A sad truth about the Canadian investment industry is that investors who lose their nest eggs to industry fraud and malfeasance have very little hope of recovering their money. Demands to do more to ensure victims aren’t left out in the cold are growing, but are policy-makers listening?

A recent report by the Toronto-based Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) concludes, “The current system for compensation in Canada is complex and full of gaps.”

Regulators traditionally haven’t done much to help defrauded people get their money back. Industry-financed contingency funds kick in only if a firm becomes insolvent; and these funds only cover dealers that belong to a self-regulatory organization.

The Ombudsman for Banking Services and Investments has become an important source for investors seeking redress, although OBSI tends to deal with smaller claims and compliance with its awards is voluntary. According to OBSI’s most recent annual report, about $3.35 million in compensation was ordered to satisfy consumer complaints within the investment industry in 2010. The average payout was $19,121; the median, $8,205.

Bigger, more complex claims can be taken to court, although that route is slow and expensive. And the Toronto-based Investment Industry Regulatory Organization of Canada’s arbitration service has largely fallen out of use (although IIROC adopted changes to the program in January to make it more effective).

FAIR Canada’s report makes several recommendations aimed at improving compensation options for investors. It suggests that: financial services firms be made financially responsible for their advi-sors; regulators have consistent powers to secure compensation, and that they have a mandate to pursue investor redress; and registered firms be required to belong to an SRO that is backed by a contingency fund.

This call for greater contingency fund coverage is echoed in a newly released report from the Toronto-based Mutual Fund Dealers Association of Canada, which recommends creation of an investor compensation fund covering fund managers and portfolio managers.

The report (written in 2008) points out there is $225 billion in client assets that have been purchased through MFDA dealers but held at the fund managers — and thus not covered by the dealer contingency fund. This figure becomes significantly higher when all the assets held by all fund managers is considered, the report notes. As a result, it says, “Market confidence and efficiency, fairness and, above all, suitable investor protection demands compensation fund coverage apply more broadly.”

The Ontario Securities Commission disagrees with the MFDA, insisting that there is no gap in the regulation and oversight of fund managers. Says Susan Silma, director of compliance and registrant regulation at the OSC: “While mutual fund assets are not held at mutual fund dealers, these assets are held at qualified custodians, which are IIROC members, or Canadian financial [services] institutions, such as banks. These are financially sound institutions regulated by [the Office of the Superintendent of Financial Institutions] or an SRO.”@page_break@As well, the OSC argues that provincial regulators have stepped up their oversight of these firms, thanks to registration reform implemented since the MFDA report was written. Silma notes that this reform has resulted in the imposition of significant, new obligations on fund managers, including asset-based insurance requirements.

The MFDA report maintains that while registration reform may close some of the gaps it has identified in fund manager regulation, it is not enough. And the MFDA argues that regardless of what the rules say should happen, the risk of client losses still exists.

But if the securities commissions do not perceive the lack of contingency fund coverage to be a problem, then it seems unlikely that anything will be done to close that gap.

Indeed, back in 2004, a provincial legislative committee in Ontario recommended that the government and the OSC work together to come up with a fast, affordable mechanism for investor restitution. Despite promises to follow through, this proposal has not been acted upon.

Then, in 2009, the federal expert panel recommending a national regulator also called for a financial services industry-financed compensation fund with the power to order investor compensation. But the draft legislation to create the national regulator doesn’t propose either feature (although the proposed entity would be able to designate an organization to serve as a compensation fund).

Quebec is the one province that has sought to provide better inves-tor restitution, having established a provincial indemnity fund to cover investor losses due to fraud. However, this indemnity fund applies only to dealers, not fund managers. And the fund has already been depleted by claims.

But there does appear to be an appetite to develop a more effective restitution mechanism in that province. Earlier this year, Quebec Finance Minister Raymond Bachand called on the Autorité des marchés financiers to examine the idea of creating a more comprehensive compensation fund for victims of financial fraud, and he asked the regulator to hold consultations this spring. An AMF spokesman says the regulator is working on setting up that process but hasn’t yet scheduled the consultations.

When the AMF is ready to host that discussion, one of the submissions it is likely to get from an investor advocacy group, the Coalition for the Protection of Investors, will propose the creation of a new fund — initially in Quebec but with the objective of expanding it across Canada.

Robert Pouliot, the CPI’s co-founder, says the proposed fund would be primarily financed by investors (along with advisors and fund managers). Fund managers would pay for an assessment of their fiduciary risk to be performed by the fund, which would be publicly disclosed, sort of like a credit rating.

The premiums charged to investors would then be linked to those ratings, so investors dealing with riskier firms would pay larger amounts. This proposed fund would compensate investors for fraud and negligence. IE