Tuesday, January 20, 2015

INVESTOR ALERT : Return of Capital Mutual Funds

Return of Capital mutual funds have given rise to a significant numer of investor complaints and concerns.This ALERT explains the issues . Read the article here

Monday, January 19, 2015

The Suitability Standard in plain Language

The suitability standard for advice giving is the standard used by most dealer Representatives to make investment recommendations to you.It's important you understand how it works so you can assess your Rep's diligence in determining suitability.It will also be of use in the event you file a complaint.Read the article here

Saturday, January 17, 2015

CRM2: Quick Guide for Retail Investors No. 2


Here’s Quick Guide # 2 for making the most of the Client Relationship Model Phase 2 disclosures.
 
NOTE: Fund Facts is a disclosure document for mutual funds. Dealers may charge fees not articulated in Fund Facts or set higher minimums for initial investments than defined in Fund Facts.While these fees will show up in CRM2 client statements , the cost for managing the mutual fund will not. Neither will the brokerage commissions incurred by the fund.These costs must be added to the CRM2 fee summation to get a complete picture of the fees you are paying.
Read the article here

Tuesday, January 13, 2015

CRM2 : Quick Guide for Retail Investors No. 3

This Guide will assist you in gatting maximum utility out of the disclosure provided by CRM2. Read the Guide here Although the deadline set by regulators is July, 2016, many firms will be providing the fee and performance information earlier. Some can already provide it now.In any event, get up to speed on the information by reading some of the plain language references provided.

Thursday, January 8, 2015

CRM2 : Quick Guide for retail Investors No. 1

This post describes Phase 2 of new securities regulations called The Client Relationship Model.This is information that retail investors should be aware of. Thanks to the Small Investor Protection Association www.sipa.ca for the information on trade confirmation slips and to the Investment Funds Institute of Canada www.ific.ca for the information on benchmarking.
Read article Other Guides to specific portions of CRM2 will be provided in the future. Stay tuned.

Sunday, January 4, 2015

Expected Impact of CRM2 on retail investors


The robust Fair Dealing Model was killed of in 2004 and replaced with the Client Relationship Model whose basis is transparency not fiduciary duty.Ten years later (!) the countdown is on for a long overdue era of transparency for retail investors on the reporting of fees and account performance by the financial-services industry. Under CSA regulatory initiatives known as the Client Relationship Model, Phase 2 - or CRM2 -- various new disclosure requirements will be phased in over the next few years. Per the current schedule ( unless lobbyists obtain another delay), effective July 15, 2016, investment brokers and dealers will be required to provide two new annual documents. One is an account-performance report, summarizing the percentage investment pre-tax returns for the previous year, the past three-, five and ten-year periods, and since the account was opened (if it was longer than ten years ago) . This report will require reporting of money-weighted rates of return, customized according to when new money was deposited or taken out of the account.There is much research that shows that the equity risk premium is wiped out by fees, the impact of active management, buying and selling at suboptimal times and the use of volatile specialty funds that sport notoriously poor investor performance. CRM2 may help reduce this loss of return if investors apply the data to their decision making.

The other new required report, as of July 2016, will disclose fees and other charges. This report will itemize the cost of everything from embedded trailer commissions, to redemption fees, point-of-sale commissions/front-end loads, switch fees and RRSP administration fees, and provide an aggregate dollar figure for the 12-month period.The part of the mutual fund management fee charged directly by the fund company - and not passed along to the dealer in the form of trailers and other commissions - will not show up on the dealer compensation/fee statement. The dealer can only provide a precise accounting of items that are paid to it (whether paid by clients or a third party).Statements of securities held by a party other then the dealer or adviser (a.k.a client name accounts,off-book accounts) on which the Dealer receives continuing compensation will also be required.:

The technology has existed for years (possibly decades) to provide information to investors that would better assist them in understanding exactly how their investments are doing and exactly how much they are paying. The most elaborate financial plan available is useless if the investor doesn’t know whether or not they are on target to achieve their goals. If the detailed financial plans that many investors are provided with, with all of its colorful charts and graphs call for a specific rate of return in order for the investor to achieve their goals , if they cannot obtain their actual net of fees rate of return from year to year (or even more often), then the entire exercise is fruitless and a complete waste of time and paper.But that hasn't stopped dealers from claiming they are in the wealth management business or dealer representatives from calling themselves “advisors”.

The majority of retail investors in Canada are treated like mushrooms by the investment industry who does absolutely everything in their power to maintain the status quo and perpetuate the knowledge asymmetry that currently exists in order to maintain their unconscionable profitability at the expense of Canadian retail investors. Then the industry has the gall to suggest that the major issue that these obvious and logical reforms have not been implemented years ago is time and expense It is shameful that it has taken over a decade to alter the current state of ugly affairs in the Canadian Investment Industry . It's been irresponsible of industry to stonewall every reform initiative as an automatic reflex and for regulators to be passive observers - not merely because that introduces undue cost and risk on Canadians, but also because it thwarts the achievement of fair and efficient capital markets and adequate protection for retail investors, particularly seniors,retirees and other vulnerable investors.

Check out a sample of what the annual charges and compensation report (Appendix D) and investment performance report (Appendix E) might look like.

Assuming the CRM2 actually comes to be as regulators intended what will the impact be on investors?:

  1. Sticker shock , possibly anger,when all the fees and charges are added up and presented in one place.The changes to the detail, timing and requirements for disclosure through CRM2 will change how Reps communicate with their clients, what they talk to them about, how often and when.
  2. Return shock when the money-weighted return ( after fees) is presented in percent which can then be compared to a benchmark , a GIC or the target return based on the financial plan ( assuming a real one exists).
  3. The Reps most likely to be grilled will be those who did little more over the course of the year than send holiday cards in December , invite clients to “Free Lunch “ seminars and solicit RRSP contributions in February.
  4. Some investors will dump their current “advisors” on the grounds that they're not getting their money's worth in performance , communication or service.
  5. Fees and expenses will become an integral element of suitability criteria
  6. Greater transparency may prompt dissatisfied investors to seek lower-cost approaches to investing. Among them are fee-based advisors who employ low-fee indexing strategies. Other alternatives include technology-driven advice substitutes -- known as robo-advice -- offered through online discount brokers. Others may join an investment club, maintain an advised account and an online account and/or become Do-It-Yourselfers .
  7. The media , bloggers , investor advocates and maybe even regulators will write insightful articles on how to use the new information provided for more informed decision making.
  8. Regulators will be forced to act on at Rep proficiency and a Best interests standard as horror stories surface in the media and courts.The value of the true financial planner will be revealed.
  9. Many investors may ask Reps why low MER mutual funds, low fee ETF's , low-cost index mutual funds or hybrid mutual funds that invests in ETFs aren't being recommended or why a price break isn't offered on large accounts.
  10. Overall, the savings and retirement nest eggs could result in more money for investors ( if they read , understand and use the information ) and less complaints about dealer/ Rep abuse- the rudimentary beginnings of professional advice giving. Robust Regulatory enforcement is critical to making CRM2 a success..

It's not all roses however. There is a real danger that unscrupulous Reps will steer people into more expensive insurance products ( segregated funds)/ exempt securities , recommend unnecessary fee-based accounts ( “reverse churning”) or just raise fees hoping that Canadians passivity will prevail.Minimum account sizes may be invoked or minimum annual fees made part of the account agreement.There is a possibility that some dealers will list so many fees that instead of opening eyes, they will glaze them.Some Reps may take some material out of the mal-disclosure Handbook and downplay the value of the added transparency.Some dealers may decide to charge for mail delivery of confirmation slips or even account statements as the telecom firms have done.Investors will have to be alert.Unless investors take ownership of their investments, the expected benefits of enhanced disclosure may be lost.


CRM2 shines a much needed light on the relationship between a salesperson ( “advisor” ) and the investing client. CRM2 may open people's eyes and potentially empower them but it won't mean they are dealing with a fiduciary. Dealer Reps who are just salespersons and don't provide good value for money ; savvy clients might drive them into thinking about getting a different day job. CRM2 may also prompt reforms by banking and insurance regulators to get off their butts and better protect financial consumers.NOTE:Although CRM2 is a net step forward , the cracks in the suitability-KYC system are being papered over and a real opportunity to reform the system has gone. It is a crying shame that FDM was killed stillborn. We are set to go into the next market downturn with an inappropriate advice system and who knows what we will unearth .


ADDENDUM Some thoughts on disclosure effectiveness

Regulators and many in the industry believe that annual fee disclosure and performance reporting will allow retail investors to make better investment decisions and assess their dealer representative. Research however suggests this dream may not be accomplished. For instance ,when executive compensation disclosure was mandated ,the result was an increase in CEO compensation.One never knows for sure of unintended consequences.The mutual fund " Simplified prospectus" is another example of a enticingly good disclosure idea that went South and has since been supplemented with Fund Facts, a streamlined two page plain language disclosure document.

Disclosure effectiveness is linked to the level of investor engagement, the investor's financial literacy/numeracy , the amount of information to absorb and the investor's dependence on his/her Rep ( and the level of trust).The usefulness of disclosure is also dependent on the nature of the disclosure, how it is presented , when it is presented and the investor's ability to compare to reference data. Rest assured that Bay Street will not readily relinquish billions of dollars in fees via better disclosure without a well orchestrated counterattack

Here's some research on disclosure  for you to peruse:

The unintended consequences of conflict of interest disclosure
http://www.cmu.edu/dietrich/sds/docs/loewenstein/UnintendedConsq.pdf The research found that people generally don't discount advice from conflicted dealer Reps as much as they should, even when the Rep's conflicts- of- interest are disclosed. The more startling findings, however, are that disclosure can have a variety of perverse effects and make the situation worse .

Duties of Disclosure

How does simplified disclosure affect individual fund choices?
http://www.finrafoundation.org/web/groups/foundation/@foundation/documents/foundation/p121994.pdf Research suggests that simplified disclosure does not improve investment decision quality / responsiveness to fees but does speed up decision process.

Worthless warnings: Testing the effectiveness of disclaimers in mutual fund advertisements
"More than $11 trillion is invested in mutual funds in the United States. Mutual fund investors flock to funds with high past returns, despite there being little, if any, relationship between high past returns and high future returns. Because fund management fees are based on the amount of assets invested in their funds, however, fund companies regularly advertise the returns of their high-performing funds. The SEC [ the U.S. Securities regulator ] requires these advertisements to contain a disclaimer warning that past returns don’t guarantee future returns and that investors could lose money in the funds. This article presents the results of an experiment that finds that this SEC-mandated disclaimer is completely ineffective. The disclaimer neither reduces investors’ propensity to invest in advertised funds nor diminishes their expectations regarding the funds’ future returns. The experiment also suggests, however, that a stronger disclaimer – one that informs investors that high fund returns generally don’t persist – would be much more effective...."
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1586530 Canadian regulators use the same worthless warnings as well.

The effect of fee disclosure on mutual fund selection

Mandatory Disclosure and the protection of investors(1984)

Financial reporting disclosure: investor Perspectives on transparency , trust and volume: CFA Institute

Reading the Fine Print: The Devil is in the Details - The Art of Retirement

Will dealers and dealer Reps really accept that transparency demands a willingness to present the facts in an unadulterated state? Will the industry be willing to be upfront with the most critical information or will there be wordsmithing and game playing? Will Reps call a “commission” a “fee” so that the fact that the Rep's compensation is tied to sales will mask the true nature of the advisory relationship provided? Will investors be shifted into inappropriate fee-based accounts thereby converting "commissions"  into "fees"? That sort of doublespeak runs contrary to the spirit and intent of CRM2. The CRM2 information must be presented prominently to ensure it’s really drawn to the client’s attention (or will its value be maligned/downplayed)? CRM2 does not specify a defined disclosure format -will dealers merely make the data “accessible”/ embed it in a mountain of details using a small font size and industry jargon? To the extent that the financial services industry remains a reluctant participant in  providing transparency, it is to that extent that the full benefits of CRM2 will be subject to sabotage.


Regulators should closely monitor the implementation and conduct a full assessment after say, 18 months.Changes to the regulations should be made based on the observations and assessment.


Tuesday, December 23, 2014

User Guide for Fund Facts



The Kenmar Associates team has prepared a User Guide for Fund Facts that should allow you to obtain the most value from this disclosure document.

The attached Guide is written in plain language and broken down by sections in Fund Facts for ease of use.While current regulations require pre-sale delivery of Fund facts only in May 2016, many firms will start providing it now. In any event, you can ask your dealer for it now- it’s your money. Get the Kenmar Guide here.
 
 
 
 
 
 

Checklist : Diligent Supervision of Off Book and Outside Business Activities



This checklist is intended to help identify diligent supervisory practices used to detect Off Book and Outside Business Activities by  "advisors".We sincerely hope it will help in the successful prosecution of investment dealers who say “ I had no idea” by identifying prudent practices that should be in place to prevent investor abuse. For seniors and retirees this abuse can be life-altering.There is no room for wilful blindness in today's advice giving industry.

 
We hope regulators and SRO’s will apply the Checklist in their deliberations as well. Too often the dealer Representative  is called to account and the investment dealer gets away with “ I had no idea” yet took no pro-active steps steps to get an idea. Read the article here

Tuesday, December 16, 2014

Comments unbecoming of a “wealth management industry”

Comments unbecoming of a “wealth management industry”

Despite fierce industry opposition ,a determined group of regulators has finally made the delivery of Fund Facts mandatory BEFORE the investor is required to make an investment decision. Imagine that!The industry should be embarassed and ashamed at its anti-investor stance over these many years.

One has only to review the comments that were made during the prolonged consultation on the pre-sale delivery of Fund Facts to realize just how big the gap is between sales and advice at the most senior levels of the mutual fund industry ( referring to itself as being in the wealth management industry) . The most basic act of advice is for a professional advisor to explain the product and why it is being recommended for inclusion in a portfolio. For investor advocates, this is so fundamental to advice giving that it is a no-brainer. Yet as you gaze upon some of the comments regulators had to wrestle with, you quickly realize the source of the many problems in the fund industry and the fierce opposition to a Best interests standard is ... top management. Given the intense industry stonewalling ,it is no wonder it took over 10 years to bring in this most fundamental reform related to being in the investment advice business ( The comments actual apply more to an industry in the sales and marketing business ).

Take a look at the rationale used to delay , bypass or kill pre-trade disclosure of Fund Facts:

A few commenters said that, given the substantial anticipated costs and the lack of a detailed cost-benefit analysis, they are unable to agree with the CSA's perspective on the benefits and costs of implementing pre-sale delivery of the Fund Facts.

A commenter noted the "specific" costs of implementing the pre-sale delivery of Fund Facts are:the administrative, production and delivery costs of sending the Fund Facts separately, instead of with the trade confirmation;the operational costs of creating and running a process to ensure for timely pre-trade delivery of Fund Facts and the costs of sufficiently documenting investor receipt of Fun Facts

It was suggested that a trial program be conducted among a sample of dealer representatives to see if the costs associated with pre-sale delivery of the Fund Facts can be justified in terms of its utility for investors.

Some commenters said that moving from post-sale to pre-sale delivery of Fund Facts is a significant change that shifts the delivery obligation from a dealer back office operation to the front line sales force. Therefore, the pre-sale delivery requirement will affect independent dealer representatives and small firms in a disproportionate manner.

Furthermore, a number of independent mutual fund companies are dependent on third party distributors, who seldom have face-to-face meetings with investors and often rely on telephone conversations or other means of communication.

Several commenters expressed the view that pre-sale delivery of Fund facts would slow down the sales process.

Some commenters that it is important to make a distinction between investors who rely on a dealer representative's recommendation and those who rely on their own research and judgment. We were told pre-sale delivery of the Fund Facts will only delay an investor from executing an investment decision they have already made.

Some commenters said that the requirements to qualify for the pre-sale delivery exception are unduly narrow and are likely to frustrate some investors, especially experienced and knowledgeable investors who do not want orders delayed pending delivery of the Fund Facts. These investors should be allowed to expressly waive pre-sale delivery of the Fund Facts in favour of post-sale delivery.

The pre-sale requirement will be less onerous for bank-owned distributors, who meet with investors at a local branch, facilitating in-person pre-sale delivery of Fund Facts.

Some commenters also noted that pre-sale delivery will impact a dealer representative's product shelf because it will be more difficult for smaller and independent dealers to distribute a wide selection of mutual funds. To ensure pre-sale delivery of the Fund Facts and to complete transactions on a timely basis, dealer representatives may be forced to narrow their "product shelf." Over time, this may affect the level of competitiveness of the mutual funds industry.

One commenter noted that an unsatisfactory transition period would pose serious human resource challenges, leading to delays, as well as customer experience and compliance concerns.

Industry commenters were generally unanimous in recommending a switch-over date that avoids the months of November through April since resources at that time of year would be heavily engaged with RRSP season [ sales ] activity, year-end trading and financial reporting. Therefore, an early summer change-over period would be preferable since it would be the least disruptive from an operational standpoint.

For telephone sales, one commenter told us that pre-sale delivery of the Fund Facts has the potential to create a negative investor experience. In such circumstances, it was suggested that dealers should be permitted to inform the clients that they can receive the Fund Facts within two days of the purchase rather than the onus being in on the investor to initiate the request

One commenter also suggested that dealer representatives be permitted to ask their clients for annual instructions or standing instructions in a manner analogous to the continuous disclosure process in National Instrument 81-106 --Investment Fund Continuous Disclosure. Alternatively, the opt out could be in the form of a declaration (e.g., a clause in the account agreement subject to annual renewal in writing) or an acknowledgement upon the purchase of a mutual fund that the investor will be responsible for getting the most recent copy for the Fund Facts prior to any new trade instructions to the dealer representative.

One commenter noted that the verbal disclosure would take approximately six minutes without taking into account additional time that might be needed to answer any questions the investor may have. This would be even more so when an investor purchases several funds at the same time. Moreover, in the case of investor-initiated trades, especially by seasoned investors, this mandatory verbal disclosure will amount to an annoyance and delay and fee-only dealer representatives will have to charge the investor.

One commenter also expressed concern that the limited number of third party service providers to facilitate implementation could place industry members at financial risk as they will negotiate contracts with a "virtual monopoly", which may result in a "concentration risk in outsourcing".

One commenter noted that the pre-sale delivery of the Fund Facts is proceeding without assurances that investors will realize costs savings. Operational savings from the cessation of prospectus distribution to investors may lead to material profits for fund companies, while the dealer representatives pay for the bulk of pre-sale delivery costs.

Some commenters lauded the removal of the previously proposed requirement to bring the Fund Facts to "the attention" of the purchaser, which was viewed as an unclear requirement that could have potentially added unnecessary costs and confusion for dealer representatives and investors.

We could go on ,but the evidence is clear. A sales mindset and culture is in place trying to masquerade as a professional wealth management/ advisory business. Until this changes, investors will be at risk .That is precisly why investor advocates are demanding increased “advisor” ( the misleading title used by the industry to portray dealer representatives) proficiency and a fiduciary standard. It's now up to regulators to bring in needed reforms or investors to implement Caveat Emptor and ignore all the industry hype about the value of advice.


Let us all hope that 2015 will see some leaders emerge and transform the industry to a trusted one – one that is sorely needed by most retail investors.

Friday, December 12, 2014

Supervision on vacation , compliance out of sight

                                                                                                                                     December , 2014
Supervision on vacation , compliance out of sight

Following a disciplinary hearing held on September 22 – 24, 2014, in Calgary, Alberta, a Hearing Panel of the Investment Industry Regulatory Organization of Canada (IIROC) found that Grant Patrick Matthews made unsuitable recommendations in the accounts of four Deele Financial Markets Inc. ( a Calgary based dealer ) clients, engaged in discretionary trading in the accounts of two clients, and engaged in excessive trading (churning) in the accounts of three clients. The Hearing Panel also found that allegations of failure to know his clients, with respect to the four clients, and discretionary trading, in the accounts of one client, had not been proven.
The Hearing Panel’s decision dated November 21, 2014, is available at: http://docs.iiroc.ca/DisplayDocument.aspx?DocumentID=E3CCCA84688043EBB50218E0C0801C75&Language=en .

Specifically, the Hearing Panel found that Mr. Matthews committed the following violations:
a) Between approximately January 2009 and May 2012, Mr. Matthews failed to use due diligence to ensure that recommendations were suitable for four clients, based on factors including the client’s financial situation, investment knowledge, investment objectives and risk tolerance, contrary to IIROC Dealer Member Rule 1300.1(q);
b) Between approximately June 2010 and May 2012, Mr. Matthews engaged in discretionary trading with respect to the accounts of one client, without being authorized and approved as having discretionary authority, contrary to Dealer Member Rule 1300.4;IIROC Notice 14-0289 Enforcement Notice/News Release – In the Matter of Grant Patrick Matthews – Discipline decision - Liability
c) In December 2008, Mr. Matthews engaged in discretionary trading with respect to the accounts of one client, without being authorized and approved as having discretionary authority, contrary to Dealer Member Rule 1300.4; and
d) Between January 2009 and March 2011, Mr. Matthews engaged in improper practices by excessively trading in (churning) the accounts of three clients, for the sole purpose of generating additional commissions, contrary to Dealer Member Rules

These are fine regulator-speak words but let's take a closer look at what really happened to one of the clients in more detail , client EF. Source : http://www.iiroc.ca/Documents/2014/5e35ee7b-0a06-4618-a4f3-b90971a9ef33_en.pdf

Know your Client (KYC): Client - EF is a 69 year old retired widow. She has a high school education, and was a homemaker for much of her working life. She also worked at one time as a franchisee operator of a lottery booth. Her late husband, RF, worked as a custodian at a local high school before he retired. Prior to that, he managed a gas stationer generally left the household financial affairs and investment decisions to her husband.11. A March 2004 New Client Account Form (“NCAF”) for EF’s RRSP account stated that EF earned $40,000 per year from the lottery booth, and RF earned $32,000 per year as a custodian. Their stated liquid assets were $100,000, and their fixed assets were listed as $300,000. The stated [ emphasis ours] investment objectives [ emphasis ours] were 50% long term growth, 50% short term speculative, [ are these are clear and proper objectives for a retiree?] and her stated risk tolerance parameters were 50% medium and 50% high. At the time, EF was 60 years old and her investment knowledge was listed as “fair” [ whatever that means but we can be confident she didn't understand the leveraged ETF's mechanics] . Her husband died in May 2010. Following her husband’s death, in June 2010, EF, met with Matthews to sign estate documentation and discuss his future handling of her accounts. She was then 67 years old. Do you think this is a well defined set of “objectives” for a person in this financial situation? Do you think this is robust KYC or a setup for a fee grab?

She completed an NCAF to open her TFSA account, which stated that she was retired,
with a modest income of $32,000 per year. The investment objectives were 25% income/50%
long term growth/25% short term speculative, and the risk tolerance parameters were
changed to 33% low/33% medium/33% high [ whatever that means]. The stated assets remained the same, as did the description of her investment knowledge as “fair”. Given the available information, her risk capacity , the ability to absorb losses, was low . Losses in a TFSA cannot be offset against capital gains. The word “ fair” is meaningless and it appears to be a slick way to justify the risky trading strategy in her TFSA account by portraying her as more knowledgeable than she really is..

Following her husband’s death, EF completed an NCAF for the TFSA, but not for her other accounts. There are no account updates between June, 2010, and EF’s transfer of her accounts to another firm in May, 2012 [ for us, this suggests a compliance systems problem] IIROC notes that for the period of June 2010 onward, the stated investment objectives and risk tolerance parameters were too aggressive for EF, who was then a retired and recently widowed senior, with limited assets and income. IIROC says Matthews failed to learn and remain informed of the essential facts relative to EF as the stated investment objectives and risk tolerance parameters in her accounts were inconsistent with her true financial situation, investment knowledge, investment objectives and risk tolerance. In our view that is being disingenuous. We say Mathews deliberately set it up so he would have a paper trail to show his actions were consistent with a knowingly defective KYC document. He didn't fail, he succeeded at deception.We also ask, where the heck was the supervisor or Branch manager to prevent this obvious information travesty? And why does the IIROC investigation report play word games?

Suitability :EF's investing knowledge was very limited so naturally IIROC has concluded EF relied upon and followed Matthews’ recommendations for the investments in her accounts. “This was particularly evident during the time period of June 2010 onward, following her husband’s death” IIROC notes. Did the Branch manager not notice the change in pattern? In general, the nature of the trading in the RRSP account [ her retirement fund] was focused on frequent trades in medium to high risk securities. The medium risk securities were primarily resource issuers trading on the TSX, and the high risk securities were primarily commodity-based leveraged exchanged traded funds (“LETF”) , a complex speculative product that works on the basis of daily returns. There were no low risk holdings according to IIROC yet the dealer's systems did not detect this wholly unsuitable portfolio construction.. From May 2010 to April 2012, the average hold period for all securities was approximately 5 months. The average hold period was just 38 days for positions in which gains or losses were actually realized. In addition, although there were some purchases made in the accounts of dividend-paying securities, in many cases the securities were not held long enough to be eligible to actually receive the dividends. By now, you'd think someone at the dealer would have woken up to the fact this poor retiree was being gamed. No such luck.

Between Jan. 2009 and Oct. 2010, there were an incredible 66 LETF transactions, which resulted in losses of $14,999 (including $7,805 in commissions). The majority of the LETF positions were held for short time periods, on average 2.74 days. However, there were 5 LETF trades which were held for a much longer period, an average of 178 days, and resulted in losses of $17,485. Between June 2010 and May 2012, the total value of EF’s accounts declined from $115,478 to $106,159, reflecting a loss of 8%. This included the payment of commissions of $13,378. During the same time period, the S&P TSX Composite Index increased by 5.29% for a differential of 13.5 %. During this time period, the performance of her holdings was very volatile in comparison to the overall market performance. The total value of her accounts ranged between approximately $160,000 to $100,000. Such volatility is a sure sign that account risk was high The dealer Reps recommendations were not suitable for this client in light of her age, employment status, investment knowledge , experience and true circumstances but inexplicably they continued for a considerable time without dealer intervention except to cash brokerage commission cheques.

Discretionary Trading : The nasty “advisor” behaviour doesn't stop with unsuitable investments. . During the period from June 2010 (after her husband’s death) to May 2012, Matthews made 113 trades ( about 1 trade per week!) in EF’s retirement and savings accouterments tells us that EF says that she instructed Matthews to “take care of her”, and that she “left everything up to him”. She wanted him to continue the type of trading activity that he had carried out with RF, as she had limited investment knowledge. Gimme a break . During the material time, Mr. Matthews executed many trades in EF’s accounts without confirming the details of the trades with EF prior to their execution. The hapless widow's retirement account savings were not designated as discretionary by Leede but they happened anyways. Leede’s supervision and systems failed to pick up on this in your face financial assault.

What do we learn form this case ?

Clearly , Risk tolerance does not match the trading patterns. It should have been 100% speculative risk. Anything else is a compliance breach. Investment knowledge is “fair”. An attentive supervisor should not ever set up a speculative account for an investor with “fair” investment knowledge. And of course Objectives did not match risk . Despite the obvious, this exploitation carried on in plain view for a prolonged period of time.

The first lesson learned is therefore quite clear. The most basic systems and processes were not in place at Leede . Nearly everything that could be wrong , was wrong. The real culprit here is Leede Financial . We do know the abusive practices by this individual impacted 4 other investors possibly many more at that Branch. IIROC tell us it is standard practice for IIROC Investigation teams to consider the issue of supervision whenever they are conducting an investigation of a dealer Rep, and to investigate where there are indications of a failure to supervise. However, given the confidential nature of their investigations, they cannot confirm whether or not they have or had an active investigation ongoing, unless and until any such matter proceeds to disciplinary action, in which case it then becomes public record when a Notice of hearing is issued. They assert that it is general practice to prosecute cases involving a failure to supervise by way of a separate Notice of Hearing before a separate Hearing panel.

Here's some 2013 IIROC Enforcement statistics for 2013 that we think speak for themselves.:
There were 1690 complaints of which 280 originated from the public
There were 203 complaints involving unsuitable investments and 88 involving unauthorized trading
There were just 63 prosecutions of individuals by IIROC of which 19 involved suitability ,1 involved discretionary trading and just 4 involved supervision
There were only 12 prosecutions of dealers of which a mere 5 involved supervision ( this is for the entire year for all of Canada)
Fines imposed on individuals amounted to $4,382,500; only 10.5% of the penalties assessed against individual registrants were collected.
Fines imposed on dealers amounted to $2,220,000 ,about half that imposed on individuals; 98.1% of the penalties assessed against dealers were collected
What do these numbers suggest to you?

In the Mathews case we say that management was asleep or willfully blind at such horrific and highly visible and prolonged financial assault. This cannot and should not ever happen in the wealth management industry especially to multiple victims over such a extended period of time. The advocacy community, including a number of former and current Reps, is of the firm conviction that SRO's are spending too much time on disciplining Reps ( and not collecting fines) and not going after the root cause : Deficient supervision / compliance systems and a broken KYC system. The great Quality Control expert Edward Deming coined the rule: 85-97% of problems are the responsibility of management. We are convinced this is correct .This is why for every Rep prosecution we expect at least one corresponding supervisory prosecution and with much higher penalties and sanctions. A few strong high profile examples would change dealer behaviour real fast.

We argue that suspected supervisory breakdowns should have at least as high investigation priority than Rep prosecutions and should carry larger fines. This is further supported by the fact that Reps are usually fired but Branch managers often remain on to be negligent again in the future.

Hopefully, 2015 will see a lot more timely prosecutions of dealers for breakdowns in supervision , compliance and KYC deficiencies/adulteration.

The other BIG lesson . CAVEAT EMPTOR ! You are not dealing with “advisors” that are required to act in your Best interests.



Kenmar SRO surveillance Team