Business

Breach of Trust

The Royal Bank’s pension arm is hit with some of the toughest penalties ever imposed on dealers—but critics say it’s not enough

D’Arcy Jenish July 31 2000
Business

Breach of Trust

The Royal Bank’s pension arm is hit with some of the toughest penalties ever imposed on dealers—but critics say it’s not enough

D’Arcy Jenish July 31 2000

Peter Larkin, the man at the center of one of Bay Street’s biggest-ever stock manipulation scandals, walked briskly last week from a disciplinary hearing at the Ontario Securities Commission—head down, shoulders stooped, and not a word to say for himself. Right behind him were eight colleagues from Toronto-based RT Capital Management Inc., including chairman Michael Edwards. They were equally tight-lipped. Small wonder. The OSC had just levied a $3-million fine on RT Capital, the pension management arm of the Royal Bank, Canada's largest financial institution. In addition, there were individual penalties, ranging from Edwards’ one-month suspension from any involvement in financial markets, to Larkin's lifetime ban on trading securities for others, and a stinging rebuke from the three-member panel that presided over the hearing. “Such actions will not be taken lightly,” OSC vice-chairman Jack Geller said of the trading techniques that led to artificially high values for some of RT’s pension funds. “Investors have the right to be dealt with fairly.

”Immediately after the hearing, Royal Bank vice-chairman Reay Mackay announced that six employees implicated in the scandal were resigning and another was retiring. Edwards was removed as RT Capital chairman but remains a director, while one executive had already retired. Also caught up in the affair were 13 outside brokers, 12 of whom acknowledged their roles and received trading suspensions of up to 2-1/2 months, as well as fines totaling $390,000. The bank, meanwhile, moved quickly to restore credibility by appointing former Tory finance minister and RBC Dominion Securities vice-chairman Michael Wilson as chairman and chief executive of the beleaguered subsidiary, which manages $37 billion worth of pension funds on behalf of major corporations such as Air Canada, Noranda Inc. and IBM Canada Ltd. “He has an impeccable reputation for integrity,” said bank spokesman David Moorcroft. “We wanted a guy like that so people know were taking this seriously.”

But several observers questioned whether the bank, or the OSC, had acted decisively enough. Montreal-based investment adviser Stephen Jarislowsky said future stock trading scandals will occur unless the corporate cultures of companies like RT Capital change. Too many firms, he says, offer employees lucrative bonus plans and apply intense pressure to meet performance standards, practices which encourage staff to bend the rules or cheat outright. “They’re going to catch more of these people,” Jarislowsky says. “If you can collect a $100,000 bonus for beating a stock market index and you’re just below it, what are you going to do? The incentive tempts people to be dishonest.”

Others said they were disappointed that the penalties were not stiffer. Mark Slipp, managing director of Marshall Capital Corp. in Toronto, described the $3 million fine as “not even as harmful as a parking ticket” for a company connected to an institution like the Royal Bank, which made $1.7 billion in profits last year. And Toronto pension lawyer Murray Gold said the OSC did not deal harshly enough with RT Capital’s six-member board, which rarely met, and failed to impose adequate controls on its employees. “They got a slap on the wrists,” said Gold.

The commission came down hardest on four employees—investment fund managers Larkin and his colleague Gary Baker, as well as stock traders Patrick Shea and Marion Gillespie—who indulged in a practice known as the “high close.” On 53 occasions between Oct. 30, 1998 and March 31, 1999, they bought shares in companies listed on the Toronto Stock Exchange just before the market closed at 4 p.m. The objective, according to the OSC, was “to create or maintain an uptick in the closing price, or alternately, to prevent or rectify a downtick.”

Larkin was the prime mover in the scheme, personally ordering 43 of the last-minute purchases. In one case, he instructed Shea to buy 1,200 shares of Multibank NT Financial Corp. at $103 apiece, whereas the price on the previous trade was only $90. In effect, Larkin and Shea artificially added $ 13 to the value of every Multibank share outstanding, including nearly 265,000 held in one RT Capital portfolio. The net increase in the value of those shares was $3.4 million. All told, Larkin and his colleagues used the high close to pump up the value of their portfolios by nearly $38.6 million.

In almost every case, they indulged in the practice at the end of the month, when portfolios are evaluated for use in compiling quarterly statements to clients. Fees are based on these values, meaning RT Capital could charge their clients more when the performance of the funds appeared to improve. The employees also stood to gain by meeting performance targets, and earning cash bonuses based on growth in the portfolios they managed. According to the OSC panel, RT Capital clients did pay higher fees due to stock manipulation, although the commission did not specify the actual amount. But the most serious issue was the breach of trust. “Clients have the right to assume that purchases and sales will be made for their benefit,” said Geller, “and not for the benefit of the adviser.” www.macleans.ca for links


High-flying traders were brought down by a telephone taping system installed to prevent errors


The scheme began to unravel when TSE market surveillance officials noticed the series of high closes on the final trading day of the month. They checked to see who was buying and selling, and found RT Capital was involved in most of the transactions. According to the OSC, Larkin, Baker, Shea and Gillespie knew that the exchange was monitoring late trades, and the two traders worked with outside brokers to conceal their actions. But they were undone by a taping system installed at RT Capital in early October, 1998 to record conversations between employees and outside brokers, which has become routine in the industry to avoid errors. They did not know that the system was capturing internal discussions as well.

A year-long investigation by the TSE and OSC ended on June 29 with the announcement of the allegations. The company could have opted for a full hearing before a securities commission panel at which both sides could call witnesses and present evidence. Instead, RT Capital negotiated a quick settlement and absorbed the fine. But there was one big plus for the company—the tapes and other incriminating evidence did not become public.

The OSC trumpeted the RT Capital case as a sign of a new get-tough policy toward companies that play fast and loose with investors. Commission spokesman Frank Switzer says the 80-member enforcement department has doubled in size over the past two years, and the budget has grown from $22 million to $46 million in the same period. Those changes followed the appointment of David Brown, who left a major law firm, Toronto-based Davies, Ward & Beck, to become chairman in April, 1998 and was determined to strengthen the OSC. “It’s all part of a plan to become a more vigilant watchdog,” said Switzer.

But some observers are looking for a commission that carries an even bigger stick and packs more wallop. Gold says the OSC should have levied a bigger fine, or imposed tougher penalties on the directors and senior executives in order to send a message about effective corporate governance. The six-member board of the company, according to the OSC, “did not convene on a regular basis and rarely, if ever, met formally in person or as a group.” Worse still, senior executives failed to monitor trading practices of portfolio managers and the traders who worked under them. “The board did not take its responsibilities seriously,” says Gold. “The absence of checks and balances was embarrassing.” And the consequences—a financial scandal, careers ruined and reputations in tatters— will be felt on Bay Street for years to come.


The OSC’s sweeping investigation flushed out RT Capital board members, managers and traders

SUSPENDED: MICHAEL EDWARDS, Chairman and director. Also president and CEO of the parent company, RT Investment Management Holdings Inc.

Penalty: Prohibited from being a director or officer of any public company or other market participant in Canada for one month. Pays $8,000 in costs.

• Replaced as chairman. Will resume his duties as RT Capital director in a month.

RESIGNED: TIMOTHY GRIFFIN, President, CEO and director

Penalty: Prohibited from being a director or officer of any public company or other market participant in Canada for 18 months. Pays $8,000 in costs.

RETIRED: PETER RODRIGUES, Vice-president, finance and operations, and director. Responsible for operational aspects of RT Capital’s business, including the taping system.

Penalty: Prohibited from being a director or officer of any public company or other market participant in Canada for six months. Pays $8,000 in costs.

ALREADY RETIRED: DONALD WEBSTER, Former senior vice-president, fixed income, and director (retired March, 2000)

Penalty: Prohibited from being a director or officer of any public company or other market participant in Canada for six months. Pays $8,000 in costs.

SUSPENDED: JENNIFER LEDERMAN, Senior vice-president, compliance, and corporate secretary and director

Penalty: Prohibited from being a director or officer of any public company or other market participant in Canada for three months. Pays $8,000 in costs.

RESIGNED: PETER LARKIN, Senior vice-president, Canadian equities, and director. Responsible for $13.5 billion in assets under management. Senior portfolio manager in the Canadian equities section.

Penalty: Permanent termination of securities trading license and prohibited from being a director or officer of any public company or other market participant in Canada. Pays $8,000 in costs.

RESIGNED: GARY BAKER, Vice-president, Canadian equities. Responsible for managing 18 Canadian funds and portfolios.

Penalty: Suspension of securities trading licence and prohibited from being a director or officer of a public company or other market participant in Canada, both for three years. Must complete an ethics course. Pays $8,000 in costs.

RESIGNED: MARION GILLESPIE, Senior equity trader. An “order executioner" at RT Capital.

Penalty: Cease trading all but personal securities for a year. Complete Canadian Securities Course and ethics course. Must be closely supervised for one year once she returns to securities trading employment. Pays $4,000 in costs.

RESIGNED: PATRICK SHEA, Senior equity trader. An “order executioner” at RT Capital.

Penalty: Cease all but personal securities trading for two years. Complete Canadian Securities Course and ethics course. Must be closely supervised for two years once he returns to securities trading employment. Pays $8,000 in costs.