined 2 British Banks in January millions of pounds Sterling for deficient complaint handling systems.
http://www.fsa.gov.uk/pages/Library/Com ... /003.shtml This included unduly lengthy processing times, unresponsive replies to complainants ,
4
Kenmar Associates Investor protection and education
poorly trained complaint assessors , deficient analysis and use of available information and failure to disclose Ombudsman referral rights. Perhaps Canadian regulators should do a sweep of a few dealers to confirm that retail investors are being treated fairly?]
In addition , there is the correct observation that NI31-103 permits dealers to select their own ombudsman as long as the entity is independent. Notwithstanding NI31-103, IIROC/MFDA member rules require investment and mutual fund dealers to utilize OBSI for all complaint investigations. Banking regulations and the Bank Act unfortunately do not. A Bank can leave OBSI as a participant at any time and pick their a dispute resolution service that better suits their needs. In fact, RBC Banking has done exactly that.
Let us discuss each of the six points
1. Use of NAAF / KYC as foundation documents
The essence of the argument is that regulators provide a framework from which to ascertain suitability. Chief among these is the NAAF and the KYC .This, according to the industry participants , should be the basis that OBSI should use to determine suitability. It is argued that this structure provides a protection for investors within which licensed representatives mus operate. Industry participants argue that the OBSI proceeds on the erroneous premise that it can establish through its suitability and assessment process, the "actual KYC facts" that will be relevant to OBSI's assessment of whether advice was suitable, without being limited to the KYC information that the dealer actually collected or should have collected.
We note parenthetically that Loss Capacity, income tax issues and liquidity are especially important suitability issues for seniors but not adequately dealt with on NAAF's. Loss Capacity is the ability to with-stand and recover from a bear market. It is primarily determined by age,health, income/expenses, time horizon and level of savings/net worth. It is not the same as Risk tolerance. Leveraging adds risk to a portfolio and undue risk , if it is unnecessary or excessive ,should also be a factor in OBSI's suitability determination(s).Our view is that neither OBSI nor industry participants deal with loss capacity adequately.
Investor advocates state that the prevailing KYC system is dysfunctional and Canadian suitability standards are weak and ill-defined. Investment Policy Statements and Engagement Letters would help but they are not required by regulators and hence , infrequently used. This lack of regulatory engagement makes the OBSI complaint handling process much more difficult than it should be. Further, there is no requirement currently to provide personal rates of return
5
Kenmar Associates Investor protection and education
on client statements and client statements are generally very poor at communicating essential information.
The Dec. 2003 OSC Regulatory Burden Task Force Report recommended that there should be a mandated KYC form with definitions that are more
understandable. Additionally, they stated:
1. Registrants should be required to follow mandated procedures regarding their use of the form with investors.
2. The form should require signature by the investor in all cases (with a copy retained by the investor) and all changes in the investor information contained in the form should require initialing by the customer.
3. The form should also contain clear bold-faced instructions to the investor as to how to best use the form to protect themselves and how to pursue a complaint regarding their account, with the registrant and its internal ombudsman and, if necessary, with the OBSI [Ombudsman for Banking Services and Investments].
4. The Commission and the IDA [now IIROC] should consider requiring registrants to send clients copies of their KYC form annually together with a request to advise the registrant if the information in the form should be amended.
Source:http://hdl.handle.net/1873/608 2 None of these recommendations have yet been implemented. Investor advocates continue to press for these unaddressed improvements but progress has been very slow.
The January, 2004 OSC Fair Dealing Model Concept Paper stated “ We continue to regulate most registrants on the basis of the products they sell, even though investors, firms and the courts consider the relationships formed and the advice given to be far more important than the actual sales transactions. The regulations allow an unacceptable lack of clarity which contributes to many of the problems in relationships between investors and advisers. Most retail financial services, including investment advice, are delivered by firms registered as dealers and their individual representatives. But the OSC‘s regulations only focus on advice as a business activity for a limited number of portfolio managers, investment counsellors, and newsletter publishers. For the majority of financial services providers, Ontario‘s existing product-based regulatory model has become
6
Kenmar Associates Investor protection and education
outdated, yet we continue to tack new regulations onto it. ” Source:
http://faircanada.ca/wp-content/uploads/2010/10/FDM.pdf Perhaps the current confrontation between dealers and OBSI will have a positive impact if it triggers a constructive review of the regulatory model from the retail investor perspective.
New Account Application Forms (NAAF) try to assess a client's risk tolerance through checking off a few blocks on the form. The form contains only barebones and generalities. Too often it's like putting a square peg into a round hole. The client might have goals to save for a house or an education, but the forms only allow advisors to check off Objectives like "growth" or "income" or "safety of principal". They come without definitions of the terminology used ( e.g. “safe” apparently means “not guaranteed “) . Nevertheless, this is often the core basis used by “advisors “ in deciding on suitable investments. SRO's have also identified problems with KYC's.
For example ,according to MFDA MR-0069 Suitability Guidelines :
1. Where ranges are used, at times they are too broad. For example, long term time horizons defined as greater than 3 years and the top category for net worth is greater than $100,000;
2. The NAAF does not collect sufficient information to assess suitability of particular products or investment strategies of the Member. For example, if selling exempt securities under the accredited investor exemption, the NAAF should include income and net worth information specific enough to demonstrate compliance with the exemption conditions. Another example, where a minimum time horizon has been established as a guideline for recommending leveraging, the time horizon on the NAAF should be able to support that this criteria has been met. MFDA Staff has also observed Members that define long term time horizon as greater than 3 years, which would not be adequate to determine whether the sale of a mutual fund with a deferred sales charge is suitable;
3. KYC choices on the NAAF are ambiguous. For example, time horizon of “none” was interpreted differently by staff at a Member to mean either extremely long term or very short term;
4. For joint accounts, Members have collected KYC information for each account holder rather than for the account itself. In some cases, the KYC information collected for each account holder conflicts and it is not clear what KYC information relates to the account;
7
Kenmar Associates Investor protection and education
5.
6.
7. 8.
KYC information that is inconsistent. For example, a client with a speculative investment objective and a low risk tolerance. A Member should either have controls to prevent such inconsistencies or have detective controls to identify and follow-up where inconsistencies are identified;
Use of calculators or other formula that focus on ability to withstand losses rather than the lesser of the client’s willingness and ability to accept risk;
Little or no explanation of terms used on the NAAF, including risk tolerance, investment objectives and time horizon;
Where the model portfolio approach is used, little or no disclosure to the client regarding the composition of the portfolio, how the portfolio was selected and no statistical analysis to support its reasonableness; .....
We could easily add a few more issues. IIROC requires one KYC for multiple accounts even though those accounts may have widely varying objectives and risk metrics. The MFDA is reviewing outsourced backoffice systems with respect to KYC and other issues. Dealers have voiced concern about the fact that an outsourced service provider is unable to make necessary changes within a reasonable time or without incurring significant costs. In some instances, third party back-office service providers have not made necessary changes to their core systems to meet new regulatory requirements or, alternatively, have made system changes that have resulted in non-compliance with MFDA requirements. Source:
http://www.mfda.ca/regulation/bulletins ... 0484-P.pdf . This results in a deficient recommendation and a defective KYC post trade analysis.
A detailed commentary on the shortcomings of KYC because of the industry transaction-based mindset can be found in the TAMRIS Special Report by respected portfolio consultant Andrew Teasdale Suitability, Minimum Standards & Fiduciary Duty in the Canadian Financial Services Industry available at
http://www.moneymanagedproperly.com/New ... hnical.htm The document argues that the prevailing “Know Your Client” form cannot safeguard the suitability of a transaction because it cannot effectively relate the transaction to financial needs, existing investments, risk preferences or current risk/return relationships. It also reminds us that Canadian regulators need to deal with the client/adviser fiduciary relationship (sales commissions platform vs. unbiased professional advice), a movement rapidly gathering steam in the U.K. , U.S. and elsewhere.
8
Kenmar Associates Investor protection and education
The Suitability Rules themselves are not understood by investors and investors are unable to assess a Dealer Member's compliance without further guidance as to the precise nature of the Rules and how they are to be applied in particular cases . Retail investors do not appreciate that the inappropriately labeled “NAAF” is in effect a contract and thus are not sensitive to how important each block ticked off may impact them in a future dispute./ complaint Additionally, investors do not possess the tools they need to knowledgeably assess whether a Dealer Member has effectively followed the Suitability Rules. Most retail clients of investment Dealers will have little knowledge of, or sophistication about suitability rules .
The industry suggestion that where the legitimacy of the objectives and risk tolerance agreed to in writing is challenged, the complainant should be held to a very high standard of proof before it is accepted that, despite the fact that they may have signed the form, they did not agree with the stated objectives or that the risk tolerance was not appropriate in the circumstances must surely be disingenuous. These forms are not designed to amplify clarity- they are so imprecise that in most cases they amount to signing a blank cheque. Sometimes quite literally, the form is filled in by the Rep and signed by the client on the basis of trust in the Rep and his/her implied professionalism.
The Canadian suitability standard is thus a weak standard and even it is not implemented well . There are numerous cases where account supervision was weak , the infamous Ian Thow case being an excellent example. We've seen KYC's that are not signed by investors and only find out about them when a complaint arises. There have also been documented cases of NAAF's being adulterated by advisers or client signatures forged . As a direct result of a weak KYC system , unsuitable investments have routinely risen to the top of the reasons for complaint list.
Given all these known deficiencies it appears entirely appropriate , if not mandatory, that OBSI validate the KYC information. It would be irresponsible not to do so.
2. The Portfolio Context
A professional financial planner would readily acknowledge that balancing of risks is an accepted part of investment advice, and "high risk" investments should be considered in the context of the client's overall portfolio holdings, rather than in isolation. If for example the equity portion of the client's holdings is conservative, an investment of a small portion of the total in an aggressive fund that might be unsuitable as a stand alone investment, could be suitable in the context of the
9
Kenmar Associates Investor protection and education
client's overall holdings. This argument makes sense if the suitability regime were not transaction based and “high risk” investments really added to the portfolio stability.
If some investments are uncorrelated with other investments in the portfolio, an otherwise unsuitable investment as a stand-alone security may indeed be suitable in a portfolio context . For example hedging US dollar securities with a gold fund may be perfectly acceptable. However this does not mean that “high risk” or speculative securities such as a Bre-X or Sino-Forest have a place in a portfolio. Registered dealer representatives should be prepared to rationalize and document their recommendations that use “risky “ securities during the complaint investigation and OBSI should take this into consideration when assessing suitability .
“Manipulation of KYC and NAAF :There is a wide range of investment objectives in many New Account Application forms[ NAAF's], with the less risk averse and more aggressive options often allowing for aggressive trading and very high risk investments. Investors risk being pushed into more aggressive allocation profiles without being fully aware of what the profiles actually mean in terms of long term transaction costs, risk and return, and asset allocation.
NAAFs and KYCs do not actually provide risk/return profiles relevant to the stated investment objective -What is the risk profile of the security or strategy that an advisor would consider appropriate for that actual profile and how would it affect the overall risk and return profile of the client’s assets? Indeed, once you study the NAAF and KYC, you find them incomplete with respect to the transparency of what the advisor is actually going to do for you. Combine this with little or no feedback on the relative risk and return and relative performance of accounts, and you find that the advisory segment of the industry is open to abuse and manipulation at a most fundamental level: -regulate the transaction, and ignore the wider service and representations made. The narrow frame of the current regulatory system is open to abuse and the average investor is not sophisticated enough to negotiate representations made and regulation of the transaction -based industry. “ Source: Andrew Teasdale , Point of Sale disclosure and regulatory failure in Canadian retail financial services , September 2010
So, while we agree with a Portfolio approach, that is not how the Advice business actually works in most cases.
3. Client Interviews
There is an implied assertion that OBSI invites or welcomes complainants to
10
Kenmar Associates Investor protection and education
challenge the KYC information collection process undertaken by the dealer and the advisor on the basis that the KYC information was not accurately recorded, that they did not understand the KYC forms they signed, that their advisor did not review the KYC forms or explain their significance or that disclosure was not understandable. This approach , it is argued, is akin to asking the complainant leading questions about the dealer's KYC process, that is likely to elicit responses concerning the dealer's KYC process that are self-serving and coloured by the client's dissatisfaction.
We are not aware of any cases where OBSI investigators have unduly cast doubt on the KYC . In our experience they act as fact gatherers .Only when the investigator assesses that the complainant's version of facts is materially different than the documented KYC information do OBSI collect and consider additional evidence by interviewing the parties and conduct research to determine if the KYC forms reflect the investor's actual KYC information .To ignore a major conflict of information would be irresponsible. The result all too often is that the KYC information is in fact incorrect, inconsistent,stale or incomplete
We are however aware of a few cases where the OBSI investigator seemed to imply that the complainant was financially literate when they were not, that the complainant understood the risks involved when they did not and that the complainant was simply greedy and unhappy with the result. These however are rare. By and large , investigators stick to a ordered line of fact finding that is logical and is congruent with high standards of ombudsmanship.
https://www.obsi.ca/images/document/up- ... ndards.pdf OBSI use internationally recognized service standards to build their Code of Practice in areas such as timeliness, accessibility, consistency and confidentiality. We note parenthetically, that dealer complaint systems do not make this declaration . And for good reason, they do not meet these higher standards. In addition , OBSI must comply with the Framework with the Regulators
https://www.obsi.ca/images/document/up- 2Framework_with_the_Regulators_EN.pdf which includes a Fairness principle.
We've observed KYC forms with investment objectives that are too broad or vague to relate to any specific trade or investment but that relate more to the overall objectives of the account (such as “retirement savings” or “tax planning”). In such cases OBSI must probe further. According to reports , MFDA Staff has observed the use of foggy terms including “capital preservation” and “speculative”. Where these terms are used, they must be appropriately defined in a manner to allow the client to understand what types of investments they relate to. It is left to OBSI unfortunately to compensate for a defective KYC regime.
11
Kenmar Associates Investor protection and education
There is of course a risk that the the ombudsmanship standards may not always be met .We therefore would not disagree that interviews be monitored/recorded to ensure the fairness standard and independent objectivity is maintained.
4. The Investor as decision maker
In one of the industry submissions investors are portrayed as informed decision makers, framing their decisions based on research, adviser communications and a knowledge of the risk/reward balance. They compare investing to the purchase of a home where a buyer does extensive due diligence. Another industry commenter stated “ .It should be clear that,although such disclosure may not make the investment suitable, if full disclosure is followed by informed client consent and direction to make the investment, the client must bear responsibility for losses relating to that investment.” Actually ,the suitability requirement is complementary to the fundamental obligation under securities legislation for dealers and their representatives to deal fairly, honestly and in good faith with retail investors. So, according to this commenter, it's OK to stick it to an investor , relying on an adviser for robust advice , with losses resulting from an unsuitable investment because some form of disclosure was made. Dealer Reps may feel morally licensed to offer biased advice once they've disclosed all the issues and conflicts-of-interest. Thus, disclosure can lead advisors to give even more biased advice to retail investors once they have disclosed their conflicts- of- interest and product risks.The OBSI argument that disclosure does not make an investment or strategy suitable if it’s otherwise mismatched with the investor’s objectives , personal situation, risk tolerance and loss capacity is just common sense.
Deficient Risk disclosure is often at the heart of most complaints. A scan of IIROC complaint files shows that risk disclosure is weak or outright wrong. Two recent examples are the sale of non-bank ABCP unjustifiably described as safe and leveraged and inverse ETF's that were totally mis-sold to small investors.
Investor advocates argue that most Canadian retail investors lack financial literacy. Indeed, that is why they are willing to pay for professional advice.“ In the case of mutual funds , the OSC research found that investors had a Grade 5 reading level and as a result ,insist on plain language disclosure for mutual fund investors. Canada’s Task Force on Financial Literacy has made public its report to the federal Minister of Finance, recommending urgent action on a national strategy to strengthen Canadians’ financial literacy.
Complex investment products, especially complex income tax-reducing investment structures,complex leveraging arrangements and an increasing appetite for global exposure among investors, have made it increasingly difficult
12
Kenmar Associates Investor protection and education
for investors themselves (as well as Dealer Reps) to determine whether certain products are suitable. To argue that a client must bear responsibility for losses relating to that investment if full disclosure is made and accepted by the client is tantamount to saying that investment advice has limited value and no accountability. The limitations of disclosure in the retail investment marketplace are well researched - see for example Mutual Fund Investors: Sharp Enough?
http://www.canadianfundwatch.com/files/sharp-enough.pdfIn respect of the suitability of specific products, we can appreciate the statement on page 7 of the OBSi consultation paper , which indicates that OBSI may disregard the investment objectives, strategies and risk ratings published in a mutual fund company’s simplified prospectus. These are often merely broad boilerplate recitations and the risk ratings and disclosure in Fund Facts have been discredited by FAIR, SIPA, Morningstar , PIAC , industry participants and ourselves. It is perfectly appropriate for OBSI staff to exercise its own judgment to confirm these ratings, particularly when the ratings are known to be misleading.
In our experience ,most retail investors do not do independent due diligence of investment recommendations. In the vast majority of cases, investors place a high level of trust in their “advisors”. This is confirmed by a number of studies including those conducted by IFIC
www.ific.ca .Lofty marketing slogans strive to induce trust in the industry [ Invest with Advice , Freedom 55, “You're Richer than you think”, Buy, Hold...Prosper , Advice you can Bank On]. Too often,investors are lured into a relationship that is unfriendly , if not hostile, to them. They , especially seniors and retirees , are defenseless in this scenario. All this hype essentially puts the retail investors nesteggs in the hands of the dealers and their salespersons whom they trust, often unconditionally. So when unsuitable investments are recommended , the idea of an informed decision being made appears ill-founded. In reality , most Advisors” are transaction oriented, have no fiduciary duty, have not prepared meaningful financial plans for clients,do not utilize IPS's and rarely, if ever, provide personal rates of return vs. benchmarks
5. Awards should be capped at actual losses incurred
Industry participants clearly are against compensating for “ opportunity costs ” - they feel compensation should be limited to losses actually incurred because the use of such a loss calculation mechanism could be considered an implied per-
13
Kenmar Associates Investor protection and education
formance guarantee .An argument is made that OBSI's loss calculation methodo- logy is silly since no one would posit that an investor should refund excess profits if the unsuitable investments provided a superior return to the suitable in- vestors.
The advocacy community believes a compensation calculation that makes people whole from an industry that holds itself out as a trusted source of advice must include opportunity costs in certain circumstances. Some abuses we see are truly disturbing . The investment industry too frequently uses false and misleading representations as to the roles and titles of those they employ as "advisors". Further information regarding the misleading marketing practices that are considered standard operating procedure by the industry can be found at
http://www.investorvoice.ca with particular attention to the MARKARIAN vs CIBC WORLD MARKETS discussion of false and misleading sales practices and title inflation by a Quebec Superior Court Judge.
http://investorvoice.ca/Cases/Investor/ ... _index.htm
In certain cases restitution should not be limited to the loss incurred - for a senior or retiree especially, that would mean several critical years of potential earnings would be lost forever. It would mean that RRSP's/RRIF's could not be repaired. It would also mean that dealer Rep misconduct, misrepresentation , incompetency,negligence or fraud would not carry much financial risk for industry participants . Respected dispute resolver Robert Goldin lists 156 ways that a broker can be culpable
http://www.macgold.ca/advisorfaultConceptually ,unsuitable investment recommendations are similar to unauthorized trades and therefore the loss calculation should include opportunity costs in certain circumstances. It is simply a matter of fairness. [OBSI is not a regulator -it cannot fine wrongdoers , order disgorgement or assign punitive damages. so opportunity costs are the only available route for fair compensation for demonstrably defective advice . The UK Financial Ombudsman Service uses notional portfolios [ portfolios chosen to mimic the likely suitable portfolio] to assess restitution. The Service has a Guide to Redress calculations at
http://www.financial-ombudsman.org.uk/p ... es/QG5.pdf We believe OBSI should make publicly available its Practices and Procedures Manual- this would support transparency and increase understanding.
We therefore support the OBSI position on opportunity costs applicability in select cases but OBSI should better define the boundaries for those cases ( as should industry dispute resolvers) . See
http://www.financial- ombudsman.org.uk/publications/ombudsman-news/37/calculating-redress.htm
14
Kenmar Associates Investor protection and education
for some case examples of the UK Ombudsman's approach to calculating redress for “ loss of investment opportunity”.
6. Use of Indexes/benchmarks
Industry participants argue against the use of indexes . They state that securities that were suitable for a client might not be available within the index utilized, and the securities within that index may not be suitable for the client at the time the investment choice was made, or at any time during the time frame applicable to their investment. This results, in part, due to the fact that a benchmark is not adjusted to reflect the asset allocation that is suitable for the given client. It is also argued that the use of indices as benchmarks presents the issue of selection bias, confuses suitability with performance, fails to account for fees that would otherwise be applicable to a client (particularly where considered over a period of a number of years), and assumes consistency on the part of the client that may not reflect actual investing history.
It makes perfect sense that working out the loss involves comparing the complainant's current position with the position they would now be in, if they had not been sold the unsuitable investment(s). We can therefore understand the use of indices as performance benchmarks under certain conditions. After all , industry marketing materials always use them to illustrate risk and performance. They also use indexes in preparing model portfolios or as benchmarks for portfolios. This may not be perfect but it is a practical , generally accepted solution to a tricky problem. As long as informed judgment is employed , there is full transparency for dealers and investors , and appropriate rebalancing is applied this should not be a material problem. We do agree that since indices are costless (and frictionless ) that performance should be reduced by fees for the comparable Index fund or ETF.
Another alternative would be to use the average target return after fees contained in the financial plan ( if there is one).
In cases where a suitable investment may originally have been discussed as an alternative to the unsuitable investment, it may be appropriate to award restitution based on that investment.
In some cases there may be no conclusive evidence as to what suitable investment would have been decided upon , if the client had not taken out the unsuitable investment. In these cases, unless the circumstances indicate otherwise, we recommend compensation on a notional capital return, equivalent to Bank of Canada base rates during the relevant period + 1%.
There is also a seventh major point to consider that was barely touched on by the Industry submission's to OBSI's request for consultation. That is mitigation . It can be a bigger factor
15
Kenmar Associates Investor protection and education
than the choice of Index in determining the amount of redress. A big issue is the loss timeline with most dealers and OBSI using the legal principle ,that once a unsuitable investment is identified by an investor, they should take steps to mitigate further losses. Defining this point in time requires considerable judgment . It's difficult to apply for retail investors for a variety of reasons. In many cases, sales Rep's counsel to buy-and-hold , so investors don't sell even if the investment is unsuitable and losing money. Investor advocates argue that a sales Rep's duty includes sell recommendations , not just buy recommendations. Of course , other factors may delay mitigation such as hefty early redemption charges or the inability to sell the security prior to maturity. Investors may not even know , thanks to crappy account statements, that they've lost money until a sizable fraction of their portfolio has been depleted. Seniors may be ill/hospitalized, out of town for the winter or suffer from dementia.
Further, behavioural finance researchers have found that contrary to expected utility theory, people place different weights on gains and losses and on different ranges of probability. They found that individuals are much more distressed by prospective losses than they are happy by equivalent gains. Some economists have concluded that investors typically consider the loss of $1 dollar twice as painful as the pleasure received from a $1 gain. OBSI should factor this human behaviour into its decision as to when mitigation should have occurred and publicly reveal its approach. Recommendation letters sent to complainants should clearly articulate how the mitigation date was determined.
Summation
Most of the industry commentary appears to be nothing more than a thinly disguised attempt to clip OBSI's wings. or dismember it. It appears too much fairness is a threat to some on Bay street The Canadian financial services industry either lacks an understanding of the role of a contemporary Ombudsman or is feigning this lack of knowledge. The ploy has been very “successful”. OBSI's reputation has been permanently impaired, OBSI staff appear intimidated/demoralized and core loss calculation methodologies based on fairness have been placed on trial.
Shame on regulators for letting things deteriorate to this level. Regulators should focus on examining industry practices to see if they comply with recently passed complaint handling rules and if those rules are achieving their intended investor protection objectives. Based on the thinking displayed in the Comment letters it appears there's a lot more work to be done and as noted in the remarks by former Ombudsman David Agnew on the front cover of this report.
The industry comments raise a number of investor protection issues. As a result,
16
Kenmar Associates Investor protection and education
regulators should ask the financial services industry to explain why the number of unsuitability complaints is so high . They should be asked to publicly reveal their loss calculation methods and justify them. They should be asked to justify why they do not compensate for “ opportunity losses”. They should be asked to correct glaring deficiencies in their investor protection protocols including , in particular , the Know-Your-Client regime.
We fully concur that the overall objective of OBSI’s approach should be to determine a fair estimate of the financial position the investor would be in had the unsuitable investment advice not been given and acted upon. Investors pay for advice and when bad advice is given, clients deserve compensation. We don't disagree that an OBSI recommendation should be well supported but so should the dealer's original rejection of an investor complaint.
Overall, we find the OBSI approach to be non-intimidating, logical , disciplined and fair to investors and dealers. OBSI appears to follow International Standard ISO 10003 Guidelines for dispute resolution external to organizations standards quite closely. From our experience , OBSI is well ahead of the more legalistic complaint handling processes and disclosure practices used by most investment and mutual fund dealers.
The Joint Standing Committee on Retail Investor Issues needs to be reactivated. to deal with this critical issue. After an initial bold declaration by the OSC, MFDA, IIROC and OBSI in the Spring of 2008, little has been heard from this Committee. The original idea to create a permanent forum in which the four organizations could discuss the problems that afflict retail investors- and to work together on possible solutions- is even more critical today than it was 6 years ago. In the end , it may be necessary to enable OBSI via Federal legislation so investors are not dependent on an industry sponsored entity. Bringing the insurance industry into the fold would also make a lot of sense.The Minister of Finance needs to also ensure all Canadian Chartered banks use OBSI.( RBC Banking broke away from OBSI in 2008).
We strongly recommend that the Canadian Securities Administrators should simultaneously revisit , update and tighten the FRAMEWORK to bring it in line with the 21st century . They should also start providing oversight for OBSI governance since OBSI is an integral part of the investor protection system in Canada . Some priorities would include governance, examination of forms used ,how the vast OBSI database can be used to improve investor protection in Canada and a detailed Guide on the criteria they must meet to be considered an independent Ombudsman service ( See the Australian Securities and Investments Commission document PS139 .Approval of external complaints resolution schemes )
17
Kenmar Associates Investor protection and education
Perhaps it's time for another Investor Town Hall. The 2005 OSC Town Hall proved to be quite an eye-opener for regulators- unfortunately, it has not been repeated since. The Town Hall brought out dissatisfied investors in droves . At the end of the prescribed time, there was still a long line of participants waiting to get to a microphone.
Scene from May, 2005 OSC Investor Town Hall
At the meeting, investors made it clear that they want regulators to address the following concerns: • the challenges they face when trying to navigate the complaints process • the desire for timely , fair and accessible redress
• the need for the OSC to consult more with investors See A Report on the Ontario Securities Commission's Investor Town Hall for what regulators say they heard . We couldn't find it on the OSC website but it can be downloaded from
http://investisseurautonome.info/compon ... ,CSA-ACVM- CVMQ-OSC-SEC-ETC%7Cdoc.342-OSC+Town+Hall+29+06+2005.pdf/
Instead of public bitching about OBSI, dealers should embrace OBSI as an invaluable investor feedback tool. Investment dealers should take account of OBSI decisions and guidance in assessing a complaint. We believe that the guidance will help firms operate fairer complaint processes by applying relevant
18
Kenmar Associates Investor protection and education
learning from ombudsman recommendations/investor dissatisfaction. This will be a WIN-WIN proposition for all concerned.
Kenmar Associates staff
19
