MFDA progressing on member reviews

(May 24, 2005) We’re just making the rounds. So says MFDA vice president for compliance Karen McGuiness regarding her association’s promise to regulators that all member firms will be reviewed by December, 2005.

“Some branches are worried we’re out on a witch hunt,” she says. “We’re not. If we find something that warrants referral to enforcement, we’ll do that. But we’ll always let the member know to expect that.”

To date, the MFDA has publicly reprimanded just one firm — Investors Group — and that was tied to a specific issue: the Ontario Securities Commission’s mutual fund market timing probe.

The examination process starts with a phone call one to two weeks prior to the time MFDA staff visit the firm. The call is followed up with a document request and examination staff can be expected to spend a week or two at a firm’s head office, and three or four days conducting branch visits. A head office exam is conducted by a team of three or four examiners. Branch office exams usually are performed by two or three MFDA staff.

Before MFDA’s team leaves, there’s an exit interview during which any uncovered deficiencies are discussed. That’s an opportunity for the firm to make its case, tell examiners if they neglected to ask questions, and provide additional information to clear up any concerns. Once the field review is complete, the exam team returns to MFDA’s offices — located in Toronto, Calgary and Vancouver — to look at the firm’s overall compliance picture.

“When we leave their premises, the examination isn’t over,” says McGuiness. “There will be some backing and forthing asking for extra information.” Say, for example, certain reps aren’t sending out customer complaint forms to clients. MFDA rules require the forms be sent out when an account is opened, and at any time a customer calls with a complaint. If a rep receives a complaint call, he or she is supposed to call the head office and ask that a form be sent out.

“If the rep phoned in and said, ‘My client says I’m churning,’ we would expect the compliance officer to have that in a log and then follow up with the rep to get his side [of the story], and then follow up with the client,” she explains.

Now, suppose one part of the process — the logging of complaints — wasn’t being done properly, but the remainder of the process was being done in a timely manner. In such a case, the exit interview would serve as an opportunity for examiners to request a procedural change and then determine whether it had been implemented during a follow up examination. Likewise, if examiners pointed out a problem early in an exam and then noticed procedural changes were put in place before the exit interview, that effort would be acknowledged.

All of the gathered information, including efforts to make improvements, is distilled into a report issued between 15 and 26 weeks after examiners leave the firm’s offices. McGuiness notes examiners sometimes are at branch offices for a week or two after they finish up at the head office. The clock that determines when the report is issued doesn’t start ticking until after MFDA is done with the branches. So far this year, all the reports have been issued inside of 15 weeks. “For every head office, we try to do at least three branches,” she says, “But for national dealers, we’re averaging six or seven branch locations.”

Once the report has been issued, firms have three weeks to respond, although extensions are granted if complex issues are raised by the exam team. If there’s nothing further to resolve, the firm receives a case closed letter. But if issues aren’t squared away, problems will be referred to the enforcement division.

What types of activities get firms referred to enforcement? McGuiness points to unsuitable trading practices, like churning and outside business activities (in which a firm sells prospectus-exempt products).

MFDA is seeing a lot of reps being conned into selling exempt securities that aren’t on their firm’s approved lists. McGuiness reminds reps if their supervisor is not qualified to oversee a sale, then they shouldn’t make the transaction. The MFDA issued a warning on these outside business activities last week.

The SRO also has an eye out for unsuitable trading, and more importantly the unsuitable leveraging that often goes along with it. MFDA is concerned about firms overextending credit to clients. “It further aggravates the problem,” says McGuiness. “The sale is unsuitable and then it’s amplified by borrowing for the client.”

After January 2006, mutual fund sellers can expect a visit from MFDA examiners every two years. The timing also will depend on a model that MFDA developed to help ensure higher risk firms get visited sooner. But the arrival of examiners could further be a function of MFDA economics. McGuiness says, “If I’m sending a team to Nova Scotia and I have two members down the street from one another, I’m going to send them to both to save some money.”

Filed by Philip Porado, Advisor’s Edge, philip.porado@advisor.rogers.com.

(05/24/05)