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  1. CANADIAN INVESTOR PROTECTION FUND Presentation to China Securities Investor Protection Fund Corporation Limited Beijing, P.R. China January 29, 2008

  2. Topics • History of the Fund • Fund Operation • CIPF Investment Policy • CIPF Investor Protection • Part XII of Bankruptcy Act • Investor Education

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. PR O P OS E D R elia n ce b y C IP F on C S A o versi ght of I DA T o b e c o n s i d e r e d : W hat r e po rtin g i f a ny f r o m C I P F to CS A , a n d tri e nn i a l r e vi e w . C SA S RO A me nd e d M O U O v ers igh t A me nd e d In d us try A g r ee m e n t I DA CIP F n o v eto M em b e r R is k R e gu l at i on M ana g eme n t i n clu di ng o f F un d M e m b e r R is k F i r ms A ss e ss men t In v e s t or Pro t ec ti o n o f P ub l i c Fund Operation CSA - Canadian Securities Administrators IDA - Investment Dealers Association MOU - Memorandum of Understanding

  9. 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

  10. 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

  11. 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)

  12. 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

  13. 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

  14. 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

  15. 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

  16. Fund Operation (cont’d)- Differential Assessment Model

  17. 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

  18. 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

  19. CIPF Investment Policy (cont’d)

  20. CIPF Investor Protection • Insolvency Costs to Date • Insolvency cost to CIPF since 1969 - 17 Firms Cdn$36 million (net of recoveries):

  21. 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

  22. 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

  23. 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

  24. 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

  25. 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,

  26. 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

  27. 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

  28. 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

  29. 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

  30. 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

  31. 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

  32. Part XII of the Bankruptcy Act (cont’d)

  33. Part XII of the Bankruptcy Act (cont’d)

  34. 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

  35. 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

  36. Investor Education (cont’d)

  37. 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

  38. 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

  39. 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