Business

A Royal Bashing

Regulators accuse top Bay Street players of share manipulation

John Nicol July 10 2000
Business

A Royal Bashing

Regulators accuse top Bay Street players of share manipulation

John Nicol July 10 2000

A Royal Bashing

Business

Regulators accuse top Bay Street players of share manipulation

John Nicol

Now that most stock exchanges have become noiseless, traderless computer centres, the hysteria of share dealing has shifted to brokerage houses. The trading floors, usually in sleek office towers, need extra air-conditioning to take away the heat of activity: traders intertwined with securities salespeople, all huddled around a jumble of desks and computer screens amid a cacophony of conversations and occasional shouts. Top traders can make close to $1 million a year for their quickthinking, quick-acting ability to handle the talk and watch as many as four screens for news breaks and market changes, all the while making deals by phone. In this den of confusion, the discussions are taped to protect buyer and seller from errors. The tapes are also there, as every broker across the country now knows, when the regulators come calling.

Investigators for the Toronto Stock Exchange and the Ontario Securities Commission used tapes of conversations between brokers and RT Capital Management Inc., one of the country’s largest, most respected investment houses— owned by the stately Royal Bank of Canada—to teach Bay Street a big lesson: an esoteric practice called “high closing” will not be tolerated. The tapes, including a boast that TSE regulators were too “stupid” to detect their illegal trades, led to the exposure of the difficult-to-prove practice of artificially boosting the price of a stock by purchasing shares just before the market closes, on or near the last day in the month or quarter. If the value of a stock, for example, goes up in a pensionfund portfolio, it enhances the fees, bonuses and reputations for the trader, the fund manager and the financial institution.

Denizens of Bay Street maintain the practice has little or no impact on investors, and only a minuscule impact on fees paid out by pension funds. But Michael Watson, director of enforcement at the OSC, is fed up with the downplaying of the offence. “It’s not like getting caught speeding,” he told Macleans. “It’s like fraud, creating a false appearance in the market.” And if unwitting citizens happen to buy just at the wrong moment around the turn of the month, they could end up paying far too much for a stock.

The impact of last Thursday’s charges against RT Capital

and nine of its employees and directors, plus 13 traders at 11 outside brokerages, was immediate. The hard-hitting move enhanced the reputations of investigators at the TSE and particularly the OSC, which was laying its fourth set of major charges in the past year. Key pension funds were reconsidering whether to invest with RT Capital, which was part of the Royal Trust group that the Royal Bank bought in 1993. The City ofToronto held back $6 million it had planned to add to its $ 100-million account. Other clients include IBM Canada Ltd., Noranda Inc. and DaimlerChrysler Canada Ltd. And John Carson, senior vice-president of market regulation at the TSE, vowed that more investigations into high closing were near completion. “We still have a problem,” he said at the end of a tumultuous week. “This is a serious market integrity issue that is clearly a violation of our rules. For those who aren’t listening, we will treat it even more severely should it recur.” The TSE investigation began when regulators detected a series of trades between Oct. 30,1998, and March 31,1999, that exhibited the hallmarks of high closing. Upon further investigation, RT Capital kept popping up as the house making the orders. The TSE demanded and got the tapes from the

brokerage houses and, with so much evidence pointing towards RT Capital, asked the OSC to obtain tapes from the firm it regulates. These included conversations between RT traders and their bosses, fund managers Peter Larkin—steward of about $ 13 billion—and Gary Baker. According to the OSC, once RT learned of the inquiry last September, the phone system was reconfigured to stop taping Larkin’s and Baker’s talks with RT traders Patrick Shea and Marion Gillespie.

Watson says the evidence revealed such “a level of comfort between traders and brokers”—openly discussing and joking about high closing—that it seemed representative of a wider problem. “If one of the funds that has one of the best reputations going thinks the rules aren’t important enough to pay attention to, we felt obviously they were not setting the right standard for the rest of the industry.”

Not that the rest of the industry looks much better. On Bay Street, nearly everyone seems to agree that high closing is common. “It’s caused by the competitive nature of the business,” says John Gilfoyle, an investment consultant at Watson Wyatt WorldWide in Toronto who has placed a number of his clients with RT Capital. “It’s very competitive—they have to beat the guy across the street.” One leading Toronto mutual fund manager said high closing is such a known factor he routinely sells certain shares at the end of the month, when he knows traders will push up prices. He then buys again a few days later when the stock comes down. Analysts call it the “month-end” effect.

Part of the problem is that the industry’s expectations have “become so unrealistic,” says Glorianne Stromberg, a former OSC member. “There is such pressure to get accounts, to keep accounts, to keep your job, to maintain and increase your compensation.” Investors, she adds, also expect unrealistic minute-by-minute performance. The pressure-

cooker atmosphere skews the judgment of traders and fund managers.

“And they don’t see what they’re doing as being wrong either in a legal sense or a moral sense.”

As of late last week, 12 of the 13 outside brokers accused in the scandal had agreed to penalties imposed by theTSE, although no details will be released until the agreements are reviewed by a three-person panel. Meanwhile, RT Capital had admitted to high closing and vowed to repay its customers, but none of its nine employees had agreed to the undisclosed sanctions, such as fines and suspensions, sought by the OSC. The whole process irritates Stan Buell, founder of the Markham, Ont.-based Small Investor Protection Association. “We would like to see them able to order restitution to the victims of these crimes,” says Buell. “The reason these practices continue is that the fines have to be agreed upon.”

Other observers believe the charges came about precisely because of greater public scmtiny. The OSC, under the twoyear leadership of chairman David Brown, has secured more funding and investigators, and this has led to high-profile securities charges, as yet untried, against Corel Corp. founder Michael Cowpland and officials of magnet maker YBM Magnex International Inc., including former Ontario premier David Peterson. The OSC’s Watson says the TSE, too, has shown it has a system in place—skilled investigators using sophisticated technology—to put more transactions under scrutiny. And with the successful use of recorded conversations, both organizations will be paying special attention to any company that decides to fiddle with its tape machines.

Tom Fennell

Brenda Branswell

ANATOMY OF A SCAM

Two key employees of RT Capital Management Inc., executive Peter Larkin and trader Patrick Shea, are among those accused of inflating share prices at or near the end of a month to make their funds’ performances look better. The methods are known as “high closing”—buying shares at a deliberately raised price near the day’s close—and “cross-trading”—selling shares between client accounts at artificially high prices. Here is what the Ontario Securities Commission alleges happened with one stock, Dia Met Minerals Ltd.:

OCT. 30,1998

On Larkin’s instructions, Shea buys 6,800 shares at five cents above the last trade, pushing up the value of RT’s holding of 1.16 million shares—as well as the overall value of Dia Met.

Added portfolio value: $58,060 Increase in Dia Met’s value: $411,079

Two key employees of RT Capital Management Inc., executive Peter Larkin and trader Patrick Shea, are among those accused of inflating share prices at or near the end of a month to make their funds’ performances look better. The methods are known as “high closing”—buying shares at a deliberately raised price near the day’s close—and “cross-trading”—selling shares between client accounts at artificially high prices. Here is what the Ontario Securities Commission alleges happened with one stock, Dia Met Minerals Ltd.:

DEC. 30 AND 31,1998

On two days, Shea buys a total of 1,900 shares at 50 cents above last trade. Total added portfolio value: $1,197,950 Total Increase in Dia Met’s value: $8,210,774

19

18

17

16

15

14

NOV. 30,1998

Shea buys 9,400 shares at a 55-cent premium.

Added portfolio value:

$652,245

Increase in Día Met’s value: $4,521,866

FEB. 26,1999

Shea buys 500 shares at 50 cents higher, boosting the value of a holding that is now 1.36 million shares.

Added portfolio value: $678,500 Increase In Dia Met’s value: $4,131,937

Closing price for Dia Met Minerals Ltd. A-class shares

October

1998

November

1998

December

1998

January

1999

February

1999

March

1999

brokerage houses and, with so much evidence pointing towards RT Capital, asked the OSC to obtain tapes from the firm it regulates. These included conversations between RT

MARCH 30 AND 31,1999

Shea buys 100 shares at $17.25, 25 cents over par, on March 30. The stock falls back to $17 the next day, and the company pays fully $1.50 extra to buy another 500 shares and cross-trade 10,000 between funds run for the City of Toronto and the Canadian Medical Protection Association.

Added portfolio value: 32,070,750 Increase In Dia Met’s value:

$12,395,811

cooker atmosphere skews the judgment of traders and fund managers.

“And they don’t see what they’re doing