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Small investors cast big vote in Canada
By Bernard Simon in Toronto and Paul J Davies

April 9 2008 03:00 | Last updated: April 9 2008 03:00

Reid Moseley was unhappy with the meagre C$13-a -month interest his C$50,000 nest-egg was earning on deposit at one of Canada's big banks. So the retired Calgary schoolteacher complained early last year to a friend who was an investment adviser at Canaccord Capital, a non-bank securities dealer.

"He said: 'I've got this nice little 30-day rollover thing'," Mr Moseley recalls. "He told me it was as good as gold. He said it would pay a lot better than $13 a month."

Mr Moseley transferred his funds to Canaccord, but within only a few months he was to become a casualty of the global credit-markets meltdown that began with the implosion of the US sub-prime mortgage market.

Mr Moseley is one of 1,400 Canaccord clients whose savings, worth a combined C$269m, found their way into Canada's non-bank asset-backed commercial paper (ABCP) market. Another several hundred small investors put their money into ABCP through other firms.

The C$32bn market has been frozen since August by the so-called "Montreal accord". Now, by a quirk of Canada's bankruptcy laws, Mr Moseley and his peers have the power to pass or to block a planned restructuring that will almost certainly see them take losses on investments even as they forfeit their right to sue.

Their vote, scheduled for April 25, will have repercussions far beyond an apparently remote corner of Canadian finance. If a deal is not reached, the conduits are likely to be forced into a firesale of structured finance assets on still weak global markets.

One market would be particularly badly affected by a "no" vote in Canada: that for complex structured products built out of pools of corporate credit derivatives, or so-called synthetic collateralised debt obligations (CDOs).

Collapse of the conduits' trades here would seriously disrupt trades held by banks, hedge funds and investors otherwise unconnected with the situation.

More than half the conduits' total assets are invested in leveraged bets on the safest, or most senior, slices of synthetic CDOs. Leverage levels of between 10- and 40-times mean the conduits' C$17.2bn-worth of investments gives them exposure of almost C$217bn, according to a report from JPMorgan, advisers to the restructuring effort.

Anger among retail holders about how they ever ended up with such exposure erupted at a series of meetings with small investors last week. It appears to make a "no" vote more likely unless the banks and other large investors involved - who stand to lose much more than the retail investors - were to come up with a compensation scheme to buy passage to the restructuring.

Mr Moseley, for one, intends to vote against the proposal, which would convert ABCP into longer-term floating-rate notes with the goal of preserving value and spurring a secondary market.

Banks, he says, will be swayed by the principle he would apply to his modest retirement business trading military insignia: "If I can pay a small amount of money to save a large amount, that seems logical. I can't see why the big banks wouldn't pay us out to save their asses."

Purdy Crawford, chairman of the restructuring committee, told reporters after the fractious final meeting in Vancouver that a top-up plan for small investors was on the cards. Observers say a payment of a few tens of millions of dollars at most to save possibly a few billion for the bigger investors seems like "a no-brainer".

That would also avoid the potential for lawsuits by small investors, which would raise potentially embarrassing questions about whether such exposures were ever suitable.

Retail appetite for ABCP was propelled by Ottawa's decision in October 2006 to clamp down on mushrooming "income trusts"; a structure that allowed companies to avoid tax by converting to trusts and paying out most, if not all, of their cash flow as dividends.

With the income-trust door closed, banks and financial advisers increasingly promoted ABCP as a safe, high-yielding alternative.

Colin Kilgour, a consultant, notes: "There are several unique elements of the Canadian ABCP market."

An important idiosyncratic problem in Canada was that the trusts need to prove a "general market disruption" to qualify for support by liquidity providers.

The banks behind the liquidity facilities maintained no such event had occurred as the much bigger ABCP market operated by the five big Canadian banks has continued to function.

Mr Kilgour says third-party conduit sponsors have a greater presence in Canada relative to other markets. Canaccord largely blames its clients' misfortune on banks that channelled the ABCP. It has enjoined Scotia Capital, the Bank of Nova Scotia's investment banking arm, to lawsuits brought against Canaccord by its clients.

Canaccord alleges Scotia misrepresented ABCP and failed to warn of risks. "At all material times, Scotia Capital actively and aggressively marketed . . . ABCP to Canaccord by means of frequent or daily written and oral solicitations and communications," says a court document.

Canaccord says Scotia marketed ABCP even as the bank began to unwind its own exposure last summer. It also accuses Scotia of failing to disclose that ABCP spreads were widening due precisely to liquidity problems.

Bank of Nova Scotia said it "acted simply as a placement agent for professional dealers, such as Canaccord. The agent is not expected to carry a fiduciary duty".

A "no" vote by retail investors would leave them able to sue but could also result in claims and counter-claims among all the big players.

Small investors' claims could get lost among a flood of much bigger suits.

Mr Moseley has little quarrel with his investment adviser friend - "I don't think he was a party to all of this" - or with Canaccord.

He blames the banks and authorities in Ottawa: "Government literally gives crooks in pin-striped suits a licence to burn people."

Copyright The Financial Times Limited 2008

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