SOCIAL: PROPOSED POLICY CHANGES/ INSURANCE FOR NOVICE INVESTORS

SUBJECT:  INSURANCE FOR NOVICE INVESTORS

PURPOSE:  This briefing note is a recommendation for changes in policy pertaining to amateur investors.

ISSUE:  There is not enough consumer protection for amateur investors. 

Background:

The financial markets consist of multiple products in which investors can stake a claim to.  Specifically, there are stocks, fiat currencies and commodities and cryptocurrencies.  Investors need only look for a broker to be able to partake in the activity of the financial markets.  When investors connect with a broker, they are given the ability to buy into these securities.  The act of investing into these products involves risk.  There is a risk of loosing money however, there is also a possibility that investors can ascertain profit.  Profit in these markets is actualized when the position is closed by an investor.  Once closed, profits are then subject to taxes.  Investment through a broker in a bank is secure and it is always backed with insurance, in the case of bankruptcy.  For example, a broker that went insolvent was MIG Investments a similar broker to ETORO.  MIG Investments is based off of Switzerland.  It had endorsed racers with vehicles from companies including Mercedes Benz.  Clearly, such brokerage wouldn’t go insolvent based off of the merits.  However, that’s just what happened. 

In Canada, TFSA or Tax-Free Savings Accounts are insured by the Canada Deposit Insurance Corporation which insures term deposits and GIC’s.  In the USA however the Securities Investor Protection Corporation reimburses investors for up to $500,000.  Protection is only provided for bankruptcy in both cases.  There are situations wherein companies commit fraud in order to gain more investment capital from the investors.  A modern example of this is Luckin Coffee.  This company claimed falsified revenue numbers in their accounting books.  This resulted in stock price increases throughout the board.  The US Securities and Exchange Commission conducted an investigation, and they verified the fraudulent activities.  The company was ordered to pay USD180 million in monetary penalties.  As for the investors, what resulted was a class action law suite to settle the matter as fraud was not insured per the Securities and Exchange Commission. 

The Canadian Investor Protection Fund is an institution designed to protect consumers if their broker is a member.  While the Investment Industry Regulatory Organization of Canada is a Self-Regulating Organization that mandates member firms and brokers to uphold high standards.  They conduct audits to ensure consumer protection and act in accordance with the Canadian Investor Protection Fund to protect consumers.  However, what is not insured is fraud or theft.  The risk or depreciation of the value of investments are not insured because such risk is inherent to investing.  “For all types of investments, the return—whether in the form of interest, dividends, or capital gains—is a reflection of the type of risk you are taking on” (Investopedia 2021).  With that said, the CIPF covers missing property (investments) that are held by a member firm or broker in the case of insolvency.  Such property is then returned to the investor, as mentioned $100,000.  To clarify, the following are not insured;  “a drop in the value of your investments for any reason; investments that were not suitable for you; fraudulent or other misrepresentations that were made to you; misleading information that was given to you; important information that was not disclosed to you; poor investment advice; the insolvency or default of the company or organization that issued your security” (CIPF 2021).  Clearly, there needs to be more protection for consumers at least when it pertains to fraud. 

Considerations:

The main way to alleviate instances of being caught in fraud, is through due diligence.  The investor must research and make queries about their potential investment before actually investing.  However, in the case of Luckin Coffee, such due diligence is not always sound.  Which is why, investors had to resort to a class action to gain their funds back.  This is not only a tedious process, but it takes years to complete the litigation procedure.  By the time the funds are returned, monetary inflation is likely which reduces the initial investment’s value.  Although such can be factored into the litigation case, the pecuniary loss is mixed with grief and stress.  This means that these investors had to go through the stress inducing litigation procedure to ascertain some of their initial investment.  More consumer protection measures should be implemented by the Canada Deposit Insurance Corporation and or the Securities Investor Protection Corporation.  A program must be created similar to the vehicle insurance programs.  People, everyday, take a risk in driving their vehicle.  If there is a collision, insurers pay the plaintiff as per the verdict.  Also, there are insurance programs offered by various institutions such as home insurance.  This form of insurance covers people for fire and theft.  Homeowners are given back a portion of what was taken.  By creating a compulsory program, investors can be protected.  Specifically for Canada, the CIPF should not only work with the IIROC but also the Canadian Anti-Fraud Centre and the RCMP thereafter.  For example, in the month of August 2021, “Police say there have been six recent incidents, most in August, costing one victim over $100,000” (Peace Arch News 2021).  Fraud and scams are a big business.    These scammers launder the money they gain from fraud or scams to “clean” or legitimize the funds.  According to the Financial Action Task Force, “criminal proceeds amounted to 3.6% of global GDP, with 2.7% (or USD 1.6 trillion) being laundered”.  In comparison however, and to combat these fraud or scams, the industry counteracting it, the global fraud detection and prevention market, is valued at USD 19.82 billion in 2019 according to fortune business insights.  Reporting to the police is the first line of defense against possible fraud or scams.  But it is advised, that at this time, investors do their due diligence to protect themselves against these as currently fraudulence is not covered. 

Options: 

Option 1:  Create an insurance corporation to protect amateur investors. 

This is the least feasible option.  It would require a lot of cooperation between the CIPF, IIROC, Canadian Anti-Fraud Centre, financial firms and the RCMP.  This would take years to create.  Procedures and protocols would be created to protect the consumers.  However, a list of legitimate places to invest would be created.  Such insurance corporation could also aggregate their customer bases investments to make a more robust list.  They could approve and deny coverage based on monthly reporting forms.  This thus is the most equitable solution for novice investors.  By selecting this option, not only insolvency is covered but also fraudulence.  This gives consumers the peace of mind that their investments are backed by insurance.  It would also dissuade companies from committing fraud because if they do, they wont be placed in the list and thus less investor interest.  This option thus is the most secure.  There is likely to be high acceptability for this however, it would be based on the rate per month.  If however it becomes a compulsory program, it is likely that some support will be lost but such program would ensure that people get supported in the financial markets.  

Option 2:  Provide education.

This is a very feasible option.  By providing education to beginner investors, they would be more aware and thus would be more likely to do their due diligence in researching the companies they would like to invest in.  This is sustainable as it would allow people to spread awareness through the community.  This is also an accountable option, as the government ensures that they have provided the information needed for people to make adequate investment decisions.  From a security perspective, frauds and scams would be caught.  Providing education also means proper reporting of such activity.

Option 3:  Mixture of option one and option two. 

This is not a feasible option.  However, the government can start with option two and slowly start option one.  This would allow the government flexibility in what it is they want to implement.  By selecting this option, the government gives novice investors equity because they will have the right information to make investments.  This option serves the long run well, because it allows people to be socialized before actually making huge commitments which should be insured. 

Option 4:  Status quo.

This option is the most feasible but the least accountable.  If this option is selected, the fraudulence and scams will continue and the only action that consumers can take is to report to the police and the Canadian Anti- Fraud Center.  Once completed, their last option is a law suite.  This as mentioned is a stress inducing process and it does not serve the public health care system well.

Recommendation:

Option three is recommended.