Trouble leads to sale

The deal, which requires the approval of the funds’ unitholders, is also subject to review by the Ontario Securities Commission (OSC). If the transaction is approved, it’s expected that the management change would take place after Dec. 15.

The deal comes amid regulatory concerns about investors’ inability to redeem certain principal-protected notes (PPNs) sold by Pro-Financial, as redemptions have been frozen by the regulator since this past spring.

In May, the OSC issued a temporary order suspending Pro-Financial’s EMD registration and imposing conditions on its portfolio-manager registration, including that the firm is not to open any new accounts or accept any new clients. The temporary order has since been extended several times — most recently, until Dec. 15 — and a hearing has been set for Dec. 12 to consider whether to vary or extend the order in light of an ongoing capital deficiency at the firm.

Much of this has happened behind closed doors because Pro-Financial had requested that hearings be held in private and that various submissions in the case be kept confidential. The confidentiality order prevents the OSC from talking about the case beyond what is set out publicly in the various orders it has made in the case. As well, executives with Pro-Financial did not respond to a request from Investment Executive seeking comment on some of the issues set out in those orders.

It appears there are two main issues that concern the OSC: a reported working-capital deficiency at Pro-Financial and a discrepancy in the accounting for a series of nine PPNs that the firm helped to distribute.

According to the latest OSC order, which was issued on Oct. 17, Pro-Financial continues to face a working-capital deficiency. The OSC order reports that Pro-Financial first advised the OSC of its capital shortfall on Oct. 31, 2012, indicating that it had a deficiency of at least $183,367. Then, in February of this year, the firm reported that the capital deficiency, as of Oct. 31, 2012, was actually $726,746; this deficiency has yet to be rectified.

The OSC’s order also indicates that Pro-Financial has been unable to explain an apparent $1.2-million discrepancy in the value of certain PPNs. According to the OSC’s order, OSC staff first became aware of a discrepancy in the number of outstanding PPNs in December 2012, when a discrepancy between the records of the record-keeper for the PPNs and their trustee was found.

The notes in question were issued by BNP Paribas Canada and Société Générale Canada between mid-2003 and early 2007; Pro-Financial served as a sales agent for those issues. The OSC has jurisdiction over the PPNs (typically considered banking products) because they were distributed under the “specified debt” exemption, which is available for the distribution of certain debt securities issued by banks.

Since the OSC first spotted the apparent discrepancy, the regulator has been discussing the issue with Pro-Financial. In February, the firm began a reconciliation process to try to resolve the discrepancy. In March, Pro-Financial reported to the OSC that there was a difference of slightly more than 2,300 opening units between the two sets of records (equivalent to $230,293) and, that there was also a “price discrepancy” in the early redemptions of the notes amounting to $566,839.

In April, Pro-Financial filed a preliminary reconciliation report with the OSC that showed the total discrepancy appears to be about $1.2 million — meaning that the total obligations to PPN holders is about $1.2 million higher than what the trustee has recorded, as far as the PPNs’ record-keeper is concerned.

Now, according to the OSC’s latest order, Pro-Financial filed a final PPN reconciliation report with the OSC on Sept. 30 that continues to show a $1.2-million discrepancy. According to this OSC order: “Pro-Financial was unable to explain the discrepancy in any more detail than as set out in the preliminary report.”

The latest order allows the OSC to provide documents related to the PPN reconciliation process to the banks that originally issued the notes, on the condition that those banks also treat the documents as confidential.

In the meantime, investors can’t redeem their PPNs. Just prior to the delivery of the preliminary report in April, Pro-Financial agreed to suspend redemptions of the PPNs. The OSC’s order indicates that the firm gave an undertaking to the regulator promising that both early redemptions and redemptions at maturity for the PPNs (the PPNs mature at various dates between December 2010 and Oct. 31, 2016) were to cease while the attempted reconciliation process took place.

However, now that the reconciliation is complete and the OSC is maintaining the redemption ban that was agreed upon in April, it appears that investors’ funds are frozen until the OSC decides to lift the restriction. IE