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Oct 29, 2014

Outside Business Activities Can Impair Your Financial Health

by Ken Kivenko

Ken KivenkoThe media have reported on many situations where unregistered financial advisors have caused significant investor harm through Outside Business Activities (OBAs). A case in point is the infamous Earl Jones case where clients, mostly seniors, were part of an elaborate Ponzi scheme, losing millions and enduring incredible emotional stresses. Several victims described the experience as a life-altering event. Such events can wipe out savings, ruin good health, embitter family and relationships, and destroy trust.

But there is also a real danger when dealing with a registered advisor (Rep) who engages in OBA. For the purposes of this article, we will define outside business activities or “off book” transactions as activities not performed on behalf of the investment dealer. More specifically, OBA includes any business activity conducted outside the dealer for compensation, or any activity that may give rise to a conflict of interest or cause client confusion.

Retail investors take comfort in dealing with the representatives of registered dealers because they are backed by a trusted brand name—they wrongly assume their money is protected even if the transactions are outside business opportunities. Investor advocates’ experience with such outside business activities is generally negative. Retail investors, particularly seniors and retirees, believe they are dealing with the investment dealer and are shocked to discover that when things go wrong, they are on their own. Typically, the dealer (sometimes rightfully) denies any involvement or accountability. OBA complicates an already complex client-advisor relationship.

In this article we include such related “off book” activities as personal financial dealings/ lending money to your advisor, referral arrangements and advisors improperly acting as a trustee or executor for you. We also include attempts by an advisor to make a secret settlement agreement with you regarding a complaint. Investment dealers also include the sale of segregated funds (an insurance product sold by licensed insurance agents), Principal Protected Notes (a banking industry product), and tax preparation services as outside business activities.

One of the most horrific OBA cases involved Ian Thow, a Berkshire Investment Group Inc. mutual fund salesperson. He was accused of defrauding dozens of clients out of as much as $30 million in a variety of non-existent investment schemes. A British Columbia Securities Commission (BCSC) Hearing Panel found that Mr. Thow committed fraud, made misrepresentations, traded in certain securities without being registered and failed to deal fairly, honestly and in good faith when he took money from clients. The panel remarked that "This case represents one of the most callous and audacious frauds this province has seen...” Further “Thow preyed on his clients by offering them non-existent securities and instead used the funds to support his lavish lifestyle. He took their money and betrayed their trust. He has left a trail of financial devastation and heartbreak." Such investment fraud can be financially and spiritually devastating, all the more so when it involves relationships of trust.

Another OBA example involves Sung Wan (Sean) Kim. Kim was a registered investment advisor who began offering off-book investments to some of his clients. He was a member of a Korean church in East Vancouver, and conducted his off-book business in a second Burnaby office. Over a 30-month period, Kim exploited his reputation as a businessman in the local Korean community and the Korean-language church to gain the trust of thirty-six Korean-speaking investors who gave him almost $16 million. As BCSC documents show, Kim lied to the investors about how their money would be invested and about the returns their money would earn, forging BCSC documents to legitimize his scheme. Far from investing their money, he deposited it into his personal bank account.

More recently, a hearing panel of the B.C. Securities Commission issued a decision indicating that it found that, between June 2007 and December 2010, David Michaels violated securities laws when he advised 484 clients to purchase over $65 million of exempt market securities without being registered. It says that he generated $5.8 million in fees and commissions through those sales, but that at least $40 million of investors' money has been lost, and that the rest remains "at risk." According to the decision, Michaels promoted his investment seminars through weekly radio infomercials that aired in Victoria, B.C .He advised clients to sell their traditional holdings, such as stocks, bonds and mutual funds, in order to purchase high-risk-exempt market securities instead. He also advised the clients, many of them seniors, to use leverage to purchase their investments. In doing so, the panel ruled that he made misrepresentations to clients, deceived them, and betrayed their trust...." He preferred elderly clients (average age 72) because they were available during the day. He misrepresented products, held high-pressure “free lunch” seminars and mischaracterized the nature of his designation (Certified Senior Advisor) as a qualification for investment advice. The radio show was key to attracting clients.

Securities regulations state that Securities regulations state that dealer Reps are expected to disclose all outside business activities to their dealer, and receive approval from their dealer. The rules require that if a dealer concludes that it cannot properly control a conflict-of-interest regarding an outside activity, it should not allow the Rep to engage in that activity. Dealers are expected to monitor approved outside business activities but seem to lack the tools and resources to do so. Critics would argue that dealers have their hands full supervising their own book of business without the distraction of OBA.

Too often, we hear how investors have suffered losses at the behest of unsupervised approved and unapproved outside business activities. No doubt it’s extremely challenging for dealers to monitor Reps’ outside business activities, since in many cases, Reps don’t disclose these activities to their dealer. Also, given the geographical challenges that many dealers face relative to the location of the Reps, the rules are very difficult to effectively enforce. Accordingly, investors have to be extra alert in an OBA situation.

Here Are Some Things To Look For:

  • Brochures or other collateral materials that don’t relate to products the dealer normally sells;
  • Annotations to business cards that indicate the Rep may be offering items the investment dealer hasn’t approved;
  • Use of misleading titles like “Vice President” or meaningless professional designations;
  • Transactions are being done off-site and/or using forms that do not bear the name and logo of your investment dealer;
  • A request to redeem or sell assets to purchase OBA products that don’t make sense or are inconsistent with the Investment Policy Statement (assuming you have one); and,
  • A request to send money to someone other than your investment dealer.

The regulations and rules state that clients must be able to easily distinguish between the activities of the dealer and the outside business activity of the Rep but investor advocates question the efficacy of the rule in practice. Boilerplate text buried in lengthy Client Relationship Disclosure documents may refer to such transactions in a generic matter-of-fact manner. Generally, the text asserts that the dealer is not responsible for OBA. Investor advocates maintain that there does not appear to be general industry compliance regarding clear disclosure, and argue that Reps rarely explain the implications of OBA to the investor. However, Burgeonvest Bick Securities Limited for example, does communicate conflicts of interest and, in particular, commits to have your Rep inform you if recommending private investments. http://www. 

Regulations and rules do not permit the Rep to use the dealer’s premises, records, logos, trade name(s), stationery/ business cards, support staff or contact facilities (phone/ fax numbers, mail/e-mail/instant or text-messaging addresses, etc.) while conducting outside business activities. But we know from bitter experience that not everyone follows the rules. You need to be aware and constructively critical. Ask probing questions if anything seems unusual or too good to be true.

Additionally, the Investment Industry Regulatory Organization of Canada’s (IIROC) Advisor Report database does not currently have a data field for dealerapproved OBA so investors are unable to independently check if the Rep has been approved for OBA.

Investors should beware of an outside business relationship with their Rep for a number of reasons:

(a) The investments may be scams, unregistered securities or at the very least, wholly unsuitable /expensive investments or contain unnecessary liquidity constraints; 

(b) The right to any compensation fund may be negated by transactions outside the dealer’s business;

(c) The dealer may refuse to address any complaints or compensation for losses for sales and transactions that were not made through the dealer’s business (Errors & Omissions insurance may not cover OBA);

(d) The use of the Ombudsman for Banking Services and Investments (OBSI) may be denied to you for investments that have been placed outside the investment dealer’s normal environment (in fact this is the case for segregated funds);

(e) Confidential personal and financial information may fall into the hands of entities and persons that are unknown to you; and,

(f ) OBSI may find that since you knew or should have known the transactions were “off book,” you are not entitled to any compensation from the investment dealer. (See this OBSI case study as an example en/?option=com_content&view=article&id=310&Itemid=55&lang=en)

Regulators have become very concerned about OBA in the wake of the financial crisis and subsequent “off book” fiascos caused by unregistered and registered Representatives. A look at several recent hearing panel notices issued by the IIROC and the MFDA shows regulators taking registrants to task when they sell products outside their registration mandates and dealers who do not provide adequate supervision. For good reason, both regulators have Outside Business Activities on their priority list.

The Small Investor Protection Association (SIPA ) has recommended tighter rules for OBA and better OBA investor educational materials. A recent FAIR Canada’s Comment letter to IIROC warns against securities-related outside business activities undertaken by dealer Reps . Like SIPA, FAIR Canada is concerned that securities-related outside business activity poses significant risk to retail investors. Additionally, the Comment letter suggests that IIROC:

(i) impose an obligation to ensure that the distinction between dealer business and any approved outside business activity is properly disclosed;

(ii) make dealers liable for harm caused by the outside business activity of their representatives; (iii) research whether insurance should be required to protect investors from harm caused by outside business activity; and,

(iv) impose a duty for all approved persons to report breaches or suspected breaches of securities regulation. ( FAIR-Canada-comments-re-guidance-note-outsidebusiness-activities.pdf)

The ageing of Canada’s population also generates concern as older investors tend to be easier prey for rogue Reps. A disproportionate percentage of suitability complaints originate with the sale of products or equities that are out of line with a senior’s risk profile, goals and investment time horizon. Because of prevailing low interest rates, seniors are vulnerable to representations of secure and higher returns and, as a result, are vulnerable to improper OBA approaches, including those approved by dealers. Another major concern is RRSP rollovers: at age 72, investors are required to cash out, buy an annuity or convert to a RRIF. At this point, improper OBA could have a devastating impact on the retirement income of trusting clients.

There is enough risk from traditional investing without the need to create more problems for yourself. Think twice before engaging in outside business activities. CAVEAT EMPTOR.

Ken Kivenko, PEng, President , Kenmar Associates, Etobicoke, ON (416) 244-5803,,