Investors Scrutinizing the Regulators

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Investors at ABCP roadshows: at top of page, retired engineer Peter Myers; from top above, Layne Arthur, Mark Wasserman, Murray Candlish.



After eight long months of phoney war and intrigue in the offices of Bay Street's top lawyers and bankers and the boardrooms of Quebec Inc., the struggle over Canada's asset-backed commercial-paper market finally erupted into a battle this week at town-hall meetings across the country.

Retail investors heckled and jeered the group of lawyers who had come to ask them to sign a truce.

The boffins from JPMorgan Chase & Co. and Canada's finest law firms have spent the best part of a year working on a restructuring of unprecedented complexity for the $32-billion market.

The committee miscalculated the sentiment of a couple of thousand retail investors whose holdings are relatively meager at $250-million to $400-million, but whose votes in a ballot scheduled for April 25 will determine whether the plan goes ahead or not.

A voluminous tome of data 'explained' the plan. Slides scalped straight from the boardroom detailed the restructuring. But the farmers, teachers, residents of a co-operative housing scheme in Kitchener, Ont., et al nevertheless spurned the advances of veteran lawyer Purdy Crawford and his lieutenants, who had put together a proposal that was too long in the making and too complex and that would see investors take a sizeable hit on their savings.

The message -- vote in favour and you get something back, vote against and you get almost nothing and the world will descend into chaos -- did not resonate with ordinary people who felt ripped off. The issue has turned political with John McCallum, the federal Liberal finance critic, demanding, and getting, parliamentary hearings into the crisis,

ABCP investors, from top above, Simon Jegher, William Wisenthal, Angela Speller.

scheduled to take place in the next couple of weeks. Retail investors and other interested parties are "clamouring to come" to Ottawa, Mr. McCallum told the House of Commons finance committee on Wednesday.


Amid all the ensuing to and fro there was one name on everybody's lips -- Canaccord Capital Inc. Every farce deserves a villain, and Canaccord -- a growth-oriented, Vancouver-based brokerage with cool downtown Toronto offices where the receptionists are ultra-hip, the walls are lined with expensive modern art and the thirtieth floor boardroom features dark blinds that glide down the windows at the touch of a button -- appears to fit the bill.

Canaccord sold asset-backed commercial paper to 1,400 or so retail investors comprising about 60% of the smaller noteholders involved in the crisis. The company's network of brokers sold the product to some fairly ordinary people, many of whom say they thought they were buying an investment that was as safe as a GIC but which turned out to be about as solid as the U.S. subprime-mortgage market, whose collapse sparked the ABCP crisis last summer.

Now, many of those same people say Canaccord should pay them back their money.

"Anything less than 100% is just simply going to be unacceptable, so they're going to have to go back and sweeten the pot," said Craig Haaf, a retail investor in British Columbia. If the potential payout falls short, he said, "why not take our chances scuttling the deal and going after Canaccord now with a class-action lawsuit?"

There are many other retail investors eager to pass on a similar message to the media, which are lapping up the David versus Goliath story. But is Canaccord really the evil ogre that it has been painted as this week? Or is the broker just one of a number of players in a broken-down process, the patsy for a shame-faced Bay Street that collectively shares the blame for a failing that has created a made-in-Canada crisis?

"People have the feeling smaller guys are being left out or got shafted," said a source from Scotia Capital with intimate knowledge of the workings of the ABCP market. "I think they're just trying to play up that angle, which I would if I was them, too. Everybody thought [ABCP] was still safe. You could put your mother in it."

Canaccord's stock price has certainly taken a beating since its role in the crisis first became apparent. Its shares have fallen from a 52-week high of $25.92 to $10.20 yesterday, erasing $739-million off the company's market capitalization.

Chairman and founder Peter Brown sent an e-mail to his staff this week saying Canaccord would be "severely impacted" if it tried to buy back the investments it sold to retail clients, who own about $140-million of Canaccord's $269-million in total ABCP client holdings. There was some speculation on the Street that the company would have to seek outside help to solve its problems. TD Newcrest analyst Doug Brown put out a research note that included the estimate Canaccord could pay its clients about $50-million before it would have to issue new equity.

The company is also facing some serious reputational damage. Its relationship with some clients is surely beyond repair, and Canaccord appears to accept some of the responsibility for sorting out the mess.

"[ABCP] was supposed to be liquid, low risk assets," acknowledged Colin Kilgour, an expert on ABCP who was recently hired by Canaccord as a consultant. "The investors don't want cute solutions. I think Canaccord knows that."

Mr. Brown, meanwhile, told the Financial Post that Canaccord will help make up some of the losses incurred by its clients. An announcement is expected early next week.

But Canaccord's executives also say their company's role has been over-blown.

Only about 1% of Canaccord clients invested in ABCP and only about 4% of total client assets were invested in the notes. The company says it has received only a handful of written complaints from its clients since the crisis began and it has parted company with a only handful of individual brokers over their part in selling ABCP.

Nor is it fair to single out Canaccord for its role.

For starters, Canaccord was not the only seller of ABCP to retail buyers. The product was sold by a dozen other brokers, too -- including Credential Financial Inc., which is part of the Canadian credit union system, as well as bank-owned dealers. About 1,000 retail investors that are currently out of pocket on ABCP were not Canaccord clients.

Nor are retail investors the only mugs who ended up with the tainted paper. There are dozens of corporations and other organizations which have bought ABCP, many of them with treasury departments staffed by well-paid and highly-qualified individuals.

The Caisse de depot et placement du Quebec has most at stake. Henri-Paul Rousseau, the head of the giant Quebec pension fund, says the Caisse has $12.6-billion invested in ABCP, and he has already announced write-downs on its holdings of $1.9-billion. National Bank of Canada has also suffered from its involvement and was forced to buy back $2-billion of ABCP from its mutual funds and clients back in August.

In fact, a parade of large sophisticated corporations bought into this stuff. Canaccord owns some ABCP itself. The broker bought $43.1-million of ABCP, which it has already marked down by $8.6-million.

"This is a system breakdown. You have a whole range of noteholders across the system who bought this as a near-cash alternative. There are probably thousands of noteholders as well as hundreds of corporations involved," said Mark Maybank, Canaccord Capital chief operating officer.

Before the crisis began, Canada was home to one of the world's fast-est-growing markets for ABCP. In 2000, there was about $60-billion of ABCP outstanding, but by the end of 2006 issuance had doubled to about $120-billion.

Though fingers are now pointing at Canaccord, there were few dissenting voices willing to put a spike in Canada's ABCP market as it was developing. Yet there were plenty of blue-chip organizations whose involvement in the manufacturing of ABCP implied either tacitly or explicitly that the investments were good.

At the root of the problem is an embarrassing misunderstanding.

ABCP is a parcel of assets such as credit-card receivables, auto loans and mortgages, packaged up and sold off as a short-term investment. The investments also included complex derivative products that made it hard to tell exactly what you were buying into. But the paper is supposed to roll over every 30 to 90 days, and in case of a collapse in demand, the companies that manufacture ABCP have typically arranged with a bank to provide emergency liquidity.

The ABCP market is global, but liquidity agreements in a part of the Canadian market that has now collapsed were unique in that providers of the emergency funding -- mostly foreign banks -- would only cough up in the case of "general market disruption."

When the world's capital markets came to a grinding halt last year, leading to a dearth of buyers for ABCP and other structured products, this definition was exposed as woefully inadequate.

Some of the foreign banks -- such giants as Deutsche Bank AG, HSBC, and Merrill Lynch & Co. that made huge profits out of the Canadian ABCP market -- balked at providing emergency liquidity and investors were left holding paper they had expected to roll over without even blinking.

"The banks that had provided the liquidity didn't have a big investment in the Canadian market," said Bill Downe, chief executive of Bank of Montreal, in an interview. "It didn't make a big difference to them to help the Canadian market. If you look at a market where one-third of the participants had no real long-term interest, it created an inherently unstable environment."

Canaccord and others who sold the product likely had no idea there was a weakness when they pitched ABCP to clients. But the brokerage was not alone in failing to spot the problem coming.

The Office of the Superintendent of Financial Institutions has resolutely denied any responsibility for the crisis. In a speech last year, OSFI chief Julie Dickson said it was not her organization's responsibility to intervene in what was an unregulated market.

But that explanation did not address concerns OSFI was aware of the loophole in Canadian-style liquidity agreements and had done little to address it.

OSFI issued rules in 1994, and renewed them in 2004, that indicated what kinds of liquidity facilities regulated banks could offer when issuing ABCP. The rules inadvertently helped establish an unregulated market for non-bank ABCP that was backed by the unhelpful "general market disruption" style liquidity agreements.

Others were aware of the peculiarity in the Canadian market.

In a 2002 report, rating agency Standard & Poors called Canadian style liquidity agreements "almost meaningless." Moody's and S&P refused to rate the investments.

Yet Canadian rating agency DBRS put its stamp on the paper, giving non-bank ABCP -- specifically the notes that have ended up in the hands of retail investors among others -- its top rating, and a degree of legitimacy.

"You kind of wonder what the rating agencies were thinking," said the Scotia Capital source.

Armed with the DBRS rating on ABCP, some of Canada's banks were out marketing the paper, and implicitly lending credibility to the market, too.

In slides for a presentation dated October, 2006, Bank of Nova Scotia notes that Moody's and S&P do not provide the same ratings that DBRS dishes out. But the document -- in which Scotia Capital boasts that it is "consistently sought out for distribution guidance in the planning of structured credit conduits" -- includes several pages explaining how the DBRS rating works.

When investors launched a lawsuit against Canaccord in the B.C. Supreme Court in December, the broker named Scotiabank as a party to the suits. Canaccord alleges the bank "actively and aggressively marketed" the investments and failed to warn of the risks involved.

"I assume Canaccord would have had people going over the literature to peek under the covers," said the Scotia Capital source. "But seeing that it was [top] rated, at that point would they have looked under the bed? Maybe not."

Nobody was talking about the problems with ABCP, she said, "but rather how this was so great and how there would be more structures and how exciting it was."

All was well until last summer, when the semblance of a functioning market collapsed. But the problems, and the embarrassment, did not end there.

Finding they could not turn over short-term investments as they had expected, a handful of the largest investors who held billions of dollars of the paper froze the market while they tiptoed around a solution. One of their first moves was to elect a committee to work on a resolution to the crisis. The group was originally known as the Montreal Accord, but it later changed its name to the more inclusive Pan-Canadian Investors Committee.

For several months, the committee, headed by Purdy Crawford, could not get everyone to sit at the same table.

"People didn't understand the depth of the problem. They didn't understand how long it was going to last," BMO's Mr. Downe said. "The process of acceptance took six months. It's happened in credit markets around the world. Every financial asset in every class has been repriced. So it doesn't matter whether you are a stockholder, or a bondholder, or a money market holder."

While the committee missed deadlines, there were casualties, including Dundee Bank of Canada -- a startup bank that struggled under the weight of its ABCP dealings and was sold to Scotiabank -- and Coventree Inc., which was one of the biggest sellers of ABCP in the market.

The committee eventually produced a plan last month--Mr. Crawford said he had expected the process would be wrapped up months earlier. Other top bankers have told the Financial Post that there would be no solution on the table without the intervention of the Bank of Canada, whose past and present governors warned all those involved to get serious or risk bringing down the economy.

The plan suited some of the largest investors, but retail noteholders, clients of Canaccord and the like, are less than impressed, as we have seen this week. The self-appointed committee, which had started out as a means for Quebec Inc. to try to save its own bacon, had apparently forgotten to make sure their plan was acceptable to the small investors on whom its success depends.

And so, here we are, with a vote on the restructuring looming, with the plan facing a number of legal challenges, and with everyone involved in the whole fiasco--OSFI and other regulators, Mr. Crawford, the Bank of Canada -- potentially to be hauled into Parliament to account for their actions. The stakes are certainly high, with the reputation of the Canadian capital markets resting on the outcome. Failure to come to a resolution would be "a black eye" for Canada, Mr. Downe said.

Others have suggested a no vote could flood the market with unwanted ABCP, sending the global credit crisis into a deeper slump.

For Canaccord there is pressure, from both sides of the equation. Note-holders want their money back, and the large institutional clients -- Canaccord's peers in corporate Canada -- want the deal done. No matter who is to blame for the crisis, the brokerage could find that pressure hard to resist.



A short-term investment (30 to 90 days) in a package of assets, such as auto-loan receivables, credit-card debts and mortgages. ABCP could also include more complex assets like derivatives. It is usually backed by a liquidity agreement -- a commitment from a bank or other party to buy the ABCP in the event it cannot be sold at the end of its stated term.


When the subprime-mortgage crisis broke last year, with record numbers of mortgagees defaulting on their borrowings, investors shied away from putting their money in anything that was less than transparent, including ABCP. Liquidity agreements were supposed to kick in. But a quirk of the Canadian system meant liquidity providers in a portion of the market (the non-bank-sponsored ABCP market) said the conditions for providing liquidity had not occurred. Investors in ABCP found they could not roll over their short-term assets. A handful of the biggest holders of ABCP froze the market for the investment and set up the Montreal Accord to come up with a workout plan.


Investors have been asked to vote on a restructuring proposal on April 25. The plan will see them get back longer-term notes that they can hold until maturity or sell on the open market, likely at a big discount. Some retail investors are opposed to the restructuring, under which they will incur losses. There are concerns that if the plan fails, capital markets will be flooded with ABCP, sending the global financial market into a deeper crisis. Some retail investors say they will vote against the plan unless they get a better offer than the one on the table. Peter Brown The 65-year-old founder of Canaccord grew the company from modest roots -- in 1968, a precursor company had 30 salespeople and less than $1-million in annual sales -- to become Canada's largest non-bank investment powerhouse, with more than $15-billion in assets under management and offices around the world. After spending nearly four decades at Canaccord's helm, Mr. Brown retired from the chief executive's desk last August but has maintained his spot as company chairman.


Nova Scotia-born, Harvard-educated lawyer who has been tasked with the most complicated restructuring in the history of corporate Canada. The veteran lawyer was chief executive of Imasco Ltd. in the 1980s and 1990s. He is now counsel to Bay Street law firm Osler, Hoskin & Harcourt LLP. If retail investors don't sign up to his plan, they will get "damn little," Mr. Crawford recently told the Financial Post. "That's not a threat. It's a reality."


Canadian debt-rating agency. While S& P and Moody's refused to rate Canadian non-bank ABCP, DBRS gave the investments its top rating.


Chief executive of Caisse de depot et placement du Quebec, he has enjoyed some success curtailing the Caisse's overexpansion and bad investments since becoming CEO of Canada's largest institutional investor in 2002. But the Quebec pension fund was also the dominant player in the ABCP market, accounting for one-third of the market.When the crisis hit, Mr. Rousseau headed the rescue effort to restucture the paper into long-term notes. His friend, lawyer Brian Levitt, suggested Purdy Crawford to head the restucturing committee.


Federal Liberal finance critic who has hauled the ABCP crisis into Parliament. "My office and I'm sure many other people's offices have had calls from many, many, many of these so-called stranded retail investors," he told the House of Commons finance committee on Wednesday. Mr. McCallum successfully tabled a motion to hold hearings on the crisis, likely to occur in the next two weeks. He has already secured the commitment of Purdy Crawford to attend the hearings, which will also call on federal and provincial regulators and the Bank of Canada.


Nobody appears to know exactly how many ordinary Canadians bought ABCP, but they likely number around 2,500. A group of them have banded together on Facebook, under the leadership of Brian Hunter. They also have legal representation. The Pan-Canadian Committee's plan will see them get new notes they can likely trade in the open market at a discount. They are being asked to vote in favour of the plan and give up their right to legal action. But sources say the retail investors still don't have enough information to understand the real value of their legal rights, which could be very little if they have to face up to years of litigation against wealthy and well-organized banks.

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