Days after an agreement in principle was reached in the Norbourg class action suit, opening the door for thousands of investors to recover nearly all the money they lost in one of the biggest investment frauds in the country, questions surrounding the efficacy and scope of investor protection provided by the debt-ridden indemnity fund overseen by Quebec’s financial watchdog have surfaced.
A group of investor advocates, financial professionals, and the body that oversees financial professionals in Quebec are beckoning the provincial government to cast a critical eye on the financial services compensation fund administered by the Autorité des marchés financiers (AMF), a call that Quebec Finance Minister Raymond Bachand seems to have heard. The finance minister recently requested the securities regulator to “see if something different should be put in place, how it should be done, while listening to industry.”
The investment sector is already laying the groundwork, beginning with the Chambre de la sécurité financière, whose 32,000 members work in five different sectors, including group savings plan brokerage, financial planning, insurance of persons, group insurance of persons and scholarship plan brokerage.
“The out-of-court settlement in the Norbourg case highlights the fact that the actual structure of the indemnity fund in Quebec is completely deficient, inadequate, insufficient, and above all, needs to be reviewed,” remarked Luc Labelle, the president and chief executive officer of the Chamber, whose mandate lays with protecting consumers by maintaining discipline and overseeing the training and ethics of its members.
The agreement in principle, reached days before a class action alleging negligence was to go on trial, was in part spurred by a court ruling issued on November 2010 when the AMF lost a legal battle before Quebec Superior Court against 138 Norbourg investors who were at first denied compensation, said AMF spokesperson Sylvain Théberge. Justice Bernard Godbout ordered the AMF to pay the 138 investors up to $7 million in compensation.
The $55 million settlement against Quebec’s securities regulator, Northern Trust Co. of Canada, Concentra Trust, accountant Rémi Deschambault and accounting firms KPMG LLP and Beaulieu Deschambault was actually the latest in a series of efforts to compensate Norbourg investors. In 2007, approximately 925 Norbourg investors received $32 million in indemnities from the AMF compensation fund. And that’s not counting the amount of $26 million which was derived from the liquidation of Norbourg assets and tax refunds from Revenue Quebec. All told, the total amounts to $113 million, or roughly 100 per cent of the capital lost.
While the AMF’s share of the $55 million settlement is $20 million, Théberge says the monies will not come from the indemnity fund but from an emergency fund. According to the AMF’s 2009-2010 annual report, the indemnity fund as of March 30, 2010 was in the red to the tune of $20 million. The fund is financed through compulsory annual contributions paid by firms and representatives registered with the AMF – in essence financial advisors. The fund may compensate victims of fraud, fraudulent tactics and embezzlement who conduct business with individuals and companies authorized to operate under An Act respecting the distribution of financial products and services, or in connection with mutual funds or scholarship plans. The maximum compensation payable to consumers is $200,000.
“There are sectors in the financial distribution services industry that do not contribute to the indemnity fund, leading to insufficient protection for the public,” said Labelle. “The fund is supposed to protect the public when it does business with professionals but there is nothing to protect investors when fraud is committed by investment managers as was the case in Norbourg. Some were compensated, others were not, so there is not a clear mechanism in place.”
Nor are investors, added Labelle, protected by unregistered financial advisors such as Earl Jones, who was sentenced to 11 years in prison a year ago, after pleading guilty to two fraud charges related to his $50-million Ponzi scheme.
Left then picking up the tab of the losses incurred by the AMF indemnity fund are financial advisors, points out the Quebec Association of Independent Personal Financial Advisors (QAIPFA). Three years ago the compulsory annual contributions paid by financial advisors ranged from $60-to-$80 per year per field of practice. Today, it stands between $220 and $240 annually per field of practice.
“We are deeply satisfied that an out-of-court settlement was reached with the Norbourg victims,” said Association spokesman Léon Lemoine. ”But it’s also left us with a bitter taste. We are the ones who have to pay the $32 million that comes out of our indemnity fund, particularly since from our point of view this was a fraud perpetrated by an investment manager and not by advisors.
“This fund is solely financed by advisors. It is wholly unjust that we are the only ones who are paying. It would be far more equitable if the entire industry would contribute, including investors.”
It’s no surprise then that Lemoine endorses an insurance scheme proposed by a coalition of investor advocates and financial professionals (in pdf and in French only). Under the proposal, the new revamped indemnity fund would be administered independently, apply to a broader range of fraud and negligence claims, draw its funds from investors through an annual portfolio levy, and operate under a cooperative regulatory framework.
“The current AMF indemnity fund is unfortunately bankrupt,” observed Robert Pouliot, a finance professor at the Université du Québec à Montréal. “It was a great initiative, and it was the only one of its kind in Canada, so it’s worth looking at why it failed so far to completely fulfill its mission. It proved to be inefficient because it had too many constraints and was not flexible enough.”
The coalition proposes a fund financed by investors, at a cost of an annual levy amounting to a few cents per hundred dollars, that would provide investor protection against fraud and negligence claims. The fund would be overseen primarily by investors, and fund directors would have the mandate of annually evaluating managers for their practices, risk management and governance, thereby enabling investors to make informed choices.
“The fund would operate like an insurance company,” said Pouliot. “That insurance fund, just like any other insurance company, will first have to assess the risk before accepting to take the risk. So investment managers with several funds will have to be rated on an asset-class basis each year. The key will be that it will be evaluated every year which will allow investors to compare.”
In a unique twist, the fund would tackle negligence claims, “which is far more frequent than fraud,” based on a no-fault approach, said Pouliot. Instead of taking legal action against the advisor or money manager, the indemnity fund would in essence adjust the fiduciary rating of the financial professional “and they would suffer in terms of their reputation,” added Pouliot. “That would be a great incentive for everyone to improve their practice in order to avoid a downgrade of their fiduciary rating without any cost.”
It remains to be seen whether the AMF or the provincial government will be swayed by the coalition’s proposal. Plans are now being sketched out by the AMF to hold consultations with the finance industry by this May.