One way to clean up Canadian stock markets
by Larry MacDonald
January 8, 2004

Offshore brokerage accounts are the bane of the Ontario Securities Commission (OSC) and other provincial securities commissions. Unable to identify the beneficial owners of such accounts, commission staff keep "running into brick walls in substantial investigations," according to OSC enforcement director Michael Watson.

In other words, regulators just can't pin the tail on many of the donkeys who do end-runs around securities laws. And it means that a good portion of the trading on Canadian stock exchanges is actually illegal: it's buying and selling by shell companies controlled by an assortment of scallywags that includes corporate insiders dodging reporting requirements, stock pools manipulating share prices, brokers front-loading their personal accounts, and mobsters investing the proceeds of crime.

Once in a while, regulators get a break and gather enough evidence to lay charges, such as those recently laid against ATI Technologies executives for illegal insider trading (through a Turks and Caicos account). Another case now before regulators involves a Pacific International Securities broker who set up Bahamian accounts for U.S. criminals (who subsequently bought and sold millions of dollars worth of stocks).

Its not just investors with stock portfolios who are getting ripped off, fleeced, and skimmed by this motley crew. It is also the ordinary Joe whose paycheque is deducted for contributions to a company or government pension plan. In trying to get a decent return on the monies entrusted to them, pension fund managers face an uphill battle investing in a stock market distorted by all the shenanigans and skullduggery.

Holders of offshore accounts don't have to travel to some faraway, tiny country to set up their schemes. A visit to a Canadian bank or brokerage firm suffices. This seems rather odd — if someone is aiding and abetting criminal activity, it would normally be judged a criminal offense.

According to a 2001 survey by four provincial securities commissions, Canadian brokerages had set up about 13,000 offshore accounts in the 23 countries blacklisted by the Organization for Economic Cooperation and Development (OECD) for their uncooperative stance on secrecy laws. Included on this list were the usual suspects, such as the Marshall Islands, Nauru, and Cook Islands. But there were also some unexpected entries, such as Israel.

Offshore accounts are not necessarily bad per se. What is inexcusable is the failure of Canadian brokerages to apply the same know-your-client rules that their self-regulating trade association, the Investment Dealers Association (IDA), requires them to follow in the case of domestic accounts.

That is, they should at least be identifying the beneficial owners of offshore accounts, if not also meeting other conditions of the know-your-client rule, such as ensuring orders are within the bounds of "good business practice." True, the IDA has "due diligence" guidelines, but they do not stipulate mandatory collection of data. Not surprisingly, the 2001 study by provincial commissions found only a handful of offshore accounts that adequately identified their owners.

The OSC and other provincial commissions have pressured the IDA to tighten the disclosure rules. But the IDA has given a fine performance of foot dragging. Last year, it circulated a draft of proposed standards to provincial securities regulators, which was rejected because it required members only to ask who the beneficial owner of an offshore account was (i.e., if the applicant refused, the account could still be opened).

After its proposal was rejected, the IDA announced it would hold off introducing another until it could find out what international agencies were going to recommend. So more time was allowed to tick by, creating the impression that the IDA was content to stall.

Last June, the IDA was jolted out of its inactivity. Two days after the OECD called on financial institutions to monitor offshore accounts, the IDA responded with its new proposals.

It offered to require member firms to verify the identity of the beneficial owners of offshore accounts "no later than six months" after the account is opened; in the case of existing accounts, "members will have one year after implementation to obtain the information."

Plainly, this is more of the same subterfuge. It still allows offshore operators to stay a step ahead of the rules. All they have to do is close their account before the six- or 12-month time limit, and then open a succession of new accounts of less than six months duration.

Who does the IDA think they fooling? Well, some Canadian financial dailies, actually. They seemed to take the IDA news release at face value and reported a "crackdown" was at hand. But this is no crackdown: it's just more of the same kind of rule-making that gives the appearance of reform while de facto protecting the status quo.

There seems to be only one conclusion to draw from the behavior of the IDA. It is a serious indictment of the Canadian securities regulatory system. The delegation of regulatory functions to so-called self-regulating organizations (SRO) just does not seem to be viable when the SROs are also trade associations whose primary loyalties are to their members.

The IDA track record on offshore accounts is a prime example of why the Canadian system is failing in its reputed goal of protecting Canadian investors. The only real solution is to separate the two functions of securities regulation and representation of membership interests.

Regulatory oversight needs to be taken over by a body free of conflicts of interest. And the IDA should not have to be put through the sham of representing the public interest. It should be cut loose to pursue industry interests in an unrestricted manner.


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