JANET MCFARLAND , BOYD ERMAN and KAREN HOWLETT AND TARA PERKINS
August 8, 2008 at 9:15 PM EDT
PART ONE OF TWO
It's been a year since the ABCP market seized up and a rescue
committee set out to salvage $33-billion in notes and avert a Canadian
financial meltdown. With any luck, the frozen funds should soon start
returning to big and small investors if a deal can clear the courts. But
the next chapter is yet to be written: How did ordinary retail investors
get so caught up in this disaster? Who was to blame? And how to ensure
it doesn't happen again?
A Globe and Mail investigation has found that breakdowns throughout the
financial system contributed to the debacle. Today, Janet McFarland,
Boyd Erman, Karen Howlett and Tara Perkins reveal the story of how the
retail brokerage industry lost its way and ended up actually encouraging
conservative investors to become the holders of inappropriate high-risk
On Monday, the two-part package concludes when the team of reporters
explores the role of regulators. Regulators are preparing two key
reports for release in coming months, placing a particular emphasis on
the retail sale of the ABCP products. As they look to have the final say
on the mess, the investigation reveals that both they and other levels
of government should also share the blame.
Throughout his life, Alan Jones's father invested his money
conservatively, favouring bonds and GICs and avoiding even mutual funds
as too risky.
When he died in late 2006 at age 87, Alan Jones and his sister decided
to continue with the conservative strategy to ensure their mother's
retirement income would be safe. In the spring of 2007, they moved more
than $500,000 into three short-term investment trusts, assured by their
investment adviser that the funds were guaranteed by big banks and had
the highest possible credit rating.
“It was never called asset-backed commercial paper,” Mr. Jones said.
“I'd never even heard that term until August.”
Within a few months, the Nanaimo, B.C., wholesale nursery worker would
learn that his mother's investments were caught up in a national
meltdown affecting the market for non-bank asset-backed commercial paper
– an obscure investment product many other retail investors had never
heard of either.
In their words
||Guilt was just one of the emotions that racked Mr. Jones, whose mother
died at age 92, just three months after the ABCP market seized up.
“I was a little bit angry, but more disturbed and embarrassed, and
obviously worried,” he recalls.
Over the year since the ABCP crisis hit, both regulators and insiders in
the investment industry have heard hundreds of similar stories from
One of the biggest surprises to emerge from the almost year-long
restructuring process has been the discovery that so many ordinary,
retail investors owned third-party ABCP – a complex product originally
created for institutional buyers and sold in the so-called “exempt”
market, which means it receives virtually no regulatory scrutiny.
At least 2,000 retail investors owned the paper, based on investment
firms' disclosures. While that's a tiny number compared with the more
than two million people estimated to have full-service brokerage
accounts in Canada, the financial pain and stress for each of those
holders has been intense.
Purdy Crawford, head of the committee to restructure the frozen ABCP
market, in a presentation to investors in Vancouver last April.
Interviews with retail ABCP holders paint a consistent picture of
ultraconservative investors seeking safe vehicles for their money. Most
went to their financial advisers asking for GICs, treasury bills or
similar products. Instead, they ended up with a product that, despite
guarantees and high ratings, collapsed when the market was blindsided by
the credit crunch because the backing banks that were supposed to
support the paper used an out clause.
Since the non-bank ABCP market collapsed last summer, teams of lawyers
and top financial industry players have battled through high-stakes
negotiations to try to restructure $33-billion worth of notes. A
proposal received court approval in June, but it remains tied up in an
appeal by corporate investors and will need a ruling by the Ontario
Court of Appeal before it proceeds.
As the saga limps closer to a resolution, investors look for answers and
where to lay blame. They have lots of suspects to choose from in the
financial system, ranging from their brokers to regulators and the bond
raters that facilitated the sale of ABCP, all the way to the companies
that manufactured these instruments in the first place.
The customers relied on their brokers. Brokers, in turn, say they relied
on their firms' stamps of approval to market the product. The firms
involved in selling the paper say they placed their faith almost
entirely in the top-tier ratings the products had received from
debt-rating agency DBRS Ltd. And DBRS says it believed the paper was
being sold in the exempt market to sophisticated investors.
As good as GICs
One common theme among retail ABCP investors is that most report they
were pitched the product as something that was the equivalent of
plain-vanilla GICs – fixed-term deposits with guaranteed principal
protection and a set rate of return.
ABCP notes, while highly rated by DBRS Ltd., had no outright guarantee
that the principal would be returned. Their interest payments and return
of principal depended on the performance of a portfolio of assets
underlying the notes. In some cases, those assets were familiar types
such as credit card receivables and mortgages. For most of the frozen
paper, however, the assets were far more complex financial derivatives.
There was a form of guarantee. Big banks such as Deutsche Bank AG and
Canadian Imperial Bank of Commerce were under contract to buy the paper
from investors if nobody else would, but when the market froze, most of
the backing banks used a loophole in the contracts to avoid paying.
Gary Carter, 75, of Sahtlam, B.C., says he bought ABCP from an adviser
at Credential Securities Inc., investing a big portion of his retirement
“Like everybody else, it was sold to me as a GIC,” he says. “I've been a
logger all my life, and I had sort of a rapport with a lady at
Credential, and I guess I had too much trust, because when you don't
know a whole lot about it, you just put your faith in.”
Mr. Carter says he would not have bought ABCP if he had understood it
was not entirely safe.
“I would not have bought it if there was any risk, especially when
you're getting, what, around 4 per cent? If you're going to go
speculative, you get paid for it.”
Credential said it is not appropriate to comment on individual
Mark Wasserman, a 54-year-old vice-president of marketing in Montreal,
says he bought the paper from a broker at Canaccord Capital Inc. who, he
says, used ABCP as a product interchangeable with a GIC.
He alleges his adviser put his money into ABCP without his written
“He had free rein to put my cash assets into no-risk investments, that
was the deal I had: ‘If it's no-risk, you don't have to ask me; if it's
risk, you have to ask me,'” Mr. Wasserman said.
Documents support a wide array of anecdotal stories collected by The
Globe and Mail that ABCP was routinely compared with GICs by financial
One illustration of the sales process can be seen in an e-mail sent to
investors on Aug. 1 last year. It contains an investment pitch from
former Canaccord Capital vice-president Mark Hewett, who explained to
his clients that his firm had obtained a block of ABCP issued by Planet
Planet Trust was among the trusts that Toronto-based Coventree set up
for its ABCP program, which had more than $16-billion outstanding in
August. Each trust would issue commercial paper to investors, and use
the incoming money to fund the purchase of assets that would back the
The e-mail, with the subject line “money market rates – higher than
1-year GICs,” explains the benefits of Planet's ABCP compared to GICs.
“Liquidity: You can sell the Planet Trust at any time before maturity.
GICs are non-redeemable,” the e-mail states.
“Protection of the capital. The rating on the Planet Trust is AAA
credit. GICs are only insured up to $100,000.”
Canaccord chief operating officer Mark Maybank said the e-mail stemmed
from an internal company communiqué letting advisers know the features
of the product. He said it is common practice to compare investments
with other, similar options, so it was not misleading to compare ABCP to
“It is the role of the adviser to assess a broad range of investment
products, so I don't think there was anything necessarily inappropriate
or factually incorrect in that e-mail,” Mr. Maybank said.
It is only with the benefit of hindsight, he adds, that people have
questioned the appropriateness of ABCP products for conservative
“These money market vehicles were accepted in the marketplace as
short-term, conservative protection of capital or protection of
principal and fit those types of client profiles,” he says.
Calgary ABCP investor Brian Hunter, who has formed an association of
small ABCP investors, is not sympathetic to that argument.
He believes firms like Canaccord should have done more to analyze and
understand ABCP before recommending it to retail clients, noting that
even some credit-rating agencies would not rate the product because they
did not think bank liquidity guarantees were strong enough protections.
“It should never have been sold to retail,” he says. “Whether it should
have been sold to anybody at all is a question, but certainly not to
retail and not as a replacement for – or described in some cases as
better than – GICs or [banker's acceptances]. What were they thinking?”
Mr. Hunter heard the pitch himself when he first invested in
asset-backed commercial paper in early 2007. The Calgary oil and gas
engineer had never heard of ABCP before his broker recommended the
product – and he didn't even know he had bought it at the time.
He said he just wanted a safe place to park about $600,000 in cash
during a period of stock market volatility.
“I was just told it was a T-bill equivalent product,” he says.
He said he only learned afterward that he even held ABCP, and
subsequently learned that his so-called “asset-backed” paper also was
not backed by real assets but by complex synthetic derivatives.
Even if he had been inclined to check into it at the time, Mr. Hunter
believes he likely wouldn't have learned much because ABCP was sold as a
so-called exempt product, which means there was no requirement to give a
prospectus to investors explaining its details.
“The reality was with the due diligence, you weren't able to do it
because there was no prospectus, there was nothing,” he said.
Now, after months of intensive research into the ABCP market, Mr. Hunter
says he feels Canaccord, and indeed the whole financial sector,
developed a “cavalier” attitude toward ABCP by 2007.
“The risk associated with this should have been recognized by
Canaccord's risk management team,” he argues. “Having that kind of risk
on your balance sheet, without taking a hard look at it, is completely
ridiculous. They just dropped the ball on this.”
Earlier this spring, Canaccord and Credential retail investors involved
in the ABCP restructuring process learned they will be repaid their
funds. The repayment, however, has faced a lengthy delay due to a court
challenge launched by corporate note holders who are opposing terms of
the proposed restructuring plan. Investors still don't know when they
will see their money.
Angela Speller, a 62-year-old retiree in Victoria, says she fears the
matter may be appealed to the Supreme Court of Canada, leaving she and
her husband waiting years to access their entire retirement nest egg of
She says they invested their life savings in ABCP notes with a triple-A
rating after their financial adviser assured them that “if these fail,
the government of Canada would fail.”
With two adult children in university, and only a small pension to live
on, the Spellers say they may not be starving, but they need their
“Some of us need these savings for dental work, medical expenses,
education, and vehicles that are falling apart,” she says.
Who started all this?
When ABCP got its start in Canada in the late 1980s, the aim was to
create a way for big lenders to offload loans from the balance sheets –
mortgages, credit card receivables – and in the process to create a
product that would be marketed to major investors.
The originators of the first paper were financial types at the
securities arms of banks such as CIBC and Bank of Montreal. The banks
won because they got cash up front by selling their loans, rather than
having to wait around to collect on them, which also freed up the banks
to make new loans.
The buyers, mostly big institutional investors in the early days, got a
few more fractions of a percentage point in yield than they would get by
purchasing more traditional assets such as T-bills or corporate
commercial paper. That higher yield became increasingly appealing over
the past decade of low interest rates in Canada.
But as ABCP became more popular, the industry also changed profile.
Independent players such as Coventree Inc. began to sprout up, seeking
to profit from the market. Coventree and other so-called sponsors such
as Newshore Financial Corp. and National Bank of Canada would seek out
third-party assets, package them up and sell them as commercial paper.
And as the players changed, so did the product. From about 2003, a
profusion of ABCP flowed forth that was backed not by traditional
financial assets but by enormously complex financial derivatives,
creating what has now become clear was a far riskier product than it had
In 2003, for example, about $5-billion of ABCP backed by derivatives was
outstanding in Canada, jumping to $35-billion just before the market
seized up in 2007. From a small sliver four years earlier,
derivative-backed ABCP grew to about 30 per cent of the total ABCP
A final stage in the evolution was the swelling number of retail
investors moving into the product.
The retail trend is hard to track because there is no central clearing
agency to record the holders. But some companies have confirmed they
began selling ABCP to retail clients only in the past few years.
For instance, Credential Securities Inc. – an investment dealer for the
Canadian credit union system – began selling third-party ABCP in July of
2006. “With an R-1 High rating, ABCP was widely viewed to be of high
credit quality, it offered a good yield and was available to meet
short-term investment needs of clients,” officials at Credential said in
an e-mailed response to questions from The Globe.
More than 30 retail ABCP investors told The Globe they bought their
paper in 2006 or 2007. None had purchased any in 2005 or earlier.
By last summer, it turns out, thousands of retail clients held ABCP
investments, although the total number is still not known because some
were quietly bought out by their brokerage firms and did not become part
of a market restructuring effort led by lawyer Purdy Crawford.
The Crawford committee, launched in September to find a way to restart
the seized-up market, had already drafted its restructuring plan earlier
this year before even it realized how many individual investors were out
there, sources on the committee said.
Mr. Crawford told reporters in Vancouver in April that he only realized
slowly during the month of March that there were almost 1,800 retail
investors who still held frozen third-party ABCP.
“To be honest, my own understanding was I didn't know,” he said. “It
blew my mind.”
Canaccord started selling ABCP to retail investors in 2004 after having
the firm's product review committee look at the paper, Mr. Maybank says.
The company took comfort from its high credit rating, served up by DBRS.
“In 2004, we basically had a policy that allowed it because it was
triple-A,” Mr. Maybank said. “There are other things such as lower-rated
and junk bonds that were not permitted in the system. But on the back of
the triple-A and the R-1(high) ratings, that got it through the
He said if a product passes the committee, the firm usually lets its
investment advisers sell it.Canaccord, founded in Vancouver by
entrepreneur Peter Brown, has grown from a small shop with West Coast
roots to the country's largest independent brokerage, with large
operations in the United States and Britain.
Mr. Maybank said the firm trained its investment advisers on ABCP
through “in-house lunch-and-learns” and by having the company's
fixed-income experts visit large Canaccord branches to do presentations
on money market products such as ABCP.
Canaccord also used third-party sources, such as information from ABCP
wholesalers like Scotia Capital, and would send DBRS reports on trusts
to its investment advisers as part of their training, Mr. Maybank said.
“They have no reason not to rely on DBRS, right? It's been successfully
performing for a number of years and there's nothing to say not to,” he
As for selling Coventree products, the situation was similar, he argues.
“They went public, their share price was performing. They had lots of
equity investors and lots of buyers,” he notes. “Everyone looks back
with the benefit of hindsight.”
National Bank also relied on DBRS's rating. ABCP wasn't subjected to a
review by a product committee because it was a short-term product that
was highly rated, which made it eligible for distribution by the firm's
money market sales desk, officials at the firm said.
“National Bank Financial, and I think it is fair to say the dealer
community, regarded asset-backed commercial paper as a suitable
investment for all investors, including retail clients with a
conservative investing strategy,” said Ricardo Pascoe, co-CEO of
National Bank of Canada's securities division.
“It offered investors a money market alternative that was among the
highest-rated instruments, being both short term and liquid, with
returns that were very competitive with other similar instruments.”
Follow the Money:
Who got rich?
While there were profits to be made from selling ABCP products, it's now
clear retail brokerage firms like Canaccord were not making the big
money when they sold third-party ABCP products to retail investors.
The creators of the ABCP made their profit thanks to the difference
between what the assets earned in interest – the collections on all
those loan payments – and the lower rate paid out to buyers of the
commercial paper. At National Bank, for example, the firm oversaw trusts
that issued about $3-billion of ABCP, which brought in about $15-million
a year in revenue.
Some of the profit also went to pay commissions to the securities
dealers who sold the product.
A small company like Coventree didn't have the wherewithal to distribute
the product itself, so like any manufacturer, it struck deals with
“It was the highest commission that's paid to money market dealers for
distributing money market paper in Canada, bar none, absolutely,” said
David Allan, Coventree's head of capital markets.
Those wholesalers, such as Scotia Capital, National Bank Financial, HSBC
Bank Canada and CIBC World Markets, could sell directly to their own
clients, but they also sold ABCP to other companies that wanted to be
able to offer the product. Canaccord, for example, got much of its paper
from Scotia Capital.
Canaccord didn't make any significant money from selling ABCP to
clients, Mr. Maybank says. The firm received no fees from Coventree for
selling the paper because it wasn't a wholesaler.
For example, in the month and a half from July 1 to the Aug. 13 market
meltdown, Canaccord processed more than 2,000 ABCP trades totalling
about $300-million for clients, and made a modest $55,000 in gross
commissions. In fact, most of the trades – 54 per cent – were done with
no commission at all and charged to the client and 82 per cent of the
trades didn't generate enough commission to cover the cost of
processing, Mr. Maybank said.
The numbers are similar for National Bank of Canada, which earned little
in the way of commissions for selling ABCP to retail investors. Of the
1,175 trades the firm processed for the 340 National retail clients who
had their paper frozen, the average commission was tiny – 0.014 per cent
of the principal – and 82 per cent of the trades were processed with a
commission of $60 or less.
For its part, Credential said “the commission structure was in line with
other money market instruments.”
Given the lack of revenue, Canaccord's investment advisers had nothing
in the way of upfront financial incentive to sell ABCP, Mr. Maybank
said. But like other products that generate little or no returns – such
as banker's acceptances and government bonds – it was offered because
the firm wanted to have a full array of standard options available for
its clients, he said.
“We offer a number of products that we don't make a lot of money on – in
some cases next to no money,” he said. “Why do you have them? Because
you have to have a range of money market alternatives in your system.”
And brokers at Canaccord have the freedom to choose the best options for
their clients, he adds.
“On this one, they weren't pushed, there was no grid, there was no push
for fees on this,” Mr. Maybank says. “The brokers have the ability to
choose the best product to suit their client needs. We didn't say you
can't sell this – but I wish we had.”
By last summer, Canaccord had more than 1,430 retail clients with more
than $138-million worth of ABCP, representing about 1 per cent of its
total account base. Credential Securities had 335 individual investors
with $48-million, meaning less than half of 1 per cent of its customers
held ABCP. Credential has investment advisers in more than 135 credit
unions in British Columbia, Alberta, Saskatchewan, Manitoba and Ontario.
National Bank of Canada had 340 clients, out of a total of about 150,000
accounts, with about $170-million of affected paper when the market
froze. National has already repurchased that paper at par, with accrued
Other individuals – a number never publicized – owned asset-backed
commercial paper last summer and had their positions bought out by their
There were almost 20 firms that reported having clients with frozen
third-party ABCP when the Crawford committee hired an independent group,
Broadridge Financial Solutions Inc., to assess who held ABCP and how
Susan Wolburg Jenah, who heads brokerage industry regulator, the
Investment Industry Regulatory Organization of Canada, said one firm,
whose identity she cannot disclose, approached IIROC last August to seek
the regulator's permission to buy back ABCP from its clients.
The cost raised concerns about the firm's capital adequacy, but the
buyback was allowed.
“They had a reputational issue, and they were trying to do the right
thing,” she said.
Surprisingly, even many involved in the creation of ABCP say they only
realized earlier this year that hundreds of small investors had money
stuck in their product.
One problem may have been the wholesaler system, which meant that the
makers of the paper at Coventree and other firms didn't have a clear
idea of who owned the paper. The dealers who directly sold the product
were the only participants who knew who was buying it.
Mr. Allan of Coventree said his firm would not have known whether or not
the product was being sold to retail investors, “and, honestly, we were
finding out with everybody else,” he noted.
“Would we have known about some of the larger institutional investors?
Sure. But most of the names, even the corporates, those would not have
been names that were known to us.”
An official at rating agency DBRS, who insisted his name not be used,
said the firm's only comment would be to note that third-party ABCP was
sold as part of the so-called “exempt” market, so it was intended for
sophisticated, experienced investors.
Unfortunately, a growing number were not so sophisticated.