Securities regulators across Canada are preparing for a wide-ranging crackdown on the retail investment industry in the wake of the scandal at Portus Alternative Asset Management Inc., warning that some firms and advisers who referred clients to the controversial hedge fund may have to "feel some pain" to dissuade the rest of the industry from shirking its responsibilities.
After months of investigating Portus, the Ontario Securities Commission is shifting its focus to examine the roughly 1,000 advisers who recommended these funds, and is working with other provincial watchdogs and self-regulatory bodies to take stiff enforcement action that will serve as a deterrent.
Michael Watson, head of enforcement at the OSC, said it appears "a lot" of these advisers failed to ensure the Portus funds were suitable for their clients, and may have been motivated instead by the promise of lucrative referral fees. Approximately 26,000 clients poured $750-million of their savings into Portus products.
"We will be making an attempt to send a very aggressive message to the . . . people who had direct dealings with clients and [who] just fell flat on their faces in a rush to make money," he said in an interview.
"People make good livings in this business, but as a quid pro quo they have responsibilities that they have to comply with.
"If people haven't got that message then I guess we haven't sent it aggressively enough, and maybe people are going to have to feel some pain out of this so the rest of them understand that this is a serious business where people have serious duties."
The scope of the review is extensive, given the sheer number of independent brokers, insurance agents, financial planners and others who propelled customers to Portus. One of the key questions will be whether these investment advisers knew enough about the complicated structure of these principal-protected "fund of funds" to ensure the investment was suitable for their clients.
There have been suggestions that these advisers may not be bound by this duty, since they were only referring customers rather than selling them products, but Mr. Watson doesn't agree. "If you're a broker looking for a place to put your client and you don't understand the product, I don't know how you can possibly comply with your suitability obligations," he said. "If the shepherds had not herded the sheep to the slaughterhouse, they would still be alive."
The OSC and KPMG LLP, a court-appointed receiver for Portus, have been trying to untangle the fund company's Byzantine framework for months now, and are still unable to pinpoint exactly where investors' money went or why much of it was funnelled offshore through complex derivative transactions.
Portus was forced to shutter its operations in February, shortly after several regulators announced probes into the company and issued orders that barred it from accepting new investments. The OSC is expected to take enforcement action shortly against the firm.
Portus did not sell its products directly to clients, but instead relied on referrals from outside salespeople. Independent brokers of Manulife Securities International Ltd. were by far the biggest single source of recommendations, with nearly 300 agents referring $235-million worth of investments. These brokers could argue that they felt the product was safe for investors because Manulife performed due diligence on the funds and struck a formal referral agreement with Portus. Manulife has since promised to guarantee the amount its customers pumped into the hedge fund.
Mr. Watson said the OSC will look at the role of firms in the Portus debacle, but suggested that most of the apparent misconduct seems to reside with individuals. Many of them, he said, appear to have referred clients "off-book," meaning the firms they worked for were not aware of the arrangement or the 5-per-cent referral fee they received for bringing customers to the fund. "The first to the post to 'fess up will probably do a lot better than the people who are the last to the post," he said. "Nobody will be exempt from our review in this process."
Mark Kent, president of Portfolio Strategies Corp., a Calgary-based mutual fund dealer, acknowledged that there were some problems in the way some clients were referred to Portus. His firm referred clients to Portus for a few months in 2003 but dropped the funds in early 2004 over concerns about the products.
"Clearly some advisers did not do any of the know-your-client suitability work," he said. "For our firm there was a cap of 5 or 10 per cent of investable assets that could go in alternative investments like Portus. Some advisers I understand from other firms would put in 40, 50, 60 per cent and in some cases even 100 per cent. Clearly they weren't practising due diligence and doing what was in the best interests of their clients."
The Investment Dealers Association of Canada, a self-regulatory body for the country's brokerage industry, is working with the OSC on the probe, as is the Mutual Fund Dealers Association of Canada.
Paul Bourque, senior vice-president of member regulation at the IDA, said it is focusing on how referrals were made by its members. About a dozen IDA firms accounted for $21.8-million that was invested in a Portus fund in 2004.
"We believe that where referrals are made by one of our members, simply to buy a product, and our member continues to receive compensation . . . that our members still have a suitability obligation. That's our sort of theory on this and we're investigating what happened and we'll take the appropriate action when necessary."
© 2007 The Globe and Mail. All rights reserved.
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