The made-in-Canada Asset-Backed Commercial Paper (ABCP) fiasco has caused a lot of a pain. It has attracted massive media attention. In fact it’s just one more example of financial assault. We could add the Norshield fund fiasco, the mutual fund market timing scandal. the Portus hedge fund meltdown, Nortel , Bre-X, Income Trust failures and many more. ABCP however was a loud wake up call for the Government.

Where were the so-called provincial securities regulators and the IDA? How could the Office of the Superintendent of Financial Institutions have allowed a gaping loophole that allowed our banks to walk away from providing emergency funds? How could Canada’s credit-rating agency, DBRS Ltd., have given a R1 rating to non-bank ABCP? Why were these Notes sold to people when it was clear there was a looming liquidity crisis? Why didn’t the Competition Bureau investigate alleged misrepresentations by the financial services industry?  What happened to the complaint system? Why weren’t retail investors at the Crawford bargaining table? Why is Main Street being asked to vote on a proposal that destroys their lives and is fully immunized from legal action?

Much of the current crisis was born by dealers apparently not knowing or not disclosing what exactly was in the Notes but selling them anyways. The lack of transparency led to a refusal to rollover when questions arose regarding the impact of the U.S. sub prime market on Canadian ABCPs. Valuations could not be established and liquidity vanished. The website http://investorvoice.ca/ABCP/ABCP_index.htm  provides a complete commentary on the crisis including the House of Commons Standing Committee on Finance Hearings. The impact on retail investors is enormous. Financial distress, emotional stress, marital discord, health problems and likely a lot more serious issues we’ll be hearing about.

Yet a number of misguided articles lay blame on the unsuspecting victims. Claims are made that they were greedy. They knew or should have known what they were being sold. They unquestioningly trusted their advisers.

The reality of the ABCP crisis

According to press reports, victims were not chasing returns. They wanted a safe haven to park short-term money. Most had no history of being even moderate risk takers. Many were seniors and retirees living on fixed income. Advisers told them the Notes were as safe as GIC’s, guaranteed and liquid—a savings product. Some reported unauthorized trading, totally surprised at what was in their account when they pored over their client statements. Others say that the statements continued to show face value even when this was obviously not the case. The toxic character of these ABCP Notes was never revealed to retail investors. A number found out about the crisis only when they needed access to the cash. Complaints were rebuffed or ignored by firms and regulators. In short, the entire investor protection system failed.

The impact

Some of the other ABCP stories are heart breaking. Seniors, pensioners and retirees do not have the luxury of time to rebuild their lost portfolio assets. Indeed, if some of the major banks had not voluntarily decided to bail out their money market mutual funds and retail owners of non-bank ABCP (National Bank capped its cash settlements at $2 billion) the situation would be far worse and would have affected tens of thousands of people. Retirees with RRIF’s face serious portfolio meltdown yet must according to law continue to make minimum annual withdrawals from a reduced asset base. Questions abound as to how sub-prime mortgages found their way into what is generally considered a safe, conservative savings product. Besides the obvious financial impact, there was a horrible human impact.

When a financial loss has occurred the stress is high. When attempts to resolve a complaint under the current dispute resolution system inevitably fail, the stress and frustration is multiplied. Canada’s dysfunctional complaint and dispute resolution system is a well recognized and documented issue. This made a very bad situation even worse.

So what did we learn ?

We learned that regulators like OSFI don’t examine risks closely enough. We learned that Dealers too readily accept Credit Ratings without adequate due diligence. We learned that financial advisers did not understand what they were selling but made unsubstantiated assertions regarding the safety and liquidity of the Notes. We learned that regulators failed to act decisively even in the face of growing, well-publicized complaints. We learned that when bad things happen, the retail investor is left to drown. We leaned that individual investors had to take matters into there own hands or suffer a nasty fate .Thankfully, they did.

The Bottom line

Small investors are increasingly exposed to financial assault with devastating effect to the social fabric of the country and the economy. ABCP is just the latest. A recent IMF report made it clear that Canada is hugely deficient in the white-collar crime enforcement arena. The Government and the Courts must, with uncharacteristic urgency, initiate major reforms. Billions of dollars are unduly lost each year and the trend is unfavourable. ABCP alone is a $350+ million problem (excluding lost interest on the Notes) for retail investors. In the end, the abused investors will be a drain on the social security system if they are not made whole.

We need a well-resourced industry-independent national investor protection Agency with teeth that would help prevent these issues and would actually enforce securities laws.
We also need a new securities crime complaints intake and assessment system to be jointly administered by the RCMP IMET and the regional and municipal police forces that have fraud squads. We need to re-assess the role of SROs and the certification and registration of  advisers who sell financial products to retail clients. We need a judicial system that treats white collar crimes as serious crimes against citizens.

As to dealing with complaints, an Ombudsman created by Parliament as is the case in the UK  and elsewhere is required to replace industry—funded OBSI and its restrictive rules of engagement. An International Standard such as ISO 10003 Quality Management - Customer satisfaction—Guidelines for dispute resolution external to organizations should be considered for this purpose.

Will the culprits behind this mess be made to account? Will any reforms take place? Who knows? Perhaps this latest fiasco has enough momentum to get some traction for change. In the meantime, it’s CAVEAT EMPTOR.

Ken Kivenko P.Eng.
Kenmar Associates
kenkiv@sympatico.ca