Your Money: Self regulation is a recipe for disaster

The need for an effective regulatory system that protects investors grows more urgent each day.

The need for an effective regulatory system that protects investors grows more urgent each day. The cavalier attitude of the investment industry towards regulations and the savings of investors are to blame for the ABCP crisis and the global repercussions that have negatively affected financial institutions, corporations and pension funds.

That calamity exemplifies the issue that Canadian investors face when regulators, lax enforcement and exemption practices fail to protect them. The Institute for International Finance blames the industry and regulators for the ABCP crisis.

A contributing factor to this market upset is that commercial paper is an exempt security with a different set of disclosure rules. Federal and provincial regulators, all deny responsibility, suggesting that investing in Canada is caveat emptor (buyer beware).

Self regulation in the investment industry is a recipe for disaster. Regulatory patchwork over the years has only made the system weaker and totally ineffective in dealing with worldwide transactions that are ever more complex. The present system is broken beyond repair. Government must institute a national regulator accompanied by state-of-the art enforcement.

The financial industry has created a continuing stream of disasters as a result of the regulatory system’s failure to protect investors and enforce regulations. We learned little from the fall of the Atlantic Acceptance Corp. in the mid 1960s, the Confederation Life disaster in the mid 1990s, the Bre-X scam of the century and now the ABCP crisis. We completely failed the victims and the alleged perpetrators of these nefarious schemes rarely suffer much or go to jail.

Why is nothing happening to correct this situation? For years the possibility of fraud and wrongdoing has been masked by industry and regulators. Self regulation, without control, simply does not work in a complex volatile industry. It is like expecting the unmanageable to keep order in schools and the workplace, or suggesting criminals run the justice system because of their experience.

Regulation works only if it has enforcement teeth, public confidence and the respect of industry. In Canada, we have exactly the opposite. Why should we trust financial institutions that do not trust each other?

Innocent investors and particularly retirees are losing their life savings faster than most of them realize. The Small Investor Protection Association (SIPA) estimates that Canadians lose over $20 billion due to wrongdoing and fraud every year.

In the 2003 mutual fund market timing scandal, five mutual fund companies were required to pay $205 million for cheating their investors.

The Investment Dealers Association (IDA) is an independent, self-regulatory body for investment dealers across Canada. Investors legitimately complain that the IDA will investigate only to see if rules have been broken and only if the penalties levied on the perpetrators seem insignificant.

The IDA has developed a comprehensive “Complaints and Settlements” database. Unfortunately, this information is not available to the public, in spite of an alleged 12 percent of registrants with complaints registered against them.

Competitive forces and the reward system can be counterproductive to the client’s best interest in a self-regulated environment. Many industry insiders privately acknowledge that regulatory reform is overdue and that their industry needs better governance from a neutral regulator. They say, “My principles are intact but I worry the practices of my peers and competitors give us all a bad name.”