Portus alternative Asset Management Inc. has become a poster child for a lot of what’s wrong in the financial services industry. It has opened a real Pandora’s box for the industry, its regulators and investors. No one involved in the situation is looking good, with one exception — Dominic D’Alessandro, president and CEO of Manulife Financial Corp.

After taking a close look at Manulife’s activities with respect to Portus, D’Alessandro stepped up to guarantee that the clients of Manulife Securities International Inc., who were referred to Portus by the Manulife subsidiary, would recover 100% of the principal amount they invested with Portus. He apologized to all Manulife’s clients and representatives who were distressed by the Portus situation and vowed to get to the bottom of how Manulife came to be in this position when almost all the major bank-owned dealers took a pass.
Manulife’s unequivocal assumption of responsibility is a refreshing act of integrity and a bright spot in the otherwise sordid Portus tale.

Portus, an investment-management hedge fund firm, reportedly sold $730 million in BancNote Trust Series investments to about 26,000 clients referred to it by as many as 100 mutual fund dealers. There has been a disturbing lack of clarity about the nature of these investments (which allegedly are principal-protected if held to maturity) and little information forthcoming to shed any light on the matter. Questions about where the assets backing these investments are held, who the custodian is and whether there are any assets left have added to investor anxiety.

The only fact about which there is clarity is that Portus paid exorbitant fees to advisors who referred their clients to Portus and provided them with sales incentives that would be banned if the investments their clients were making were in conventional mutual funds.

It is also clear that the dealers/advisors who referred their clients to Portus did not look beyond the dollar signs and sales incentives in determining the suitability of the Portus investments for their clients. Nor did they seem to understand or appreciate the need for due diligence inquiries respecting the nature, structure and governance of these investments, or the nature and validity of the principal-protection arrangements.

The arguments that the dealers/advisors were relying on Portus to do this points out serious weaknesses in the securities regulatory system.

Aggravating the situation is the length of time it took regulators (which reportedly became concerned about the Portus situation last year) to act. It was not until this February that they mobilized themselves to take action. Some of their actions (or lack thereof) have raised even more questions — for example, why they did not take immediate steps to prevent Portus’s reported destruction of records?

The Portus situation highlights several shortcomings in current regulatory requirements. One of the most serious relates to the inability of many independent mutual fund dealers to assess the suitability of particular mutual fund investments or mutual fund alternatives for their clients.
These dealers lack the requisite proficiency, training, discipline and expertise. They have been able to function because the regulatory regime for conventional mutual funds has provided them with a safety net that does not exist in the exempt market. With their clients reaching for alternative investments, it is time to raise the minimum competency and proficiency requirements for mutual fund dealers.

It is also time to move to common, basic money-management standards. And it is time to re-examine the continued existence of the exempt market, which reaches beyond sophisticated institutional investors to the ordinary retail investor. Investors’ need to know is not being satisfied by self-focused intermediaries who stand to gain through referrals or otherwise.

Major changes are needed in financial services regulation. Is Portus a wake-up call or a signal that investors are in a new Dark Age? IE