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Playing the blame game

In the aftermath of the ABCP fiasco, investigators are looking for answers. What went wrong and who is to blame? So far, the regulatory agencies under fire seem to only be pointing fingers at one another.

August 11, 2008 at 4:00 AM EDT


In the two years before the asset-backed commercial paper market collapsed, the investment was undergoing a transformation, morphing not only into a much riskier product but one that would start to look less out of place on the shelf among a broker's range of products on offer to ordinary clients.

Regulators failed to notice the change in structure and seemed completely unaware that the asset class had even found a new market with retail investors.

Susan Wolburgh Jenah, who heads the Investment Industry Regulatory Organization of Canada (IIROC), said she and her staff had no idea last year that any individuals even held ABCP. To their minds, it was still a sophisticated product with large institutional buyers as target customers. It took disaster to strike before they knew what was really happening.

"Back in August, I had no clue," Ms. Wolburgh Jenah says. "I didn't know there were retail investors, or how many retail investors. Nobody here knew, either ... It took us a long time to start getting answers to those questions."

Yet IIROC, the regulator for the brokerage industry, now joins the Ontario Securities Commission and its other provincial counterparts in trying to find their own conclusions to how it happened. They are soon expected to reveal a proposal to curtail the sale of ABCP to retail investors.

At the same time, a federal Parliamentary committee has launched hearings, talking to federal banking regulators and provincial securities regulators as well as numerous angry investors to understand what went wrong with ABCP and what should be done to prevent it from recurring in the future.

In the process, the saga's history will be written and lessons offered on how it can be avoided in the future. What's clear from an investigation by The Globe and Mail, however, is that the regulators must share the blame and, in fact, may have inadvertently made matters worse.

"My impression is that all of these different agencies are treating this like a hot potato, trying to pass it to the next agency and saying that they themselves are blameless," says John McCallum, the senior Liberal on the finance committee in Ottawa.

"With hindsight, there are probably many things that could or should have been done to avoid this crisis."

Opening the door

Regulators can be accused of more than benign neglect in this story: They helped to open the door for ABCP to become a retail product, thanks to a quiet rule change in late 2005. That's when six provinces, including Ontario, removed a long-standing threshold limiting the ABCP market to investors who could afford at least $50,000 of paper - a standard that was intended to keep relatively unsophisticated investors out of the sector. All of a sudden, small investors were able to buy commercial paper created by so-called "third-party companies" like Coventree Inc., which specialized in the ABCP market and ultimately was destroyed by its collapse.

By last August, industry sources say, many of the least-sophisticated buyers caught in the ABCP crisis had holdings below the former $50,000 minimum investment limit.

James Turner, vice-chairman of the OSC, said the change was made because regulators felt the $50,000 threshold was so low that it was not a meaningful restriction for many investors anyway. The OSC felt the new requirement to have a high credit rating would be a better protection and with so many ABCP trusts receiving high ratings by DBRS Ltd., the flood gates were opened.

"That was a much more appropriate exemption than just [requiring] units of $50,000," Mr. Turner said. The rationale for the change was never publicly discussed in 2005. The rule change was part of a move by provincial securities regulators to have uniform rules across the country. But to do so, Ontario and five other provinces lowered their standard to match the other provinces that never had a minimum investment level. The threshold was also lifted in Alberta, Manitoba, Quebec, Nova Scotia and Prince Edward Island.

In essence, the regulators decided to treat commercial paper issued by special purpose trusts as if it were similar to more-traditional commercial paper notes issued by blue chip, publicly traded Canadian companies. Investors were supposed to rely on the rating of an unregulated agency. But what no one appeared to focus on at the time was that DBRS was the only agency that rated these notes. Both Moody's Investors Service Inc. and Standard & Poor's Corp. refused to rate them.

"I know it sounds like all the regulators are ducking responsibility," Mr. Turner said. "But in terms of what would have prevented this from happening, it was a whole bunch of different factors. If the subprime problem in the U.S. had never happened, then we probably wouldn't be here."

Indeed, the ABCP problem was not entirely foreseeable. But there was a pattern that should have merited closer monitoring.

The OSC was aware by 1999, for example, that there was a rampant trend emerging for simple debt instruments to evolve into far more risky derivative-backed products. In a report that year, a high-level task force set up by the commission recommended that investors be given more information about products that were backed by derivatives.

"The types of debt instruments sold by these issuers have evolved over the years and ... certain risk and other disclosure is required for investor protection," the report recommended.

ABCP was exempted from the recommendations because it was not seen as a similar derivative-backed product in that era. But within a few years, it too had evolved from plain vanilla commercial paper sold by creditworthy companies into the same sort of complex derivative instrument the committee was trying to address in its report.

As it turned out, much of the non-bank paper that froze up during the credit crisis last summer was the most complex and derivative-based product that existed.

Ms. Wolburgh Jenah, who was previously a vice-chairwoman at the OSC and worked on the derivatives task force, says in hindsight the task force demonstrated that many exemptions in securities law need to be regularly re-examined as markets and products change from their original conception.

She said when ABCP was created as an "exempt" product, no one was thinking it would be backed by complicated derivatives such as credit default swaps. Regulators, she says, have to watch how products "morph" along the way.

"Did anybody think about these products when they created that exemption? Are you kidding? These didn't exist back then." Following a flurry of opposition, some of it coming from the Canadian Bankers Association which argued the OSC did not have jurisdiction to regulate bank debt products, the task force's recommendations on debt-like derivatives were not implemented.

Never again

On Bay Street, there is already speculation that new independent ABCP originators similar to Coventree will emerge fairly soon to fill a gaping hole left in the market.

While big banks are still selling their own brands of ABCP, which never froze up like the independent paper, the demand for new versions of Coventree comes because there are many small lenders who need a place to sell assets such as loans. With independent creators like Coventree gone, there is no way to do that.

The more complicated ABCP - the paper backed by derivatives - is less likely to return any time soon. In whatever form ABCP returns, the question now is: What will be different next time? There's no doubt market discipline will play a key role in the future. Investors have been burned and will demand improvements: clearer disclosure, better-quality assets, clearer guarantees from banks pledging to support the paper, and better credit ratings.

But for retail investors in particular, a critical part of the solution will also lie in the work of regulators which are now considering new rules to restrict the retail market.

The Canadian Securities Administrators (CSA), an umbrella group representing all the provincial securities commissions, is weighing new restrictions for retail investors buying ABCP, in essence narrowing the wide-open market that was created with the 2005 rule change.

Mr. Turner says one possible solution would be imposing the so-called "accredited investor" rule for ABCP. That would mean ABCP could only be sold to individual investors if they meet criteria (such as having up to $5-million in total assets) designed to limit a product's sale to those people with a greater level of financial sophistication.

Despite the work under way to tighten up the sale of ABCP, however, the OSC is making no admissions that it was a mistake to have removed the $50,000 threshold in 2005.

When asked whether the decision was wrong in hindsight, OSC vice-chairman Larry Ritchie repeatedly stressed that it was the role of the brokerage firms to determine whether ABCP was suitable for each client.

"The more complicated a product, the more there is an obligation for the people selling and recommending it to fully understand what it is," he said.

The final response to the ABCP crisis, however, may prove the most frustrating for some investors. While IIROC has launched some investigations of how ABCP was sold to retail investors, no individual or firm has so far faced any disciplinary action for improperly selling ABCP to people for whom it was an unsuitable investment.

And it is unclear whether anything will emerge. Ms. Wolburgh Jenah warns it may be difficult to pursue cases once retail investors are repaid their funds.

"One of the practical issues we have is that, historically, when people get their money back, sometimes they lose interest in pursuing the complaint. You want to go to a hearing and have a witness say, 'This is what the broker told me or this is what happened to me.' It's hard when you don't have that."


Canadian Securities Administrators will soon propose new rules requiring more disclosure of details about ABCP products for investors, and is mulling an accredited investor rule that would make their purchase impossible for many investors. As well, the committee is also planning to seek new powers giving securities commissions the ability to regulate credit rating agencies.

IIROC has conducted its own "compliance sweep" to consider whether new rules or standards are needed for ABCP sales. A key issue to be addressed is the product review process that goes on within brokerage firms to assess whether new or evolving investments such as ABCP are being adequately reviewed before being sold to retail clients.Brokerages such as Canaccord say the industry itself will have to be diligent to rely on more than ratings before selling a product to retail investors. "If you can't get the level of disclosure that you may need," says Canaccord CEO Mark Maybank, "you may not be able to sell that product."

Purdy Crawford, chairman of the Pan-Canadian Investors Committee for the Third-Party ABCP, says he would like to see more co-operation between the Office of the Superintendent of Financial Institutions and IIROC, which could combine their expertise in reviewing financial products, and such areas as capital and liquidity requirements. "These meetings probably need to happen at a more senior level."


In the aftermath of the ABCP fiasco, investigators are looking for answers. What went wrong and who is to blame? So far, the regulatory agencies under fire seem to only be pointing fingers at one another

K Barkley from Moscow on the Don, Canada writes: Yes it’s all well and good to talk about disclosure. But what about the underwriting and pricing aspects? The situation allowed junk to be priced triple A. In fact that junk seems to be our covert subprime market. Regulators in Canada are an embarrassment to all except themselves. The American system is better equipped to sort this out and will likely do so, while we dither. This is because the Canadian system is ostensibly about prevention rather than fault finding. Therein lies the comedy – first you shrug and then you talk, followed by more talk, and then more talk ... it really doesn’t have to lead anywhere.
Posted 11/08/08 at 5:36 AM EDT

Happily Retired from LupinLand, Canada writes: "Back in August I had no clue" is quite a statement to be made by the head of a regulatory agency, but so appropriate, and so sad. It is simply the nature of a bureaucracy. A bureaucracy is established for a specific purpose, but once established it's main purpose quickly becomes self-perpetuation and self-promotion, and the original purpose for which it was established becomes purely secondary, if not incidental. So my bet would be that in August everyone in the organization knew exactly who was in line for promotion, but as far as what was going on in the world of finance, they had "no clue". How sad.
Posted 11/08/08 at 6:54 AM EDT

The Defender from Whitby, Canada writes: What went wrong....nothing, it all went as planned. The crooks have disappeared with the money, and left all the hard workers in the dust...Jack-asses.
Posted 11/08/08 at 7:12 AM EDT

Gardiner Westbound from Canada writes:
No prospectus was required. Oral assurances and guarantees were bogus. Regulators must require all undertakings be given in writing and without weasel clauses.
Posted 11/08/08 at 7:51 AM EDT

reint farmer from Canada writes: the only question that i have is, how many heads have rolled from the regulators and from bank managers that invested in these shady investments? most likely none.
as long as no one head rolls and no public reprimands are given we, the general public will pay the price, but that is what we expect in a market driven economy. what ever you can sell is allowed as long as you can find enough idiots to buy. in this case idiots with Harvard degrees in which we entrust our monies.
Posted 11/08/08 at 8:34 AM EDT

Mike Glatt from Canada writes: Let's not kid ourselves very few if anyone who bought this product knew what they were buying. In this case being a sophisticated investor wouldn't have helped one bit. The investor was buying a rating and a product which had a yield which was a little higher than they could get from a Tbill. No one had a clue how these prodoucts generated income and what the assets were that backed the paper. It was like a giant pyramid scheme where everything goes well until you can't sell any more paper to pay the guy who bought it before you.
The whole securitization thing is a mess as even good mortages etc are going bad (just look at Freddie and Fannie.)
I am sure Warren Buffet would have understood this stuff right? (wrong).
Get rid of this crap and don't let anything that even looks like this out on the street again.
Posted 11/08/08 at 8:35 AM EDT

Diane Urquhart from Mississauga, Canada writes: There is another reason the OSC can be accused of more than benign neglect. On October 26, 2006, two OSC Commissioners at the time, Paul Moore and Harold Hands, granted a 3 year Exemptive Relief Decision that allowed CIBC and CIBC World Markets to trade in Non Bank ABCP that had credit ratings which failed to meet the minimum standards set out in Ontario securities regulation. The regulation says “no approved credit rating organization has rated the security or instrument in a rating category that is not an approved credit rating.” The way the Non Bank ABCP prospectus exemption works is like being a medical student who cannot get his degree, if he fails any of the compulsory courses in his degree program. The failing student goes to his dean and asks to be granted his medical degree, if he is able to pass just one of his compulsory courses. The OSC is the dean who grants this exemption to his medical student. It tells CIBC and CIBC World Markets it only needs to get one credit rating that passes the minimum standard in the regulations and it can ignore the fact that Standard and Poor’s graded Non Bank ABCP below investment grade and that Moody’s was unwilling to give it the top grade required in the regulations. Not surprising, the medical doctor, who was falsely granted his degree despite failing compulsory courses, ultimately causes harm to his patients. The CIBC and CIBC World Markets and all the other banks and securities dealers involved in the Non Bank ABCP, which had failed the Standard and Poor’s and Moody’s minimum credit ratings test in the securities regulations, caused at least $16 billion of harm to Canadian individuals, pension funds, corporations and governments who bought this ABCP. DBRS was the one professor who knowingly inflated his students' grades, and as such was an accomplice to the slack dean, the OSC.
Posted 11/08/08 at 9:15 AM EDT

Charles ANTHONY from Canada writes: Regulators assisted in this debacle! They are the problem along with long winded lawyers who continue to operate unchecked in this society. Bureaucrats are more interested partaking in the cronyism within the capital markets. BreX, Nortel, Conrad Black,H uge pay packs for BC bureaucrats, Gomery, SRTC's, Champagne 100 million dollar public works RIPOFF etc..It is time for a complete overhaul of this system. It's not about politics, it's about corruption in government over 30 years and no one is even remotely close to a jail cell and never will be. Champagne paid a small time in jail. Purdy's Brex-x solution was National Instrument 43-101. Really useful in Southwestern Gold/John Paterson. There are so many huge commercial crimes going on that it is now impossible to track them.
Posted 11/08/08 at 10:44 AM EDT

donald from Alberta from Not from Bay or Wall Street, Canada writes: "I know it sounds like all the regulators are ducking responsibility," Mr. Turner said. "But in terms of what would have prevented this from happening, it was a whole bunch of different factors. If the subprime problem in the U.S. had never happened, then we probably wouldn't be here." I would like to state categorically, that I have never invested in these products nor worked in the investment community. Furthermore, my main source of information on the financial markets is mainstream newspapers, network TV and the internet. That being said, even as a lay person the above statement has me at a complete loss for words. Here's why, it doesn't take a rocket scientist to figure out that if interest rate are dropping to 40yr lows (after 9/11), the industry is slashing mortgage approval requirements and house prices are skyrocketing that thing might get out of control. True, none of what I just said indicates a possible crisis on its own until its put in context. Lets look California, a full two years before the subprime implosion, 60% of all mortgages in that state were 0% down interest only with an initial five year term, the condition of these mortgages included large increases in interest rates when the term was up. Furthermore, even then most of this paper was being sold and converted to ABCP. Let see, this means that if house prices fall or even fail to rise the owners of the house have no equity and at a minimum they face a steep rise in mortgage payments. The key to this is the 60% number, this indicates that house prices are already well above what the average person can afford. And this does not even include the people who purchased homes with no employment. I guess lenders forgot, no asset goes up in value forever? Mr. Turner, of course there is no problem until there is a problem, that's a rhetorical statement. But that no one could see this coming is a complete nonsense. Don't these regulators follow the news or are they simply collecting a paycheck.
Posted 11/08/08 at 11:41 AM EDT

Green Canada from Edmonton, Canada writes: so let me see...companies cry and cry and cry to "regulate" themselves and then they screw up and who gets blamed (at least in part), the regulators. In my book the brokerages and the investors should share the entire burden of this fiasco. If there were misrepresentations to the investors they should be able to made whole by the banks/brokerages.
Posted 11/08/08 at 11:50 AM EDT 

herb f. from Vancouver, Canada writes: the banks moved the junk to suckers like me, they will not be sued so no banker goes to jail- the courts are holding up my money now, how much longer will they take to come to a result that will give me back some off my money? for me - hang the bankers and hang some regulators and lets get on and pay me back!!! now!!!
Posted 11/08/08 at 12:13 PM EDT

baldev sood from Canada writes: ABCP papers were sold to me as triple A rated in July August 2007.
I was assured it is top qualty.

Was it or is it??????

Promise fater promise to buy back has not matured yet.
There are millions of excuses.
If this will let go through the courts i think may be I will be dead by that time.
seniors like me who has put all rrif money into it are suffering monetarily as well phsologically.
Posted 11/08/08 at 12:26 PM EDT

Simon Crouch from Canada writes: Wasn't it within the last couple of weeks that American Regulators reached settlements with major banks doing business in the U.S. that essentially forced them to buy back this junk?

That was to avoid prosecution I believe.

Here in Canada we allow a high priced lawyer to pile up big fees (we presume here that Mr. Purdy Crawford isn't working on this for free if we are wrong on that, sorry Mr. Crawford) trying to create a "workout" of this mess. a workout that will guarantee no lawsuits and no legal penalties.
It's not often that I think the American System is better, but in this case it clearly is. Our government should tell Mr. Crawford to stay home and start legal proceedings against any company and any individual that sold this junk as anything other than a role of the dice.
Posted 11/08/08 at 1:12 PM EDT

James Follwell from Charlottetown, Canada writes: Rule: As an individual investor, never purchase a security (or sell one) based on the advice of a financial intermediary.
Posted 11/08/08 at 1:37 PM EDT

K. O'Brien from Kingston, Canada writes: At one public hearing Purdy Crawford was asked "Who is going to jail". He did not answer so they must have picked the wrong lawyer to investigate the ABCP mess..
Posted 11/08/08 at 3:45 PM EDT

Crusty Curmudgeon from Ottawa, Canada writes: Well, we had military intelligence, honest politicians, business ethics a --- now we can add the term financial regulators to the list of oxymoronic terms.
Posted 11/08/08 at 4:27 PM EDT

The Middle Finger ..I.. from Canada writes: To baldev sood from Canada who wrote: ABCP papers were sold to me as trippleA rated in july august 2007.
I was asured it is top qualty.
Was it or is it??????
Promise fater promise to buy back has not matured yet.
There are millions of excuses.
If this will let go through the courts i think may be I will be dead by that time.
seniors like me who has put all rrif money into it are suffering monatrily as well phsologically.


Do you have any ownership in/responsibility for your problem status?
Posted 11/08/08 at 5:59 PM EDT t

Horace Graves from Sudbury, Canada writes: Congratulations to the ROB staff on a wonderful investigative report. Clearly the OSC screwed up on the ABCP file and according to the Globe, the OSC was not only neglectful, but may have contributed to the growth of this ABCP market and to the increased sale of ABCP crap to many unsophisticated retail investors.
Last time I looked, the OSC is a Crown agent of the Ontario Government and reports to and is accountable to the Minister of Finance Duncan.
How do you police a policeman?
I would be interested to hear from the other posters on this article as to what Minister of Duncan should do to the OSC.
According to the Globe, the OSC is partly responsible for the loss of billions of dollars in the ABCP mess. If the OSC is partly responsible, and the OSC is an agent of the Ontario Government, then the Ontario Government is responsible for compensating in part the billions of dollars lost in the ABCP mess due to the actions of the OSC.
I was wondering if anyone on these comments shares this view.
Posted 11/08/08 at 7:14 PM EDT
The Accountant from Canada writes: It's a good thing we have more than one finger because each deserves pointing.The Raters and Sellers however deserve the special finger.
Makes you wonder how many other derivatives and other swaps are out there that regulators are "clueless" about.As for "sophisticated investor", usually means someone smart enough to get out at the right time to avoid getting burned.
Posted 11/08/08 at 7:51 PM EDT

Jon Stone from Canada writes: The simple truth of the ABCP mess in Canada is that the regulators have worked hand and hand with the Banks to ensure the public never knew the extent of the ABCP debacle. The Banks (led by the National Bank the main participant) pretended that this mess "fell out of the sky on a warm summer's day in August 2007". The Banks were well aware of the problems in this market prior to August 2007and knew specifically that the ABCP contained non-performing sub-prime assets. The Quebec regulators apparently turned a blind eye when a certain Quebec Bank used false representations to purchase ABCP from their executive officers and clients as clearly they were concerned the ABCP might bring down the Bank.

If this happened in the US, bank management would be paying huge fines in lieu of facing jail time, but here in Canada with the Bank Board's asleep, it is just another day at the office.
Posted 12/08/08 at 9:56 AM EDT

In Trouble from Victoria, Canada writes: As a retail investors unwittingly placed in ABCP and barely afloat after a year of being unable to access my life savings, I am enormously disappointed at the disparity between the swift and fierce action taken by the US Government, and the hand-wringing and buck-passing taken by the Canadian Government. If the US can force their banks which created and sold auction-rate securities to repay their clients, why is there no will to do the same here? Canada appears to be not only inept in regulating the financial industry, but equally inept at assessing responsibility and forcing recompense.
Posted 12/08/08 at 1:22 PM EDT

Fred Savage from Montreal, Canada writes: I totally agree with the previous postings. The OSC and the Quebec securities regulators screwed up badly with respect to this ABCP mess. Why isn't Finance Minister Duncan and his Quebec counterpart calling OSC Chairman Wilson and the Quebec securities head into their offices and demanding answers and a clean up of their respective securities commissions. The OSC is a disgrace.

Where are opposition leaders John Tory and Howard Hampson? Millions of dollars of ABCP invesmtents were lost due to the negligence of the OSC and the Quebec Securities Commissions.
Posted 12/08/08

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