Bailout of Canadian brokerage nearly swamps insurance fund

The Canadian brokerage industry had to bail out one of its own this month, and the contingency fund set up to protect investors is almost dry. And the deal has little, if anything to do with the October stock market plunge. The broker involved managed to do it by taking on too much. The Toronto brokerage house of Osler Inc. suffered a C$25 (US$32.5 million) potential setback when it didn't have the cash to cover a bond deal with a credit union. Three directors have resigned, and Bay Street - Toronto's financial center - expects criminal charges to follow. ``I'd be disappointed if they weren't,'' said one Toronto banker.

Osler got in over its head in the bond market. The relatively small brokerage house was handling more business than it could handle in case of an emergency.

The bond deal was with Canadian Co-Operative Credit Society, which is basically a bank for other smaller credit unions in Canada. The society has $1 billion in assets, and places its money through investment dealers such as Osler, usually in bonds or other high quality investments such as Treasury bills. But when the society went to the window for the cash, Osler was short $25 million.

While the deal itself was a shocker, observers were even more surprised that the Canadian brokerage industry did not have the cash to cover a relatively minor setback. The Ontario Securities Commission - the closest Canadian equivalent to the Securities and Exchange Commission in the United States - is investigating whether the safety valve for the brokerage industry was underfunded.

The National Contingency Fund, set up by the Canadian Stock Exchanges and the Investment Dealers Association - which represent the brokers - had to bail the company out or it would have gone under. ``The firm is a going concern,'' said Keith Boast, vice-president of member regulation at the Toronto Stock Exhcnage.

The contingency fund only put up $10 million; the credit union decided not to ask for the rest just yet, working on the sound theory that it can't get its money from a bankrupt brokerage house. But brokers can be thankful the credit union is being lenient. It is owed the money and could probably collect from the contingency fund. ``The odds are the firm would have to pay out much more than $10 million if the firm became insolvent,'' said Mr. Boast of the Toronto Exchange.

And there are doubts that the fund was used properly. Some brokers feel the fund should be used to cover clients' losses, not to keep a brokerage house in business. ``This is supposed to protect clients at risk, not bail out mistakes,'' said one Toronto broker.

There are supposed to be rules about how much risk a company can take on. The Toronto Stock Exchange has minimum capital requirements that are supposed to relate to the amount of bonds and other securities in inventory, margins on clients' business and other factors. But Osler only has a capital base of $13 million.

Canadian brokers are angry that they have to pay for Osler's mistakes. The National Contingency Fund is to get an infusion of $10 million; brokers pay according to their revenue. Many of them - still hurting from the October debacle - find this an unhappy prospect.

Many of the brokers want an insurance scheme to cover such losses in the future. ``What we need is something like the CDIC [the Canadian Deposit Insurance System which covers bank losses]'' said a Toronto dealer.

Back at Osler, the firm is being run by Robert Morgan, a former member of the Ontario Securities Commission. The brokerage house is being kept in business to bolster public confidence and so Boast can say, ``No bona fide retail customer has ever lost money as a result of a brokerage firm failure in living memory.''

The Canadian brokerage community hopes there isn't another ``mistake'' in the near future, so they don't have to dig deep into their own pockets to shore up an inadequate emergency fund.

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