Quebec financial regulator cracking down on illicit money-services businesses

Quebec’s financial watchdog is cracking down on businesses that illegally run a money-services business.

More than a dozen small bars and restaurants were accused by the Autorité des marchés financiers over the past year of operating private automated teller machines without a license issued by the provincial financial regulator.

Now, the verdicts are trickling in. So far this year the AMF announced that 11 small businesses or individuals pled guilty before the Court of Quebec to illictly operating a money-services business, the overwhelming majority of whom were fined $15,000 for each infraction.

On April 2012, Quebec became the first province to regulate the money-services industry. The Money-Services Businesses Act and its Regulations, administered by AMF, governs businesses that offer money-services such as currency exchange, funds transfers, cheque cashing, the operation of private automated teller machines, the issue or redemption of traveller’s cheques, and money orders or bank drafts.

Under the regulatory framework, these businesses must hold a license issued by the AMF and must meet obligations such as know-your-customer and maintaining records.

According to the AMF’s 2016-17 annual report, there are 1,956 enterprises licenced to run a money-services business in the province, including 704 that were granted a new license in fiscal 2016. The annual report reveals that the financial watchdog launched 32 investigations into illicit money-services businesses in 2016-17, completed 47 investigations, and have yet to complete 11.

Monies recuperated from sanctions imposed on businesses illegally offering money-services appears to be minimal. Total sanctions and fines imposed by the AMF, or on its behalf, amounted to $13.6 million in fiscal 2016, a sizeable increase over $10.1 million in fiscal 2015. The maximum fine for a “natural person” for contravening the Act is $50,000 (and not less than $5,000), and $200,000 for a “legal person” or entity.

New virtual currency targeted by Quebec financial watchdog

The Quebec Financial Markets Administrative Tribunal issued a series of expansive ex parte orders prohibiting Dominic Lacroix and several of his companies from promoting and soliciting investors for a new virtual currency set to be launched.

The Tribunal, at the request of Quebec’s financial watchdog, issued a broad order barring Lacroix, DL Innov inc., Gestio inc., PlexCorps, and PlexCoin from engaging in activities for the purpose of directly or indirectly trading in any form of investment covered by the section 1 of the Quebec Securities Act, either in Quebec or from Quebec to outside of the province. Section 1 lists a variety of investment vehicles, including securities, instruments, deposits of money, shares in an investment club, and options or non-traded derivatives.

The Tribunal also ordered them to pull out advertisements or solicitations on the internet over any securities or investment vehicles, and to shut down the site and – or at the very least make them inaccessible to Quebec consumers.

The Tribunal also ordered Facebook Canada Ltd. to shut down the Facebook pages of PlexCorps and PlexCoin. Facebook declined to comment. “We can’t share details about cases,” said a spokesperson.

PlexCoin describes itself as the “next decentralized worldwide cryptocurrency.” It boasts that its “new revolutionary operating structure” will make transactions faster, easier and safer than any other cryptocurrency.

According to its Facebook account, PlexCorps is a group of forty people, including programmers, engineers, and cryptocurrency specialists, “all independent” located throughout the world.

“We decided not to reveal the identities of our team to make sure no one is getting harassed on social media or recruited by other cryptocurrency companies, thus preventing the concept of PlexCorps from being copied,” according to its Facebook account. “However, be assured that we will be very transparent with our customers concerning our projects and our finances.”

The firm is working on launching a new initial coin offering by early August.

Lacroix was the target of another order by the Tribunal, again at the request of the Autorité des marchés financiers, Quebec’s financial regulator. The Tribunal issued on June 13, 2017 ex parte freeze and prohibition orders against Lacroix, Régis Roberge, DL Innov inc., Micro-Prêts inc. and Gap Transit inc. in connection with failures to comply with the Securities Act.

The Tribunal froze the bank accounts, funds, securities and other assets of Dominic Lacroix, DL Innov inc., Micro-Prêts inc. and Gap Transit inc.. The Tribunal also ordered them not to dispose, directly or indirectly, of the funds, securities or other assets in their possession or custody, and to refrain from withdrawing or appropriating, directly or indirectly, funds, securities or other assets from any other person having them on deposit, under control or in safekeeping on their behalf at any place whatsoever.

The decision in Autorité des marchés financiers c. Lacroix, 2017 QCTMF 67 makes no mention of PlexCoin.

Two weeks later, on June 29, 2017, the Tribunal partially rescinded its far-reaching order after an agreement was reached between the AMF and the parties.

Earlier still, on February 2013, Lacroix and his company Micro-Prêts plead guilty before the Court of Quebec to six charges of illegal distribution, illegal practice and misrepresentations. The Court ratified the parties’ joint proposal and imposed a $25,000 fine.

Quebec regulates virtual currency ATMs and trading platforms

In a move that caught the business and legal community by surprise, Quebec became the first jurisdiction in Canada to regulate the digital currency sector by requiring businesses that operate virtual currency automated teller machines or trading platforms to obtain a licence to operate in the province.

But the recently published amendments to the Policy Statement of the Money Services Businesses Act (Act) by Quebec’s financial watchdog has drawn criticism from industry observers who assert that it is brimming with ambiguities and risks hindering the burgeoning digital currency industry.

“Time will tell if they will stifle innovation in the province and deter people from starting ATMs there or whether or not people are willing to accept that regulation,” remarked Stuart Hoegner, CPA, CMA, and an international gaming lawyer whose practice is principally focused on cryptocurrencies. “I query whether it provides the certainty that the public really wants, and certainly that business wants – and believe me I have clients that are desperate for regulatory certainty. I really don’t think this provides it.”

Quebec is the only province to regulate the money-services industry. Touted as part of an offensive against money laundering and tax evasion schemes, the Act introduced a licensing regime three years ago that is administered and enforced by the Autorité des marchés financiers (AMF), Quebec’s securities regulator. Under the Act, entities or persons operating automated teller machines or offering such services as currency exchange, funds transfer, the issue or redemption of travelers’ cheques, money orders or bank drafts, or cheque cashing, must obtain a licence from the AMF. In order to obtain a license, money service businesses are required to provide personal information on officers, lenders, business partners, directors and owners for analysis. The AMF, along with local authorities and the provincial police, then reviews submissions and performs background checks in order to issue clearance reports and licenses based on integrity and “good moral character.”

Bitcoin. ATMs. 2015Under the revised Policy Statement, ATMs that sell virtual currencies like bitcoins from an automated distributor and without human intervention is covered by the Act. But apart from digital currency ATMs, it is not clear what virtual currency businesses need to be licensed, noted Jillian Friedman, a Montreal lawyer whose practice is focused on cryptocurrencies. The Policy Statement does not define what a “platform for trading virtual currencies” is and does not spell out whether that means virtual currency exchanges or websites. It is also not clear under what licence category virtual currency businesses fall under, aside from those that operate ATMs,. The Policy Statement identifies five classes of licences, including currency exchange, funds transfers, cheque cashing, the operation of ATMs, and the issuance or redemption of traveller’s cheques, money orders or bank drafts. The virtual currency business community fear that they may fall into the funds transfer category, which could make business onerous.

“There remains a lot of opaqueness as to whether or not certain activities are considered to be funds transfers,” said Friedman, who along with Hoegner, edited a book entitled “The Law of Bitcoin” that is expected to be published shortly. “Clarification about what they mean by a trading platform would be greatly welcome. We don’t know if a person selling bitcoins as a business is a funds transmitter. That is going to be a huge detriment to the growth of the industry because it would make it very onerous to get into the business of selling cryptocurrency.”

A trading platform in the virtual currency business generally involves an online site that allows individuals to buy and sell digital currencies such as bitcoins. These online sites are market makers that connect buyers and sellers, algorithmically. But it is not clear whether the AMF will consider sites that specialize in on-ramp exchanges that convert fiat money to bitcoin and on-ramp exchanges that convert bitcoin to fiat money as trading platforms that require a funds transfer licence, points out Hoegner. It is also not apparent if exchanges that concentrate on cryptocurrency to cryptocurrency conversions will be classified as trading platforms, he added.

An AMF financial markets specialist of the specialized investigation support unit said last month before the Standing Senate Committee on Banking, Trade and Commerce, which is now in the midst of examining digital currency, that if operators of platforms for trading digital currencies transfer money directly from one person to another in transactions, that meets their definition of fund transfer under the Act. “They then have registration obligations, record-keeping obligations and other obligations set out in the legislation,” testified Moad Fahmi.

The AMF also stated before the Senate Committee that digital currency is not comparable to legal tender. They also cannot “currently” be considered to be securities, a position echoed by other Canadian security regulators. However, digital currencies could be part of an investment contract, and that would be covered by the Quebec Securities Act. And while digital currencies are not considered to be derivatives under the Quebec Derivatives Act, the “same derivative with an underlying principle of digital currency would be regulated by the Act,” said Jean-François Fortin, AMF’s executive director of the enforcement branch. The AMF is not aware of the existence of such financial products in Quebec.

Bitcoin walletsBut the AMF betrays a shallow understanding on the challenges faced by virtual currency business, said Friedman. Under section 29 of the Act, money-services businesses must maintain and update certain records and registers, including a register of accounts and bank reconciliation reports, which would allow for auditing. To comply with this obligation, a money-service business that files a licence application must hold a bank account at a financial institution. But it is proving to be a daunting challenge for Canadian cryptocurrency businesses to obtain a regular commercial services bank account, say observers. “That’s another huge hurdle for cryptocurrency businesses,” said Friedman. “If their business model requires them to have a permit, and the permit requires them to have a bank account, it effectively eliminates the potential for this high tech industry in this province, which is unfortunate.”

More fundamentally, the decision by the AMF to regulate the digital currency business illustrates the confusion that state actors suffer from in their attempts to come to grips with cryptocurrencies, observed Michael Citrome, a tax and business lawyer in HazloLaw Professional Corporation in Ottawa. A case in point is the way that the AMF views cryptocurrency ATMs. Instead of viewing them as vending machines, the AMF now treats them as the equivalent of private, fiat currency ATMs. That will lead to problems, said Citrome. For harmonized sales tax (HST) purposes, fiat ATMs are an exempt supply of a financial service, meaning that there is no HST on the fees that the ATM operator charges. But the Canada Revenue Agency has taken the position that bitcoin transactions are bartered transactions, and so HST needs to be charged by the vendor on the value of the purchase of bitcoins.

“There appears to be a mismatch between how the financial regulators understand virtual currencies versus how the tax authorities understand it,” noted Citrome. “People who are developing businesses to advance the technology behind virtual currencies are going to be operating in a state of uncertainty. If we want to be a cutting-edge nation that is open to new technologies and new ways of doing business then you have to have public policy that is consistent across the board where all the stakeholders, both federal and provincial, have the same understanding of what the substance of virtual currencies are.”

The objective behind the new policy is laudable, says Elliot Greenstone, a Montreal lawyer specializing in corporate securities information technology matters. Overseeing the digital currency business marketplace to ensure that the public and investors are protected is a “great” objective. But it will be challenging to police it, he adds. “This is a new area so it’ll be interesting to see how it is regulated,” said Greenstone, a partner with Davies Ward Phillips & Vineberg LLP, who also testified before Senate Committee recently. “It’s unchartered territory so it’ll be interesting to see how the AMF will police it.”

Risk management advisors must be registered with the provincial securities regulator, says court

Independent risk management advisors must be registered with the provincial securities regulator in order to carry on advisory activities related to insurance product offerings, following a precedent-setting ruling by the Court of Quebec that is being hailed as a victory for Quebec consumers by insurance and legal experts.

Up until the ruling Quebec consumers had no recourse against risk management advisors because they operated outside the scope of An Act respecting the distribution of financial products and services (Act) thanks to a loophole in the law.

“This ruling sheds light on what has been considered to be a grey zone,” noted Sylvain Théberge, a spokesman with the Autorité des marchés financiers (AMF), the regulatory and oversight body for Québec’s financial sector. “It’s not because you are an unregistered risk management advisor that the repercussions of the advice being offered will have less of an impact than a consultant who is duly registered. The ruling clearly states that by the very nature of their work these consultants must be duly registered.”

Independent risk management advisors, also known as damage insurance consultants, tend to be hired on a project or retainer basis to help assess and identify risks associated with insurance policies as well as assist with negotiations with insurance brokers. They do not sell insurance, and hence do not receive commissions. The potential gain or loss of commission income does not enter into the decision-making process, which ostensibly eliminates potential conflict of interest. There are no hard figures on how many damage insurance consultants operate in Quebec. But at least one organization encouraged members to use their services. The Union of Quebec Municipalities, which has represented municipalities of every size and in every region of Quebec since its founding in 1919, required its members to hire risk management advisors who were not brokers, agents or insurance representatives.

But on March 2012, after repeated warnings fell on deaf ears, the AMF charged a numbered company operated by damage insurance consultant Claude Descheneaux with three counts of carrying out activities reserved for registered firms and representatives.

Descheneaux argued that there is no mention in the Act that risk management advisors is a profession reserved to brokers, representatives or firms that sell damage insurance. He also noted that Article 6 of the Act states that a damage insurance broker is a natural person who offers a range of damage insurance products from several insurers directly to the public, or who offers damage insurance products from one or more insurers to a firm, an independent representative or an independent partnership. Damage insurance consultants, however, do not offer insurance products and therefore could not have infringed the Act, asserted Descheneaux.

Court of Quebec Justice Monique Perron dismissed his arguments. Justice Perron pointed out that the Act is a law of public order that strives to protect consumers, and it imposes duties and responsibilities on natural or legal persons who offer damage insurance products. Justice Perron added that if the legislator wanted to limit the reach of Article 6 of the Act only to representatives who have the “capacity to sell products,” it would have chosen the expression sell rather than offer. “By using the word offer, the legislator wanted to regulate the greatest number of activities relating to insurance products,” said Justice Perron in her 23-page ruling. She also noted that Article 6 of the Act specifically states that a damage insurance broker also acts as an advisor in damage insurance.

“Whether or not the counsellor sells insurance products, the counsellor plays a role well-beyond of someone who informs a person,” said Justice Perron in Autorité des marchés financiers c. 9111-3258 Québec inc. 2013 QCCQ 13994. “The doctrine in insurance law underlines that a counsellor is an essential actor who guides clients for the best possible coverage…They influence the decision taken by a client to choose one protection over another. After all, the insured consult them to obtain their opinion.”

Justice Perron also pointed out that the simple fact that a risk management advisor does not receive commissions is not a gage of his competence but is “strictly a guarantee of his independence.” She added that the legislator had no intention of prohibiting clients from using the services provided by damage insurance consultants but only that they be regulated by the AMF.

“This is a case where there was a loophole that was exploited by people who did not want to be registered under the guise of being independent,” said Jean Mathieu Potvin, an in-house counsel with La Capitale assurances générales inc. who is also the secretary and treasurer of the Corporation des assureurs directs de dommages du Québec, an industry group representing the Quebec damage insurance industry. “What’s interesting about the ruling is that it states unequivocally that offering advice does not necessarily encompass selling. Whether there is a sale or not, if the advice is inadequate and the consumer suffered harm, the consumer must be protected.”

Yvan Paradis, a lawyer based in the Laurentians who unsuccessfully represented Descheneaux, has a complete different take on the ruling. Paradis, who has in the past worked as a consultant in the former incarnation of the AMF, believes that the ruling may have closed a loophole in the Act but does not respond to the needs of the marketplace. Small business and municipalities will be particularly hard hit by this ruling because they cannot afford to hire a full-time risk management advisor to advise them on damage insurance.

“Insurance representatives and brokers may have a permit but they do not have the experience or expertise in providing advice on damage insurance, especially when risks are complex as is often the case in commercial matters,” said Paradis. “The solution to the problem would be for the government to oblige people who are giving advice over damage insurance to receive training, but that is going nowhere.”

Ironically, says Paradis, the ruling may put into jeopardy the protection of the public. By allowing consultants to be able to offer insurance products and receive a commission, it “considerably modifies his role. He will no longer be independent, and may possilbly lose his objectivity as there is a personal interest involved, that is, the commission he may receive. The conflict of interest is evident,” said Paradis.

Descheneaux, who received a certificate from the AMF as a broker in damage insurance on July 2012, was found guilty of the three charges laid against him by Quebec’s financial watchdog.

Investors delighted but insurers concerned

A ruling that ordered an insurance company to pay $460,000 to a Quebec couple after their financial advisor invested their retirement nest egg in promissory notes in scandal-plagued Montreal financial group Mount Real Corp. has raised questions over the scope of professional liability insurance coverage in the province and ostensibly broadened investor’s protection.

Quebec’s financial and insurance sectors are now worried over the impact of a Quebec Court of Appeal unanimous decision that declared inoperative clauses excluding gross negligence in professional liability insurance policies under the Act respecting the distribution of financial products and services (ADFPS). Law insurance experts are speculating that the finding may have a reach beyond the ADFPS, and affect professional liability insurance policies held by the indemnity funds of Quebec’s 44 professional corporations, including the Barreau du Québec. The Quebec legal society declined to comment.

“Indemnity funds have reason to worry,” said André Bois, an insurance lawyer with the Quebec City law firm Tremblay Bois Mignault Lemay. “They have the same kind of clauses cited in the ruling. This will have an enormous financial impact because by excluding gross negligence insurers face higher exposure to risk” which in turn will lead to higher costs that will ultimately be passed on to professionals who need liability coverage to practice.

Questions have also surfaced over whether the Autorité des marchés financiers, Quebec’s securities regulator, will now accept professional liability insurance policies that contain clauses that exclude gross negligence. AMF spokesperson Cathy Beauséjour said in an email that while the regulator is ensuring that all professionals who operate under the ADFPS are covered by liability insurance, it is too early “to appreciate the impact” the ruling will have. A lawyer who used to work for the AMF said he doubts the financial watchdog will now scrutinize insurance policies to determine if they have the exclusionary clause because it would be a moot exercise. “The court has already established that the exclusion doesn’t apply,” said the lawyer.

Grocery store operators Denis Guillemette and France Mercier lost $232,000 when scandal-plagued Mount Real was shut down by the AMF in 2005, leaving 1,600 investors holding an estimated $130-million worthless promissory notes. The couple, who had little knowledge about financial markets, had entrusted their life savings to financial advisor and planner Yves Tardif and gave him instructions to invest only in secured assets which he did not do. The couple then sued Tardif, his firm iForum Financial Services Inc. and their liability insurer Lloyd’s Underwriters. (Tardif was fined $104,000 last year after pleading guilty to acting illegally as a dealer, aiding with illegal distributions and making misrepresentations in securities transactions. In 2010, he was fined $453,000 for similar violations in connection with the Mount Real matter).

Lloyd’s argued that the couple were partly to blame for their financial woes, and that the financial advisor acted outside the areas of professional responsibility covered by the insurance policy. But in a 36-page ruling that upheld a lower court ruling, the Quebec Court of Appeal in Souscripteurs du Lloyd’s c. Alimentation Denis & Mario Guillemette Inc. 2012 QCCA 1376 dismissed those arguments, and seemingly broadened the scope of  what constitutes “professional activities” covered by professional liability insurance policies.

Willful blindness was not an issue in this case, wrote Justice Marie-France Bich in her reasons. The appeal court found, based on the lower court’s appreciation of the evidence against Tardif, that the financial planner had breached his legal and professional obligations under the ADFPS. Informed by the oft-cited Supreme Court of Canada ruling in Laflamme v. Prudential-Bache Commodities Canada Ltd. 2000 SCC 26, [2000] 1 SCR 638, Justice Bich said that given the complexity of the investment sector and its inherent risks, “it must be recognized that if a person entrusts such decisions to a financial advisor or intermediary because he or she has little investment knowledge, that person is not under an obligation to constantly check and double check when, rightly so, the person has deferred to a professional in order to avoid” doing that.

Serge Létourneau, who successfully plead the case for the couple, said that allowing an investor with little investment know-how to “lower his vigilance” and defer to a professional is an important finding because Quebec courts often have interpreted the relationship between investor and financial advisor as a business relationship. That means that investors had to demonstrate that they paid the same attention and care as they would in a business relationship in their dealings with financial advisors. “The essence of a professional relationship is confidence, and this confidence allows an individual to defer to a professional,” said Létourneau, founder of  the Quebec City law firm Létourneau Gagné.

But Yan Paquette, a Quebec City litigator specializing in financial markets, warns that investors with limited knowledge do not have a free pass. Last October the Quebec Court of Appeal in Immeubles Jacques Robitaille inc. c. Financière Banque Nationale 2011 QCCA 1952 held that “even less seasoned” investors must be prudent, collaborate with the financial advisor and make a minimum effort to understand financial markets. Coupled with the Lloyd’s decision, Paquette says the appeal court is clearly stating that a financial advisor’s duty to inform is directly proportional with an investor’s knowledge. “The Lloyd’s decision places a burden on financial advisors to respect its duty to inform, said Paquette of Langlois Kronström Desjardins in Quebec City. “The less an investor understands the financial markets the greater burden a financial advisor faces to inform the client, and the reverse is true.”

The Lloyd’s ruling has also drawn concerns over what constitutes “professional activities” under liability insurance policies. Lloyd’s argued that since Tardif illicitly procured financial products governed by the Québec Securities Act, his actions were outside the scope of professional activities covered by the insurance policy. But the appeal court held that Tardif’s actions should be viewed as a whole, and that his unauthorized actions were the manifestation of improper financial planning. Since “the harm suffered by the couple stems directly from his bad financial planning,” the fault arose out of services governed by the ADFPS and therefore meets the definition of professional activities covered by the insurer.

“This ruling says that there can very well be a link between offering advice while performing financial planning and the act of selling financial products,” remarked Létourneau. “Each should not be examined separately. That finding has plainly overturned conclusions reached by Superior Court judges in other cases.”

Létourneau now wonders whether the provincial financial regulator will compel financial professionals to obtain insurance coverage that will encompass all activities as opposed to coverage that is limited to professional activities they are authorized to perform.

At the very least the finding will lead insurers and professionals to closely examine professional liability insurance coverage, says Bernard Larocque of Lavery, de Billy in Montreal. Thanks to the ruling, the scope of professional activities must be considered in light of the specific circumstances surrounding the case and all of the actions taken by the financial professional to determine if the fault is covered by the insurance contract, added Larocque.

Lawyers representing Lloyd’s declined to comment.

Quebec first province to regulate money-services industry

A recently passed bill that made Quebec the first province to regulate the money-services industry has elicited mixed reactions, drawing praise by some who see it as a blessing for legitimate small businesses catering to ethnic communities, unease by others who are concerned about the potential broad reach of the law, and baffled some legal observers who wonder why the provincial government appears to be duplicating an already existing federal law.

Touted as part of an offensive against money laundering and tax evasion schemes, the Money-Services Businesses Act (Act) introduces a licensing regime for money-services businesses that will be administered and enforced by the Autorité des marchés financiers (AMF), Quebec’s securities regulator.

Under the Act, entities or persons operating automated teller machines or offering such services as currency exchange, funds transfer, the issue or redemption of travelers’ cheques, money orders or bank drafts, or cheque cashing, must obtain a licence from the AMF. They must also disclose information about their directors, officers and associates as well as certain types of lenders they deal with.

The Act does not apply to entities, such as banks, already governed by other specified legislation. But it does apply to both Quebec-based money-services businesses and money-services businesses that are either not constituted under Quebec legislation or do not have their headquarters or establishment in the province but who offers services in Quebec, including money services through the Internet.

“This legislation is a blessing for legitimate small businesses,” remarked Terry Didus, a banking and finance lawyer with Heenan Blaikie in Montreal. “One of the consequences of being in the money-services business, and being unregulated, is that it is extremely difficult for those small businesses to get Canadian banks to agree to provide banking services. There will be more paperwork and reporting but it will make their life easier.”

Not all business share this view, particularly since the regulations are not yet finalized. Though the legislative process, from the introduction of Bill 128 to consultations to a detailed study by the National Assembly’s Committee on Public Finance to its adoption, took an astonishingly short period of time, a mere month, the regulations are only now being written by the AMF. “The devil is in the details,” said Martine Hébert, vice-president of the Canadian Federation of Independent Business(CFIB), Quebec. The CFIB is concerned that regulatory compliance may be far too burdensome and expensive for small business that simply host automated teller machines as a value-added service for their clients.

“Even if you subscribe to the objectives behind the law, it is how it is going to be done that is of concern to us,” said Hébert. “We’re worried about the regulations, and what will it do, what shape it will take and how it will affect our members.”

The scope of the regulations is also a source of preoccupation for Western Union Financial Services (Canada) Inc. Though not opposed to the new Act nor to its regulatory framework, Western Union is however keen on receiving more clarity, said Derek McMillan, the director of anti-money laundering compliance for Western Union Canada.

“There are a lot of things we don’t know yet,” said McMillan. “When the Act first came out, it seemed to suggest that identification on people transmitting funds would be required for every transaction. However, that is left to the regulation. That is one example of what it is that is going to be required.”

Western Union Canada, like others, are also worried about how the Act will mesh with the federal Proceeds of Crime (Money Laundering) and Terrorist Financing Act, given that it seems to cover the same ground. It remains to be seen whether the regulations the AMF will propose will streamline administrative and compliance requirements with the federal authorities, says Jaime Brown, Western Union Canada’s assistant general counsel. “There are some record-keeping and recording requirements in the Quebec Act that we’re not sure how they mesh with our federal obligations,” noted Brown. “We want to make sure that the discrepancies between the new legislation in Quebec and some of the federal compliance obligations are resolved.”

Alix d’Anglejan-Chatillon, a partner in the Montréal office of Stikeman Elliott LLP, believes that the regulations will need to underscore the differences between the two pieces of legislation because as it stands the Act is “problematic,” if only because “you’ve got two overlapping sets of rules” that are regulating the same industry. D’Anglejan-Chatillon suspects that the Quebec government moved at lightning speed to adopt the law in order to assert its jurisdiction.

“The underlying impetus for passing the legislation so quickly is perhaps the political desire to be seen as really combating tax evasion and money laundering at a provincial level,” said d’Anglejan-Chatillon, who practices principally in the areas of investment management, the regulation of capital markets and derivatives.

That is something that worries John Teolis, a partner in the Financial Services Group with Blake, Cassels & Graydon LLP. Noting that regulation is “very costly,” Teolis wonders whether Quebec’s efforts to regulate the money-services industry will be emulated by other provinces and lead to a situation “like our securities legislation where we have provinces occupying the field and requiring one to deal with individual provinces as opposed to the federal government.”

Teolis is also uncomfortable over the reach and scope of the AMF’s powers. The Act, he points out, has provisions that provide and allow for sharing of information between the AMF, the Quebec tax department and law enforcement agencies, particularly with respect to licensing decisions. Indeed, the Act gives the provincial police force the power to issue security clearance reports which the AMF will use to decide whether or not to issue a licence.

“It’s very broad,” said Teolis. “You always worry when agencies have very, very  strong investigative powers, and what they do with that information. So there is some concern.”

New indemnity fund proposed following out-of-court settlement in Norbourg class-action

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.

Investor complaints rising

Thanks to an economy that is still in doldrums and equity markets showing few signs of solid recovery, a growing number of investors faced with the prospect of shrinking investment portfolios are lodging complaints with provincial and federal bodies that oversee the investment community.

The federal Ombudsman for Banking Services and Investments (OBSI) and the Quebec Chambre de la sécurité financière are reporting dramatic increases in investor complaints since the beginning of the year while Quebec’s financial watchdog, the Autorité des marchés financiers (AMF), has received a surging number of calls requesting information over investment products.

Indeed, the Ombudsman has received so many calls over the past ten weeks that it has already opened up more files than it did in all of 2006 when it received 328 complaints, 197 of which led to investigations. The OBSI is the national dispute resolution service for customers of more than 600 financial institutions, including domestic and foreign banks, investment dealers, trust companies, mutual fund dealers, credit unions and scholarship trust plan dealers. Established in 1996, OBSI reviews unresolved disputes between consumers and firms, and may recommend compensation up to $350,000. An alternative to the court system, OBSI is free to consumers.

“We certainly anticipated a busy year, given what is going on in the economy, but it is showing no signs of abating,” said David Agnew, who stepped down as Ombudsman last May to become the president of Seneca College. “In fact, quite the opposite. It’s picking up.

“I think people are reacting quicker, and that’s a good thing because it’s always easier to address a file that you see sooner than later. Memories are sharper. Records are intact. People are still in the jobs they’re in.”

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