What began as a small enforcement case against Portus Alternative Asset Management Inc. this past summer has blown up into the latest PR nightmare for the investment industry.

The Toronto-based hedge fund firm first came to regulators’ attention last summer when the Nova Scotia Securities Commission brought an enforcement action against two reps, alleging, among a variety of other things, that one of them had an improper referral arrangement with Portus, in contravention of Mutual Fund Dealers Association rules.

This resulted in the first-ever enforcement of an MFDA rule (albeit by the NSSC), back in September 2004.

However, the ruling didn’t gain much public attention until the Ontario Securities Commission, and several other regulators, issued a 15-day temporary order against Portus on February 2, blocking the firm from opening new client accounts or accepting new funds in existing client accounts.

The OSC issued the temporary order on the suspicion that the firm has violated two sections of the Securities Act dealing with record-keeping and account statements, and a couple of sections of an OSC rule dealing with KYC obligations, suitability, and general duties of registrants.

No specific allegations have been made, and the firm has not yet faced a hearing. The commission has scheduled a hearing for Feb. 17 to consider whether that order should be extended.

The NSSC has also said it will ask for an extension to the 15-day temporary order.

In response to the OSC’s temporary order, Portus’ president, Boaz Manor, issued a statement indicating, “We have been working closely with provincial regulators in response to the 15-day Temporary Order that is in place. We are taking the matter seriously and believe that it will be resolved within this timeframe.”

He also noted that, “Our investment strategy is sound and all of the assets invested with Portus Alternative Asset Management Inc. are principal protected if held to maturity. Investors’ money is held in secure notes with an independent trustee and the principal is protected by one of the world’s major financial institutions.”

Following the provincial regulators’ orders, the MFDA issued a bulletin of its own alerting its members to the OSC order, and demanding that its members stop referring clients to the firm. The MFDA says it is aware that a number of MFDA members have entered into referral arrangements with Portus regarding managed accounts involving its BancNote Trust Series investments. It advises, “MFDA members in the affected jurisdictions must immediately cease referring clients to Portus during the period covered by the temporary order and any subsequent orders.”

The regulator also directs its members to “take appropriate steps” to determine if any of their reps have entered into referral arrangements directly with Portus and if so, cease such activity immediately. It reminds dealers and reps that securities-related referrals cannot be entered into by reps either directly or indirectly through another entity, such as an insurance agency or a personal service corporation, these sorts of referrals can only be made through an MFDA member. “Any cases of non-compliance with the requirements identified in this notice will be referred to enforcement,” it warns.

The OSC order says that the firm has about $800 million in assets under management, 26,000 clients, and was gathering $20 million per week, most of it from Ontario residents in funds of hedge funds sold under offering memorandum.

Yesterday, Portus suspended all redemption requests from investors, effective immediately.