Sunday, July 28, 2019

Case study: Excessive leveraged trading in IPO’s in fee based account generated huge trading commissions while supervisor watched

Kevin Frederick Price (Settlement) – Toronto, Ontario

Over a two-year period, Price recommended to a client that she use significant margin, which was unsuitable. Price also earned significant compensation by engaging in a short-term trading strategy for the client. This short-term trading was not within the bounds of good practice.

The client was retired [born in 1948] with limited investment knowledge and just under $1 million in assets. She opened four accounts with Price, all of which were fee-based and required the client to pay a percentage fee based on the market value of the securities held. The client required regular income from her portfolio for living expenses. Since inception, Price purchased securities on margin, which increased the income generated but also increased the risk, which eventually exceeded her risk tolerance.

Price recommended a significant number of trades in new securities. Over a two-year period, he purchased $4.1 million of new issues, representing approximately 71 percent of all securities bought. These purchases were also part of a short-term trading strategy that, overall, was not profitable for the client. However, the new issue purchases generated additional commissions, which were paid by the issuers, for the firm and Price. Over the same period, he earned approximately $40,000 from the new issues, in addition to the account fees paid directly by the client. The underlying new issues were not unsuitable and consistent with her investment objectives.

The client lost approximately $369,000 in her accounts.

Price paid an internal discipline fine of $21,000 to his employer, completed the Conduct and Practices Examination, and was subject to strict supervision for six months. He also contributed $55,000 towards compensating the client for her losses. Price agreed to pay a fine of $15,000 and costs of $5,000


2017 IIROC Enforcement report.

Questions: Does anyone believe Supervision was robust, that the fine was fair and proportionate and that general deterrence has been achieved?  The really good news? Mr. Price is now registered as a Dealing representative in Ontario, BC and Alberta with Mackie Research with no terms or conditions on his registration.This case demonstrates the value of checking IIROC registration (?}.😉 It might be wiser for clients to assess their trade confirmations, account statements and performance reports. Note the elegance of the IPO strategy is that the commissions won’t show up in the fee based account statement. We urge IIROC to provide rules and guidance re fee based accounts/ reverse churning and sanction deficient supervisors, branch managers, compliance staff and firms with uncharacteristic vigour. 

IIROC Settlement Agreement


Saturday, July 27, 2019

Reverse Churning | IIROC is watching ( we hope)

According to the 2018 PriceMetirx report, revenues from fee accounts grew by 17% in 2018 over 2017, while revenues from transactional accounts declined by 5% year over year. Revenue growth was further propelled by the fact that fee assets are more productive than transactional assets. Average revenue yield (revenue over assets) for fee accounts was 0.91% in 2018 compared to 0.37% for transactional accounts. The (asset-weighted) average client age stands at 67.6 years. For the household segment (those with $1 million to $1.5 million in assets), the top 10% of clients (based on rate paid) pay 1.40%, while the bottom 10% pay 0.73%, or half as much as the top 10%. For those households, fee account pricing dropped 2 bps (from average 1.08% in 2017 to 1.06% in 2018), compared to a drop of 5 bps the previous year.

The PriceMetrix report further shows that 52% of advisor-client relationships included a fee-based account in 2018, up from 31 % in 2015. Investment dealers value fee-based accounts because they are much more predictable and reliable as a revenue generator than charging clients sales commissions. In a fee-based account, clients pay roughly 1 % to 2 % or more of their total invested assets (including cash, GIC’s and bonds)  per annum depending on account size.

When you consider these statistics, it is abundantly clear that conflicts-of-interest will come into play and seniors / retirees will be prime targets. Fee-based accounts are very lucrative arrangements for salespersons (aka “advisors”). There is a very real danger that reverse churning will rear its ugly head particularly under the low suitability standard for advice giving. 

Given the rapid rise of fee- based accounts, regulators should take action to address reverse churning.  First, firms should be required to ensure that there is an adequate supervision system in place to guarantee that accounts are handled properly.  IIROC should make it clear that it will hold firms accountable if there is no system in place for supervision.  Second, salespersons should take care to monitor their client’s accounts.  Advisory service going beyond the provision of statements, such as fulsome conversations confirming the client’s goals and objectives (and appropriate documentation of such conversations), is both prudent and necessary.  Finally, decisions to hold or stand pat in any account, and decisions to move from commission-based accounts to fee-based accounts, should be documented carefully with an eye towards avoiding claims that the move was reverse churning.

We expect and hope that IIROC is particularly concerned with : (1) accounts in which securities are purchased and portfolios are designed in commission paying brokerage accounts and then transferred to a fee-based account in which the same trades could have been initiated without paying commissions; (2) accounts that consist primarily of cash or bonds that are transferred to fee-based wrap accounts in which the fees are higher but the investments do not  materially change; and (3) accounts that are fee-based accounts in which few if any transactions are made.

Additional concerns include including embedded commission funds in these accounts (double billing) as well as defining how IPO’s are to be treated.

IIROC should not depend on general principles to regulate the choice of proper account type. Rules and guidance are required to give dealers the IIROC perspective on reverse churning. The controversial IIROC principle that conflicts -of-interest are to be resolved in the best interests of clients is too vague for operational application.

Kenmar look forward to regulatory actions to protect retail investors from the latest threat to their retirement income security.


Wednesday, July 3, 2019

Why are financial advisors reluctant to speak freely about the industry?

We’ve always wondered why so many IIROC regulated professionals have remained silent on how to improve the industry. It is extremely rare to read an article or a Comment letter to a Consultation that points out what needs to be done to fix the wealth management industry .After reading John DeGoey’s latest book, STANDUP to the financial services industry , we now know why. From his book we quote:
Speaking personally, I have never once agreed with the interpretation of IIROC Rule 29.7 (1) that allows compliance departments to vet legitimate STANDUP advisors' ideas regarding how the industry might be improved, as a form of corporate censorship disguised as maintaining a level of decorum. That interpretation is also a direct contravention of section 2 of the Canadian Charter of Rights and Freedoms, where "freedom of thought, belief, opinion and expression" are expressly enshrined as basic rights that all Canadian citizens enjoy.
According to compliance departments, if one were to point out that things are not being done in the best possible manner, that would be seen as "contrary to the interests of the industry." In My Life and Work, Henry Ford recalled that he'd once said, "Any customer can have a car painted any colour that he wants so long as it is black." Securities firms in Canada effectively say, "You can say whatever you want about the industry as long as it is not critical-even [especially?] if it is demonstrably true."

So now you know why. Advisors (“Registered Representative’s”) are constrained on what they can say just like investors who settle a complaint with a dealer. (John’s Book is available at