IIROC steps in

The parent firm had fallen into bankruptcy amid allegations of fraud from U.S. regulators and criminal charges against the founder of the firm, Russell Wasendorf, who had attempted suicide as the scandal was emerging. U.S. authorities allege the firm and Wasendorf had misappropriated customer funds, violated customer fund segregation laws and made false statements in financial filings after a regulatory audit uncovered a shortfall in customer funds (about US$200 million). The allegations have not been proven.

In the meantime, IIROC has suspended Peregrine Canada and transferred its accounts to another dealer, RJ O’Brien & Associates Canada Inc. IIROC maintains that: all client assets are accounted for at the Canadian subsidiary; the firm is not affected by the U.S. regulatory actions; and Canadian accounts aren’t impacted by the U.S. bankruptcy.

In suspending Peregrine Canada, IIROC says, the firm is to be liquidated by Aug. 20. In the meantime, Peregrine Canada will require regulatory approval to reduce its capital, repay debt or make any payments apart from “reasonable operating expenses”; and Peregrine Canada must preserve all of its books and records.

IIROC had sought the suspension after Peregrine Canada dismissed most of its staff. IIROC was worried about Peregrine Canada’s ability to preserve its capital, which will be needed to satisfy any claims from former clients. IIROC also is concerned about harm to the reputation of other dealers, and to IIROC itself, if the firm remained active. Once Peregrine Canada is wound down, IIROC can then seek to terminate its membership.

This case sounds like a rerun of events of slightly more than six months ago, when MF Global Canada Co. was suspended by IIROC after its U.S. parent, MF Global Holdings Ltd., had filed for bankruptcy in the U.S. amid concerns that it was using customer assets to cover proprietary trading losses. However, unlike Peregrine, MF U.S. has yet to face any regulatory or criminal charges.

In the MF Global Canada case, the Canadian Investor Protection Fund (CIPF) had to deal with a firm’s bankruptcy for the first time since 2002. The final cost of this event is not yet known, but it is expected to be less than $3 million. The CIPF has not been called into the Peregrine Canada case yet.

Nevertheless, the failure of two firms in barely six months in similar circumstances – Canadian subsidiaries of U.S. firms brought down by the actions of their parent companies – raises questions for Canadian regulators, and the industry, about the added risks both clients and the industry face from subsidiaries of U.S.-based firms.

“Clearly, recent events in the U.S. have sensitized us to U.S. firms operating in Canada despite the fact these firms are stand-alone legal entities,” says Lucy Becker, IIROC’s vice president of public affairs, adding that these cases highlight the ways in which the operations of foreign affiliates can have a significant impact on domestic dealers.

IIROC is aiming to be proactive and preventative, Becker says, by identifying relationships between firms during its compliance work and by co-operating with foreign regulators, so that IIROC is in a position to deal with events at a foreign firm, that ends up affecting a domestic one.

“The events surrounding MF Global and Peregrine [Canada] are illustrations of how IIROC requirements have served us well in protecting Canadian client assets,” Becker notes, pointing to IIROC’s requirements for external auditors, rules regarding the segregation of client securities and IIROC’s quick action to suspend the affected dealers and preserve clients’ assets. “[These measures have] led to more positive results for Canadian clients.”

Yet, these two cases are not the only source of worry regarding U.S.-based firms operating in Canada; recently, Canada’s regulators also have become concerned about U.S. firms that are registered as exempt-market dealers and are engaging in brokerage activities for accredited investors without IIROC oversight, which can: create an unlevel playing field between these firms and IIROC dealers; expose clients to firms with less regulatory scrutiny; and allow regulatory arbitrage and fragmentation.

Canada’s regulators are reluctant to shut down this activity for fear of driving these firms out of the market and possibly harming clients. Instead, IIROC is proposing to close this loophole and bring these firms under its oversight by establishing a new registration category to be used by U.S. firms as an interim step toward full IIROC membership.

© 2012 Investment Executive. All rights reserved.