Rob Paddick Senior Deputy Ombudsman, Investments

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Rob PaddickSenior Deputy Ombudsman, Investments
OBSI Know Your Product INFO Conference June 25,
2009 Rob Paddick Deputy Ombudsman, Investments
Rob PaddickDeputy Ombudsman, Investments
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Who we are

• OBSI is the independent dispute resolution
  service for Canadian banking services and
  investment clients with a complaint they cant
  resolve with their firm
• We cover over 650 participating firms including
  banks, credit unions, investment dealers, mutual
  fund dealers, mutual fund companies, and
  scholarship trust plan dealers
• Our service is free to clients of participating
  firms
• OBSIs recommendation limit is 350,000

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Case volumes for fiscal 2008

• OBSI cases opened 670 (43 increase over 2007)
• OBSI cases closed 646 (45 increase over 2007)
• OBSI cases that client received compensation 155
  (24)
• Investment cases opened 346 (57 increase over
  2007)
• Investment cases closed 325 (57 increase over
  2007)
• Investment cases that client received
  compensation 111 (34)

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Case volumes for fiscal 2009

• Our case volumes are up significantly this year,
  in particular on the investment side
• We anticipate opening about 65 more investment
  cases than in 2008
• Causes
• Performance of the markets
• Increased awareness of OBSI

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KYC, KYP, and Suitability

• Know Your Client (KYC) obligation as discussed
  at INFO 2008, investment advisors must determine
  the personal and financial circumstances, risk
  tolerance, and investment objectives of their
  clients
• Know Your Product (KYP) obligation investment
  firms and advisors must understand the
  characteristics and risks of the investments they
  are recommending to their clients and explain
  them in a fair and balanced manner to their
  clients
• Suitability obligation investment advisors must
  recommend investments that are appropriate for
  their clients

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KYP Regulatory Obligations

• Investment firms and their advisors must have a
  full understanding of the terms and features of
  the investment recommended
• Sales material, and other information regarding
  the investment, must be fair and accurate
• Investment firms must have procedures in place to
  ensure these obligations are met and follow those
  procedures

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An Increasing Problem

• Investment firms and advisors are increasingly
  turning to alternatives to conventional equity
  and fixed-income investments in search of greater
  safety and higher returns for their clients (and
  in some cases, higher fees and commissions for
  themselves)
• However, if they are not fully informed about the
  characteristics and risks of the investments they
  are recommending, they are unable to fulfill
  their KYP and suitability obligations

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Asset Backed Commercial Paper (ABCP)

• ABCP is a complex investment vehicle
• ABCP notes are backed by long-term assets such as
  residential mortgages, credit card receivables,
  auto loans etc.
• By the summer of 2007, investors had become
  concerned about the sub-prime mortgage market in
  the United States
• Investors stopped buying ABCP notes and existing
  noteholders stopped rolling over maturing notes
  causing a liquidity crisis in the ABCP market
• In August 2007, the third-party ABCP market in
  Canada froze as a result of a standstill
  agreement (the Montreal Protocol) under which the
  various stakeholders attempted to preserve the
  value of the notes and their underlying assets

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Asset Backed Commercial Paper (ABCP)

• Approximately 2000 retail investors held
  third-party (non-bank) ABCP totaling
  approximately 500 million
• In the end, fortunately OBSI did not need to be
  involved and most retail clients (all clients
  holding less than 1 million in ABCP) were fully
  compensated by the investment firms involved
• However it was a long, drawn out process lasting
  almost 18 months during which we answered
  hundreds of calls and inquiries

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Asset Backed Commercial Paper (ABCP)

• In the complaints we received, we were told by
  clients that ABCP was sold to them as a safe,
  short-term investment that could provide them
  with a slightly higher return than guaranteed
  investments certificates and other low-risk or
  risk-free investments
• It was clear that in many cases neither the firm,
  nor the investment advisor, appreciated the risks
  involved with ABCP and therefore did not fulfill
  their Know Your Product and suitability
  obligations
• Luckily, disaster was averted in this case

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Leveraged and Inverse ETFs

• The Investment Industry Regulatory Organization
  of Canada and and the Financial Industry
  Regulatory Authority (US) recently distributed a
  KYP reminder regarding leveraged and inverse
  exchange traded funds (ETFs)
• ETFs are securities that track the performance of
  an underlying benchmark or index
• Leveraged ETFs seek to deliver multiples of the
  performance of the underlying benchmark or index
• Inverse ETFs seek to deliver the opposite of the
  index or benchmark they track

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Leveraged and Inverse ETFs

• Most leveraged and inverse ETFs reset daily
  they are designed to achieve their stated
  objectives on a daily basis
• Due to the effect of compounding, their
  performance over longer periods of time can
  differ significantly from the performance of
  their underlying index or benchmark over longer
  periods of time
• This effect can be magnified in volatile markets
• Therefore, leveraged or inverse ETFs typically
  are not suitable for retail investors who plan to
  hold them for more than one trading session

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Leveraged and Inverse ETFs

• We are hoping that the preventative measure on
  the part of the regulators will help investment
  firms and advisors better fulfill their KYP and
  suitability obligations and reduce the number of
  potential complaints regarding these products

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Our Process

• When a client complains that their investments
  are inappropriate, our Research Analysts analyze
  the investments to determine their
  characteristics and risks
• If we find that the investments recommended to
  the client are inappropriate given the clients
  KYC information, we determine if the client has
  suffered a compensable loss

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Some of the factors we consider

• Nature of the issuer
• Market capitalization of the company, its
  industry sector(s) and the nature of its business
• Company history and its financial situation
  including comparing common valuation and risk
  ratios to industry/peer group norms
• Companys lifecycle stage (i.e. start-up, rapid
  growth, mature, decline)
• Price and trading histories
• Dividend and/or interest payment history

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Some of the factors we consider

• Analyst ratings
• Credit ratings, term to maturity
• Significant corporate, market, social or economic
  events shortly before an investors purchase
• News releases
• Offering documents and regulatory filings
• Other relevant information

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Analyzing the information

• Once we have collected the information, our
  Research Analysts create an Analysis Summary
• The Analysis Summary includes
• the key characteristics and data for the
  investment
• the timeframe in question
• our summary risk rating for the investment during
  the timeframe
• We store the Analysis Summary along with the
  relevant documents in our e-library for future
  reference allowing us to be efficient and
  consistent in future investigations

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Contact

• www.obsi.ca
• Rob Paddick
• Deputy Ombudsman, Investments
• [phone] ext. 2231
• rpaddick_at_obsi.ca