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There has been quite a fuss over the decision by the British Columbia Securities Commission’s (BCSC) decision to censure the Mutual Fund Dealers Association (MFDA) for its proxy solicitation practices. In fact, it has not been a particularly good year for the MFDA so far when, added to the BCSC’s decision, we have the Saskatchewan court’s refusal to toss a civil suit against it and the ruling in the Mallard case as well. Both have raised questions about the integrity of the MFDA.

“We find that the MFDA board’s decision to conduct the proxy solicitation process as it did for the October 2009 special meeting would have led an objective observer to question the integrity and credibility of the MFDA in managing that process,” said the BCSC in its statement.

In my experience, there has never been a decision like the BCSC’s – where the credibility of a SRO has been put under such a spotlight by its overseer.

Even in the face of the findings, the MFDA has refused to acknowledge any wrongdoing in the process and maintained it had fixed any perceived problems with its new proxy solicitation policies. The panel disagreed.

“It is with great reluctance that we issue directions to the MFDA about how to conduct its proxy solicitation process for member meetings. However, the MFDA insists it did nothing wrong in connection with the October 2009 special meeting, in the face of blatant deficiencies associated with that process. It also says its new policy will solve any perceived shortcoming in its proxy solicitation process, when that is clearly not the case. Regrettably, direction is necessary,” they stated.

The Commission also took the time to analyze the MFDA’s defence and comment on it as well.

“The MFDA’s excuses for adopting the process it did are weak. That it had no rules to look to externally did not excuse it from making appropriate ones of its own. That it had proceeded as it did for past meetings only shows that it failed to recognize that the unique circumstances of the October 2009 meeting might call for something different. That it heard no concerns about the process before the meeting is irrelevant – the factors that established the risk of inappropriate pressure were evident. It relied on legal advice, but it was not a solely a legal matter – it was a matter of what process was appropriate for an SRO from a public interest perspective.”

Although the BCSC was careful to limit the scope of its decision to the proxy solicitation process around the October 2009 meeting, it is impossible to look at the judgment and behaviour of the MFDA throughout the process and the proceedings, and not question its integrity and effectiveness overall. If it could have exercised such poor judgment in this circumstance, one wonders what is happening during its day-to-day operations?

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Special Section: Proxygate

The situation brings to mind the review of the IDA’s enforcement operations by AssetRisk led by Robert Chambers in 2001, after a scathing report was issued by the OSC on the IDA’s ineffective enforcement. In that situation, the IDA as SRO was also being questioned about its effectiveness. The OSC’s report highlighted — and a full-scale review and report by Chambers confirmed — there were operational and structural issues that needed to be addressed if the IDA was going to operate well as a regulator to the brokerage industry.

But in this case, what we are dealing with is arguably a more serious issue: the actual trustworthiness of the MFDA to do its job.

The MFDA was entrusted with the duty to operate as the self-regulatory organization for the mutual fund dealer industry by recognition orders made by various members of the CSA at various times since February 2001. Delegation by the CSA to an SRO is a necessary and efficient mechanism for achieving regulatory goals. However, there must be parameters around the recognition and a rigorous and ongoing analysis of the SRO’s success in achieving those goals.

The Report of the CSA SRO Oversight Project Committee, contained in CSA Notice 24-303 and dated December 2006 sets out the parameters that must govern the recognition and ongoing proper functioning of an SRO.

“Each SRO… should be able to demonstrate and explain in writing how it meets its public interest mandate when making regulatory decisions and, while they should remain flexible in determining how they meet this mandate, they should consider certain high-level criteria in the process, including:

• The decision would be in the interest of, or would not negatively impact, investors;
• The decision would not inappropriately stifle innovation or competition;
• The decision would not unfairly discriminate against certain types of businesses, participants, products or investors;
• The decision would appropriately balance investor protection and the efficiency of the capital markets; and Any other criterion that may be appropriate for the subject of the specific decision.

In addition, the SROs…must meet high-level standards covering areas such as governance, rule-making and membership.”

When the CSA talks of “balancing investor protection and the efficiency of the capital markets” it is talking about giving more or less equal weight to the interests of public investors and the interests of the market intermediaries – the members of the MFDA – who are an integral and critical part of the health and efficiency of the Canadian capital markets.

Yes, they must be regulated, but they must also be supported in order to create a healthy, thriving marketplace for Canadian investors.

The July 2010 release of the CSA Oversight Review Report of the MFDA raised no concerns in the area of integrity or credibility. But we must remember:

a) The oversight process is not chiefly designed to detect “soft” problems such as judgment and trustworthiness. It is designed to review staff complements, complaint and enforcement rates and timing to resolution etc. — largely hard data and numbers that are purportedly meant to measure the success and effectiveness of an SRO.

b) The CSA did not have the benefit of the factual details that came to light in the BCSC’s proceedings nor of the allegations set out in the Statement of Claim filed by Mr. Mallard.

The MFDA, as with any other individual or entity being called to task, should be presumed innocent until proven guilty, but given its enormous self-regulatory responsibility, its major role in the health of the capital markets and the severity of the facts and allegations that have come to light, a full review of its internal workings is the only responsible option for the CSA.

Stephanie A. McManus LL. B., is a member of the Bar in Ontario and Alberta and a Principal of a Compliance Support Services, a firm that has been providing compliance help to the financial services industry since 2005.