The Importance of Supervision

In Straus Estate v. Decaire, 2011 ONSC 1157 (“Straus”), the Ontario Superior Court of Justice reaffirmed the importance for dealers to ensure that compliance policies and proper supervision of advisors are practiced and enforced.

The plaintiffs in this case sought damages for losses arising from an “off-book” investment recommended by their advisor.  The recommended investment was not part of the dealers’ mutual fund financial products, nor was it suitable for the plaintiffs.

In their defence, the dealers argued that the advisor acted outside the scope of his contract with the dealers and that the plaintiffs knew that the investment was not a mutual fund and, therefore, beyond the scope of authority of their advisor who was a mutual fund representative.

Although the judge found that the plaintiffs were aware that the investment was not a mutual fund investment, the judge denied the dealers’ defence and found them vicariously liable for the plaintiffs’ losses.  The dealers failure to conduct training and monitor and supervise the advisor’s activities weighed heavily on the judge’s mind, ultimately resulting in the finding of vicariously liability for the dealers. 

The plaintiffs were awarded the full amount of their losses.  Despite the fact that the plaintiffs’ request for punitive damages was denied, the trial judge went so far as to award the plaintiffs substantially all of their costs.  According to the judge’s reasons, the judge preferred the principle of restoration to that of punishment so that the plaintiffs could be restored to their original financial position.

A costly lesson for the dealers on the importance of supervision.   

A National Securities Regulator is Unconstitutional says Alberta and Quebec

The Alberta Court of Appeal in a unanimous decision in early March held that the proposed federal Securities Act (the “Act”) is unconstitutional. 

Justice Slatter, writing for the unanimous court stated that if the legislation “were to be enacted, it would be unconstitutional”.  The core of Justice Slatter’s reasoning is that securities regulation has always been within the provincial jurisdiction, so to allow the federal government to usurp the provinces constitutional powers, would be unconstitutional.  The court acknowledged the federal government’s argument that the securities industry has changed and evolved, however the court felt that those changes did not convert who has constitutional jurisdiction over the matter.

In a split decision released March 31, the Quebec Court of Appeal handed down a similar pronouncement to that of the Alberta Court of Appeal.  The court said "The proposed Act does not constitute a valid exercise of the general trade and commerce power."  Again, it was an issue of provincial versus federal constitutional jurisdiction.  Justice Dalphond however, accepted the federal government's arguments.   

The proposed legislation has been the subject of controversy since it was released last May.  Supporters of the Act hoped that it would bring about a more efficient and effective regulatory system.  Both Alberta and Quebec have been strongly opposed to the Act since the beginning. 

So, the plot thickens.  With the conservative government now in the midst of a federal election, where does the issue of a national securities regulator stand?  Both Alberta and Quebec will be arguing their positions before the Supreme Court of Canada this month, where the question as to the constitutionality of the Act will ultimately be decided.  

IIROC and the Social Media Phenomenon

Recently, IIROC published updated guidelines dealing with the supervision of communications using social media web sites, such as Facebook, Twitter and blogs.  The draft guidelines which were published February 7 are out for a 60-day comment period.

The guidelines aim to address “the unique compliance and supervisory issues” that may arise when advisors use social media tools as a means of communicating with their clients and the public for a business purpose says IIROC.  The proposed guidelines are also intended to assist Dealer Members with designing firm policies and procedures to ensure they satisfy their compliance function.

Although IIROC in issuing the proposed guidelines has recognized that the nature of client communications has changed, the guidelines do little in the way of giving Dealer Members “meaty” guidance on how to supervise the activity, leaving Dealer Members to their own devices on how to satisfy their legal and regulatory obligations.  The guidelines tend to blur the lines on the types of communications that have to be pre-approved and those that have to be supervised, the difficulty being determining what constitutes static versus interactive communications.  It is no surprise then that many Dealer Members are hesitant to allow their advisors to use such tools. 

The potential risks associated with using social media are significant, and there is no guarantee of any great returns.  The added costs to Dealer Members in having to establish additional procedures and train staff on how to monitor twitter feeds or advisor blogs can become expensive and time consuming.  There is no requirement for Dealer Members to permit their advisors to use such tools, however, the message is clear, if they are using social media to communicate with clients, the Dealer is required to either pre-approve or supervise the communication, and maintain copies of advertising material. 

Despite the potential risks, Dealer Members and advisors will find it difficult to ignore the explosion of social media tools in everyday business.  Clients have come to expect a different level of service with the social media tools available, and those firms not looking at ways to employ them, may fall behind the eight ball.

Nevertheless, the fact that IIROC has stepped out and tried to provide some guidance to the industry is better than keeping their head buried in the sand on the social media phenomenon that is taking the world by storm.   

OSC Approves MFDA Rule Regarding Transaction Fees

You may recall in January I talked about the proposed MFDA rules requiring a dealer member to inform clients of any fees or charges to be deducted, while also requiring the member to maintain evidence that the client was so informed. Moving full steam ahead, the MFDA has received approval from the Ontario Securities Commission.

THE BEST KEPT SECRET IN TOWN: TSX – LSE MERGER

On Wednesday, the TMX Group, which operates the Toronto Stock Exchange announced that they intended to merge with the London Stock Exchange, creating the biggest global exchange for mining and resource financing.  The merger which is subject to government approval, has been met with both optimism and apprehension from the Canadian business community.  

For many firms, this merger represents a great opportunity for expanded growth and access to international capital, and for investors, the benefits that come from a larger pool of investment choices.  When you put it this way, it is tough to see the downside.  However, the questions on my mind and I am sure on the minds of many others are, who will have the oversight role for the markets, Toronto or London?  Who will be responsible for protecting the interest of investors?  What does this mean for a national regulator in Canada?  According to the Federal government’s plan, the national regulator is to be responsible for the exchanges, how does this new proposed structure fit into their plan?  What about those who argue against a national regulator, stating that regional interests would be lost with a centralized regulator, how would they view their position today in light of this merger?

There are still many unanswered questions and we can only hope that those involved in reviewing the merger will seek to resolve the underlying questions.  One thing is for certain, the merger has again sparked the debate about Canada’s role in the global financial markets.

GETTING READY TO REGULATE – THE FEDS TAKE ON THE PROVINCES IN A BATTLE OVER SECURITIES REGULATION

In May 2010, the federal government released a draft version of the Canadian Securities Act, which outlines its proposed national securities regulatory body.  The federal government contends that a national regulator will create a national voice for Canada in the global market.  Canada will be able to better respond to global events that may pose a systemic risk to its financial markets.  The feds also argue that a national regulator will be both effective and proactive in dealing with securities-related crime. It will be better able to protect investors from securities fraud, since it will have stronger enforcement powers, greater expertise and more resources.

There are a number of hurdles that the federal government must overcome to create a national regulator, starting with the strong opposition of the provincial governments in Alberta and Quebec.  The provinces’ position is that a national regulator is an unwanted intrusion by the federal government into an area that is provincially regulated, and doing so very well. The idea of a national regulator strikes fear into the heart of many provincial governments who believe that centralized regulation will result in significant economic and job losses in the provinces.  Several provinces argue that the “passport system” which allows registrants (dealer members and investment advisors) a single point of access to the capital markets regulated by those provinces that have signed on is working fine, so why fix something that isn’t broken. 

While the passport system does work well, the system does not deal with matters related to securities enforcement, such as regulating securities exchanges, self-regulatory organizations (the MFDA and IIROC) or clearing agencies, all of which are currently regulated at the provincial level and are fundamental elements of an efficient regulatory system.

The jurisdictional battle lines between the federal government and the provinces of Alberta and Quebec have been drawn.  The federal government has referred the proposed Canadian Securities Act to the Supreme Court of Canada on the question of whether the Act is within the legislative authority of the Government of Canada.  The constitutional reference is expected to be heard by April 2011.  The provinces have also brought reference cases to the courts.

Whatever the merits of creating a national regulatory system, it is clear that it must be an all encompassing system.  Since the federal government has already provided an “opt out” provision in its proposed national scheme, which will almost surely leave one or two provinces out, it has "shot itself in the foot".  The proposed system will be fragmented, and will likely leave many of the inefficiencies it was aiming to cure. Still, the situation is not fully settled, and perhaps a sensible solution will be found. 

We will keep you abreast of the process as the federal government continues its journey down the road to a national securities regulator

IIROC Members will now face an increase arbitration award limit to $500,000 under the IIROC Arbitration Program (the “Program”)

There are a number of options available to investors to resolve disputes with dealer members, including the Program.  Up until recently, the award limit under the program was $100,000 which in many instances, did not provide sufficient recovery for investors, who would then turn to the courts as a means of obtaining compensation from the dealer member.  With the increase award limit, the Program just became more attractive to investors.  Coupled with the increase award limit, arbitration is a faster process and more cost-effective than suing in court.  Many might say that with the higher limits, the Program is a real choice for investors to use as a recourse to resolve disputes with the dealer members.

In increasing the award, IIROC has also implemented a change to the rules of procedure under the Program to permit a claimant at the commencement of the arbitration proceeding to opt to eliminate the arbitrator’s discretion to award costs against a party, unless the arbitrator finds that the party has acted in a manner that may be characterized as unfair, vexatious, improper, in bad faith or has unnecessarily and unreasonably prolonged proceedings.  The opt-out relates to cost awards, which includes legal fees and expert fees.  Some argue that placing the authority in the hands of the investor to unilaterally decide to eliminate cost awards is unfair.  IIROC takes the position that there still remains discretion in the hands of the arbitrator to award costs in certain circumstances.

Overall, in my view, the move to increase the award limit is a good one.  The Program becomes a viable option for investors, and in turn helps reduce defence costs for dealer members who would otherwise find themselves in the throes of civil litigation.