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Fund firms under fire over Portus

Hedge fund sales practices to be probed

The self-regulatory body that oversees Canada's mutual fund dealers is expected to investigate a handful of firms, including Manulife Securities International Ltd. and the Berkshire Group of Companies, whose sales agents referred clients to embattled hedge fund Portus Alternative Asset Management Inc.

The Mutual Fund Dealers Association plans to examine the sales practices at these firms to determine whether agents made sure the Portus funds were suitable for their customers. The MFDA has sent a notice to its members, saying they must immediately stop referring clients to Portus.

"We will be looking at any and all cases that we identify where this was sold to determine if the referrals were appropriate for clients and if the product was explained properly," said a source familiar with the probe.

Portus is under investigation by securities regulators across Canada. Last week, eight provincial watchdogs imposed a two-week bans on the company that prevent it from signing up new clients or accepting more money for existing accounts.

Hedge funds rely on sophisticated strategies, such as short-selling and derivatives, to earn returns regardless of which way the stock market is moving. They have been subject to less regulatory scrutiny than more traditional investment vehicles, like mutual funds, but that is changing with the torrid growth of the industry in North America.

The minimum investment required to participate in a hedge fund has put them beyond the reach of the ordinary Canadian, but new products like "funds-of-hedge-funds," which pool investments to generate more stable returns, are catching on.

Provincial regulators raised a number of concerns about Portus in separate notices last week. The Ontario Securities Commission alleged that the company broke a handful of securities laws, including one that deals with the suitability of investments for clients.

Enforcement staff at the Prince Edward Island Securities Commission alleged the hedge fund manager "appears to have contravened" parts of the securities act dealing with fraud.

The New Brunswick Securities Commission alleged there could also be irregularities with sales practices and bookkeeping at Portus, which has become the fastest growing Canadian hedge fund with an estimated $20-million in new investment funds pouring in each week. It caters to 26,000 investors, most of whom are from Ontario.

"We were sufficiently concerned that we thought some action had to be taken now," Rick Hancox, executive director of the New Brunswick regulator, said in an interview.

Independent agents at Manulife Securities, a unit of insurance giant Manulife Financial Corp., have referred more than $200-million worth of investments to Portus in less than two years, or nearly 30 per cent of its approximately $800-million in assets under management.

Tom Nunn, a spokesman for Manulife, said the company conducted due diligence on the Portus products before it agreed to begin a referral arrangement with the company in 2003. He said Manulife has not terminated its relationship with Portus, and is awaiting the outcome of the regulatory probe.

"We're reviewing the situation and monitoring it extremely closely, but we are not pre-judging," he said. "For us to comment on the upcoming hearing I think would be improper."

Executives at Portus did not return calls seeking comment. The firm has posted a notice on its website, saying it continues to manage clients' investments. "We have been working closely with provincial regulators in response to the 15-day Temporary Order that is in place. We are taking the matter seriously and believe that it will be resolved within this time frame."

Officials at Burlington, Ont.-based Berkshire, a sister company to Michael Lee-Chin's AIC Ltd., could not be reached for comment. A spokeswoman for AIC declined to discuss the issue.

Manulife's roster of about 1,000 agents are independent, but the company still must approve the products they sell. Some of these fi- nancial planners promote Portus funds on their personal websites and in published articles.

Manulife said it has contacted its sales representatives to alert them to the regulatory order and remind them that Portus cannot accept new referrals.

The referral business can be a lucrative one for financial planners. Agents who send clients to Portus receive a fee of 5 per cent of the initial investment, according to the fund company's portfolio management agreement.

They are also entitled to receive one-quarter of an 18 per cent "performance fee" in addition to a 1-per-cent fee if the assets remain with Portus for a specified period of time.

A number of smaller mutual fund dealers including FundEx Investments Inc. and FundTrade Financial Corp. also refer clients to Portus. FundTrade president Chris Enright says his company is reviewing its relationship with Portus in light of the OSC action but no decision has been made.

The fact that compliance staff from Manulife Securities and Berkshire vetted the Portus offerings may have put some dealers at ease with the complicated hedge product. "It was comforting," said an executive who asked not to be named.

Portus bills itself as a provider of alternative-investment products. Its name is Latin for safe harbour. The PEI Securities Commission says in a notice that Portus has created the impression through "direct and indirect misrepresentation" that clients are purchasing securities whose principal is guaranteed by a bank. No client portfolios were structured to contain such guarantees, the regulator says.

Portus initially came to the attention of the Nova Scotia Securities Commission last summer, when staff were investigating the sales practices of two mutual fund salesmen, said Scott Peacock, director of compliance and enforcement at the commission. The salesmen's employer, Select Money Strategies Inc., had a referral arrangement with Portus.

During a meeting in Halifax last summer, staff asked Portus executives to explain what they were selling. That did little to resolve the commission's concerns. Last November, its staff spent three days in Portus's offices conducting a compliance review, Mr. Peacock said.

Following that review, staff sent a "notice of deficiencies" to Portus on two separate occasions.

By mid-January, with many of its questions still unanswered, the commission alerted other provincial regulators about its concerns during a conference call, Mr. Peacock said.

The call prompted regulators in some other provinces, including Ontario and New Brunswick, to conduct their own compliance reviews of Portus. Part of the problem is that regulators do not have all the information they need on Portus's dealings with clients, said Mr. Hancox, the New Brunswick regulator. Without that information, "it's so hard to make the total determination of what we think is wrong."

Andy Hoffman is a reporter with Report on Business Television

© 2007 The Globe and Mail. All rights reserved.

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