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Brokerages failed to protect investors in ABCP fiasco: regulator

Friday, October 17, 2008 | 5:48 PM ET

Canadian brokerage firms did not provide proper oversight when they sold now-worthless asset-backed commercial paper, said the organization that regulates Canada's investment industry on Friday.

In a 93-page report, the Investment Industry Regulatory Organization of Canada (IIROC) said that none of the 21 Canadian investment dealers surveyed who were flogging third-party asset-backed commercial paper actually knew whether the financial instruments they were selling were risky.

Instead, those dealers believed the products similar to the U.S. mortgage-backed securities for which financial institutions are now writing off billions in losses already had the highest possible credit rating and did not need more scrutiny, the report said.

So, the investment houses, which sold ABCP paper to both companies and individuals, decided not to spend the time doing their own assessment of the value of the underlying debt securities.

"Some dealer members indicated that they relied in part upon the carrying broker... presuming that the carrying broker had done due diligence on the product," IIROC said.

Instead, in 2007, the $35 billion ABCP market in Canada seized up when large corporations stopped buying the securities.

At that time, retail investors, including many retirees, complained that they did not understand the risks in buying these securities.

Soaring market
In the past decade, Canadian brokerage firms, in a manner similar to their American and British cousins, had become enthralled with the sale of derivatives.

(Derivatives are complex financial products that offer a higher rate of return but usually with a coincident higher risk.)

In 1996, the global market in these exotic financial products was worth an estimated $180 billion US. By 2006, that market had mushroomed to $20 trillion.

The report said, in Canada, 2,542 retail clients held ABCP worth about $372 million Cdn from IIROC member firms before the market collapse last year. That represented just one per cent of the total non-bank ABCP market.

In 2007, however, the American mortgage-backed market collapsed as the underlying mortgage fell into default.

Since this September, financial companies have lost value and been taken over as those firms with large holdings of these derivatives have been writing down the value of these assets.

IIROC said the industry must improve its due diligence of the products it sells and boost the transparency of these types of instrument so purchasers know what they are buying.