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From June 2, 1999

Can You Trust Your Broker?
by Marco den Ouden 

This article appeared on my website before I started publishing the Break Out Report as a subscription newsletter. It is of interest on several counts. First, the basic premise is still valid - it is beneficial for an investor to know something about investing and not rely entirely on the advice of his broker. Secondly, it makes specific reference to Bre-X, the notorious gold mining stock of the late 90s. Now that gold is in a bull market, the landscape is ripe for other Bre-X like scams so the gold stock investors should also be wary rather than seeing the world through rose-coloured (or should that be gold-coloured) lenses.

On May 13, 1999 Ontario Court Judge Warren Winkler ruled that a class-action suit could be launched against bankrupt Bre-X and its insiders. However, he also declined to authorize such a suit against seven Bay Street brokerages that had hyped the stock. The brokerages involved are a who's who of the Canadian investment scene - Nesbitt Burns, TD Securities, ScotiaMcLeod, CIBC Wood Gundy, First Marathon Securities, Midland Walwyn Capital and Levesque Beaubien Geoffrion. The first four are all investment arms of some of Canada's largest banks.

This is hardly the first time a broker or investment advisor has steered a client down the wrong path and it certainly won't be the last. But it has stirred up a storm of controversy over the accountability of brokers and investment advisors to their clients.

The National Post's Diane Francis and Terence Corcoran are at loggerheads over the issue. Francis has argued in several columns that the brokerages are liable. "I believe stock brokers all have a moral obligation to reimburse investors who bought Bre-X or any other stock that turns out to be a fraud," she declared in a May 1999 column.

Corcoran, on the other hand, argues that the numbers are misleading. While a certain amount of money went into Bre-X's treasury with the issuing of shares and options, most of the $6 billion loss figure from market peak to wipe-out was created by market action. The share price was bid up and up. Some people sold at a profit and others leapt in hoping the stock would go higher. The greater fool theory in action. "For every loser," says Corcoran, "there was a winner".

"Every investor who made money off Bre-X trading is sitting on tainted profits," he argues. "In an ideal world," he concludes, "all the Bre-X profit takers should return their ill-gotten gains" so the money can be distributed back to the losers. Clearly an untenable idea.

Even well known speculator and newsletter writer Doug Casey recommended Bre-X to his readers. But he also advised them to get out when the stock hit $160.

The case gets even messier. The Ontario Teachers Pension Fund lost $100 million on Bre-X because it bought it automatically when Bre-X was added to the TSE 300 Index. Should the Toronto Stock Exchange be liable because it added a fraudulent stock to its index?

Some time ago, Pat McKeough told the story in his newsletter, The Successful Investor, of a farmer who sold his farm for around $400,000 and entrusted it to a major brokerage to manage. He told them he was a conservative investor but wanted to have some growth. After going through the biggest bull market in history, his account had grown a paltry few percent. The reason? His broker had traded him in and out of stocks constantly eating up most of his gains in commissions and missing out on rebounds that some of his stocks would have had if they had not been sold.

That fellow was lucky compared to other tales of woe. In the National Post, Peter Kuitenbrouwer devotes a whole article to the question of advisors giving bad counsel, particularly to widows after an insurance settlement. He tells the story of Anna Nekanovic who invested $100,000 with her broker in 1995. At first things went fine as the money was put into a money market fund and grew modestly to $101,649. But in 1998 her advisor talked her into borrowing $100,000 to invest in equities and bonds. When in 1998? June! Just before the market imploded.

"Leverage," writes Kuitenbrouwer, "is good for financial advisors, since if a client doubles her investment with borrowed cash, the broker earns twice as much in commissions and mutual fund trailer fees".

Jim Roache of Kitchener, Ontario has had a long running battle with his former broker, Nesbitt Burns. They got him into, as he puts it, "such stalwart investments as: Leicester Diamond Mines, Conquistador Mines, Pacific Amber Resources Ltd., Borneo Gold Corp., South Pacific Resources, Loewen Group, Corel (bought high) and Bre-X on margin".

No shrinking violet, Roache launched an aggressive website denouncing the broker in no uncertain terms. Brokers and advisors, he says, have a duty to:

  • disclose all relevant facts so that a client can make informed decisions;
  • not misrepresent the degree of risk associated with a recommendation;
  • understand the clients willingness or lack thereof to accept risk and be guided accordingly;
  • behave in a way which protects the client's reasonable expectations and avoids all possible conflicts of interest.

Roache contends that this did not happen. He fairly screams in large letters that "Their unwillingness to assume responsibility is totally UNACCEPTABLE!!!".

Despite an implied threat by Nesbitt Burns spokesman, Paul Gamel, to sue for libel, the broker has not taken any action against Roache's website. "Strange indeed," says Roache, "if the information presented here is in any way incorrect".

Meanwhile Stan Buell of Markham, Ontario is suing CIBC Wood Gundy after his $450,000 portfolio dwindled to $40,000 in their hands between 1984 and 1987. That case and Roache's are still before the courts. Buell, like Roache, eventually took action outside of the lawsuit. Buell formed the Small Investor Protection Association (SIPA) which now has over 80 members.

The most devastating case, and perhaps the most instructive, is that of Catherine Rahal of Montreal who received $1.6 million in insurance and legal settlements after her husband was killed in a plane crash in 1983. By 1991 that money was almost entirely dissipated through bad investments. But the feisty Ms. Rahal learned from her mistakes and herself became a financial advisor forming her own consulting service, CSR Consultants. She is a licensed insurance and mutual funds rep.

And she has also become a columnist for Canoe, one of Canada's leading web portals. (She is no longer with Canoe but is a consultant with North American Lifestyle Planning.)

"If you sit in a corner and howl, it doesn't take long before no one will have anything to do with you," she writes in a recent email. " Trite as it sounds, life goes on, and you have to go on with it." She now "teaches her clients to think before they invest," reports Kuitenbrouwer in his Post article.

That has to be the key. Think before you invest. Although some pundits like Garth Turner strongly recommend using a financial advisor - most people, he says, "entrust their money entirely to rank amateurs with no formal training. That's right, they try to do their own financial planning" - as the above stories show, even professional advisors can steer you wrong.

Every investor owes it to himself to understand some basics about investing. Seek counsel. Listen to advice. But ultimately, the buck stops with you! Don't let someone else do your thinking for you

 

Contents copyright Marco den Ouden       All Rights reserved
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