Internal disciplinary action on the rise

By James Langton | February 2015

IIROC sanctions dropClient complaints, civil suits and regulatory sanctions are on the decline amid strong markets over the past couple of years. Yet, investment firms have been dishing out more internal discipline than ever before.

The latest enforcement statistics from the Investment Industry Regulatory Organization of Canada (IIROC) highlight a notable drop in regulatory enforcement activity over the past year. In 2014, the total number of events reported by the industry through the complaints and settlement reporting system - known as ComSet - was down by more than 20% vs 2013 and down by more than 30% from 2012. Similarly, client complaints were down by slightly less than 20%, and civil suits involving the industry have dropped by about 44% over the past year.

With fewer complaints in the pipeline, regulatory enforcement action against the industry also is down significantly. According to IIROC data, the total number of files that entered the case-assessment stage of self-regulatory organization's (SRO) enforcement process declined by 18.4% year-over-year, and those numbers are down by slightly less than 30% from 2012.

Moreover, the number of penalties that IIROC has meted out also have plunged. Although the SRO rendered the same number of decisions against individual representatives in 2014 as the SRO did in 2013, the total monetary penalties - including fines, costs and disgorgement orders - dropped to $2.8 million in 2014 vs $5.3 million in 2013.

Monetary sanctions against firms dropped even more significantly. In 2014, IIROC hearing panels ordered a total of just $251,000 in fines and costs against investment dealers, down by about 90% from 2013, when more than $2.6 million in total sanctions were ordered against firms.

These substantial declines in the size of the penalties levied reflects the divergent nature of the cases the SRO has handled over the past couple of years, suggests Paul Riccardi, IIROC's senior vice president, member regulation. He points out that in 2013, the SRO "successfully prosecuted some very significant disciplinary actions, involving fraud and/or quasi-criminal behaviour. Due to the gravity of these cases, the fines levied were significant."

In 2014, IIROC "did not have similar matters to prosecute," Riccardi says. As a result, he adds, "the total amount of fines levied declined in comparison with the previous two years."

Indeed, the size of enforcement sanctions can vary tremendously from year to year, based upon the cases that regulators take on; one or two major cases can have an outsized influence on a year's enforcement statistics. For example, IIROC handed down $35.2 million in fines against both firms and individuals in 2009, when the SRO brought forth cases involving the meltdown of the asset-backed commercial paper market that occurred in 2007. But, in 2010, enforcement penalties dropped sharply without IIROC having such a large event to deal with.

Despite the volatility in these numbers, there's no question that 2014 was an exceptionally good year for the investment industry, in terms of regulatory enforcement penalties. In fact, 2014 appears to be the industry's best year for monetary penalties since IIROC was created in 2008.

The SRO publishes enforcement statistics back to 2011 only. But, based upon the numbers in IIROC's annual reports, which works on the SRO's fiscal year that ends in March rather than the calendar year, the industry appears to have seen a record low in monetary sanctions in 2014.

Undoubtedly, the markets played a big part in that. In addition to the types of cases that were brought forward during the year, the fact that the markets have been rallying for the past several years affects enforcement volume. When markets are up and returns are healthy, investors typically have less reason to complain. At the same time, unsuitable investment strategies may be less likely to fail and, therefore, be less likely to be exposed to clients and regulators when markets are rising.

Although, Riccardi notes, it's difficult to attribute the recent decline in client complaints, regulatory prosecutions and lawsuits to specific causes definitively, he also acknowledges that "one contributing factor is probably the general strength of the markets."

Yet, amid the drop in complaints, enforcement action and civil claims, the one enforcement metric that seems to be bucking the downward trend is the industry's use of internal discipline. Although just about every other indicator is down substantially from the previous year, the use of internal discipline is on the rise, according to IIROC data.

In 2014, there were 37 cases of in-house discipline reported through ComSet. This is up by 27.6% from the previous year and more than double the number of these cases that were reported in 2012. Moreover, internal discipline now is almost as common as regulatory discipline - the 37 cases that firms handled in-house during 2014 is not far off the 45 hearings that IIROC held.

The IIROC report states that the number of internal investigations carried out by firms ticked upward in 2014. Although the increase was modest, and the frequency of these internal probes is down from 2011 and 2012, this trend nonetheless is notable in the context of an overall 20% decline in complaints against the industry.

What's more striking is the increasing likelihood that an internal investigation leads to disciplinary action. Although firms carried out a greater number of in-house investigations in 2011 than they did in 2014, only 20% of the 2011 inquiries resulted in some sort of discipline. But, in 2014, more than 50% of the investigations resulted in discipline.

Riccardi won't speculate on the reasons for the recent rise in the use of internal discipline, but he notes that IIROC is "encouraging this practice, as it is appropriate for dealer members to address the conduct of their employees effectively and to foster a culture of compliance.

"Internal discipline is not, however, a substitute for the IIROC enforcement process," he stresses, adding that the SRO will continue to investigate complaints that it receives even if a firm has already taken its own corrective action.

In mid-January, IIROC published updated guidelines for hearing panels to follow in handing out disciplinary sanctions, along with a couple of policy statements, which note that the fact a rep has already been disciplined by his or her firm may reduce the sanctions he or she receive from IIROC for a rule violation, but will likely not eliminate sanctions completely.

"It would be an exceptionally rare circumstance where internally imposed disciplinary sanctions would result in no IIROC disciplinary proceeding," IIROC's policy statement says.

A statement from the Investment Industry Association of Canada (IIAC) notes that the final version of IIROC's policies, which are slated to take effect on Feb. 2, has been revised to address a concern the IIAC had with the initial proposals that may have undermined the importance of internal discipline: "The final rules now clarify that internal discipline is to be encouraged and will be considered when determining the quantum of regulatory sanctions."

IIROC's new guidelines and policies also detail the SRO's view of the credit it will provide for co-operation from those facing enforcement scrutiny. IIROC staff will only consider "proactive and exceptional co-operation" as a mitigating factor when considering enforcement action. This includes self-reporting violations and actively assisting an investigation. IIROC also values co-operation that ensures a case is resolved more quickly than it would otherwise be, which helps to improve the efficiency of enforcement.

This co-operation surely will be welcome at IIROC in the years ahead. Given the recent market turmoil, the trend to fewer client complaints, less disciplinary action and fewer court cases is unlikely to continue. Whether the popularity of internal discipline continues to rise, though, is something to watch.

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