Troubling Canadian connections to Lake Shore

These allegations have not been proven. So far, they haven’t really been contested as the firm and the regulators are engaged in prolonged legal jousting over access to Lake Shore’s books.

David Gary, deputy director in the CFTC’s office of external relations in Washington, D.C., said earlier this year that the firm denied the NFA access to its books. When the government regulator, the CFTC, moved in with the same request, it was also refused.

In response, the regulators have moved against the firm in court. The CFTC has won a restraining order freezing its assets, and a preliminary injunction that essentially bans it from trading, soliciting new clients and destroying its records, among other things. The NFA imposed similar disciplinary restrictions on the firm and suspended the firm’s membership in the SRO.

The firm is trying to have these orders lifted. So far, its motions have been denied, but the appeal has yet to be heard. It is scheduled for Oct. 23.

Lake Shore says in a statement it will argue: “The fraud findings underlying the preliminary injunction are not supported by the evidence, and that the district court does not have jurisdiction to freeze assets of foreign investment funds with foreign investors who are not parties to the U.S. case.” It will also contend that the NFA does not have the right to freeze assets, and that U.S. regulators do not have the right to review records of non-U.S. clients of offshore funds.

In the meantime, the regulators’ case seems to be stymied by the firm’s refusal to open its books. Gary says the court has directed the regulators to continue to seek access to the records, but hasn’t issued an order holding the firm in contempt.

A status call is expected to occur in late September (after Investment Executive goes to press for this issue) and, if the regulators still don’t have the access they are seeking, Gary says, they will probably file a motion under civil procedure rules. The reason for taking this route rather than seeking a contempt citation, he says, is because the court will have greater “discretion and variety, in terms of the types of sanctions it can impose” on the firm than it would with a contempt order.

For now, the question of whether there really is trouble at Lake Shore — beyond the dispute over regulators’ right to access its records — is unclear. According to court filings, the evidence of assets and trading performance on which the regulators are basing their claims has been uncovered through the firm’s depositories, and the NFA had access to the firm’s password-protected Web site earlier this year. However, it claims access was disabled after a few days.

“There are probably more questions than answers at this time,” Gary says. “There are a lot of allegations that need to be proven. But you can’t prove them unless you have access to books and records.”

Lake Shore has refused to give access on the basis that it is protecting the privacy of its clients, virtually all of whom are foreign investors in offshore accounts.

It appears that some of these clients have connections through Canadian firms. In its petitions to have the asset freeze lifted, Lake Shore names CIBC and Royal Bank of Canada among those that have assets affected by the freeze (either as investors or investor representatives). Lake Shore says the banks would like the freeze lifted.

Beja Rodeck, director of media and public relations at Royal Bank, confirms it was a distributor for Lake Shore and that it signed a form stating that clients are being harmed by having their assets frozen.

@page_break@There are other Canadian connections to Lake Shore, as well. According to U.S. regulators’ court filings, regulators were told the firm’s books and records are not available for inspection because they are located in Toronto. They also say all calls to the company’s registered head office in Bermuda are forwarded to a telephone number in Toronto and that all Lake Shore’s trading was apparently carried out in Toronto. Lake Shore claim that Toronto address is simply a “mail drop.”

Unrelated to the connections to Canada uncovered by the ongoing U.S. proceedings, last year the firm came to the attention of Canadian regulators. The Mutual Fund Dealers Association of Canada had become concerned about referrals from some of its members to Lake Shore and its agent in Canada, Toronto-based Meridian Global Investors.

At the time, the MFDA’s concerns were not about the business of Lake Shore or Meridian or their products, but about the possibility that advisors at fund dealers could be acting in furtherance of trades that were beyond the scope of their registrations by referring clients to a firm that essentially just sold a product (rather than a referral for a managed account).

The MFDA published a notice spelling out its concerns about the referrals. The Ontario Securities Commission also reportedly outlined some issues of its own in a report to Lake Shore and Meridian, although it didn’t make public its concerns.

In response, the two firms said they unwound their transactions with Canadian clients and returned the money to the investors. At the time, a Lake Shore spokesman stressed that the firm didn’t intend to leave Canada. It has been approved to operate here since 2003 under a registration exemption granted by the OSC. Instead, he said, it planned to alter its arrangements to assuage regulators’ concerns.

It now appears Meridian is no longer registered in Ontario. The OSC will not say whether it is aware if lake Shore has any Canadian clients. And, Karen McGuinness, director of compliance at the MFDA, reports that she is not aware of any complaints about either firm.

The OSC also refuses to say whether it has any part in the U.S. regulators’ investigations. The OSC’s manager of public affairs, Laurie Gillett, points to the commission’s policy of neither confirming nor denying the existence of any investigation. She notes it is common practice for the commission to share information with other regulators, but doesn’t say whether it is doing so in this case.

Nevertheless, the run-in with regulators over access to its books isn’t Lake Shore’s only worry. The firm also appears to be one of the casualties of failed Northbrook, Ill.-based hedge fund manager, Sentinel Management Group Inc. In August, Sentinel filed for Chapter 11 bankruptcy protection, and has been hit with fraud charges by the U.S. Securities and Exchange Commission, although these allegations haven’t been proven.

Court filings identify Sentinel as one of four custodians of Lake Shore accounts. A couple of Lake Shore funds show up on a list of Sentinel’s 20 largest creditors that was disclosed as part of its bankruptcy filing; an NFA filing records the firm having US$160 million domiciled at Sentinel as of June 30, and the firm identifies itself as Sentinel’s second-largest creditor.

The downfall of Sentinel and the regulatory turmoil at Lake Shore seem to be just an unfortunate coincidence. But there are plenty of questions still to be answered and Canadian connections to be clarified in this case. IE