The COVID-19 pandemic brought with it a host of novel issues that have had an impact on markets, companies, investors and consumers. Without a doubt, 2020 was a challenging year, and it was also certainly a complicated one for market regulators. Concurrently, organizations and regulators were forced to, and continue to, navigate new compliance challenges. Regulatory enforcement activities have continued to hold weight amongst ongoing regulatory efforts. In this regard, a string of insightful publications in 2020 and 2021 signal the Investment Industry Regulatory Organization of Canada's (IIROC) ongoing focus on its enforcement activities and, in particular, how IIROC members can avoid damaging outcomes. For example, a recent IIROC announcement emphasizes the merits of early resolution of regulatory disputes and recent settlements highlight the importance of having robust controls and supervision measures in place to mitigate the risks of being caught up in enforcement actions.
As we ready ourselves for the release of regulators' annual enforcement reports for 2020 — including IIROC's — we review some of IIROC's enforcement initiatives and priorities over the past year.
IIROC adopts early resolution offers
On April 8, 2021, IIROC announced that it is adopting [PDF] the use of Early Resolution Offers (ERO) effective immediately. According to IIROC's press release, "The [EROs] promote the efficient resolution of cases at an earlier point in the enforcement process, while also ensuring investor harm is addressed through voluntary acts of compensation and the implementation of remedial measures by firms."
Firms and advisors who choose to resolve a case by EROs will be granted a reduction of 30% on the sanctions IIROC would otherwise seek in a settlement agreement and a quicker resolution of the proposed enforcement proceeding. In offering the reduction, IIROC staff will consider the extent to which there has been proactive and exceptional cooperation, remedial measures put in place and compensation paid.
Interestingly, IIROC also announced (in the same press release) that it will withdraw the Minor Contravention Program (MCP), after public commenters expressed concerns about the scope of the proposed program. Under the MCP, an Approved Person or Dealer Member would agree to a fixed sanction for minor rule contraventions ($2,500 for individuals and $5,000 for firms). The firm or individual would not be required to admit a breach of IIROC rules, it would not form part of a formal disciplinary record, and their names would not be published.
We have previously reported on both of these disciplinary programs here.
The flexibility that the EROs provide suggest that the regulator is taking very seriously its stated objective to have robust and, most importantly, appropriate enforcement tools to address wrongdoing in a fair and proportionate manner.
CSA's Oversight Review Report
On August 5, 2020, the Canadian Securities Administrators (CSA) released its Oversight Review Report of IIROC [PDF] (the Oversight Review). The Oversight Review evaluates whether IIROC has complied with the terms and conditions of its recognition orders, and whether specific regulatory processes are effective, efficient and applied consistently and fairly. Notably, the CSA determined that "no findings were identified during the review," and that it "did not identify concerns" with IIROC meeting the terms of its recognition orders.
CSA staff did, however, specifically focus on two aspects of IIROC's enforcement function; IIROC's new integrated case management (ICM) system and its approach to determining when to hold a disciplinary hearing behind closed doors. Two expectations were outlined by the CSA staff for IIROC to address moving forward: CSA staff have asked IIROC to complete a comprehensive review of user access to the ICM system and make improvements where appropriate. CSA staff have also asked IIROC to enhance training for hearing panel members and update its policies and procedures for determining when it is appropriate to hold disciplinary hearings that are closed to the public.
IIROC priorities for 2021
Further to the theme of enhancing enforcement authority, IIROC published its 2021 Priorities [PDF] on June 29, 2020, outlining areas of focus where the regulator will take action to enhance investor protection and promote healthy capital markets. Key priorities for this year include:
- effectively managing issues that arise from the COVID-19 pandemic;
- advancing various initiatives and commitments related to investor protection; and
- supporting industry transformation through the evolution of the self-regulatory model.
With respect to the second priority, IIROC noted that it does not currently have clear authority to directly return funds to harmed investors. However, the regulator notes in this regard that "returning wrongdoers' ill-gotten gains to investors would be an additional layer to IIROC's existing investor protection efforts." In order to further this priority, IIROC notes that it will undertake research directly with complainants to improve its complaint handling process and seek direct input from investors about the potential return of disgorged funds collected from individuals or firms disciplined by IIROC. IIROC's 2021 Priorities also notes that the regulator will continue to seek additional authority to strengthen its enforcement toolkit in all jurisdictions across Canada.
IIROC highlighted its 2019 enforcement successes
IIROC hinted at its expanding enforcement authority in its annual Enforcement Report released on May 11, 2020. The report highlighted key cases prosecuted in 2019 and the regulator's progress on enhancing its legal authority. The 2019 Enforcement Report demonstrates that the regulator continues to seek an ever-more active position in the Canadian regulatory environment. To this end, 2019 was a year of increased enforcement activity for IIROC.
Of the various successes championed in the 2019 Enforcement Report, a few stand out. In particular, IIROC imposed sanctions of $1.8 million against IIROC-regulated firms in 2019 — the most since 2013. 2019 also saw total sanctions of nearly $2 million imposed by IIROC against individuals, although this represents a marked decrease from the $3.2 million in sanctions levied against individuals in 2018.
- The 2019 Enforcement Report also highlighted other achievements. Most notably, in 2019, IIROC:saw the number of disciplinary hearings initiated nearly double — from eight in 2018 to 14 in 2019, resulting from an increase in contested matters, some of which are still ongoing;
- completed 104 investigations (a decrease from 127 hearings completed in 2018), and prosecuted 28 individuals and eight firms;
- suspended 14 individuals and permanently barred three individuals; and
- collected 29% of fines against individuals and 97% of fines against firms.
IIROC Enforcement pursued a variety of cases in 2019, including novel trading and gatekeeping cases. Suitability continues to be a core focus, representing approximately one third of prosecutions and all matters reviewed by Case Assessment.
The 2019 Enforcement Report also highlights IIROC's continued crusade to pursue additional legal authority to strengthen the effectiveness of its enforcement actions. Chief among 2019's touted achievements is the addition of New Brunswick to the roster of provinces providing IIROC with the full enforcement toolkit.
In December 2019, New Brunswick became the fifth province to provide IIROC with the full enforcement toolkit, which includes: fine collection, authority to collect and present evidence, and statutory immunity. IIROC has now acquired fine collection authority in 12 of the 13 Canadian jurisdictions, with the full enforcement toolkit in five provinces (Alberta, Quebec, Nova Scotia, Prince Edward Island and New Brunswick). IIROC notes that it is actively seeking similar legal authority in all other jurisdictions across Canada to ensure a consistent level of investor protection from coast to coast.
IIROC continues to highlight the importance of proactivity, controls and supervision in published settlement
On June 30, 2020 IIROC approved a Settlement Agreement [PDF] with a dealer member and an individual registered representative. The settlement relates to the dealer member's admitted failure to implement proper controls that would have caught an error created by a third-party system, and inadequate supervision of several employees.
The settlement requires the dealer member to pay a fine of $500,000 and costs of $50,000, and is a further reminder of the need for regulated businesses to maintain adequate systems of controls and supervision to ensure compliance with regulatory requirements.
IIROC alleged that the dealer member breached IIROC's Dealer Member Rule 17.2A as a result of insufficient controls leading to the pricing error in their calculation system. IIROC also alleged that they knew or ought to have known about this mistake almost two years before the error was eventually discovered, and therefore the error continued for an excessively long period of time instead of being examined and amended. As a result of these breaches, the clients were charged incorrect amounts on their accounts and relied on inaccurate information for their trading, which, unbeknownst to them, led them to accumulate large equity deficiencies.
Ultimately, the dealer member took action to remediate the compliance failings that led to these breaches of supervision, including: hiring a new chief risk and compliance officer, additional compliance officers and additional senior compliance staff; engaging in better governance and risk management; increasing transparency into compliance risks at the executive and board levels; and implementing new policies and procedures and introducing new training sessions for employees. The dealer member was positively called out for working to make what IIROC described as their "overall culture of risk" better by improving their "risk classification methodology, reporting, and governance tools" and improving the company's technology in various ways.
This settlement highlights the necessity for IIROC dealer members to make sure their internal controls and supervision systems are effective. This case reinforces the fact that it is not enough to have some system in place – the actual effectiveness of the system, from individual employees to the entity as a whole, will be considered in the context of the dealer member's whole risk management and compliance structure.
Implications and best practices
Understanding IIROC's concerns and priorities is a significant component in managing risks and opportunities by regulated firms. Overall, IIROC's adoption of EROs, the 2019 Enforcement Report, and 2021 Priorities highlight the regulator's gradual – yet consistent – increase in enforcement activity. IIROC's escalating reach will undoubtedly have an effect on its member firms, encouraging them and their personnel to develop, maintain, and enhance a culture of compliance.
The trends emphasize the meaningful and impactful benefits of ongoing and appropriate enterprise risk management.
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