Enforcement of rules in the securities industry has proven ripe for innovation in the past couple of years, with the Ontario Securities Commission’s new no-contest settlement process and whistleblower program paying major dividends. Now, the Investment Industry Regulatory Organization of Canada (IIROC) is getting creative as well, with plans for two new measures designed to enhance enforcement of disciplinary rulings.
On April 25, IIROC proposed it adopt two enforcement tools that the self-regulatory organization (SRO) hopes will bolster enforcement by giving IIROC new ways to deal with rule violations.
The proposals, which are out for public comment until July 24, include a new procedure for sanctioning relatively minor rule violations, tentatively called the “minor contravention program” (MCP), with a standard monetary penalty ($5,000); and a new proceedure for settling cases early, which would provide a 30% discount on the sanctions being sought by the regulator as a trade-off for a quick resolution.
The underlying objective of IIROC’s proposals is to give the SRO greater flexibility in the way it deals with misconduct. For example, the proposed MCP would enable IIROC to impose penalties for violations that deserve more than a slap on the wrist – a slap such as a warning letter from the SRO – but may not warrant the time and expense of a full disciplinary hearing.
At the same time, the proposed early resolution procedure would give the regulator the ability to wrap up certain cases more quickly, which could enable IIROC to process a higher number of cases within a given time frame.
Just how dramatically this could affect IIROC’s enforcement efforts isn’t clear. At this point, the regulator states that it can’t estimate the number of cases that would be suitable for its proposed early resolution process, but the SRO plans to track this data if the procedure is introduced. However, IIROC declines to speculate on the volume of cases that could be processed under the MCP.
“We anticipate that we will be able to address minor violations more efficiently and have another option to effectively address regulatory violations,” says Andrea Zviedris, IIROC’s manager, media and public affairs. “Overall, these proposed programs would give us the ability to optimize our resources so we can focus on matters that are more serious or harmful to investors.”
Under the proposed MCP, IIROC is proposing a standard $5,000 fine on reps who admit to rule violations in cases that don’t involve investor harm. However, these admissions would not be made public and would not form part of the rep’s disciplinary record.
While the identities of the reps involved would not be reported, IIROC does plan to publish the basic facts of these cases on a quarterly basis as a way of providing transparency into the program’s use.
The proposed anonymity of minor violators was a key objection from investor advocates when IIROC first raised the subject of introducing this kind of mechanism back in February 2018. Investor advocates argued that keeping the identity of violators secret undermines the deterrent effect of disciplinary action and doesn’t provide transparency for investors.
IIROC’s latest version of its proposals aims to address other criticisms levelled at its original idea by limiting the MCP to dealer and brokerage reps. Under the SRO’s initial proposal, firms would have been eligible for the program too (although IIROC indicates that it may be expanded to dealers in the future after the SRO evaluates how well the mechanism works).
IIROC also doubled the proposed fine that was contemplated under the regulator’s first draft to $5,000 from $2,500 for individuals.
Despite that increase, IIROC states, the fine still would represent a discount to traditional enforcement penalties.
In addition, IIROC proposes that these cases be subject to approval by one person rather than the three-person panels that review traditional regulatory settlements now. These proposed reviews would be carried out by public panel members – not industry representatives – who would determine whether to approve settling a particular case via the MCP.
In cases in which an MCP settlement is rejected, IIROC staff still can proceed with traditional disciplinary action, but couldn’t propose a new MCP settlement.
Moreover, while the details of these cases would not be reported publicly, they would be available to other regulators – both provincial regulators and SROs. IIROC staff would be able to rely on admissions made by violators of the rules during a hearing under the MCP in future disciplinary hearings as a possible aggravating factor.
IIROC states that admissions made under the MCP are not likely to have other legal repercussions for reps, which was a concern for the industry. Trade groups worried that admissions made in these cases could come back to haunt reps in future civil litigation. However, IIROC points out, given that these cases will be limited to isolated incidents that don’t produce any meaningful investor harm, they aren’t likely to be fodder for lawsuits.
While IIROC can’t predict how much activity it anticipates under the MCP if it’s adopted, the latest enforcement statistics suggest that these kinds of relatively minor cases may be on the rise. According to IIROC’s enforcement stats through the first three months of 2019, the SRO has issued seven cautionary letters against reps this year, compared with nine for all of last year and just one in the full year 2017.
In theory, MCP cases would fall somewhere between SRO warnings and full-blown enforcement action.
Currently, the Mutual Fund Dealers Association of Canada (MFDA) has its own mechanism for dealing with relatively minor violations: the “bulk track” process, which involves resolving such cases more efficiently by holding multiple hearings before the same panel on the same day. This program accounts for roughly half of the SRO’s enforcement action in a given year.
For example, in 2018, the MFDA held 136 disciplinary proceedings, and slightly more than half of them (70) were held under the bulk track process.
Whether the proposed MCP reaches this level of significance in the IIROC world remains to be seen. Full-blown disciplinary action against IIROC reps has been relatively limited so far this year. The regulator handed down only six disciplinary decisions against reps in the first quarter of 2019, which is on pace for just 24 decisions for a full year – well below the 42 disciplinary decisions against reps rendered in 2018.
However, IIROC’s six decisions involving individual reps this year already have produced more than $1 million in monetary penalties (including fines, disgorgement and costs) – which is on track to surpass last year’s total of $3.2 million. (There was no disciplinary action against firms through the first three months of this year.)
The other enforcement tool IIROC proposes also may help generate more enforcement activity by enabling the SRO to resolve cases that are destined for settlement more quickly.
The proposal, which is similar to the approach of the U.K.’s Financial Conduct Authority, would enable IIROC to offer a 30% discount to dealers and reps facing discipline that the regulator intends to seek in exchange for a quick settlement that doesn’t require the full-blown enforcement process.
To qualify for this approach, the firm or rep would have to compensate clients or disgorge any ill-gotten gains in cases that involve client harm.
And, while these early settlement offers still may be subject to negotiation, there would be a time limit so that they don’t lapse into protracted discussions, thus undermining the SRO’s goal of resolving cases more quickly.
Accelerating enforcement may not be the sort of innovation that the industry appreciates, but the process could benefit investors and the markets in general.