Fraud, embezzlement, misappropriation @ IFIC chair's company

[Norbert Schlenker]

The chairman of the Investment Funds Institute of Canada stepped down Thursday after RCMP and other police officers swooped down on several offices in Montreal and Toronto as part of a major fraud investigation against his company, Norbourg Asset Management Inc.

... The Autorite des marches financiers said it will investigate a number of issues, including a difference of $70.7 million between the company's latest financial results and its assets under management, as well as allegations that annual financial reports for the last three years were misleading or false.

... Autorite president Jean Saint-Gelais said Norbourg has only $84 million left in its accounts - $70.7 million less than it has on its books.

Authorities will also investigate the alleged misappropriation of $69.8 million belonging to Evolution and Norbourg funds and the alleged falsification of documents for Norbourg's operations.

Fortin, Canadian Press (via canada.com)

[NormR]

Yikes!

[Arby]

From an article in GlobeInvestor on the same topic:

... This is the third time an IFIC chairman has had to resign amid controversy. Terrence Wright of Winnipeg-based Investors Group Inc. stepped down last year following a market timing probe, and in 1998, then chairman Dax Sukhraj resigned over his involvement in a fund company that collapsed. ...

[DanH]

From an article in GlobeInvestor on the same topic:

... This is the third time an IFIC chairman has had to resign amid controversy. Terrence Wright of Winnipeg-based Investors Group Inc. stepped down last year following a market timing probe, and in 1998, then chairman Dax Sukhraj resigned over his involvement in a fund company that collapsed. ...

Just for clarification and a bit of background, Dax Sukhraj - if memory serves - was the head of a dealer, not a fund company, that failed. I believe there was some commingling of the trust account (through which client money flows) and the firm's operating account.

That dealer (who's name escapes me...money something or other) was acquired by Fortune Financial at that time (which was later bought by Dundee). David Singh founded and was the head of Fortune - and was also a long time friend of Mr. Sukhraj. Not one dollar of client money was lost.

[Norbert Schlenker]

With 40% of the declared assets missing, what was the external auditor doing? Every year at the non-profit which I chair, I sign authorizations for our auditor to obtain year-end asset balances directly from the custodians. Surely a mutual fund auditor would do at least that.

There are other weird things. There is no mention of Fragasso, the now-resigned IFIC chair, in either the Norbourg or Evolution annual reports. Google does turn up his name as a board member of Fundserv, which is the primary order entry system for funds in Canada. Phone calls to IFIC and Fundserv this morning reveal that Fragasso remains on both boards.

[beaverlodge]

That is correct
No dollars were lost by clients
Dax was a dealer and it was not a fund company
Further he was an interim dealer brought in to right the company at that stage.

[DanH]

With 40% of the declared assets missing, what was the external auditor doing? Every year at the non-profit which I chair, I sign authorizations for our auditor to obtain year-end asset balances directly from the custodians. Surely a mutual fund auditor would do at least that.

There are other weird things. There is no mention of Fragasso, the now-resigned IFIC chair, in either the Norbourg or Evolution annual reports. Google does turn up his name as a board member of Fundserv, which is the primary order entry system for funds in Canada. Phone calls to IFIC and Fundserv this morning reveal that Fragasso remains on both boards.

All good points - and good investigative skills. Yesterday, I was looking here for details of the registrations of Norburg, Vincent Lacroix and some of the other individuals listed as managers on the various funds. Neither Norburg nor Lacroix showed up yesterday. And when I looked at the fund details - i.e. min inv. total assets, etc. - they seemed to be much less than when I last looked at them several months ago.

Plus, I came up empty looking at their website, at www.norburg.com

[AltaRed]

Leaves the investor feeling that the financial industry is potentially little more than a scam to milk investors dry. The head of IFIC no less.... Auditors apparently asleep at the wheel no less...

Given all the recent incidents in the last 5 years, it is probably time to head to the exits and stick with government bonds and GICs.

[Bylo Selhi]

More disturbing is this...

Are fund investors protected? [Toronto Star, 27Aug05]

Allegations that about 42 per cent of reported assets have been embezzled from two Quebec mutual fund families have sent shivers across Canada. "If such a thing could happen at one mutual fund company, what protection is there for my mutual fund investments?" many investors are wondering. Well, there's none at the moment, apart from the capital and public reputation of the owner of the fund management company itself. Tom Hockin, president of the fund industry's Investment Funds Institute of Canada, says such a thing as is being alleged in Quebec was not thought possible in Canada.

Yet Quebec's Autorité des marchés financiers, or AMF, dropped the bombshell Thursday that it had initiated steps to protect investors from further losses in the Norbourg and Évolution funds managed by Norbourg Asset Management Inc. It alleged in a news release that "almost $69.8 million belonging to investors in Évolution and Norbourg families of funds was embezzled through various schemes."

It's not as though no one has ever considered the potential for investor losses due to fraud inside a mutual fund management company. Lawyer Stephen Erlichman of Fasken Martineau in Toronto urged the creation of a consumer compensation fund that would cover losses due to fraud or insolvency in a report to the Canadian Securities Administrators in 2000. But the idea was laughed off as totally unnecessary, because fund companies are supposed to turn over investors' deposits of new money to a major trust company at the end of each day. Once with the trust company, the investor's only risk of loss would be from a decline in the value of the stocks, bonds or other investments held in safekeeping on their behalf...

[Bylo Selhi]

Just for clarification and a bit of background, Dax Sukhraj - if memory serves - was the head of a dealer, not a fund company, that failed. I believe there was some commingling of the trust account (through which client money flows) and the firm's operating account.

That dealer (who's name escapes me...money something or other) was acquired by Fortune Financial at that time (which was later bought by Dundee). David Singh founded and was the head of Fortune - and was also a long time friend of Mr. Sukhraj. Not one dollar of client money was lost.

Controversy new blow to fund industry

[beaverlodge]

Credentials: Mr. Sukhraj, a successful financial adviser in the Toronto area, founded Keybase Financial Group in the 1996. He was active in many industry associations, including IFIC.

What happened: In 1997, Keybase considered buying a piece of ailing Provident Financial Services Inc. As part of the deal, Mr. Sukhraj promised to reimburse three elderly clients who had lost $800,000. He reneged on the promist, prompting the Ontario Securities Commission to take up the case, and Mr. Sukhraj resigned his IFIC post. Today, he continues to oversee Keybase and its team of 150 advisers with about $1-billion dollars in assets under administration.

A market loss. Not fraud.
If I recall it correctly.

[worthy]

So what's a broken promise? Where would we get our political "leaders" without them?

[DanH]

Credentials: Mr. Sukhraj, a successful financial adviser in the Toronto area, founded Keybase Financial Group in the 1996. He was active in many industry associations, including IFIC.

What happened: In 1997, Keybase considered buying a piece of ailing Provident Financial Services Inc. As part of the deal, Mr. Sukhraj promised to reimburse three elderly clients who had lost $800,000. He reneged on the promist, prompting the Ontario Securities Commission to take up the case, and Mr. Sukhraj resigned his IFIC post. Today, he continues to oversee Keybase and its team of 150 advisers with about $1-billion dollars in assets under administration.

What I wrote about Dax, then was not correct. The scenario I recall did happen - that I know. But it was obviously a different dealer (that did fold) and perhaps another old friend of Mr. Singh.

[DanH]

More disturbing is this...

Are fund investors protected? [Toronto Star, 27Aug05]

Allegations that about 42 per cent of reported assets have been embezzled from two Quebec mutual fund families have sent shivers across Canada. "If such a thing could happen at one mutual fund company, what protection is there for my mutual fund investments?" many investors are wondering. Well, there's none at the moment, apart from the capital and public reputation of the owner of the fund management company itself. Tom Hockin, president of the fund industry's Investment Funds Institute of Canada, says such a thing as is being alleged in Quebec was not thought possible in Canada.

...

It's not as though no one has ever considered the potential for investor losses due to fraud inside a mutual fund management company. Lawyer Stephen Erlichman of Fasken Martineau in Toronto urged the creation of a consumer compensation fund that would cover losses due to fraud or insolvency in a report to the Canadian Securities Administrators in 2000. But the idea was laughed off as totally unnecessary, because fund companies are supposed to turn over investors' deposits of new money to a major trust company at the end of each day. Once with the trust company, the investor's only risk of loss would be from a decline in the value of the stocks, bonds or other investments held in safekeeping on their behalf...

Count me among those that disagree with a contingency fund - at least for now. Why not first look at procedural standards and see if there isn't something on that level that can further curtail such activity. The issue here is not at the dealer level so it should not cost investors any more to further tighten up processes. This issue appears, at this point, to be at the trustee-fund co. level. Why not look there first for reasonable measures rather than introducing yet another layer of regulatory costs. Trust me, regulatiory compliance is too expensive as it is and it is part of the reason why investors pay as much as they do.

[Bylo Selhi]

More disturbing is this...

Count me among those that disagree with a contingency fund...

My point Dan is not that we need another contingency fund, but rather:

1. Contrary to standard industry propaganda, mutual fund investors are not absolutely protected from malfeasance on the part of all industry members. ("Well, there's none [protection from fraud] at the moment.") No bank or insurance company would be viable under such a situation. AFAIK they all carry insurance (or self-insure.) That too costs money and that cost too is borne by customers, but at least the cost is inversely related to their internal controls and ability to make customers whole when fraud happens.

2. Consistent with standard industry practice, whenever someone points out a flaw in the system the standard response is denial ("But the idea was laughed off as totally unnecessary.") I dare Hockin and his gang to repeat that publically to those who lost money with Norbourg (or Portus or Crocus or ...)

[beaverlodge]

The articles I read over the weekend mentioned that the Head of IFIC who resigned, who is a Senior Vice President of Norbourg, mentioned that he said words to the effect that "he had no idea this kind of thing was going on, it was a complete surprise to him. This from the Sr Vice President of the firm in which he was a senior officer and where embezzlement seems to have occured.

Further the article mentioned that three qualified auditors had been involved in the audits over the years.

Hardly a confidence builder in any respect.

[DanH]

More disturbing is this...

Count me among those that disagree with a contingency fund...

My point Dan is not that we need another contingency fund, but rather:

1. Contrary to standard industry propaganda, mutual fund investors are not absolutely protected from malfeasance on the part of all industry members. ("Well, there's none [protection from fraud] at the moment.") No bank or insurance company would be viable under such a situation. AFAIK they all carry insurance (or self-insure.) That too costs money and that cost too is borne by customers, but at least the cost is inversely related to their internal controls and ability to make customers whole when fraud happens.

I think more information is needed, Bylo, before you can reach any firm conclusions. Do we really know what actually happened? I don't. And unless you have some insider info, you don't know any more than what papers are printing at this point - and who knows what's accurate and what has been left out? In other words, embezzlement may well have taken place. But shouldn't we confirm exactly what went down before condeming the system?

Maybe it was the audit side of the process that was most at fault. If so, that's not really a fund industry issue - it's an accounting/auditing regulatory issue. Maybe there's a dirty trustee. Maybe....there are numerous possibilities that are really indirectly related to the fund industry, so let's hold off until we figure out what went wrong.

2. Consistent with standard industry practice, whenever someone points out a flaw in the system the standard response is denial ("But the idea was laughed off as totally unnecessary.") I dare Hockin and his gang to repeat that publically to those who lost money with Norbourg (or Portus or Crocus or ...)

The comparison with Portus and Crocus is misplaced in that those two incidents involve products that are not regulated in the same way as mutual funds - the former not at all. And in the case of Crocus, there is suspicion that gov't was at least partly to blame. If you have bad government overseeing the system, then no system will protect you.

Do you know if ETFs (in the U.S. and Canada) are protected from corporate fraud? I suspect not since incidents like Enron, Bre-X, etc. have taken place so presumably any exchange traded vehicle can be the direct victim of embezzlement.

[Bylo Selhi]

I think more information is needed, Bylo, before you can reach any firm conclusions. Do we really know what actually happened? I don't. And unless you have some insider info, you don't know any more than what papers are printing at this point - and who knows what's accurate and what has been left out? In other words, embezzlement may well have taken place. But shouldn't we confirm exactly what went down before condeming the system?

Some $70M is AWOL. There's no explanation. I think it's safe to assume it wasn't just accidentally misplaced in some suspense account. Agreed that we don't know exactly what happened. That's why I said "malfeasance" rather than "embezzlement."

Maybe it was the audit side of the process that was most at fault. If so, that's not really a fund industry issue - it's an accounting/auditing regulatory issue. Maybe there's a dirty trustee. Maybe....there are numerous possibilities that are really indirectly related to the fund industry, so let's hold off until we figure out what went wrong.

It's still most likely an act of malfeasance by a fiduciary. It further tarnishes the industry. The distinction between direct or indirect will I imagine be lost on most people, especially those who lost money as a result.

The comparison with Portus and Crocus is misplaced in that those two incidents involve products that are not regulated in the same way as mutual funds - the former not at all. And in the case of Crocus, there is suspicion that gov't was at least partly to blame. If you have bad government overseeing the system, then no system will protect you.

Ditto. It further tarnishes the industry and any such distinctions will be lost on most people, especially those who lost money as a result.

Do you know if ETFs (in the U.S. and Canada) are protected from corporate fraud? I suspect not since incidents like Enron, Bre-X, etc. have taken place so presumably any exchange traded vehicle can be the direct victim of embezzlement.

Why only ETFs? Aren't mutual funds in the same situation? Either way there may be no way for a fund sponsor to completely avoid such situations absent a direct act of malfeasance on their part. (Certainly indexed securities can't. But we know that many actively-managed funds, including conservatively-managed ones, held these stocks when the music stopped, so active management offers no guarantee against such losses either.)

[DanH]

Some $70M is AWOL. There's no explanation. I think it's safe to assume it wasn't just accidentally misplaced in some suspense account. Agreed that we don't know exactly what happened. That's why I said "malfeasance" rather than "embezzlement."

I'm making no conclusions Bylo. It was also printed that three different auditors saw nothing wrong with the books. That doesn't make sense - but that's only because we don't have enough information to make sense of it. I interpreted your use of the word malfeasance, taken in the context of your many past threads, as blaming the fund industry. In fact, we don't know where the system failed and if it something outside of the industry - i.e. audit.

It's still most likely an act of malfeasance by a fiduciary. It further tarnishes the industry. The distinction between direct or indirect will I imagine be lost on most people, especially those who lost money as a result.

Neither you nor most of the people that frequent this forum are "most people", hence my effort to make the distinction. True, people who lose money simply want to be made whole - understandably. But when trying to determine fault and in designing ways to ensure this is not repeated the arguments I've been making are relevant. But we're talking hypotheticals at this point because we just don't have enough info.

Ditto. It further tarnishes the industry and any such distinctions will be lost on most people, especially those who lost money as a result.

See my above response.

Why only ETFs? Aren't mutual funds in the same situation?

I single out ETFs because you are generally critical of the fund industry but sing the praises of ETFs. I just wanted to point out that the same could probably happen to an ETF.

But we know that many actively-managed funds, including conservatively-managed ones, held these stocks when the music stopped, so active management offers no guarantee against such losses either.

I'm not talking about funds holding shares in dirty companies. That happens to both passive and active managers. I'm talking about the potential for things like embezzlement in an ETF structure.

But, just for the record, I can't think of any "conservatively managed" equity fund that was caught holding a bunch of shares of some high level corporate scandal. At least I can't think of any. Bre-X, YBM, Cartaway, Nortel, etc. The closest I can come up with is Sceptre Equity Growth - which was caught with YBM Magnex when the Russian mob connection was confirmed but I'm not sure one would have considered that fund - then considered a small cap fund - "conservative".

Do you know of any that I've perhaps forgotten rather conveniently?

[Shakespeare]

Bre-X, YBM, Cartaway, Nortel

I think some "conservative" funds drifted away from value and held NT. IIRC, PH&N Dividend wasn't one of them.

[DanH]

Bre-X, YBM, Cartaway, Nortel

I think some "conservative" funds drifted away from value and held NT. IIRC, PH&N Dividend wasn't one of them.

But which ones are you talking about?

Now I can recall Ivy Canadian and Trimark Canadian holding NT at different times between late 1999 and late 2000. But that was only detected in trading summaries and statements of holdings. And it's not clear that these funds were hurt much by NT.

The problem that also arises is how one defines "conservative". Other than Ivy Canadian, I cannot think of a fund that really drifted. Trimark didn't drift - they made an error in judgement (i.e. it was this one stock and it was never a big bet).

[Bylo Selhi]

But, just for the record, I can't think of any "conservatively managed" equity fund that was caught holding a bunch of shares of some high level corporate scandal. At least I can't think of any. Bre-X, YBM, Cartaway, Nortel, etc. ... Do you know of any that I've perhaps forgotten rather conveniently?

Well, as a matter of fact, yes I do, now that you ask

Would you believe that PH&N was holding Bre-X in their Canadian Equity fund when the fall guy flew out of the helicoopter? As I recall (I was there) they apologized profusely for that gaffe at the following Outlook roadshow.

Added: Thus spake zaraSEDAR [Average Cost Beginning, Cost of Purchases, Proceeds from Sale, Gain(Loss), Average Cost Ending]

PHILLIPS, HAGER & NORTH CANADIAN EQUITY FUND
STATEMENT OF PORTFOLIO TRANSACTIONS
YEAR ENDED DECEMBER 31, 1997
Bre-X Minerals Ltd. 2,945,688.20 2,046,213.75 1,032,738.29 (3,959,163.66) zilch
...
Canadian Equity Plus:
Bre-X Minerals Ltd. 825,580.84 570,041.40 288,817.74 (1,106,804.50) zilch
...
Balanced:
Bre-X Minerals Ltd. 661,758.72 485,642.40 232,372.88 (915,028.24) zilch

[Tanstaafl]

I sincerely hope they will be taking away a few passports from certain people, unlike the last time.

Nobody noticed half the money disappeared, not one person from the incompetent committee, sorry I meant Audit committee. Maybe some people should have their accreditation checked to ensure they passed grade 2 math.

[yielder]

It was also printed that three different auditors saw nothing wrong with the books. That doesn't make sense - but that's only because we don't have enough information to make sense of it.

Unless the rules of game have changed, it's pretty simple. The fund auditor requests the fund manager to ask the fund custodian bank to forward directly to the auditor, a list of assets including cash held in safekeeping on behalf of the fund. Of course if audits are annual, there's lots of time to play games which is where the auditor comes into play to insure that there is clear separation of function between the investment manager, the custodian bank, and the registrar/transfer agent. If an audit cycle was passed and these auditors saw nothing wrong with the books, something is terribly wrong at the audit firms or something is terribly wrong with current investment industry audit standards.

Hmmmmmmmm

[yielder]

Other than Ivy Canadian, I cannot think of a fund that really drifted.

So you're saying that most are not closet indexers in varying degrees? If the bogey is the TSX, how could they not have owned NT or whatever was hot? I don't know about then but today it looks to me like they don't stray far from the index.

Code: Select all


Fund                          Financial   Energy Materials
Investors (7/31)               36.1         24.5     12.7
PH&N (6/30)                    38.8         14.9      7.6
SEI (6/30)                     27.8         26.5     16.5
London Life (7/31)             35.3         24.2     13.8
Fidelity (6/30)                32.1         22.6     13.8
Benchmark (8/26)               30.6         27.1     12.4