merger / matdesign24

This article appears in the Mid-November 2020 issue of Investment ExecutiveSubscribe to the print edition, read the digital edition or read the articles online.

For many in the investment industry, a simple merger of self-regulatory organizations (SROs) is all the reform that’s needed. Others, however, are thinking much bigger.

Feedback to the Canadian Securities Administrators’ (CSA) consultation on overhauling the SRO framework reveals that much of the industry would like to see an easy win. Many firms would be content to marry off the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA), taking the cost savings that would hopefully result and getting on with things.

But the goal of wringing costs out of the system by merging IIROC and the MFDA isn’t resonating with many commenters. Investor advocates and academics believe a fundamental rethink of self-regulation is required.

“Cost savings alone should not be determinative of how to reform the SRO framework,” states a submission from the Investor Protection Clinic (IPC), which is run by the University of Toronto’s faculty of law.

“A simple merger for cost savings, without more detailed proposals for reform on investor access to advice, products and complaint resolution, might lead the regulatory industry to become tired of this process, and stop before any real change has taken place,” the IPC’s letter cautions.

Moreover, the submission from the Ontario Securities Commission’s (OSC) Investor Advisory Panel (IAP) questions how meaningful those cost savings will be. A study commissioned by IIROC estimated that merging with the MFDA could save $500 million in compliance costs over 10 years. However, the IAP’s submission notes most benefits would flow to the 25 dual-platform dealers. And the savings would be marginal in the context of the revenue generated by those firms over that 10-year period.

The IAP’s submission argues that improving investor outcomes should be an equal objective for reform — and that the CSA review should focus on optimizing the regulatory framework for both investors and the industry before tackling cost-effectiveness.

Submissions from investment industry segments regulated directly by provincial authorities — such as exempt-market dealers and portfolio managers — question whether self-regulation should be used at all.

The Portfolio Management Association of Canada (PMAC) and the Private Capital Markets Association of Canada (PCMA) are dead set against being drafted into the SRO world — either as the second step following an IIROC/MFDA merger or as part of the MFDA’s proposal to create a single SRO that covers all registered firms.

Both PMAC and the PCMA point out that the SRO model has fallen out of favour in markets such as the U.K., Australia, Hong Kong and Singapore amid concerns about inherent conflicts of interest.

“Given the global regulatory shift away from SROs, the PCMA is wondering why the CSA would consider expanding the scope or restructuring of the existing SROs,” the PCMA’s letter states.

PMAC’s letter also states that it “strongly opposes” having its members regulated by a new SRO or a merged MFDA and IIROC.

“Expanding the mandate of the SROs to include [portfolio managers] would only serve the interests of the SRO, and not investors,” PMAC’s submission states. The association favours direct regulation by provincial authorities — and, ultimately, by a national regulator.

“We believe that a national regulator is a better first step towards improving the regulatory system,” the PMAC letter states. “In our view, direct regulation is stronger regulation and better serves the public interest.”

However, there has been little progress toward national regulation and there’s growing skepticism that the political will to see such a project to fruition exists.

“If [SROs] are going to continue to exist in Canada, the inherent flaws with the SRO model need to be addressed,” PMAC’s submission states.

In particular, PMAC’s letter argues, investor protection and protecting the public interest should be regulators’ primary objectives. To that end, the letter states, SROs’ governance arrangements should be enhanced and structures such as IIROC’s district councils should be reformed to address concerns about transparency and conflicts of interest.

Investor advocates are calling for similar measures. The IAP’s submission suggests that if self-regulation remains the CSA’s preferred approach, then “self” should be redefined to refer not just to the investment industry, but to the broader investment community: “[The CSA] must abandon altogether the notion of investment industry self-regulation and instead embrace and internalize the concept of investment community self-regulation for the communal benefit of the industry and investors.”

This call for SROs to prioritize the public interest is echoed in the Canadian Advocacy Council of CFA Societies Canada’s submission, which suggests that the concept of “public interest” has been added to the SROs’ mandates over time rather than baked into their cultures.

Toronto-based investor advocacy firm Kenmar Associates’ submission echoes these concerns: “Trying to merge existing entities with existing cultures and processes is not the way forward.”

Instead, Kenmar’s letter argues that a new SRO “with a new board, new accountability framework, new mandate and new culture” is needed.

The IAP’s submission argues that the regulatory restrictions and requirements on investment dealers shouldn’t be classified as “burdens” on the industry. In fact, the costs that rules inflict on dealers — and the restrictions those rules impose — are a feature of regulation, not a bug: “Many of the regulations that the industry now characterizes as burdensome were put in place as speed bumps to address problems dealers themselves created through a multiplicity of sales channels, opaque fee structures and complicated products that they promoted aggressively to retail investors.”

Furthermore, the IAP’s letter states, rigidities and inefficiencies in the system represent safeguards for investors.

Comments on the CSA’s consultation also argue that SRO enforcement and mechanisms for investor redress must evolve in order to restore confidence in self-regulation. In particular, enforcement often targets individual advisors rather than firms or senior industry personnel. The fines imposed on individuals frequently go unpaid and investors are left trying to recover their losses, either through a confusing industry complaints process or via litigation.

The IPC’s submission suggests regulators could require firms to pay the sanctions owed by disciplined former advisors: “This would increase collections, while also incentivizing compliance and supervision at the firm level.”

The comment from the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) also argues that SROs should secure compensation for harmed investors: “SROs should have the power to order disgorgement of profits and to direct payment of disgorged profits to harmed investors where appropriate.”