PCMA’S Concerns With CSA’S Proposed “Essential Process Test” For Complaint Reviews By OBSI

The Private Capital Markets Association of Canada (PCMA) supports fair and balanced regulation. This article is part of a PCMA series commenting on the Canadian Securities Administrators’ (CSA) proposal to give the Ombudsman for Banking Services and Investments (OBSI) binding decision-making powers of up to $350,000 (the Proposal) under proposed amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103).

No Additional Procedural Rights with Binding Decision-Making Powers

In granting OBSI with the power to make binding decision-making of up to $350,000, the CSA does not propose to give dealers and advisors any additional procedural rights. Instead, the CSA seeks to maintain the status quo and allow OBSI to determine what rights it believes, in its discretion, are essential to the dispute resolution process involving a particular complaint. The CSA calls this the “essential process test”.  

 The CSA describes the “essential process test” in the Proposal as follows:

“The [OBSI] would achieve a proportionate process by following a procedural threshold test under which [OBSI] would engage only in processes essential to achieving as efficient, quick, and understandable a process as possible in resolving disputes in a fair manner (the essential process test)… During the review and decisions stage, the essential process test would enable [OBSI] to use processes ranging from inquisitorial to adversarial, if they are essential to achieving a proportionate process for both parties to resolve a dispute fairly. [OBSI] would decide which procedural tools to apply in each review. In all scenarios, the [OBSI] would apply processes that achieve procedural fairness for both the firm and complainant and that do not create disproportionate burden on the parties. The use of procedural tools that are more commonly found in the adversarial system during the review and decision stage is anticipated to be infrequent and would be limited to circumstances that meet the essential processes test.”

PCMA’s CONCERNS WITH ESSENTIAL PROCESS TEST

CSA Created Test

The essential process test represents an innovative approach to dispute resolution within the financial services sector. However, this approach raises concerns due to its apparent lack of precedent in Canadian administrative law, suggesting that it is not a well-established legal principle that has been tested and honed through application and judicial scrutiny.

The CSA has not provided evidence or comparative analysis to affirm the validity of this test within the context of legal or regulatory frameworks, nor has it demonstrated that a similar test has been effectively employed in other jurisdictions with comparable legal or regulatory systems. This absence of supporting information is problematic because it does not allow stakeholders to evaluate the test’s effectiveness or fairness based on historical application or empirical data.

Legal tests typically gain acceptance and legitimacy through a process of development that includes academic debate, practical application, and often judicial review, which helps to refine the principles and ensure that they are applied consistently and fairly. By contrast, the essential process test appears to be an ad hoc creation without the benefit of this rigorous process. The lack of a clear definition or articulated standard for what constitutes an “essential process” leaves room for interpretation and potentially introduces a level of uncertainty and arbitrariness into the dispute resolution process.

In addition, the CSA has not provided concrete examples or detailed guidance on the implementation of this test which adds to the ambiguity, making it challenging for advisors, dealers, and other stakeholders to anticipate how the test would be applied in practice. This is particularly concerning because decisions made under this test could involve substantial sums of up to $350,000, and the outcomes could have significant financial and reputational impacts on dealers and advisors involved.

Given the potential consequences of the application of the essential process test, the PCMA members ask the CSA to provide more guidance on its purpose and intended operation. There should be a thorough and transparent discussion about the test, including a clear rationale for its introduction, an explanation of its objectives, and a demonstration of how it aligns with the principles of fairness and due process that are fundamental to Canadian law. Without such information, stakeholders are left with an undefined process that may not meet the rigorous standards typically expected in the Canadian legal and regulatory landscape. The PCMA believes that it is problematic to allow OBSI to continue with its undefined complaint review process when regimes that impose binding decisions for much smaller amounts have detailed procedures that are fair to all parties (e.g., small claims court has small claims court procedures, which in Ontario the limit is $35,000).

The PCMA believes the CSA must provide greater detail of the “essential process test” in a further request for comment by all stakeholders since it has not been properly explained and is fundamental to the dispute resolution process contemplated in the Proposal.   

Discretion

The use of discretion with the essential processes test poses concerns involving impartiality and predictability of OBSI’s decision-making authority. When an organization such as OBSI is given the ability to interpret and apply a test without clear, predetermined criteria, there is a risk that decisions may be made arbitrarily and inconsistently. This concern is magnified since OBSI decisions can have material financial impacts, up to $350,000 per complaint, on the dealers or advisors involved.

Without transparent guidelines, firms cannot adequately prepare and represent themselves. This unpredictability can undermine confidence in the dispute resolution process. Transparency allows all parties to understand the rules and how they are applied. It enables stakeholders to navigate the system with an informed awareness of their rights and obligations.

The lack of clear criteria can also raise questions about accountability. If OBSI’s decisions are not based on a clear set of standards, it can become challenging to scrutinize these decisions or hold OBSI accountable for any perceived inconsistencies or biases. This is a fundamental concept in administrative law, where decisions must not only be fair to all parties but must also be seen to be fair.

Furthermore, when discretion is not bounded by objective criteria, there is a risk that similar cases will not be treated similarly, which is a violation of the principle of equality before the law. This inconsistency can lead to a perception that decisions are influenced by factors other than the merits of the case, which can erode trust in the integrity of the dispute resolution system.

Therefore, the PCMA believes it is crucial for the CSA to consider implementing a framework that defines the boundaries of discretion and ensures that any exercise of this discretion is based on consistent, objective, and transparent criteria. Such a framework should ideally be subject to oversight and review to maintain the integrity of the process and to ensure that decisions are made fairly and with due regard to the rights of all parties involved. This would not only protect the interests of the dealers and advisors but would also serve the public interest by promoting a fair, efficient, and transparent capital markets system.

Risk of Bias and Error

Under the Proposal, the delegation of responsibility to OBSI to determine what constitutes an essential process in dispute resolution creates the potential risk of bias and interpretational error. This risk is amplified in the absence of clearly defined rules and oversight mechanisms.

Bias, whether conscious or unconscious, can manifest in decision-making, particularly when a single entity is vested with broad discretion. The subjectivity involved in determining what is “essential” can lead to inconsistencies, where similar disputes may receive different treatment not because of the merits, but because of varying interpretations of what processes are deemed necessary. This necessitates the need for a framework of robust rules.

OBSI’s decision-making process is also susceptible to errors in judgment. These errors may not be the result of any intentional bias but can occur simply because of the complex nature of the disputes and the nuances involved in interpreting securities law, especially by non-lawyer decision-makers. When errors occur in the absence of a clear set of rules, they become harder to identify, address, and rectify.

The PCMA’s concerns involve the concept of fairness, which is a fundamental principle of administrative justice. Fairness is not just about the end result but also about the procedures used to reach that result. When procedures are determined on a case-by-case basis without clear guidelines, the fairness of the process can be called into question. Stakeholders may perceive that the process is not even-handed or that their case was not given the same consideration as others. This is concerning to exempt market dealers and their dealing representatives since firms have no right of appeal as currently contemplated in the Proposal.

Oversight is a critical component of mitigating bias and errors. It helps to ensure that decisions are made with consistency and are also subject to review and correction, if necessary. Oversight mechanisms, such as the ability to appeal decisions help to provide checks and balances that are essential for maintaining fairness and accuracy in administrative processes. However, the Proposal does not allow appeals for registrants and only permits limited judicial review.

Need for Procedural Certainty

Procedural certainty is an important component of a trustworthy and effective dispute resolution system.

The CSA’s Proposal introduces a level of uncertainty that is detrimental to the confidence that dealers and advisors need to have in any mandatory dispute resolution system. Such uncertainty can hinder their ability to prepare for and respond to complaints and disputes effectively.

While the CSA contemplates incorporating the essential process test into legislative amendments and harmonized orders within local jurisdictions, the lack of detailed articulation in the Proposal about these essential processes is very concerning for its lack of transparency. The CSA’s decision to defer the specification of these processes to the discretion of individual CSA members and provincial/territorial governments further exacerbates this uncertainty. This approach does not afford industry participants the opportunity to fully understand, prepare for, or comment on the proposed processes that could significantly impact their business. Stakeholder engagement is a critical aspect of the regulatory process, providing valuable insights and helping to ensure that the regulations are fair, understandable and proportional, and consider the perspectives of those who will be most affected by them.

The PCMA believes it is incumbent upon the CSA to provide a comprehensive description of the procedural rights and processes that will apply. This transparency is particularly crucial given the binding nature of OBSI’s decisions, which can have substantial financial implications for the parties involved.

Ambiguity in Proportionality

The principle of proportionality is intended to ensure that the means employed to resolve a dispute are appropriate to the scale and complexity of the issue at hand. However, without concrete criteria to define proportionality, there is ambiguity. This ambiguity can lead to disputes about the very process used to resolve the complaint.

The term “proportional” is inherently subjective without a frame of reference or a set of parameters to provide meaning and context. This subjectivity can lead to inconsistency, with different decision-makers arriving at different conclusions about what is proportional in similar cases.

In practical terms, proportionality should balance the need for a thorough investigation against the burden of the investigatory process on the parties. The processes should not be so onerous as to be punitive or so lax as to be ineffective. They must be sufficient to uncover the facts and allow for a fair judgment without causing unnecessary delay or expense.

To mitigate the ambiguity surrounding proportionality, the CSA and OBSI should establish detailed guidelines outlining what may be considered proportional in various contexts and publish the guidelines so that all interested parties can be informed. These guidelines could include factors such as the complexity of the case, the amount of money at stake, the potential impact on the parties, and the precedence of similar cases. Additionally, there should be a mechanism in place, such as a procedural appeals process, through which decisions about proportionality can be reviewed and, if necessary, adjusted while a complaint is being reviewed. This would help ensure that all parties have a clear understanding of the rules and can trust that the processes will be applied fairly and consistently.

Establishing these guidelines and mechanisms would not only clarify what is meant by a “proportional” process but would also provide a benchmark against which OBSI’s decisions can be measured and reviewed. It would help prevent disputes about the process itself and ensure that all parties can focus on resolving the substantive issues at the heart of the complaint.

Absence of Check and Balances

The principle of checks and balances is fundamental to any system vested with decision-making power. The absence of clearly defined procedures under the essential process test creates a gap in the system of accountability.

If a firm believes that the process leading to a decision was flawed, the Proposal does not provide a right of appeal to an external body. The internal review by one or more senior decision-makers within OBSI does not suffice as a check on the power of the initial decision-maker because it remains within the same organization. This internal review creates the potential for conflicts of interest or confirmation bias, which could lead to a perpetuation of the initial error or bias.

The concentration of power within OBSI, without the possibility of appeal to an external body, could also lead to an erosion of trust in the impartiality and fairness of the dispute resolution process. The situation is further compounded since the CSA seeks to not require OBSI to follow the procedural requirements that typically apply to tribunals under arbitration acts or other relevant legislation. Such requirements generally exist to ensure that tribunals operate within a framework that promotes fairness and accountability.

Without the application of legislative procedural standards, OBSI would not be held accountable, which may lead to decision-making that is unchecked and opaque. This is contrary to the principles of administrative justice, which require that decisions by quasi-government entities be made in a manner that is transparent, fair, and subject to review.

The CSA should consider establishing a clear appeals process that allows firms to challenge OBSI decisions before an independent body. The PCMA believes appeals should be heard by the tribunal of the applicable CSA member, similar to how decisions by Canadian Investment Regulatory Organization can be appealed to a CSA member (this will be the subject of a separate PCMA article). This would help to ensure that OBSI’s decision-making is both fair and perceived as fair by all parties and follows applicable securities law. Additionally, the PCMA believes the CSA should clarify the circumstances under which OBSI’s decisions can be reviewed and to ensure that OBSI’s processes align with the procedural standards expected of similar tribunals.

Implementing such checks and balances would provide greater assurance to market participants that their rights are protected and that the dispute resolution process is capable of correcting its own errors. The PCMA believes this, in turn, would contribute to the overall integrity and credibility of the dispute resolution system.

Assumption of Correctness

There also appears to be an assumption that OBSI will determine the essential processes accurately without a set of predefined rules. There is  an inherent human and institutional propensity for error and bias, which can significantly affect decision-making processes.

In any dispute resolution system, it is critical that the processes used to determine outcomes are grounded in a well-defined set of rules and procedures that are universally understood and applied. This standardization helps to eliminate ambiguity and ensures that all parties have a clear understanding of what to expect from the process.

Without such a framework, there is a risk that OBSI’s discretion in identifying essential processes could lead to inconsistent or biased interpretations, which would ultimately affect the fairness and equity of the resolutions provided. As stated above, bias can stem from various sources, including but not limited to, individual perspectives, past experiences, or institutional culture. Moreover, interpretive errors can occur due to misapprehensions of law or regulations, misunderstandings of the facts, or the complex nature of the complaint at hand. It is for this reason that a mechanism of checks and balances, including oversight by an external body and a clear set of procedural guidelines, is important. These safeguards would serve to provide accountability, allowing for decisions to be challenged and reviewed, thereby helping to ensure that fairness is not achieved.

To foster trust by all stakeholders and to uphold principles of justice, there must be an acknowledgment of the possibility of error and bias within the assumption of OBSI’s correct application of the essential process test, along with procedural checks and balances, to mitigate these risks.

Equating Speed with Fairness

The CSA’s statement that OBSI will engage only in processes deemed essential to resolving disputes efficiently and quickly raises concerns about the underlying assumption that speed equates to fairness. While an efficient and understandable process is desirable, it should not come at the expense of a thorough and equitable resolution. In complex financial disputes, particularly within the private capital markets, the complexities of various transactions often require a careful examination of extensive information, including due diligence on products, client (know-your-client) information, and suitability assessments.

The volume and complexity of information in such disputes cannot be understated, and the pressure to resolve cases swiftly could lead to oversights. Securities law and financial practices are complex and nuanced fields where the details matter. A decision-making process overly focused on efficiency could potentially overlook the subtleties and depth required for a fair assessment of each case.

The pursuit of expedience must not overshadow the importance of reaching a resolution that is grounded in the facts and the law. The right decision should be one that is fair and based on a thorough evaluation of all relevant information. The potential for OBSI to prioritize the rapid closure of cases to appear efficient could compromise the quality and fairness of the outcomes. The PCMA is not aware of statistical information in the Proposal about investor concerns over the length of the process, and there appears to be few abandoned or withdrawn cases.

Additionally, without an appeal mechanism, there would be no opportunity for firms to challenge decisions that they believe have been made in haste or without adequate consideration of all the relevant facts. This could leave firms without recourse and undermine the perceived integrity of the dispute resolution process. It is essential for the CSA to consider these concerns and ensure that the dispute resolution procedures adopted by OBSI strike the right balance between efficiency and justice. This could include implementing safeguards against rushed judgments and providing a means for the review of decisions to confirm their fairness and adherence to relevant laws and practices.

Proposed Change is Not Fair and Balanced Regulation

The PCMA supports fair and balanced regulation and believes that it is in the public interest for the CSA to find the right balance between investor protection and fair and efficient capital markets. The PCMA does not believe the right balance has been struckbetween these objectives. The PCMA’s criticism of the “essential process test” focuses on the lack of transparent and articulated processes or determinations of what are “essential” and/or “proportional” processes as applied to different types of complaints which also vary depending on the amount claimed.

The concentration of procedural discretion within OBSI, without the establishment of transparent, predefined rules or an external appeal mechanism, creates a scenario where the processes and outcomes may not be perceived as fair or balanced. When significant dollar amounts are at stake, discretion, bias, ambiguity, lack of an appeal mechanism and other factors become significant to outcomes/decisions which collectively may jeopardize the perceived fairness and reliability of the dispute resolution process. For the financial services industry to maintain confidence in the regulatory framework, it is important that the rules governing OBSI’s procedures be explicitly articulated and readily accessible.

Furthermore, the PCMA believes it is important that OBSI’s determinations are anchored in the established tenets of securities law, regulatory policies, and accepted industry practices. The absence of such grounding may lead to decisions that, while expedient, do not necessarily reflect the complex realities of securities transactions.

The PCMA believes that firms should have a right to have clear written procedures and a procedural appeal option if they believe that their rights are not fully addressed to allow them to present their case.  The PCMA further believes that the absence of any such guidance within the Proposal should require the CSA to provide such further guidance and resubmit an amended and restated Proposal to all stakeholders.

The PCMA strongly believes that for regulation to be considered fair and balanced, it must be transparent, accountable, and subject to review. This ensures not only the protection of investors but also the integrity and proper functioning of capital markets. Therefore, the PCMA urges the CSA to reconsider the proposed changes, to align them more closely with these principles, and to foster a regulatory environment where due process and fairness are paramount.

Additional Information:

• Other PCMA Articles on this Topic: For more information about this Article and similar articles, please see the PCMA’s dedicated website to this topic at: https://fairandbalancedregs.com/

• Link to Full CSA Proposal to Give OBSI Binding Decision-Making Powers: https://www.osc.ca/sites/default/files/2023-11/csa_20231130_31-103_proposed-amendments.pdf