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CANADIAN INVESTOR PROTECTION FUND Presentation to China Securities Investor Protection Fund Corporation Limited Beijing, P.R. China January 29, 2008. Topics. History of the Fund Fund Operation CIPF Investment Policy CIPF Investor Protection Part XII of Bankruptcy Act Investor Education.

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slide1
CANADIAN INVESTOR PROTECTION FUND

Presentation to

China Securities Investor Protection Fund Corporation Limited

Beijing, P.R. China

January 29, 2008

topics
Topics
  • History of the Fund
  • Fund Operation
  • CIPF Investment Policy
  • CIPF Investor Protection
  • Part XII of Bankruptcy Act
  • Investor Education
history of the fund
History of The Fund
  • Fund created in 1969
    • Investment dealers in Canada are permitted to use client cash balances in their businesses, (as are deposit taking institutions, such as banks and trust companies)
    • Three successive investment dealer failures in 1968 caused securities regulators to question this practice
history of the fund cont d
History of The Fund (cont’d)
  • Cost to lose the use of client cash balances would have been significant
  • To address securities regulators concerns, five self-regulatory organizations (SRO) created the National Contingency Fund (NCF)
  • No government backstop
history of the fund cont d1
History of The Fund (cont’d)
  • Board of Governors appointed to oversee the Fund and develop coverage policies:
    • Coverage was “unlimited”, i.e. all cash and securities would be returned to client but there was no market value protection
    • All customers of an SRO Member received CIPF coverage
  • All SRO Members paid an assessment into the Fund
history of the fund cont d2
History of The Fund (cont’d)
  • By 1988:
    • Osler insolvency in 1987 had consumed almost all of the NCF resources
    • The ownership profile of the industry had changed - investment dealers could be owned by banks, trust companies or insurance companies or could be public companies
history of the fund cont d3
History of The Fund (cont’d)
  • The Fund Governors decided to restructure the Fund:
    • Set limits on coverage (currently $1 million), and
    • Employed full time staff to perform a risk management function for the Fund
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Fund Operation

CSA - Canadian Securities Administrators

IDA - Investment Dealers Association

MOU - Memorandum of Understanding

slide9
Fund Operation (cont’d)
  • Must be registered with a securities commission to operate as an investment dealer
  • Condition of registration requires investment dealer to be a Member of an SRO
  • SRO for investment dealers is the Investment Dealers Association (IDA)
  • Investment dealers must comply with all provincial securities legislation as well as SRO by-laws and regulations
slide10
Fund Operation (cont’d)
  • IDA by-laws set out:
    • Capital levels required at all times - differs based on types and levels of business
    • Minimum books and records
    • Requirement for annual audit
    • Requirement for monthly capital reporting to IDA
    • At a minimum, a biennial financial and sales compliance examination by the IDA
slide11
Chair of Board of Governors

Executive Assistant

President & Chief Executive Officer

Receptionist/Admin. Assistant

Part-time

Chief Financial Officer

Vice-President & Secretary

Administrative Assistant

Office Manager

Director,

Strategic Initiatives

Director,

Financial Examinations

Director,

Policy & Operations

2 Managers,

Financial Examinations

IT Administrator

2 Examiners

Research Analyst

Fund Operation (cont’d)

fund operation cont d
Fund Operation (cont’d)
  • How was CIPF Funded until 2007?
    • Members of the self regulatory organizations pay a percentage of their revenue into the Fund
    • Assessment rate was set each quarter by the CIPF Board of Governors
    • Amount cannot exceed 1% of gross revenue in any year
    • Firms that have had a capital deficiency pay a risk assessment for one year
slide13
Fund Operation (cont’d)
  • Significant growth in the investment industry
    • Client net equity was Cdn$1.2 trillion at end of 2006
    • Industry revenue has grown substantially
  • CIPF’s existing formula, based on growth of revenue and capital employed, not a good predictor of the Fund size required for its risk exposure
  • An assessment based on a flat percentage of revenue does not reflect differences in the level of risk presented by CIPF’s various Members
slide14
Fund Operation (cont’d)
  • External consultants retained to develop a model to measure CIPF’s “credit worthiness” as a function of its size in relation to the probability of loss from the underlying portfolio of Members that it protects
  • Desired “credit worthiness” is a Board decision, but consultants noted that “insurance providers” need to operate at an exceptional solvency standard so that the insurer is at least as safe as those to whom it is providing insurance
slide15
Fund Operation (cont’d)

CIPF Funding after 2007

  • As a result of review, CIPF Board:
    • Increased size of the Fund in order to stay within a range of “investment grade” credit rating equivalent by securing a $100 million “reinsurance” policy - reduce impact on Member firms
    • Changed assessment calculation from:
      • flat percentage to a differential basis
      • gross revenue to client net equity
    • Introduced New Member Assessment
slide17
Fund Operation (cont’d)
  • Two-year implementation period, during which:
    • Members will be charged the lesser of the two assessments, i.e. flat percent of revenue versus differential basis of client net equity
    • Client Net Equity base will be reviewed to determine if different classes of securities should have different weightings
slide18
CIPF Investment Policy
  • 100% debt instruments issued by Government of Canada or Provinces of Canada
  • 11 year ladder of maturities with minimum of 15% under 1 year
  • Maximum 50% Province of Canada debt
  • Maximum 20% exposure to any one province
  • Credit rating on debt minimum “A” for maturities over 1 year, minimum R1-low for maturities under 1 year
  • No Coupons, derivatives, foreign pay bond and or inflation indexed bonds
cipf investor protection
CIPF Investor Protection
  • Insolvency Costs to Date
    • Insolvency cost to CIPF since 1969 - 17 Firms Cdn$36 million (net of recoveries):
cipf investor protection cont d
CIPF Investor Protection (cont’d)
  • Osler
    • Covered up bond trading losses
    • Trade tickets were not reported
    • Collusion between trader and client
  • Thomson Kernaghan
    • Conservative firm taken over by young, aggressive manager
    • Lending to offshore accounts on thinly traded high tech securities whose value dropped when TK was suspended
cipf investor protection cont d1
CIPF Investor Protection (cont’d)
  • Essex
    • Fraud perpetrated by owner-manager of investment firm who ran a ponzi scheme in an unregulated affiliate
  • Rampart
    • Lending to accounts on thinly traded securities and ineligible control blocks
  • McConnell
    • Conservative firm managed by son who hired a “real estate whiz”
    • Misused client money to finance the construction of time share condominiums that the firm was selling as tax shelters
cipf investor protection cont d2
CIPF Investor Protection (cont’d)
  • CIPF covers customers’ losses of securities and cash balances, within defined limits, that result from the insolvency of a Member
  • CIPF does not cover customers’ losses that result from changing market values of their securities, regardless of the causes of such losses
cipf investor protection cont d3
CIPF Investor Protection (cont’d)
  • Cdn$1 million per account as defined for any combination of cash and securities
  • Protection is available only in the event of an insolvency
  • Protection is provided to cover a shortfall that may arise after the calculation of the estate distribution by the trustee
  • Designed to ensure clients receive their assets back and does not protect against market losses, however they occur
cipf investor protection cont d4
CIPF Investor Protection (cont’d)
  • Often provided by providing a single payment (rather than individual payments to customers) to the Trustee
  • Customer accounts are transferred to another investment dealer where customers can access their investments
  • Trustee will request that customers review their monthly statement for accuracy
  • Discrepancies should be brought to the attention of the Trustee on a claim form and it can be obtained on the CIPF website, www.cipf.ca
cipf investor protection cont d5
CIPF Investor Protection (cont’d)
  • To file a claim form - expected time for recovery of assets from date of dealer bankruptcy
  • Time of account transfers depends on the state of the records, the technology and whether the firm was in the process of selling itself
  • Trustee takes control of the estate and confirms customer accounts similar to an auditor at the annual audit
  • Other internal accounts must also be reconciled
cipf investor protection cont d6
CIPF Investor Protection (cont’d)
  • This process can take anywhere from 4-8 weeks
  • Trustee provides a process for liquidating trades so that customers can reduce their market exposure if they choose
  • Trustee also establishes a emergency payment process
part xii of the bankruptcy act
Part XII of the Bankruptcy Act
  • On September 30, 1997, Part XII was enacted
  • Industry representatives had spent almost 30 years to obtain modern bankruptcy legislation for the securities industry
  • Legislation was modeled after the US SIPC Act
part xii of the bankruptcy act cont d
Part XII of the Bankruptcy Act (cont’d)
  • Part XII provides:
    • Efficient framework to administer estates and faster access for clients to their accounts
    • Eliminates old “tracing” methodology and replaces it with “pooling”
    • Client claims are distinguished from general creditors and assigned specific assets in the Customer Pool
    • General creditors assigned specific assets in the General Pool
part xii of the bankruptcy act cont d1
Part XII of the Bankruptcy Act (cont’d)
  • Before Part XII, losses had to be “traced” to specific clients
  • If a client held a unique position and that security was missing, the loss was entirely attributed to that client
  • If the loss exceeded CIPF protection limits, the client experienced the loss
  • Part XII “pools” and removes the random effect on clients
part xii of the bankruptcy act cont d2
Part XII of the Bankruptcy Act (cont’d)
  • How does pooling work?
  • First the assets, other than Customer Name securities, and liabilities of the firm as assigned to one of two pools, the Customer Pool or the General Pool
  • The most significant benefit of pooling is the prorating of the loss based on client net equity
investor education
Investor Education
  • Website
  • Brochure
  • Advertising policy for Members
  • Annual report
  • Joint website (with other Compfunds)
  • Limited trade show participation or sponsorship
  • Logo/name of Fund
  • Education (reference in Canadian Securities Institute material / Canadian Institute of Chartered Accountants Broker/Dealer course)
  • Participation on Industry Committees
investor education cont d
Investor Education (cont’d)
  • CIPF launched a web portal with 5 other compensation plans (CDIC, AMF, DICO, PACICC and CompCorp) in December 2004.
  • The web portal helps financial services consumers find information about how their savings, investments or insurance policies are protected against loss from a financial institution insolvency.
  • The address for the new website is www.financeprotection.ca
investor education cont d client complaint processes
Investor Education (cont’d) - Client Complaint Processes
  • SRO Process
    • For regulatory infractions
    • Investment Dealers Association and Mutual Fund Dealers Association
    • Members must report complaints to SROs
    • Timeframes for Member acknowledgement and substantial response
  • SRO Arbitration Process
    • At option of client
    • For limited amounts
    • Final and binding
investor education cont d client complaint processes cont d
Investor Education (cont’d)- Client Complaint Processes (cont’d)
  • CSA Process
    • Parallel to SRO process for Portfolio Managers, Limited Market Dealers, Scholarship Plant
  • Ombudsman for Banking Services and Investments
    • Take complaints from public that are not legal or regulatory matters
    • Objective is compensation
    • Recommendation, but not binding
investor education cont d client complaint processes cont d1
Investor Education (cont’d)- Client Complaint Processes (cont’d)
  • Financial Consumer Agency of Canada Act
    • Regulatory agency
    • Ensure financial institutions comply with consumer provisions of various Federal Acts relating to financial services
    • Seek a commitment from financial institution to remedy the issue with a short timeframe
    • Can impose a monetary penalty
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