The IIROC complaint handling policy analyzed below is posted at the OSC website (13feb09). The SIPA response to the policy, submitted in March, was prepared by myself and contains the previous Dec 2007 submission as an appendix together with related documents (23mar09). These documents include an in-depth principles-based analysis of the dealer complaint process, initially submitted to the Ontario Securities Commission in August 2004. The same analysis was submitted to the Investment Dealers Association (now IIROC) in October 2004. I received no response or expression of interest from either regulator in response to these submissions.

In the 2004 analysis, which can be downloaded here, I take the principles of fair dealing identified by the OSC in its Fair Dealing Model Concept Paper (Jan 2004) and apply them to the dealer complaint process. The outcome of my analysis is that the dealer complaint process is “objectively impaired relative to the factors that constitute fair dealing”. Clients are vulnerable to harm in the context of such dealings, i.e. where the OSC principles indicate the potential for unfairness. Of particular concern is the fact that dealers are incented to deny meritorious complaints while at the same time the firm’s decision about the client’s complaint is communicated in a manner lacking in “transparency”. The OSC regards this kind of situation as being problematic in principle, i.e. where there is a profit motive, conflict of interest, together with a lack of transparency in the communication of information, which has to serve as the basis for a financial decision on the part of a client. The transparency issue is analyzed in §§21-41 of my 2004 OSC submission.

There are additional factors, which further increase the risk of harm to clients’ interests in this situation, in particular, the imbalance in power and asymmetry in knowledge between the client and the firm. These factors are discussed in detail in my article, “Risks Inherent in the Complaint Process”, published in the SIPA Sentinel, (Dec 06) and in my submission to the Canadian Securities Administrators on their National Instrument 31-103 (Jun 07).

The issues identified in these papers are systemic factors that affect the dealer complaint process in general as opposed to issues relating to particular complaints. Nevertheless, there is evidence that a relatively high number of meritorious complaints are being denied by firms in the Canadian context. Over the past few years, a large percentage of decisions by investment firms (50-60%) have been overturned by the Ombudsman for Banking Services and Investments (OBSI) indicating that such decisions are unreliable. The regulators are well aware of the unreliability of these decisions.

Last month former Ombudsman, David Agnew, commented: “I think we’ve got a lot of work to do on the culture of complaint handling and dispute resolution in financial services” (Globe, 14may09). The existence of problems in complaint handling by investment firms has been known for many years as per the summary in my recent SIPA submission on the MFDA complaint handling policy, posted here, also discussed in my initial IIROC submission.

The Ontario Securities Commission and self-regulatory organizations received information and advice on complaint handling and restitution from the OSC’s Investor Advisory Committee, which sat from Jan 06 to Dec 07, of which I was a member. At one point I was invited by the Commission to give a presentation to senior management from the IDA, MFDA, and OBSI on my application of the OSC’s fair dealing model principles to the dealer complaint process. In addition, the OSC and SROs heard the views of dispute resolution professionals who were members of the IAC.

In January 2007, I forwarded to the Commission a further development of my original FDM analysis incorporating a consideration of the regulatory oversight of the dealer complaint process (download here), also included in my IIROC submission. This analysis builds on my previous application of the FDM principles to the complaint process and also incorporates consumer theory. The integration of consumer theory focuses attention on the outcome of the dealer complaint process as a regulated product or service requiring risk management and risk communication to the public by regulatory authorities:

1. In exercising its public interest mandate, a regulator provides protection to the public from harmful products and practices. The need for this protection arises not only in circumstances involving actual harm, but also with the occurrence of the conditions of harm.
   

There is a clear application of this principle to the dealer complaint process in virtue of the demonstration of the conditions of harm in my original FDM analysis, i.e that the dealer complaint process is “objectively impaired relative to the factors that constitute fair dealing”.

Moreover the occurrence of actual harm is clear as well, for example, in view of the high overturn rate by OBSI of dealer decisions as well as other evidence. I conclude with a recommendation that flows directly from the logic of the analysis and which is again based on an OSC publication:

1. ... the OSC and SROs with oversight of the internal complaint process, should caution investors that the process is adversarial and advise them to seek an outside opinion on the merit of their complaint. This is consistent with the approach of informing investors to make them “partners in their protection against unfair, improper or fraudulent practices” (OSC, Goal 2, Statement of Priorities 30 Jun 06).
   

Two years later, no action has been taken to caution investors—nor, apparently, are there any plans to do so. This is in the best interests of the industry.

The regulators have been proceeding in their typical, decided-for-you manner, controlling both the process and the product—for which they are, therefore, responsible. Although the topic of complaint handling and restitution was under discussion by the OSC’s Investor Advisory Committee, the Committee was abandoned by the OSC in Dec 2007. Although SIPA made a request to IIROC in its Dec 07 submission for further consultation regarding the complaint handling policy, the request was turned down.

In late May 09, following a second round on comment on both the IIROC and MFDA policies, and a close comparison of the IIROC policy with the complaint handling rule of the UK’s Financial Services Authority (FSA), all of this work pro bono, I expressed concerns to IIROC CEO Susan Wolburgh Jenah about certain apparent deficiencies in the IIROC policy. The IIROC policy lacks a level of prescription, clearly present in the FSA rule, which has significant implications for the fair handling of client complaints.

In response, I was granted a 90m meeting with IIROC policy staff on June 2nd to discuss these and other concerns (detailed below). The next day, I sent a detailed followup memo also copied to the CSA working group with oversight of the policy. Nevertheless, unless significant late-stage amendments are made at this point, the outcome will be a demonstrably defective regulatory product. Moreover, the policy development process is at such a late stage and so many individuals have approved the existing policy by this point, that questions are inevitably raised about (1) competence and (2) ‘capture’.

A demonstrably defective regulatory product

In the context of present concerns “defective” means, for one, the failure to prescribe or qualify Dealer Member conduct in a way that embeds the purpose of the rule in its provisions. It also refers to the evident inferiority of the IIROC rule relative to the FSA rule (and perhaps other rules). The introductory material to the IIROC policy revisions makes clear that a comparative study was made with the FSA rule. In view of this, the IIROC policy represents a known departure from the stronger investor protection provisions of the FSA policy, see following.

The complaint handling section of the FSA rulebook is posted here. The entire complaint handling policy is categorized under the overarching principle, “Treating complainants fairly”. In fact there is an equivalent principle that governs the IIROC rule to the extent that the proposed amendments have a purpose or are aimed at promoting the achievement of fair dealing in the context of complaint handling. This aim is evident in the stated objectives of the proposed Rule as outlined in five bullet points in the introductory material:

1. Proposed Rule classification
   

2. IIROC has determined that the proposed rule is a Public Comment Rule.
   

3. The purposes of the proposed rule are to:
   

4. •ensure compliance with securities laws;
   

5. •prevent fraudulent and manipulative acts and practices;
   

6. •promote just and equitable principles of trade
   

7.         and the duty to act fairly, honestly and in good faith;
   

8. •foster fair, equitable and ethical business standards and practices; and
   

9. •promote the protection of investors.
   

Nevertheless, as I queried in my memo to IIROC policy staff: “How can a policy promote or foster anything unless the objective of the policy is cashed out, as it were, in the nuts and bolts of the [policy] provisions?” As I put it in the SIPA submission of 23 Mar 09, there is need for a “comprehensive perspective”

1. which includes taking into account the regulatory outcome(s) that the rule is supposed to achieve, together with the ‘framing’ of the conduct at the firm level, which is supposed to achieve these outcomes. One then may consider whether the regulatory framing of this conduct—which specifies what is to be done, when it is to be done, and how it is to be done—is sufficient to achieve the regulatory outcome(s) in question (page 4, 23mar09).
   

The question at this point relates to the evident deficiencies in the IIROC rule, which has been through two years of development and multiple levels of review and approval.

There are some positive developments: the rule has introduced timeframe constraints on complaint handling that will benefit clients of its Member firms. After 90 days, clients are able to access the industry Ombudsman (OBSI) whether or not they’ve been through a review with the firm’s internal ombuds service (where available at bank-owned firms). There are also provisions aimed at ensuring that clients are provided with the requisite information about dispute resolution alternatives (although concerns remain about the enforcement of these provisions).

Nevertheless, clients may well have their complaints dealt with promptly, without the above objectives being achieved—as indicated in the April newsletter from the Ombudsman (OBSI) which reported an increased incidence of malpractice at firms: “Instead of a proper response to the client, the firm has fired off a template letter dismissing the complaint, and has done none of the proper groundwork of responding to a client” (OBSI 07apr09). Unlike the FSA policy, the IIROC rule contains no standards for the investigation and assessment of complaints, see following.

Complaint handling standards

This consideration shifts attention to the nature of the “Complaint substantive response letter” that must be provided to the client, as outlined in section 4 of the IIROC rule under “Complaint procedures/standards”. The substantive response letter has been a main focus of my critical comments from the beginning. The IIROC policy requires that the “substantive response” to the client include:

1. (a) A summary of the complaint;
   

2. (b) The results of the Dealer Member’s investigation;
   

3. (c) The Dealer Member’s final decision on the complaint, including an explanation;
   

In addition, the Dealer Member (DM) must provide information about options should the client be unsatisfied with the response. The contrast with the FSA rule concerns the complete absence of any qualification in the IIROC rule regarding performance standards relating to the firm’s investigation, assessment, decision or summary and explanation in the letter. In contrast, the FSA rule has the following requirements (DISP 1.4):

The respondent must (among other things)

1. (1) investigate the complaint competently, diligently and impartially;
   

2. 
   

3. (2) assess [the subject matter of the complaint] fairly, consistently and promptly;
   

4. 
   

5.     “taking into account all relevant factors”; the respondent must
   

6. 
   

7. (3) offer redress or remedial action when it decides this is appropriate
   

8. 
   

4. (4)explain to the complainant promptly and, in a way that is fair, clear and not misleading, its assessment of the complaint, its decision on it, and any offer of remedial action or redress;
   

There are several points of contrast between the IIROC and FSA rules and notable deficiencies in the IIROC rule, which lacks any prescriptive layer regarding the firm’s execution of the above obligations. The highlighted qualifications in the FSA policy prescribe how things are to be done as opposed merely to what is done (investigate, summarize, decide, explain). Clearly, the regulation of conduct by the IIROC rule is much weaker. Impartiality, which certainly cannot be presumed in the context of the such dealings, is not mandated at all by the IIROC rule. Moreover, the firm is not required to offer appropriate redress or remedial action nor to explain the basis of its calculations in the event it does offer redress.

The above or similar qualifications, relating to manner of conduct, are needed in order to align the IIROC rule with its stated purpose (among other things) to “the duty to act fairly, honestly and in good faith” and to “foster fair, equitable and ethical business standards and practices”. These objectives, which are implicit in the FSA principle “treating complainants fairly” are embedded in the provisions of the FSA rule in and through the above qualifications. In contrast, the provisions of the IIROC rule are entirely disconnected from their objective. This lack of specification also provides a weaker basis for subsequent disciplinary action in the event of misconduct.

Management intervention in response to frequent & repetitive complaints

The above lack of qualification in complaint handling conduct is not the only deficiency in the IIROC rule relative to the FSA rule. There also is a notable disparity in the actions mandated by each policy in the face of frequent and repetitive complaints, which may indicate a serious problem potentially affecting many clients at a firm.

It needs to be kept in mind that complaints are a way for management to make discoveries about internal systemic problems and deal with them in order to protect other clients. Both the FSA rule and IIROC contain provisions that mandate how firms are to deal with recurring complaints, however, the IIROC rule is again notably inferior.

The relevant FSA policy, stated in section 1.3.3 of DISP 1.3, mandates internal procedures at firms arising from complaint handling—specifically, the identification and correction of any recurring or systemic.

The equivalent provision in the IIROC policy would be:

1. 1. “Each Dealer Member must put procedures in place so that its senior management is made aware of complaints of serious alleged misconduct and of all legal actions.
      

   2. 
      

   3. “Dealer Members must have policies and procedures in place to monitor the general nature of complaints. When a Dealer Member reasonably determines that the number and / or severity of complaints is significant, or when a Dealer Member detects frequent and repetitive complaints made with respect to the same matter which may on a cumulative basis indicate a serious problem, then internal procedures and practices must be reviewed, with recommendations to be submitted to the appropriate management level.”
      

2. 
   

The FSA policy mandates a kind of internal audit function in the face of information about abuses coming to the attention of the firm via client complaints. This contrasts significantly with the level of response required by the IIROC rule.

The FSA policy is much stronger and more specific, requiring that the firm take “reasonable steps” to identify and remedy “any recurring or systemic problems” which it may become aware of in handling complaints. Moreover, the rule gives an example of what would constitute taking “reasonable steps” e.g., analyzing individual complaints “so as to identify root causes” with consideration being given to the bearing of such causes on other processes or products, as well as their correction.

In striking contrast, the IIROC rule mandates only that internal procedures and practices must be reviewed and recommendations made to the “appropriate management level”.

Then what? The IIROC rule specifies no further obligation on the part of management. Clearly, a higher level of responsibility and accountability is embedded in the FSA rule. Moreover, the FSA rule is much clearer about regulatory expectations and provides a basis for stronger disciplinary action in the event of a breach.

The shortcomings of the IIROC rule are evident also in relation to a case involving an IDA Dealer Member: Markarian v CIBC World Markets Inc., [2006]. The decision of Justice Jean-Pierre Senècal with English translation and related media articles are posted here:

http://investorvoice.ca/Cases/Investor/Markarian/Markarian_index.htm

Consider the nature and extent of the responsibility mandated by the IIROC rule, quoted above, relative to the excerpts from the Markarian decision, which specifically concern the response of senior management at a Canadian bank-owned brokerage to the actual confession of an employee regarding the his fraudulent mishandling of several client accounts.

Which rule – that of the FSA or IIROC – would best address this incident? Which rule would have the strongest preventative effect on future incidents of a similar nature? Which rule creates the strongest foundation for disciplinary action? Which rule best protects investors?

In its lack of prescriptive provisions regarding required intervention on the part of senior management at firms in the event of serious problems coming to their attention via client complaints, the IIROC rule simply hands over any judgment about what is to be done to the discretionary judgment of management. This extremely unintrusive and deferential approach leaves the nature and extent of the response entirely up to management discretion. All that is required by IIROC is that the appropriate management level should be made aware of problems.

What happens once management has become aware of a serious problem that may affect the financial interests of multiple clients? At DISP 1.3.5 the FSA rule provides guidance as to kind of action that should be undertaken by firms in this kind of situation:

1. 1. “A firm should have regard to Principle 6 (Customers’ interests) when it identifies problems, root causes or compliance failures and consider whether it ought to act on its own initiative with regard to the position of customers who may have suffered detriment from, or been potentially disadvantaged by such factors, but who have not complained.”
      

   2. 
      

2. There is nothing equivalent in the IIROC policy, even as guidance, i.e. no indication of any expectation on the part of IIROC that its Dealer Member firms, in the event of becoming aware of problems, will have regard to the financial interests of those “who may have suffered detriment from, or been potentially disadvantaged” by serious misconduct or problems at firms “but who have not complained”. IIROC studied the FSA policy. Why should retail investors in the UK have the benefit of this protection and not Canadians?
   

A 1-page table with a summary of the above comparison may be downloaded here.

The FSA complaint handling rule was studied by IIROC policy staff. The IIROC policy amendments were twice approved by the IDA/IIROC Board of Directors. By this point, the policy also has been substantively ratified by the Canadian Securities Administrators. Yet, there are multiple points of weakness in the policy’s investor protection provisions. What are the “root causes” of these deficiencies?

This is the second known departure in the Canadian context from a superior policy or approach in another country that I am aware of. The other example is the OSC’s Investor Advisory Committee. In 2005, the Ontario Securities Commission studied the UK’s Financial Services Consumer Panel (FSCP) prior to setting up its Investor Advisory Committee (IAC) of which I was a member. I eventually started looking at the Consumer Panel and noted substantive discrepancies with the well-established body in the UK. In December 2007, Investment Executive published my comparison of the IAC with the UK Panel, “Consultation framework needs makeover” (05dec07). I subsequently incorporated this research into my submission to the Expert Panel on Securities Regulation (15jul08), recommending that a body similar to the UK panel be established in Canada. This recommendation, also endorsed by other participants in the consultation process, was accepted by the Panel and is included in section 25 of its draft legislation for a common securities regulator.