Wednesday, February 27, 2019

CSA- please make complaint handling tolerable for retail investors

Eliminating Step 3 (internal Ombudsman) in the investment dealer complaint process - the rationale and request for action

This past year has not been kind to retail investors. The CSA, defying both evidence and reason, has decided to retain embedded commissions and abandon an overarching Best interest standard. Even the welcome CSA proposal to ban the DSC option has been derailed by the Ontario government’s unilateral intervention. At the same time, the CSA has allowed risky alternative mutual funds to be sold to retail investors.

As of Nov. 1 , 2018 less than 30% of bank assets will be with OBSI -the recent departure by the Bank of Nova Scotia sent a clear message: The banks do not support an independent dispute resolution provider. As a result, retail investors are even more vulnerable to industry mis-selling and unfair complaint handling.

Bank-owned and insurance company owned dealers usually have a three step process. The first step is with the branch, the second step is at the dealer's Care center (or equivalent) with escalation to their internal "ombudsman “if the client remains unsatisfied as step 3. A 4th step would be to OBSI if the client still remain unsatisfied. Four steps can wear already stressed clients down to the point they lose their resolve to achieve a fair result. This should not be the outcome of a contemporary complaint resolution system in the wealth management industry.

The CSA has not yet acted on Kenmar recommendations or those of PIAC and FAIR Canada to fix obvious flaws in the complaint handling system. In Oct. 2017, PIAC and FAIR Canada sent a letter to the CSA identifying numerous complaint handling issues .The letter strongly recommended  that OBSI’s Terms of Reference and the internal complaint handling rules (be they policies or rules) of IIROC and the MFDA be amended to conform with NI 31-103. OBSI’s Terms of Reference and the SRO complaint handling rules should be revised to require firms to provide a substantive response to a complaint within 90 days, whether they use a second review process (an “internal ombudsman”) or not. The letter stated that “Within the 90 days, firms may choose to provide a second level of review. However, they should not be permitted to take more than 90 days to do so.”.

The lack of CSA action on these recommendations has left complainants exposed to diversion. Investors are being channeled to “internal ombudsman” while critical OBSI-related time periods and civil action limitation periods continue to run to the prejudice of investor complainants. The use of “internal ombudsman” services is detrimental and prejudicial to investor complainants and is contrary to sections 13.16 (3) and (4) of NI 31-103.

It is emotionally and physically draining for a retail investor to file a complaint. It is also highly intimidating for most people. To have a complaint dismissed even once, let alone multiple times is a very debilitating experience. Many people give up as they feel they have no chance of prevailing against the big bank-owned dealers. Other consumers opt to not file complaints about their dealers because they are intimidated by the complaints process, do not understand their rights or how to navigate the process itself, are afraid of the possible negative consequences of complaining about their dealer and do not possess the written or oral skills to effectively advocate for themselves. This process can also impact physical, emotional health and family relationships. For many, sustaining undue losses is life-altering. One major reason that the current system isn’t working for investors is the banks insertion of an internal “ombudsman”.

An unsatisfactory response at the first step results in escalating the complaint further - this necessitates a complainant to redraft a cover letter and resubmit the complaint with supporting records as if nothing had occurred prior to this step having taken place. An appeal to the internal ombudsman also requires the signing of a Consent Agreement which may prejudice future proceedings. Among other items, the Agreement contains a confidentiality clause and in at least one case, gives the right of the ombudsman to access all of the complainant’s accounts with the bank.

Complainants can legitimately conclude that the dealers’ complaints process is designed to wear them out. Does this repeating of steps, as mandated by the process and placed on the shoulders of the complainants, contribute in any way to a fair and reasonable complaint resolution process? Does the internal ombudsman add value or risk? The CSA surely knows the answer. In 2011, the UK FCA eliminated the internal “ombudsman “step in order to streamline the complaints process. The CSA should do the same.

Securities regulators have tried to improve the process by requiring that dealers provide a substantive response within 90 days of filing a complaint. Prior to that, dealers would drag out complaints to the point where complaints just threw in the towel. This was followed up by a CSA/IIROC/MFDA Staff Notice in Dec., 2017  attempting to deal with several system failures.

That has not been effective as banks continue to deceive complainants. For example, the TD Bank website states “If you require further assistance after the decision of the TD Ombudsman, the following independent services may provide you with information and a further review of your complaint. These agencies may contact TD to facilitate their investigation and work toward a resolution”. The independent service referred to is the OBSI option.

Section 13.16 of NI31-103 specifies that a firm must make available the services of OBSI at the earlier of when the firm informs the client of its decision with regard to the complaint or 90 days after receiving the complaint. Companion Policy 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations concerning compliance with the requirements under section 13.16, provides that a registered firm should not make an alternative independent dispute resolution or mediation service available to a client at the same time as it makes OBSI available.

But Section 13.16 of NI 31-103 does not prohibit the use of an internal “ombudsman”. As a result, for investment dealers, the 90-day timeline, which is supposed to apply to all internal complaint-handling processes, doesn’t include the use of an affiliate’s internal ombudsman. These dealers are able to divert hundreds of complaints each year from OBSI to their own “ombudsman” without fear of sanctions.

Bank-owned dealers have cleverly subverted CSA intentions by offering the optional (sometimes not) third step choice- their own internal “ombudsman”. Complainants sidetracked there are entering a no man’s land with an entity that is neither an ombudsman nor independent of the dealer, nor under CSA/IIROC/MFDA jurisdiction. Trusting and gullible complainants, to their detriment, assume that this entity is a real ombudsman and voluntarily agree to subject themselves to this entity instead of the regulated, independent ombudsman service-OBSI. It should be noted that proposed Federal Bill C-86 would not permit these internal ombudsman to assert they are independent or use the misleading nomenclature “ombudsman”. This is a clear recognition by lawmakers that these internal “ombudsman” are merely an artifice to mislead clients and add a completely unnecessary step in resolving complaints.

How can an investigator from the bank’s ombudsman’s office be impartial given that he/she is an employee of the bank, may have existing relationships with parties being complained about and is ultimately accountable to the legal team of the bank? The use of the descriptor “Ombudsman” is not being made in good faith by the banks as the banks know that the ombudsman’s true purpose is to protect the bank at the expense of the consumer (in some countries such misrepresentation is illegal). In contrast to its true purpose, the bank internal ombudsman is marketed to the consumer as that of a fair, impartial and independent investigator. Most clients do not realize they are in an adversarial relationship. The inclusion of an internal ombudsman in the dispute resolution process is solely for the benefit of the dealer/banks and most definitely not in the complainant’s best interests.

Kenmar have therefore concluded that, while some dealers may use the three-step complaint process appropriately, it is inherently prone to misuse and abuse, in particular because it gives investment dealers an incentive to reject complaints at the first two steps on the basis that only a relatively small number of complainants will persevere and the dealer then has a third chance to rectify any shortcomings or, more likely, again provide an unsatisfactory offer.

Unlike OBSI, internal Ombudsman are not transparent - their loss-calculation methodology is not publicly disclosed. Kenmar argue that any interaction with the internal ombudsman helps the Dealer as part of its risk reduction and defence-building processes. Complainants are not cognizant of the fact that any information provided can later be used by the Dealer to defend itself if an external complaint process is commenced. In other words, complainants are in harm’s way.

The reason OBSI was purposefully created was to deal fairly and expeditiously with cases where clients are not satisfied with the dealer's substantive response letter delivered within 90 calendar days.  There is no need for a third step involving a non-independent, unregulated internal "ombudsman". It unduly increases the complaint cycle time beyond 90 days, eats into precious statute of limitation time , exposes complainants to conflict-of-interests and legal risks and adds to complainant stress and disillusionment.

We have found that if a complainant is rejected 3 times, it is highly unlikely he/she will proceed further. This may explain the relatively small number of investor complaints that reach OBSI. Therefore, we recommend that the CSA abolish the three-step process. The new rules would mean that the firm’s step 2 response would be its definitive ‘Final response’.

Complainants would then be given a crystal clear message that they can escalate their complaint to OBSI (where the limitation time clock is stopped), must do so within 180 calendar days or pursue litigation/IIROC arbitration. We believe that this will lead to investment dealers focusing their attention on providing robust responses to complaints at the first two points of contact. This should lead to fairer, higher quality complaint decisions. It would put an end to consumers having to restate their complaints twice or more, something that stops many people taking their cases further. This would also reduce the complexity of the process for retail investors therefore reducing the abandonment rate of valid complaints.

Kenmar believe this is a major socio-economic issue, aggravated by an increase in complaints by seniors/ vulnerable investors, a rapidly growing demographic.

A fair and effective independent dispute resolution service is important for investor protection in Canada and is vital to the integrity and confidence of the capital markets OBSI is the last line of defence in a Caveat Emptor investing environment. Accordingly, we are of the firm conviction that an elimination of step 3 (internal ombudsman) is in the Public interest. Kenmar urge the CSA to act given the overwhelming evidence of investor harm we have provided.

Ken Kivenko, President

Kenmar Associates


Monday, February 11, 2019

Root Cause Analysis: Increasing the utility of IIROC Hearing Panels

IIROC investigates and initiates disciplinary proceedings to determine whether there has been a breach of IIROC Rules , securities legislation, or other requirements relating to trading or advising in respect of securities, commodities contracts or derivatives. Enforcement staff review the findings of the investigation and recommend an appropriate course of action.

If the evidence establishes a contravention of IIROC requirements, Enforcement staff may initiate a disciplinary proceeding in order to resolve the matter before an IIROC Hearing panel. The Rules require that the Hearing Panel be made up of one public chair (generally a retired judge or lawyer) and two industry members (either active or retired).Hearing Panels decide the case based only on the evidence that is put before them. This limitation is a barrier to corrective action as we discuss in this document.

The stated purpose of IIROC disciplinary proceedings is to maintain high standards of conduct in the securities industry and to protect market integrity. Sanction Guidelines are intended to promote consistency, fairness and transparency by providing a framework to guide the exercise of discretion in determining sanctions which meet the general sanctioning objectives. IIROC Sanction Guidelines assist Hearing panels in determining whether to accept settlement agreements.

The Hearing Panel is responsible for the hearing process, determining whether any misconduct occurred and if so, whether any sanctions should be imposed on the Respondent. At the conclusion of a hearing, the Hearing Panel issues written reasons for its decisions concerning misconduct and sanctions.

The declared purpose of sanctions in a regulatory proceeding is to protect the public interest by restraining future conduct that may harm the capital markets. In order to achieve this, sanctions should be significant enough to prevent and discourage future misconduct by the respondent (specific deterrence), and to deter others from engaging in similar misconduct (general deterrence). We note that investor compensation is not on the Panel radar- something that needs to be addressed because client restitution is in the public interest. 

Deterrence is a key component of any effective enforcement strategy. Deterrence is credible when would-be wrongdoers perceive that the risks of engaging in misconduct outweigh the rewards and when non-compliant attitudes and behaviors are discouraged. Deterrence occurs when persons who are contemplating engaging in misconduct are dissuaded from doing so because they have an expectation of detection and that detection will be rigorously investigated, vigorously prosecuted and punished with robust and proportionate sanctions.

Misconduct is defined as unacceptable or improper behavior by a dealer and/ or Dealing Rep. However, not all rule breaches are a result of deliberate registrant misconduct. We could include negligence / errors of omission, inadvertent error, ineffective disclosure processes and honest misunderstandings. Other more likely  potential causes include but are not limited to poorly framed rules, deficient prospectuses, outdated policies and procedures, weak business / IT control systems, unqualified staff, deficient KYC process, inadequate staff training, lax supervisory processes , an ineffective compliance function and poor complaint handling.

Consider poor client complaint handling- it is a recurring issue. If client complaints were handled more effectively, much investor grief could be avoided. It is our firm conviction that IIROC rule 2500B is a root cause. The rule lacks depth, favors dealers, allows diversions to internal “ombudsman” and is open loop as regards systemic issues. See More issues with IIROC complaint handling Rules  and Fairness and balance in the complaint process where interests of the dealer and registered representative must be considered!

Leveraged ETF’s are another example .LETF’s may be mis-sold to a buy-and-hold investor because the Rep did not understand the mechanics of LETF’s.  The reason for the mis-selling could be that he/ she did not fully understand the product because the dealer did not ensure Reps were adequately trained to recommend such complex products.  The root cause of the breach then is a deficient dealer training program for Reps coupled with lax dealer supervision. Another example might be weak risk profiling tools provided by the dealer. Any Rep using such tools might conclude with an improper client risk profile which could in turn result in unsuitable recommendations. In such a case, the root cause of the rule contravention is dealer management which had provided Reps with inadequate tools of the trade.

A root cause is defined as a factor that caused a non-conformance/ Rule breach and should be permanently eliminated through process improvement. Root cause analysis (RCA) is a collective term that describes a wide range of approaches, tools, and techniques used to uncover causes of problems. The highest-level cause of a problem is called the root cause. Root cause analysis is part of a more general problem solving process and an integral part of continuous improvement.Because of this, root cause analysis is one of the core building blocks in an organization’s continuous improvement efforts.

Root Cause Analysis (RCA)

Many rule breaches have their root cause in dealer compensation models. Compensation drives Rep behaviour which leads to misconduct if the design is defective and dealer monitoring is sporadic .For instance: supervisors obtaining commission over-rides on staff supervised, branch managers compensated solely based on branch profitability, commission grids biased towards proprietary products and conflicts-of-interest associated with recommending a fee -based account. Unless Hearing Panels dig deep, such systemic issues may not be identified or dealt with. In fact, we now know via the IIROC compensation survey that such investor-unfriendly practices have been alive and well for years. They were there in full sight but not dealt with by Hearing Panels.

Hearing Panels are structured to decide cases where there had been a breach of IIROC rules /securities laws -misconduct. A critical role to be sure, but breaches can also provide invaluable information about how the regulatory control system is functioning (or not).

While it is necessary to sanction Dealers /individuals for breaches, it is also necessary to drill down further. Is the Rep proficient in dealing with de-accumulating accounts? Is the compensation and reward system designed to incent individuals to cross the line? Are sales quotas unrealistic and/or inappropriate? Have Reps been provided the tools they need to do their job? Are supervisory control systems robust? Are dealing representative recruitment criteria matched up with the ethical and conduct standards to comply with securities regulations /laws and the provision of trustworthy personalized financial advice? Are controls and information systems designed to promptly detect system breaches? It is only by addressing root causes that we can improve the system , reduce breaches and improve the fairness of decisions.

It is well known that discount brokers have been improperly collecting trailer commissions for services and personalized advice that was not and could not be provided. Yet until this was recently challenged via several Class Actions, the dealers did nothing to stop the investor abuse. In a very real sense this was organized theft. Discounters could have easily set parameters to exclude the purchase of funds that have a fee for personalized advice or services just like the parameter to reject a stock or fund purchase if there is not enough cash in the account to pay for the purchase. Over all these years, were there not hearings where this could have been dealt with before hundreds of millions of investor retirement savings were transferred to dealers? This abuse is clearly a management responsibility- tone at the top.

Since we believe that management is responsible for 80-90 % of problems, Hearing Panels should be checking to identify root causes rather than just deal with symptoms of episodic misconduct. In that way the overall system can be corrected and failure mechanisms eliminated. This is called continuous improvement and it is missing from the current Hearing process design.

Too many Panel hearings fail to establish corrective actions based on Root Cause analysis. Kenmar have observed that dealers with sound supervisory practices for suitability generally identified risks, developed policies, and implemented controls tailored to the specific features of the products they offered and their client base. These controls help identify any bad practices by Dealing Reps long before they become big problems. These controls include, for example, restricting or prohibiting recommendations of products for certain investors ( e.g. seniors) , as well as establishing systems- based controls (or “hard blocks”) for recommendations of certain products to retail investors to ensure that representatives adhered to those restrictions or prohibitions. Technology and specialized software ( e.g. security risk-rating ) can greatly assist supervision and compliance. These are the kind of corrective actions we’d like to see considered on every case.

Some dealers also implement methods to verify the source of funds for leveraged transactions. In addition, certain dealers require representatives, including principals with supervisory responsibilities, to receive training on specific complex or high-risk products before the representatives recommend them so the representatives fully understood the products’ risks and performance characteristics, as well as the types of investors for whom the product might not be suitable. Control System issues should always be part of Panel decision making as they are often the best form of lasting corrective action.

We’ve also observed some Dealers facing challenges with their supervisory control systems and other operational issues relating to quantitative suitability. For example, as concluded by PlanPlus Research ( }, most risk profiling processes in use today are unfit for use. Deficient risk profiling processes were never explicitly flagged by Panels as a systemic root cause – the belief was that it was always the individual that was responsible.  “Misconduct” and unsuitable recommendations will continue until core KYC processes are corrected. See SIPA report  Improving the KYC process

The scandal involving double billing is a prime example of a breakdown in control systems. The inability to correctly assign fees and promptly detect the mischarging was a systemic issue within firms and across the industry. It is clear from the no –contest Settlement agreements that the wealth management industry needs to beef up the quality assurance of its systems and controls. This requires ongoing system audits, periodic system testing and review of client complaints/ feedback. Process owners need to be held accountable. Root cause analysis was not employed by securities regulators. Hearing Panels should have enumerated a corrective action plan in addition to fines and other sanctions. Merely consenting to fix the systems for fee calculation robustness does not explain the poor initial design and failure to uncover fundamental system flaws, in some cases, for over a decade. CRM2 reporting was instrumental in bringing the internal control issue to light.

When a Dealer or Rep has “actual or de facto control” over a client’s account, there must be a reasonable basis that a series of recommended securities transactions are not excessive and unsuitable in light of the client’s investment profile. DSC mutual fund manipulations and fund churning are a classic example that should not be permitted to happen. Some progressive dealers have developed parameters for trading volume and cost to identify and prevent excessive trading/fund churning as well as restrictions on frequency or patterns of clustered or single product exchanges. In some cases, clients whose accounts breached the firm’s thresholds should receive telephone calls from principals or detailed activity letters setting forth the frequency and cost of trading over specific periods. These are the kind of learnings and action plans we’d like to see integral to Panel Decisions.

The best dealers have an organized, validated risk profiling process. System triggers should kick in when certain KYC criteria are incongruent or suspicious. Too many dealers do not have controls in place to validate changes in risk profile. All too often we see risk tolerance increased simply to justify what has been sold to clients. Better supervisory controls should be applied to risk profile changes increasing the client’s risk tolerance. Our review of numerous Panel cases suggests that Seniors/ retirees should not be put through the same KYC processes as clients of other age groups and the frequency of KYC updates /type of KYC information gathered should vary with age.

We would like to see IIROC formally build corrective action into its Panel Decision objectives. IIROC should summarize these observations for industry action and/or a change in Rules.

The bottom line

IIROC has worked on improving the efficiency of enforcement /Hearing Panels and the collection of fines , primarily from individuals. This may improve investor protection at the margin. A true corrective action program would yield much more substantive, lasting effects and thereby less need for Hearings and fine collection. As professor Peter Drucker has said “  Doing the right thing is more important than  doing things right”. When tactics and strategy balance, regulation is enhanced.

Obviously, individuals should be sanctioned for misrepresentation, unauthorized trading, Off book sales, signature forgery / document adulteration and fraudulent acts. But even in these cases, the Dealer should be jointly held accountable for the actions of its representatives. It is therefore our view that the Hearings process should be reviewed and updated to reflect prevailing thinking on securities regulation, dealer accountability and enhanced investor protection expectations.

We’ve found that currently dealers and Dealing Reps are not doing enough to uphold the suitability standard for their clients, .They must be able to demonstrate why their recommendations are a good fit for the client’s unique needs/goals, risk profile, personal and financial circumstances – in other words, to practise KYP ,KYC and responsible supervision. One solution might be a recommendation that Investment Policy Statements be employed as industry standard practice. That is the kind of deliverable we’d expect if Panel decisions were analyzed with a corrective action perspective rather than on case by case basis limited to sanctions. As currently structured , such a recommendation from a Panel is unlikely .

Each Panel decision should, as a Best practice, look not only at sanctions/deterrence but also at underlying management control and supervisory systems. Every breach of the rules is an opportunity for improvement. An ounce of prevention is worth a pound of cure.

The Panels can be given a form of score sheet or checklist that could be used to help Panel members test for common weaknesses; the information from these can be entered and analyzed for even broader value.  FAIR Canada and others have called for considerably stronger analytics and publicly accessible, relational, searchable databases that will better focus regulatory action. 2019 is the year to get this initiative under way.

Ken Kivenko