Fraud Bailout Fund Hits Wall?

Theresa Tedesco and Barbara Shecter of the National Post report, Fraud bailout fund hits wall (HT: Pierre):

A recent proposal by a group of Quebec-based advocates to create a shareholder insurance fund for victims of financial fraud could put the province on a collision course with Canada's big banks.

The Coalition for the Protection of Investors (CPI), an organization comprised of academics and financial industry representatives, says a compulsory indemnity fund to protect against fraud for Quebec, which has suffered numerous high-profile investor scandals in recent years, is running into resistance from the major chartered banks.

Robert Pouliot, a co-founder of the coalition that tabled the proposal last month, says the country's large financial institutions have indicated they are not interested in financing a universal insurance fund for investors, arguing the industry already provides investor protection through IIROC.

"There is resistance to the concept of restitution," explained Prof. Pouliot, a director at the Canadian Foundation for the Advancement of Investor Rights (FAIR), who teaches corporate governance and fiduciary risk at the Universite du Quebec a Montreal. "What the banks don't want is to be taxed directly to finance the fund or made responsible for indemnifying investors."

Officials at the major banks confirmed they were "aware of this discussion," but declined to comment further, saying it is being reviewed by the Investment Industry Association of Canada (IIAC).

The national trade association for investment dealers began considering the Quebec proposal Tuesday at a meeting of its compliance committee.

"The proposal is interesting but it's at a very early stage," said Michelle Alexander, a director of policy at IIAC. The initial response from the industry, she said, is that while the Quebec proposal "highlights the need for more investor education and literacy," there is already protection for investors who use advisors and firms monitored by the industry self-regulatory agency -- the Investment Industry Regulatory Organization of Canada (IIROC).

Last month, the cap on settlements reached through IIROC-brokered arbitration was increased to $500,000 from $100,000.

Mr. Pouliot and the Quebec-based investor coalition asked the provincial government and the province's Autorite des marches financiers last month to consider creating a mandatory indemnity fund. Investors would fund it through premiums and financial advisors covered by the fund would make contributions.

An independent board of directors, based in Quebec and composed of industry participants, would collect and invest the money. Premiums charged to investors would be determined based on the risk practices of investment managers and financial advisors in an asset class. Investors would pay basis points annually according to the risk levels in each of the funds in which they invest their money.

Each year, investment managers and financial advisors would be rated on their fiduciary practices by comparing the quality of the practices with the actual performance of the asset class. For example, if the fund's performance is good but the fiduciary practices are suspect, it would be deemed risky and designated accordingly.

Ultimately, the goal is to improve fiduciary practices in an industry with assets valued at more than $1-trillion, while providing fraud insurance for investors. "If you choose a fiduciary riskier manager, then your premium will be higher. It's the consumer's choice," Mr. Pouliot said.

Although the Quebec-based coalition has not held direct talks with the Toronto-headquartered major banks, the industry group indicated it will not likely endorse the universal compensation fund now on the table.

"We would like to work with the coalition to discuss the initiative and see if we can find the right framework that best supports the investing public and the investment industry," said the IIAC's Ms. Alexander.

While Quebec Finance Minister Raymond Bachand announced last month that the province's securities commission would hold consultations to examine the proposal, he also expressed concern about adopting a plan that would be an additional burden to investors.

Some industry participants in Quebec, which already has a limited fund to compensate victims of financial fraud, warned that mandatory adoption of the fund could isolate the province from the rest of Canada.

Others expressed concern over so-called moral hazard, that investors will take unnecessary risks or be less prudent with their money if they know their losses will likely be recovered.

But Mr. Pouliot dismisses the concern saying, "Just because you have car insurance doesn't mean you drive dangerously. It doesn't make people any more negligent."

Most of the retirement savings in Canada are channelled toward the banks, but Mr. Pouliot questions whether that's because investors believe the large banks are best able to provide restitution in the event of fraud.

"We're not protecting against market risk. We're not talking about free or idle money or blind protection," Mr. Pouliot said. "Just because you think the banks have more money they'll pay you back if something happens. You should go to the banks because they are really good, not because you feel better-protected."

If Quebec formally adopts the indemnity fund as mandatory, the banks will be forced to participate -- and the coalition expects that to create momentum elsewhere in the country.

"If Quebec could launch it, the rest of Canada will buy into it because consumers across the country will want the protection," Mr. Pouliot says.

I met Robert Pouliot in August before leaving for Greece. We discussed this indemnity fund in vague terms and I was skeptical because I knew the big banks would fight the proposal. But Mr. Pouliot is a stand-up individual who has gotten this far and I won't be surprised if he succeeds in this venture.

On Thursday, I had lunch with my former boss from PSP Investments, Pierre Malo. We talked about a lot of things including this proposal for an indemnity fund. Pierre is very concerned about defined-contribution plans. "People spend more time shopping for a car than understanding their investments." I told him flat out: "Defined-benefit plans are no panacea but defined-contribution plans are a disaster which will only ensure more pension poverty".

It's sad how we expect people to do well with defined-contribution plans when the truth is there is no way they can succeed in these wolf markets dominated by high-frequency traders, big banks and big hedge funds. They're like lambs being led to their slaughter. Don't get me wrong, you can make money if you're in the right stocks or sectors, but you got to be lucky, have nerves of steel and you got to be on top of things. For the majority of the population, this is simply impossible.

An indemnity fund would pressure professional fund managers to be a lot more responsible. That's why the big banks are so dead set against it. Because if they're negligent, they're going to end up paying for their mistakes. They prefer the status quo where investors are clueless and helpless so they can continue raping them with outrageous fees.

It makes me sick to my stomach and one day I'm going to write a blog post on how to make money by taking everything you learned about investing and chucking it in the garbage. That's how strongly I feel about the shenanigans the investment industry keeps getting away with. The amount of nonsense that goes on in the stock market is criminal. Yes, the time has come for a fraud bailout fund but I fear that it will go broke when the next financial crisis hits us.