Saturday, December 18, 2004
Brokerages ignored warnings on market timing

KAREN HOWLETT AND JOHN SAUNDERS

Three of Canada's bank-owned brokerage firms continued to execute trades for a handful of sophisticated market players after repeated written warnings from mutual fund companies that they were hurting long-term fund investors.

Two of the brokerages -- RBC Dominion Securities Inc. and TD Waterhouse Canada Inc. -- let a select few clients buy mutual funds until 3:59 p.m., ignoring a 3 p.m. cut-off they imposed on other clients.

These revelations, contained in settlements reached this week, show that the brokerage firms were not just passive order takers but "actively encouraged and promoted market timing activities in a number of ways." These included entering into written special arrangements that let the market pros engage in rapid in-and-out trading, the settlements acknowledge.

The scope of the admissions is far-reaching. At BMO Nesbitt Burns Inc. alone, four clients made 3,500 round trips -- in and out trades in a fund -- in funds managed by 15 different companies.

RBC had two market-timing clients, the bigger of which placed bets ranging from $500,000 to $58.4-million. Some of the trading was in the bank's own Royal Mutual Funds.

Fund managers eventually halted the trading, but an RBC broker tried to get it started again. The broker told Royal that similar trading arrangements had been reviewed and accepted by RBC's compliance department "and had been in place with 10 other mutual fund companies for years."

The activity at all three firms spans a two-year period, beginning in January, 2002.

A TD internal report prepared in February and quoted in a settlement document says that "senior management at TD Waterhouse may have encouraged and approved" the establishment of market timing accounts in "an attempt to generate additional revenues for TD." At that time, the practice was hugely controversial in the United States.

A subsequent internal memo said the report's conclusions were "rejected by management as unfounded." This week, market timing became a $20.7-million problem for TD as it joined other firms in paying fines and restitution to investors.

The special arrangements with market timers allowed them to zip in and out of a company's funds and pay a fee for doing so that was significantly less than the maximum that could be imposed, the settlements say.

The activities were lucrative for the brokerage firms. TD Waterhouse had revenue totalling $10.3-million while RBC had revenue of $8.5-million and BMO $3.3-million.

The three brokerages have agreed to pay fines totalling $42-million -- double the revenue earned.

Most of the market timing clients traded through accounts in offshore tax havens, renowned for their secrecy.

BMO received at least 21 warnings from 15 fund companies, putting the firm on notice that market timers were not welcome in their funds. TD received at least eight warnings from six companies and RBC at least seven.

The companies issued the warnings because they determined that market timing was potentially harming the funds and long-term investors, the settlements say. These warnings went unheeded or were ignored, they add.

Even after one of these warnings, a TD broker continued to facilitate market timing trades in the fund through a different account, the settlements say.

The firm provided one client with a $42.3-million margin loan.

BMO executed market timing trades not only on behalf of four clients but in the firm's own proprietary trading account.

Following a broad crackdown on market timing in the United States in September, 2003, BMO notified Canadian securities regulators about the activities in the firm's account and repaid the revenue to the fund companies.