Background checks and registration reform

Imagine hiring an employee with an apparently sterling reputation, one who instills confidence and ease with his self-assured manner and personable daily banter. Now, imagine paying $40,000 six months after hiring that employee just to make him go away.

That’s the average cost American firms report paying for a “bad hire,” including severance, training, wasted human resources time, possible firm fees, loss of productivity and impact on employee morale. It’s also a cost that can be easily and cheaply avoided.

“When we started in 1997, background checking was fairly unpopular — it was thought of as anti-Canadian,” recalls David Dineson, president and CEO of BackCheck, a national pre-employment investigative firm. “After 9/11, this attitude changed. Employers realized they had a duty. Now we represent about half of the larger financial-sector firms, though we don’t have a huge number of financial services outside of big banks. It makes me wonder if they are doing it in-house or not doing it at all.”

One way Canada’s financial sector attempts to deter fraud is by requiring securities dealers and mutual fund dealers to register all employment changes with the Investment Dealers Association (IDA) and provincial regulators.

Each time a firm terminates any advisor’s registration, a fairly regular occurrence given the current state of competition for talent in the industry, dealers must file a unified termination notice (UTN) that describes the circumstances surrounding an advisor’s departure — whether or not the individual died, was dismissed for cause or dismissed in good standing, details about unresolved client complaints, internal discipline matters, restrictions for regulatory violations or financial obligations the representative might have to clients.

It sounds great in theory, but firms hiring agents from other firms often have stories or examples of this communication process breaking down. Although it’s sometimes known who the bad apples are, registration information can fail to give a complete picture. What’s more, neither the firm terminating an advisor’s registration nor the regulators are under any obligation to pass pertinent information on to the new firm.

Even if this information were readily available, there can be discrepancies between the reporting and the truth of the matter when an agent is released.

When pressed, Alex Popovic, vice-president of enforcement at the IDA, agrees there is “always tension between general counsel (lawyers) at a firm about how employees describe termination for cause.”

That’s about as strong as it gets, though. In fact, very few are even willing to talk about the subject, about how full disclosure might open dealers up to libel or slander accusations or about how some agents are allowed to quit before being terminated for cause, particularly since dealers are warned, right on the UTN, that it is an offence to submit misleading or untrue information.

The regulator says it is usually in the former employer’s interest to give a frank and truthful account of all factors when a firm terminates any advisor’s registration. “We have the same interests as a new employer,” says Popovic, “so, we want to know specifically why an individual was terminated or left the firm.” As such, he “expects all disclosure to be full, plain and true.”

William Donegan, chief compliance officer at Markham-based Worldsource Wealth Management, agrees. “My counsel and advice is to be clear, honest and factual in disclosure. It is what it is; the facts are the facts, and the onus is quite clear,” he says, later adding that “it is [also] very important for any dealer to conduct full background checks and to have a policy around these types of checks.”

At present, he explains, dealers can determine only where a potential new hire was last employed — that is the extent of the information disclosed by the IDA or the provincial regulators. For more extensive information, “[Worldsource] has to rely on an extensive questionnaire [for potential advisors] that requires self-disclosure. This is standard for most dealers.”

Ralf Hensel, general counsel and director of policy for manager issues at the Investment Funds Institute of Canada (IFIC), agrees that any hiring firm needs to conduct its own due diligence on prospective reps.

The current “disconnected process for disclosure to new sponsoring firms,” though, is scheduled to change. Revisions to the UTN form are being proposed in a relatively uncontested section of the Registration Reform Project’s, proposed National Instrument 31-103. The changes will require dealers to disclose more precise information by answering specific, closed, yes or no questions that require no interpretation, about the termination of an advisor’s registration.

The comment period on the latest round of amendments to 31-103 is open until May 29. Following the review of comments, Hensel says the associated legislation changes could be in place by April 2009.

“Right now, we rely on goodwill,” he says. “The issue is that current processes just don’t ensure the relevant information gets to the new firm. There’s not really a structure [for] asking and monitoring; this new form [outlined in National Instrument 31-103 puts a structure in place [so] certain information will move from one firm to the other firm.”

Still, Dineson is surprised that more firms don’t want to go above and beyond the standard prevention of fraudulent hires given the financial and human resource implications. In making his point, he adds that one in 10 people in Canada have a criminal record.

Hiring less-than-desirable employees happens regularly enough that many groups studying the phenomenon are able to quantify the costs:

• University of Dallas professor Blake Frank says it costs $8,839 to cover the turnover of an $8/hour unionized employee, while retail store managers cost their employers $56,844, on average. His findings show the costs generally rise with the level and position of the employee.

• The Vancouver-based Certified Fraud Examiners Association (CFEA) says occupational fraud — theft of supplies, embezzlement, inappropriate use of company assets — costs employers 6% of revenues each year. This translates into losses of approximately $667 billion, or nearly $5,053 per employee.

• Small businesses are the most vulnerable to occupational fraud and abuse. Small businesses report average losses of $128,883, compared to losses of $98,062 reported by the largest companies.

• The average fraud scheme lasted 18 months before it was detected.

“We only hear about the bad guys we catch, but we know a lot more is going on undetected,” says Dineson.

If the costs aren’t already enough, he says negligent hiring litigation is becoming more popular in the U.S. — if an employer fails to do something considered reasonable, like a background check, that employer can be found liable for placing clients in harm’s way.

“I think the public and the courts have less patience in a post-9/11 world for a company that does not have a reasonable background-checking process,” says Dineson. “Whether or not you conduct the check in-house or outsource, you need a process that is auditable and consistent.”

Dineson suggests that every pre-employment screening process include five distinct disciplines:

•An interview between the candidate and his or her would-be direct managers.

• Employment verification, separate from the interviewing process, to confirm facts on the candidate’s resumé.

• Credit inquiry and ID verification (can be done simultaneously).

• Criminal record check.

• Education verification.

Costs for such screening can range between $150 and $200, depending on the company’s size and the number of services outsourced to a third party.

Originally published in Advisor’s Edge Report in April 2008 

Scroll to Top