Kenmar Associates
Investor Education and Protection
FMF, Nortel, Atlas Freezer, YBM, Hollinger Bre-X, market timing scandal etc. 1
SPECIAL REPORT-INVESTOR PROTECTION IN CANADA-9 months, 2009
While equity markets improved , progress on investor protection stalled. Chairpersons of
provincial securities regulators publicized their wonderful contributions to regulation, but
real actual progress was not achieved . Ottawa took the first steps toward a national
regulator . Billions of dollars were lost to unsuitable investments, excessive fees and
leveraging, misleading marketing, Ponzi schemes and crooked advisers and brokers.
While the rest of the world is tackling fundamental issues ,our regulators toy with minor
adjustments to regulations. Here’s a small sampling of the rat traps retail investors had to
endure in the first 9 months of 2009.
2009 trend not reassuring for investor protection
Early in 2009, Manulife Securities Investment Services Inc. was fined $200,000 and costs
of $50,000 for its lack of disclose related to its relationship with Portus Alternative Asset
Management Inc., the Mutual Fund Dealers Association of Canada has announced. The
fines are related to allegations that Manulife had a referral arrangement with Portus
Alternative Asset Management Inc. between 2003 and 2005, and failed to disclose to its
clients a component of the compensation that it received under this arrangement. Portus
went bankrupt in 2005 as a result of “misappropriation of investors’ funds,” and its co-
founders have been charged with fraud. Investors have suffered tremendous emotional
distress.
The availability of MFDA IPC investor protection fund coverage - up to $1 million for
each of a client’s aggregated general and separate accounts depends on the form in which
the securities are held. IPC coverage provides protection only to assets held in nominee
or dealer name rather than client name- roughly 80% of client mutual funds assets at most
fund dealers are actually held in client name, so they are not insured by IPC. (this
restriction is not publicly disclosed to customers at point of mutual fund sale)
The Canadian Securities Administrators (CSA) announced that they are seeking
comment on proposed amendments to the CSA’s corporate governance and audit
committee regimes using a principles-based approach rather than the current rules-based
regime. We believe this is untimely and adds significant risks for retail investors. It will
be very difficult to ensure similar interpretation of compliance with principles and rules
in a multi-jurisdictional system like Canada. Most responder comments were neutral or
negative.
Canadian investors haven't been unscathed by the US$50-billion collapse of the Bernard
Madoff hedge fund empire, potentially the world's largest ever fraud case. Mackenzie
Financial will be affected. Tremont is one of the managers of the Mackenzie Alternative
Strategies Fund. Monteith Illingworth, a Tremont company spokesperson, confirmed that
"there was exposure in that fund." The fund lost 59 % in 2008.
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Two labour-sponsored funds -- Ven-Growth I and VenGrowth II--moved to a policy of
annual distributions and ceasing weekly redemptions in order to preserve shareholder
value. From now on, investors will receive a return through an annual distribution of the
proceeds from the disposition of portfolio companies, rather than through weekly
redemptions. "This measure will prevent any mid-term liquidity challenges, help achieve
optimal exit values for maturing portfolio companies once market conditions improve
and ensure that proceeds generated from those exits are returned to all shareholders," it
said at the time. At the end of December, VenGrowth I (formed in 1995) had $45-million
in assets while VenGrowth II (formed in 2000) was home to $255-million in assets.
About three-quarters of the investments in both funds were in private companies. The two
funds have 2% management fees.
The OSC alleged Weizhen Tang was the "operating mind" of a scheme that had promised
to pay investors weekly profits of 1% through investments in stocks, options, futures and
mutual funds through stock markets in the United States, China and Hong Kong. Among
the allegations contained in documents filed by the OSC to obtain a freeze on Tang's
Oversea Chinese Fund LP, the commission said that "on the evidence presently available
it would appear that almost all of the funds have been dissipated. Tang told the OSC the
fund had lost $15 million in 2007 but did not disclose this to investors. In an affidavit
filed with the Ontario Superior Court of Justice in Toronto, Jeffrey Thomson, senior OSC
investigator, says Mr. Tang admitted to regulators that he lost US$15-million last year,
which he did not report to investors
A hearing panel of the Mutual Fund Dealers Association terminated the membership of
Farm Mutual Financial Services Inc. and has fined the company more than $2.5 million
for the sale of certain securities to unaccredited and inappropriate investors. Farm Mutual
was a non-attendee. The MFDA found that between June 2003 and April 2007, the firm
approved and allowed the sale of debentures issued by FactorCorp Financial Inc. to
approximately 680 clients without having conducted reasonable due diligence on the
product and without having made reasonable inquiries to determine whether the product
was suitable for sale to its clients. In May 2007, FactorCorp suspended redemptions, and
two months later, the Ontario Securities Commission issued a temporary Cease Trade
Order against the company. At the time, roughly $49 million of Farm Mutual clients’
debentures remained outstanding and unredeemed. In March 2008, FactorCorp went into
bankruptcy. The MFDA also found that Farm Mutual failed to develop guidelines or
investor profiles to identify clients for whom the debentures might have been a suitable
investment. Unfortunately, other than writing up reports nothing meaningful was done
about it so investors now must try to recover via a class action lawsuit.
In a study of funds in 16 countries, conducted by Chicago-based Morningstar Inc.,
Canada received a C for taxation and an A for transparency (in both the prospectus and
reports segment) But the report hammered the Canadian mutual fund industry on fees and
expenses, giving it the only F in this category."Canadian investors do not pay much
attention to fees," reads the Morningstar Global Fund Investor Experience. "Canadian
investors are comfortable with the fees because they don't know how low these fees
should actually be.” Canada's failing grade in fees is the lowest grade received in any of
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the surveyed areas. Canada has notoriously high management expense ratios." The report
lays much of the blame for this at the feet of advisors, saying that funds with higher
trailer commissions are pushed harder."Assets tend to flow into average- or higher-fee
funds because Canadian investors use financial advisors to help them make decisions,"
the report says. "Advisors direct client assets to funds that pay better trailers. And since
the trailer is included in the MER, the result is that assets flow into higher-fee funds.
Controversial new POS disclosure proposals from the CSA have been critiqued as wholly
inadequate by investor advocates.
A hearing panel of the Investment Industry Regulatory Organization of Canada imposed
penalties on Dustin Rene Lamontagne for forging client signatures. The violations
occurred when he was a registered representative with the Edmonton branch of CIBC
Investor Services Inc. At a disciplinary hearing held in Calgary, the panel found that in
August 2006 Lamontagne forged 13 client signatures to his client investment plans and
financial advice disclosure documents. The panel also found that on Oct. 23, 2006,
Lamontagne misled CIBC by providing false information in respect of client signature
irregularities, all involving his client investment plans and financial advice disclosure
documents. Adulteration of documents including KYC’s happens too often without
serious consequences.
Former OBSI Chief David Agnew had this to say upon his departure "I think we said at
the time that it's [ RBC Banking resignation from OBSI] a threat to the integrity of the
system. I mean, everything that we're trying to do is to make sure that consumers have a
single-window access to the complaints system ... and so I don't think that was helpful at
all." Consider these other comments he made:
“While we’ve made progress, complaint-handling in financial services has a long way to
go.” ... “Instead of a proper response to the client, the firm has fired off a template letter
dismissing the complaint, and has done none of the proper groundwork of responding to
a client.” (OBSI Newsletter, April 7, 2009)
“I think we’ve got a lot of work to do on the culture of complaint handling and dispute
resolution in financial services.” (Globe & Mail ,May 14,009)
The controversial Sentry Select Diversified fund restructuring proposal put forth by the
firm was approved by Unitholders . We believe this is due to retail investor financial
literacy shortcomings, complacency or blind trust in the manager and the lack of any
meaningful OSC intervention to protect investors. This case puts the integrity of the
proxy voting system in disrepute and the OSC in an inexplicable situation. Ask for our
SPECIAL REPORT The Curious Case of the Sentry Select Diversified Income Fund
Restructure by contacting
kenkiv@sympatico.ca Earl Jones ,the unlicensed investment manager, now known as the mini-Madoff of
Montreal, was accused of running a Ponzi scheme that may have cost about 150 investors
in Canada and the U.S. up to $50 million. On July 29, 2009 about 100 people attended a
rally in front of the court that released Jones on $30,000 bail. Hoisting placards that read
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“100 victims, 100 years,” they called for U.S.-style jail terms while demanding that
Quebec drop its opposition to the creation of a national securities regulator to replace
Canada’s controversial patchwork system of 13 regional authorities. Protest organizers
couldn’t accept that an unlicensed investment adviser - who allegedly bilked the elderly
and disabled, along with relatives and lifelong friends - managed to openly conduct and
advertise his services in Canada for decades. They can’t believe a man accused of
stealing millions was trusted to remain free while awaiting trial. And they can’t
understand the lack of co-ordination that exists between securities regulators and
Canada’s three levels of police. The allegations against Jones have not been proven in
court. But concerns over how authorities have handled the affair so far speak to a deeper
problem.
JovFunds Management Inc. [ JOV:TSX] suspended redemptions in its Deans Knight
Income and Growth Fund [ DKI.un:TSX] for up to 120 days (the "Suspension Period")
to get more time to sell debt securities to pay for potential annual payout requests. The
$28-million closed-end fund is run by Vancouver-based Deans Knight Capital
Management Ltd Return since inception = -7.15% pa .
In 2008 we stumbled on the news that the Investor Advisory Committee was kaput. It
was announced with great fanfare but has died with a whimper. The OSC’s Investor
Advisory Committee was supposed to be a listening post for retail investor concerns. It
ended its 2-year turbulent life at the end of 2007. One of its members publicly criticized it
suggesting it was nothing more than PR and extracted its Unpublished Report via Access
to Information. The results are not pretty which is why the OSC may have blocked its
release. A new consultation regime was implemented - the Joint Standing Committee on
Retail Investor Issues –of course there are no actual retail investors on the committee.
Rumours are that recent scandals may motivate the Commission to re-establish its
connection with retail investors.
This reconnection doesn’t apparently include an Investor Town Hall. The last one , held
in 2005 ,was tumultuous to say the least. There has not been a similar event since.
The CSA’s proposed Fund Facts disclosure document is geared to a Grade 6 reader.
Under the proposed framework, delivery of the Fund Facts before or at the point- of- sale
is required for all initial purchases of mutual funds that are recommended by an adviser.
Risk is measured using a scale which appears to be based only on volatility (stnd
deviation) - essentially it’s meaningless. Prospectuses will now only be delivered on
request. Of course, no performance benchmark is required to be provided. We expect a
major issue to develop regarding whether or not a fund purchase was driven by a
salesperson or the investor. Overall, the latest proposal isn’t acceptable to investor
advocates. IFIC still wants to challenge delivery requirements and talk about it so more-
it’s been a decade in incubation.
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Investor Education and Protection
FMF, Nortel, Atlas Freezer, YBM, Hollinger Bre-X, market timing scandal etc. 5
A review of MFDA cases reveals unsuitable investments , misappropriation of funds and
fund churning are alive and well. In Canada, commission-paid stockbrokers and mutual
fund sellers do not have a legal duty to put a client's needs ahead of their own. Don’t
assume your “advisor” is just facing a conflict- of -interest. He/she may also be
unqualified to design portfolios and manage risk and taxes. Mutual fund salespersons can
be registered with very little formal education and training.
A recent survey of Chartered Financial Analysts revealed concerns about advisor
conflicts-of-interest and competency. The CFA is recognized as a sign of professional
excellence in the global investment community. Charterholders must pass three rigorous
examinations and complete several years of qualifying work experience. Survey
respondents showed little change in their views about the ethics of market participants
from last year to this year. CFAs want a single national regulator and better enforcement
mechanisms for wrongdoers. That's the opinion voiced most fervently. They do not want
individual investors to suffer unnecessary losses due to unsuitable advice. Here's what
they said about weaknesses in Canada's securities regulatory system:
"Does not provide enough scrutiny that investors are receiving fair advice and service from
investment advisers/ brokers."
Investment industry groups "try to pretend that licensed salespeople are highly trained, when
in fact the vast majority have little investment knowledge."
"Focus on the end consumer and the requirements that they need to make informed decisions
– that is, transparency with respect to fees and commissions."
"There needs to be an office that can investigate real complaints/concerns raised by
investors."
Canada may have excessive MER’s but our funds don’t have excessive performance. The
Standard & Poor's Mutual Fund Performance Persistence Scorecard periodically provides
semi-annual results on the persistence of top performing funds in the current market.
These reports show performances of actively- managed mutual funds within their
capitalization peer groups and monitor the consistency of their performance results.
For the first half of 2009, only 34.5% of Canadian Equity active funds were able to
outperform the S&P/TSX Composite Index. Over longer periods, S&P continue to
observe indices outperforming the majority of domestic funds. In three-year and five-year
periods, only 16.7% and 7.6%, respectively, of actively managed Canadian Equity funds
have outperformed the S&P/TSX Composite Index.
The year 2009 will be the year any vistages of OBSI’s independence evaporated. All of
its key proposals for improved Terms of Reference were kept on ice pending industry
SRO action thereby ignoring an independent assessor's 2007 recommendations and
persistent pleas from retail investor for changes. Perhaps things will improve under the
new Chief Ombudsman , Doug Melville.
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In August, FAIR Canada called on the MFDA to review its by-laws to include at least
two representatives with expertise in retail investor issues and perspectives on its Board
of Directors. At this point in time, neither the MFDA or the IIROC have retail investor
representation on their Boards.
SIPA, the Small investor Protection Association ,continues to press for more effective
complaint handling processes. Little progress has been made in implementing any
improvements thusfar in 2009. The process is so deficient that many abused investors
report greater stress and frustration in dealing with the resolution of their complaint than
the complaint itself. SIPA has also been duelling with the OSC calling for public release
of their findings of a money market sweep assessing the impact of distressed credit
markets on the funds. Canadians have over $65 billion invested but the OSC refuses to
release detailed findings.
A group of aggrieved retail investors seeking redress from securities regulators in the
wake of the collapse of the $32-billion non-bank ABCP market has accounts with some
of the country's largest bank-owned investment dealers and two independent brokerages.
Of the three dozen investors, representing families and individuals who were stranded
with investments worth more than $1-million each when the ABCP market seized in
August 2007, at least one has an account with Canadian Imperial Bank of Commerce,
four with National Bank Financial and most of the remaining are with Canaccord Capital
Inc. and Credential Securities Inc. Securities regulators in Ontario, Quebec and British
Columbia, as well as the Investment Industry Regulatory Agency of Canada (IIROC), are
currently in discussions with the banks and the brokerages that sold third-party ABCP
investment products in the weeks shortly before the market collapsed. The watchdogs are
said to be seeking record settlements worth as much as $400-million on behalf of the
distressed investors. Meanwhile , it’s been 2 years of pain and suffering for these hapless
folks.
As we neared the end of Q3 , Alberta RCMP arrested one man and are looking for
another after the pair allegedly set up a Ponzi scheme that raised more than $100 million
from unsuspecting investors. Police say Milowe Allen Brost, 55, of Chestermere and
Gary Allen Sorenson, 66, of Calgary gathered investments from people throughout
Canada, the United States and internationally between 1999 and 2008. Brost has since
been arrested, although Sorenson remains at large and is believed to be out of the
country.It is unclear what has happened to the investments. Police say the scheme was
based on the investment commodity of gold. The suspects allegedly created Syndicated
Gold Depository S.A., which was suppose to loan money to a Merendon Mining Corp.
Ltd. with a high rate of return. Investors were lured into investing due to the promises of
high returns and tax advantages. Regulators and law enforcement watched for years as
the pair worked their magic on Main Street.
While the impact of deficient investor protection is financially enormous, the collateral
damage is often more devastating. Besides losing their life’s savings, victims of financial
assault are affected in many ways:
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Investor Education and Protection
FMF, Nortel, Atlas Freezer, YBM, Hollinger Bre-X, market timing scandal etc. 7
Adversely impacts their health and accelerated their ageing
Eliminates their capacity to trust other people
Destroys their sense of self- respect and their dignity
Creates a sense of hopelessness -an abyss of shame and self-doubt
Paves the road for many of them to near destitution.
Causes terrible stress within families
Causes them to have to get part-time jobs to help make up for the losses, despite
their ill-health
Makes it impossible to ever buy any gifts for their grandchildren –living with a
broken heart
Destroys any hope of leaving a legacy to family members
In other cases we’ve also heard of marital breakdown, severe emotional distress, nervous
breakdowns, heart attacks, drug over-dose and even suicide.
We thank all the contributors to this Report and regret we could only a tiny fraction of the
debacles , scams , deceptions , fiascos and injustices submitted. Eight pages is enough to
bring anyone to tears.
All in all, the first 9 months of 2009 were horrible for investor protection, continuing, if
not accelerating, the five-year trend. Virtually every entity charged with protecting
investors capitulated under financial services influence or due to their own
inertia/incompetence. The end result could well be the decimation of the middle class in
Canada. Let’s hope the balance of the year starts to reverse the trend before it’s too late.
Ken Kivenko October , 2009