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April 10, 2001

Don't get even, get mad

Jonathan Chevreau
Financial Post

A bull market can cover a multitude of sins at full-service stock brokerages. Sins of commission or of omission are more easily forgiven by clients as long as they are making some money.

But when bear markets arrive and inflict crippling losses, securities regulators brace themselves for a quintupling of investor complaints, such as the ones revealed in the Financial Post in the past week against senior investment executives at BMO Nesbitt Burns.

What we are seeing is the inevitable consequence of a bull-market. It's not a pretty picture and we've only seen the tip of the proverbial iceberg. "The market's basically collapsed. People on margin have been taken to the cleaners. It's quite catastrophic what's going on," says Robert Goldin, author of Investor Beware: Protect your investments from broker misconduct.

Mr. Goldin says he has been swamped with calls in recent weeks from investors wondering whether they should sign so-called "happiness letters" being sent to them by brokers. He suggests that investors NOT sign them, since they may take the brokerage house off the hook if the client later wants to go to court over losses resulting from investments unsuitable to their stated risk tolerance.

In theory, a full-service brokerage relationship involves a partnership between broker and customer. The latter should have the final say on investments. But as trust develops after a few winning trades, the busy client may stop paying attention to monthly statements. That opens the door for a less than scrupulous broker to act in effect as a "discretionary" manager -- buying and selling securities in a client account without getting approval.

Again, in a bull market, no client will be too upset when such trades go their way. But when markets reverse the broker granted de facto discretion can put his client deep in the hole in a desperate attempt to "catch up" or even conceal past losses.

Cases involving inappropriate investments, churning (excess trading of securities to generate commissions), opening up unnecessary margin accounts and other breaches of fiduciary duty have been going on a long time in Canada, says a former securities regulator who didn't want to be named.

Many small investors automatically put their trust in the advisory arms of this country's large financial institutions just because they're household names. They assume senior management and compliance departments are checking up on the trading practices of a firm's advisors but forget it is senior management that is also driving the brokers to "perform" with commission-generating trades.

"The issue is how skewed is compliance when the compensation system rewards the very behaviour that hurts the individual investor," says the former regulator.

There really is no one looking out for the consumer/investor. In theory, the provincial security commissions are supposed to protect investors, but they have largely offloaded their duties to self-regulatory organizations, such as the Investment Dealers Association.

What's most troubling in the current cases is the seeming breakdown in the ability of the self-regulatory system to do just that. SROs have to juggle both the needs of the industry they serve as well as that of their customers -- and the two can come into conflict.

Unfortunately, the lone investor going up against one of the big banks is in for a long, hard slog. Even if they win in court, they're likely to end up settling for only 50¢ on the dollar.

Sadly, Canadian investors have had plenty of warning from a handful of investor advocates for at least the past five years. For the most part, they have been ignored, although their respective Web sites draw together communities of aggrieved investors.

For disgruntled Nesbitt Burns customers, the lightning rod is Jim Roache, a retired public servant who lost some retirement savings at the firm. His site [www.http://members.home.net/jfroache/nesbitt.html] chronicles four years worth of investor complaints. Some horrendous cases aren't even on the site, such as that of a Manitoba quadriplegic whose $750,000 insurance settlement fell by $600,000.

Roache puts some of the blame on the broadcast media, which paid more attention to being a cheerleader for the growing stock market bubble in the late 1990s than warning investors about possible abuses.

But the problems exposed at his site extend far beyond the Bank of Montreal. Another investor advocate, Stan Buell, runs the Web site of the Small Investor Protection Agency (www.sipa.com), which chronicles complaints against CIBC Wood Gundy and other brokerages.

In the mutual fund arena, Joe Killoran (www.investorism.com) and Hans Merkelbach (www.strategicsector.com) also do what they can to educate investors before the horse slips past the barn door.

Roache has no quibble with the country's discount brokers, which after all, don't pretend to be giving full-service advice. His mission is against full-service brokers that charge top dollar for allegedly good investment advice and then provide the polar opposite.

It's the conflict between bull market greed and bear market performance. As almost always happens, the small investor pays the price.

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