Notice of Hearing

NOTICE is further given that the MFDA alleges the following violations of the By-laws, Rules or Policies of the MFDA:

 

Allegation #1: Between 2006 and 2016, the Respondents engaged in securities related business that was not carried on for the account of ICM, through the facilities of ICM or recorded on the books and records of ICM by:

1. selling, recommending, referring or facilitating the sale of at least $24.5 million of investments in a non-arm’s length company to least 170 ICM clients; and
2. selling, recommending, referring or facilitating the sale of at least $1.7 million of investments in a non-arm’s length company to at least 19 ICM clients;

contrary to MFDA Rules 1.1.1 and 2.1.1, or in the alternative, MFDA Rules 2.4.2 and 2.1.1 and sections 13.8 to 13.10 of National Instrument 31-103.

Allegation #2: Since 2006, John and Javier Sanchez have engaged in outside business activities that were not approved by ICM in writing or reflected on the books and records of ICM, and in any event were prohibited, contrary to MFDA Rule 1.3[1].

Allegation #3: Since 2006, John and Javier Sanchez solicited at least $26.2 million from ICM clients for investment in two non-arm’s length companies, thereby engaging in conduct that gave rise to conflicts of interest which the Respondents failed to address by the exercise of responsible business judgment influenced only by the best interests of the clients, contrary to MFDA Rules 2.1.4 and 2.1.1.

Allegation #4: Between 2006 and 2016, the Respondents recommended that at least 170 ICM clients purchase investments distributed by two non-arm’s length companies, without conducting adequate due diligence to know the products, and/or without ensuring that the products were suitable for sale to ICM clients having regard to the essential Know-Your-Client (“KYC”) information relevant to each individual client, contrary to MFDA Rules 2.2.1[2] and 2.1.1.

Allegation #5: Since October 2006, the Respondents have disregarded or failed to comply with the terms of an Agreement and Undertaking entered into between the Respondents and Staff, thereby engaging in conduct contrary to MFDA Rule 2.1.1 and engaging the authority of the Hearing Panel to impose a penalty on the Respondents pursuant to sections 24.1.1 and 24.1.2 of MFDA By-law No. 1.

Allegation #6: Since 2008, the Respondents have failed to cooperate with Staff’s investigations into their conduct by, among other things, providing false or misleading statements to Staff, concealing and withholding information about some of their business activities, and withholding, concealing or destroying emails on ICM’s systems during an on-site inspection conducted by Staff, contrary to section 22 of MFDA By-law No. 1 and MFDA Rule 2.1.1.

Allegation #7: Since February 2009, the Respondents have failed to:

1. establish, implement and maintain policies and procedures which ensured adequate head office account supervision;
2. maintain records of trade supervision that was conducted including inquiries made, responses received from Approved Persons and resolutions achieved as a result of supervisory inquiries; and
3. establish,implement and maintain policies and procedures which ensured the identification of trends in trading activity,

contrary to MFDA Rules 2.1.1, 2.5.1, 2.5.7, and MFDA Policy No. 2.

 

PARTICULARS

NOTICE is further given that the following is a summary of the facts alleged and intended to be relied upon by the MFDA at the hearing:

Registration History

1. ICM is registered as a mutual fund dealer and exempt market dealer in both Alberta and Ontario, and has been a Member of the MFDA since February 8, 2002. ICM is jointly owned by John and Javier Sanchez, who are brothers.

2. Since June 1, 1996, John has been registered in Ontario and Alberta as a mutual fund salesperson (now known as a dealing representative^[3]), officer and director of ICM. John is an Approved Person of ICM, as well as the President, Ultimate Designated Person (“UDP”), Chief Compliance Officer (“CCO”), and primary directing mind of ICM.

3. Since July 1, 1996, Javier has been registered in Ontario as a mutual fund salesperson, officer and director of ICM. Javier is an Approved Person of ICM, as well as the Vice-President and Alternative CCO of ICM.

4. At all material times, the Respondents conducted business at ICM’s head office located in Toronto, Ontario.

 Background 

Invoice Payment Systems Corporation

5. Invoice Payment Systems Corporation (“IPS”) is an Ontario corporation that was incorporated on September 9, 2003. IPS is a factoring company that purchases the accounts receivable of other businesses at a discount, with the intention of collecting the full value of the accounts receivable.

6. 75% of the shares of IPS are owned by holding companies controlled by John, Javier, Javier’s wife, and the estate of Juan Sanchez (the late father of John and Javier). The other 25% of the shares of IPS are owned by a holding company controlled by GS, the President of IPS. 

Energentium Inc.

7. Energentium Inc. (“Energentium”) is an Ontario corporation that was incorporated on May 31, 2012. Energentium was established as a waste management and recycling services company.

8. Since May 31, 2012, John has been the President of Energentium and has participated in the management of the company’s operations along with his son, MS, who is the general manager of Energentium.

9. The outstanding shares of Energentium are owned as follows:
   1. one third are owned by holding companies controlled by John and Javier;
   2. one third are owned by the Caldwell ICM Market Strategy Trust Fund (defined below); and
   3. one third are owned by Sodanol Inc., an arm’s length corporation. 

Caldwell ICM Market Strategy Trust Fund

10. The Caldwell ICM Market Strategy Trust Fund (“Caldwell Fund”) is a mutual fund that is distributed exclusively or primarily to ICM clients. The Caldwell Fund is a non-prospectus qualified mutual fund that was distributed to unit holders as an exempt market product. The Caldwell Fund is managed by Caldwell Investment Management Ltd., an investment fund manager registered with the Ontario Securities Commission (“OSC”).

11. John and Javier have, from time to time, exerted influence with the fund manager overseeing the Caldwell Fund regarding the content of the Caldwell Fund’s portfolio. 

The Distribution of Promissory Notes by ICM Prior To 2006

12. Not later than October 1, 2003, ICM was appointed as the exclusive distributor of promissory notes issued by IPS (the “IPS Notes”). According to IPS, monies solicited from investors in connection with the distribution of the IPS Notes were used to finance its factoring business by funding the purchase of accounts receivable.

13. Prior to June 28, 2004, ICM also distributed promissory notes for Sales Linked Finance Ltd. (“SLF”), another factoring company. SLF was owned by Juan Sanchez, the late father of John and Javier, until SLF was acquired by IPS in 2003 or 2004.

14. During a compliance examination of ICM conducted by Staff in 2004 (the “2004 Compliance Examination”), Staff discovered that IPS Notes and promissory notes issued by SLF (the “SLF Notes”) appeared to have been issued to ICM clients. Staff raised concerns with the Respondents about whether the distribution of the IPS Notes and SLF Notes was compliant with MFDA Rules and applicable securities legislation.

15. Following the 2004 Compliance Examination, ICM informed Staff that IPS had acquired SLF, and IPS Notes were issued to SLF noteholders to replace the SLF Notes. 

The 2006 Agreement and Undertaking between ICM and the MFDA

16. On October 11, 2006, ICM entered into an Agreement and Undertaking with Staff (the “Agreement and Undertaking”) in which ICM agreed to address compliance deficiencies identified during the 2004 Compliance Examination, including deficiencies with respect to the distribution of the IPS Notes, the SLF Notes and other exempt products. Pursuant to the terms of the Agreement and Undertaking, ICM agreed to, among other things:
    1. advise all clients invested in the IPS Notes, in writing, that the notes are a high-risk investment;
    2. obtain updated KYC information and re-evaluate the suitability of the investment for all clients who had invested in the IPS Notes and ensure that only clients that have an appropriate risk tolerance remain invested in the IPS Notes;
    3. recommend that clients who did not have a high risk tolerance cease to invest in the IPS Notes;
    4. refund the full amount of the original investment and any accrued interest owing to all clients who did not wish to continue to hold the IPS Notes or for whom continuing investment in the IPS Notes was unsuitable;
    5. produce a report to Staff outlining its implementation of the terms of the Agreement and Undertaking together with its October 2006 monthly financial report;
    6. provide the MFDA a written report evidencing compliance with the Agreement and Undertaking on or before December 31, 2006, including:
       1. updated KYC forms signed by its clients who invested in the IPS Notes;
       2. confirmation that all clients invested in the Notes have been advised in writing that the IPS Notes are a high-risk investment; and
       3. evidence of refunds made to clients for whom a continuing investment in the IPS Notes is unsuitable;
    7. ensure when recommending high-risk exempt products to clients:
       1. that the product is suitable for the clients based on their documented KYC information; and
       2. that the clients sign an acknowledgement indicating the following:
          1. that the product is a high-risk investment;
          2. the rate of commissions (if any) and the amount of commissions (if any) being paid to ICM; and
          3. the relationship between the Issuer of the product and ICM (if any) and the potential conflicts of interest that may arise from the relationship (if any).

17. As set out in more detail herein, between 2006 and 2016, the Respondents failed to comply with the terms of the Agreement and Undertaking and failed to disclose to Staff, or deliberately concealed from Staff that the Respondents continued to distribute IPS Notes and other investments that were not prospectus qualified mutual funds. 

Allegation #1 – Securities Related Business Outside the Member 

The Distribution of IPS Notes

18. Since IPS was incorporated in 2003, the Respondents have been the exclusive or primary distributors of IPS Notes.

19. Between 2006 and 2016, the Respondents sold, recommended, referred or facilitated the sale of at least $24.5 million[4] of investments in IPS Notes to at least 170 ICM clients.

20. The transactions relating to the distribution of IPS Notes to ICM clients were not recorded on the books of ICM, were not carried on for the account of ICM, and were not processed through the facilities of ICM.

21. The IPS Notes have generally been distributed subject to the following terms:
    1. arms-length noteholders have typically been offered an interest rate of between 7% and 8% per year, whereas non arms-length noteholders have typically been offered an interest rate of 10% per year;
    2. interest on the IPS Notes was payable monthly, quarterly, annually or upon maturity, depending upon the preference of the noteholder;
    3. the IPS Notes were typically issued for a one or two year term and could only be redeemed on the maturity date;
    4. 60 days prior to the maturity date, investors were offered the option of redeeming their principal as of the maturity date or continuing the investment for a new term. Unless investors communicated an intention to redeem the IPS Note prior to the maturity date, the notes were automatically renewed for an additional term; and
    5. the investments in the IPS Notes were not secured by any collateral.

22. No disclosure (such as a prospectus or offering memorandum) was provided to investors before, or at the time, the investors purchased IPS Notes concerning, among other things, the risks of the investment, the manner in which the money would be used by IPS, the compensation that IPS intended to pay to the Respondents for soliciting investors in the IPS Notes and the non-arm’s length relationship between IPS and the Respondents.

23. Between September 2010 and August 2015, John and Javier, through holding companies they controlled, were paid compensation attributable to the distribution of IPS Notes to ICM clients. John and Javier received approximately $1.8 million, which is approximately 8% of the amount of the IPS Notes distributed during that period.^[5]

24. The compensation paid by IPS to the Respondents in connection with the distribution of the IPS Notes was not paid or credited directly to ICM and was not recorded on the books of ICM.

25. By engaging in the conduct described above, the Respondents acted contrary to MFDA Rules 1.1.1 and 2.1.1. 

The Distribution of Energentium Notes

26. Since Energentium was incorporated in 2012, the Respondents have been the exclusive or primary distributors of promissory notes issued by Energentium (the “Energentium Notes”).

27. Between 2012 and 2016, the Respondents sold, recommended, referred or facilitated the sale of at least $1.7 million[6] of investments in Energentium Notes to at least 19 ICM clients.

28. The transactions relating to the distribution of Energentium Notes to ICM clients were not recorded on the books of ICM, were not carried on for the account of ICM, and were not processed through the facilities of ICM.

29. As described in paragraph 0 above, the Caldwell Fund held one third of Energentium’s outstanding shares. From time to time, the Caldwell Fund has also held Energentium Notes. As a result of the fact that from time to time the Caldwell Fund was a noteholder and shareholder of IPS Notes, unit holders of the Caldwell Fund (who were exclusively or primarily clients of ICM) were indirect investors in Energentium.

30. The Energentium Notes have generally been distributed subject to the following terms:
    1. noteholders have typically been offered an interest rate that is usually set by John at his discretion, at a rate between 6.5% and 9% per year;
    2. interest on the Energentium Notes was payable monthly, quarterly, annually or upon maturity, depending upon the preference of the noteholder;
    3. the Energentium Notes were typically issued for a one or two year term and could only be redeemed on the maturity date;
    4. 60 days prior to the maturity date, investors were offered the option of redeeming their principal as of the maturity date, or continuing the investment for a new term. Unless investors communicated their intention to redeem their Energentium Note prior to the maturity date, the notes were automatically renewed for an additional term; and
    5. the investments in the Energentium Notes were not secured by any collateral.

31. No disclosure (such as a prospectus or offering memorandum) was provided to investors before, or at the time, the investors purchased the Energentium Notes concerning, among other things, the risks of the investment, the manner in which the money would be used by Energentium, the compensation that Energentium intended to pay to the Respondents for soliciting investors in the Energentium Notes and the non-arm’s length relationship between Energentium and the Respondents.

32. Interest payments owed to Energentium noteholders have not been paid out on an ongoing basis. Energentium noteholders were not informed at the time they purchased the Energentium Notes that there was a significant risk that, as a startup company, Energentium might be unable make interest payments on a periodic basis as interest payments came due (e.g. monthly, quarterly or annually) prior to redemption of the Energentium Notes.

33. Between October 2012 and October 2013, John and Javier, through holding companies they controlled, were paid compensation attributable to the distribution of Energentium Notes to ICM clients. John and Javier received approximately $196,178, which is approximately 24% of the amount of all Energentium Notes distributed during that period.

34. The compensation paid by Energentium to the Respondents in connection with the distribution of the IPS Notes was not paid or credited directly to ICM and was not recorded on the books of ICM.

35. By engaging in the conduct described above, the Respondents acted contrary to MFDA Rules 1.1.1 and 2.1.1. 

In the Alternative: Referral Arrangements for IPS and Energentium

36. In the event that the Respondents’ activities in respect of the investments by ICM clients in IPS and Energentium did not constitute securities related business, then John and Javier participated in a referral arrangement which did not comply with MFDA Rules 2.4.2 and 2.1.1 and sections 13.8 to 13.10 of National Instrument 31-103 for the following reasons:
    1. the Respondents did not enter into written agreements with IPS and Energentium documenting the services that they would be providing in return for the payment of fees/compensation that they received from the issuers of those investments;
    2. the Respondents did not document the compensation that they received from IPS and Energentium on the books and records of ICM; and
    3. the Respondents did not provide written disclosure to the ICM clients who purchased investments from IPS and Energentium with respect to:
       1. the conflicts of interest arising from their non-arm’s length relationship with IPS and Energentium and the compensation that they were being paid to solicit investments in IPS and Energentium;
       2. the method of calculating the compensation that the Respondents were paid for soliciting investments by ICM clients in IPS and Energentium, or to the extent possible, the actual amount of the fees that they received as a consequence of the investments that they solicited from particular clients; or
       3. other material information that a reasonable client would consider important in evaluating whether to proceed with an investment recommended by an individual who was receiving compensation for referring them to the investment. 

Allegation #2 – Undisclosed Outside Business Activities

37. Between 2006 and 2016, John did not disclose his roles as a director of IPS, President of Energentium and his role in efforts of IPS and Energentium to raise capital by soliciting purchasers of promissory notes, on Forms 33-109F4 that were filed with the OSC.

38. Between 2006 and 2016, Javier did not disclose his role in efforts of IPS and Energentium to raise capital by soliciting purchasers of promissory notes on Forms 33-109F4 that were filed with the OSC.

39. The Respondents did not otherwise disclose the involvement of John and Javier with the business activities of IPS or Energentium to Staff.

40. The Respondents also failed to document written approval from ICM of John’s and Javier’s business activities relating to IPS or Energentium on the books and records of ICM, or stipulate any terms and conditions with respect to the approval of any engagement by John or Javier in such outside business activities, contrary to MFDA Rule 1.3.2(c).

41. In any event, John and Javier were not permitted to engage outside business activities in connection with the distribution of IPS Notes and Energentium Notes to ICM clients because:
    1. such outside activities would be contrary to MFDA Rule 1.3.2(a) because they constituted impermissible securities related business that was not carried on for the account of ICM, contrary to MFDA Rule 1.1.1; and
    2. such outside activities would be contrary to MFDA Rule 1.3.2(a) because the solicitation of investments by ICM clients in businesses that were owned and to some extent operated by John and Javier, their family members and associates gave rise to conflicts of interest that were not addressed in accordance with MFDA Rule 2.1.4.

42. By virtue of the foregoing, John and Javier engaged in outside business activities in contravention of MFDA Rule 1.3. 

Allegation #3 – Conflicts of Interest

43. John and Javier have a non-arm’s length relationship with both IPS and Energentium as both companies are substantially owned, operated, or controlled by John, Javier, their families and associates.

44. Between 2003 and 2016, the Respondents solicited investments in IPS and Energentium by ICM clients, which gave rise to conflicts of interest which the Respondents failed to address by the exercise of responsible business judgment influenced only by the best interests of ICM clients.

45. The conflicts of interest were aggravated because the Respondents:
    1. failed to disclose that the transactions concerning the investment by ICM clients in IPS Notes and Energentium Notes were not being carried on for the account of, or through the facilities of ICM;
    2. failed to provide ICM clients with any financial disclosure about either IPS or Energentium;
    3. failed to accurately disclose in writing the amount of compensation that they were receiving for soliciting money for investment in IPS and Energentium;
    4. determined rates of return that they were prepared to offer to ICM clients at their own discretion, which were ordinarily set at rates that were lower than IPS or Energentium paid to the principals of the companies, their families and their associates (collectively, “Non-Arm’s Length Investors”)[7];
    5. failed to inform clients that the IPS Notes and Energentium Notes were high risk investments or explain the reasons why the investments were high risk; in fact, the Respondents misrepresented the IPS Notes and Energentium Notes as “safe” and/or “secured” investments;
    6. withheld material disclosure from ICM clients, including disclosure about their non-arm’s length relationship with IPS and Energentium including their ownership interests in both companies.

46. Specifically, the Respondents withheld the following information from clients who were solicited to invest in IPS Notes:
    1. holding companies owned and controlled by John, Javier and their family members owned or controlled 75% of the outstanding common shares of IPS;
    2. the IPS Notes were unsecured;
    3. the risk associated with IPS’s substantial liability to noteholders which amounted to more than $24.5 million, as well as the risk attributable to the fact that more than $23 million of the company’s $27 million in assets related to outstanding and unsecured accounts receivable that IPS intended to collect;
    4. during the fiscal year ending August 31, 2015, IPS paid $240,000 to a related party for unexplained consulting fees and extended $450,000 in unsecured interest-free loans to related parties (including $130,000 to a company owned by John and Javier); and
    5. during the fiscal year ending August 31, 2015, more than 20% of the accounts receivable included among the assets of IPS were accounts receivable acquired from related parties including companies owned or operated by John and Javier, their families and associates.

47. The Respondents also withheld the following information from clients who were solicited to invest in the Energentium Notes:
    1. John was the President of Energentium and his son MS was the general manager;
    2. holding companies owned by John, Javier and Javier’s spouse owned 33% of the outstanding common shares of Energentium through holding companies they owned or controlled;
    3. the Energentium Notes were unsecured;
    4. Energentium lacked sufficient cash flow to pay interest to noteholders as it came due;
    5. between 2013 and 2015, Energentium incurred losses in excess of $700,000 per year; and
    6. as of May 31, 2016, Energentium’s liabilities included, in addition to the $1.7 million that Energentium owed to noteholders, more than $1 million owed on a mortgage obtained from an institutional lender and more than $1.2 million in outstanding shareholder loans.

48. By soliciting money from ICM clients for investment in IPS and Energentium, the Respondents engaged in conduct that gave rise to conflicts of interest, which were not addressed by the exercise of responsible business judgment influenced only by the best interests of the clients, and failed to deal fairly, honestly or in good faith with their clients and engaged in conduct that was unbecoming and detrimental to the public interest, contrary to MFDA Rules 2.1.4 and 2.1.1. 

Allegation #4 – Suitability

49. Between 2006 and 2016, prior to recommending and distributing IPS Notes and Energentium Notes to at least 170 ICM clients, the Respondents failed to conduct sufficient due diligence on the products to fulfill their suitability obligations and to abide by the standard of conduct. In particular, the Respondents failed to:
    1. determine whether the notes were eligible for sale without a prospectus and if so, what exemptions from prospectus requirements would be applicable;
    2. ensure that evidence was obtained from each client to whom the notes were offered to demonstrate their eligibility for any exemptions relied upon;
    3. document criteria or limitations with respect to the types of clients to whom the investments should be offered having regard to the relevant KYC information such as risk tolerance, time horizon, investment objectives, net worth, income, and investment knowledge; and
    4. identify the risks associated with the products and ensure that those risks were appropriately documented and disclosed to clients.

50. When the Respondents recommended and distributed the IPS Notes and Energentium Notes to ICM clients, they also:
    1. failed to document the KYC information applicable for each client in respect of the sale of the IPS Notes and/or Energentium Notes;
    2. failed to ensure that each order accepted or recommendation made to ICM clients with respect to the IPS Notes and/or Energentium Notes was suitable for the clients and consistent with the investment objectives of the clients; and
    3. misrepresented or failed to adequately and accurately disclose the risks, benefits, material assumptions and features of the IPS Notes and/or Energentium Notes to ICM clients and to present the products in a fair and balanced manner.

51. By engaging in the conduct described above, the Respondents acted contrary to MFDA Rules 2.2.1 and 2.1.1. 

Allegation #5 – Breach of an Agreement and Undertaking with the MFDA

52. As set out at paragraph 16 above, the Respondents entered into the Agreement and Undertaking with Staff on October 11, 2006, in order to address compliance deficiencies that had been identified by Staff during the 2004 Compliance Examination. 

53. Between 2006 and 2016, the Respondents contravened the terms of the Agreement and Undertaking by, among other things, failing to:
    1. record KYC information for ICM clients who invested in the IPS Notes and Energentium Notes on the books and records of ICM, in order to ensure that the products were suitable for those clients; and
    2. obtain signed acknowledgements from ICM clients indicating the following:
       1. that IPS Notes and Energentium Notes were high risk investments;
       2. the amount and rate of compensation payable to the Respondents in connection with the sale of the IPS Notes and Energentium Notes; and
       3. the relationship between the Respondents, and IPS or Energentium, including disclosure of any potential conflicts of interest arising from the non-arm’s length nature of the relationship between the Respondents and IPS or Energentium. 

Allegation #6 – Failure to Cooperate with Staff of the MFDA

 A) Misleading Statements to MFDA Compliance Staff

54. The Respondents provided the following misleading statements to MFDA Compliance Staff:
    1. between 2006 and 2016, the Respondents submitted nine (9) responses to annual Membership Questionnaires to the MFDA in which the Respondents were required to disclose, among other things, the value of ICM’s Assets Under Administration (“AUA”) for the previous year, the types of investments held by clients of the Member and the amount (in dollar value) of each investment type sold. The Respondents failed to disclose the sale of IPS Notes in any of the nine (9) responses to the Membership Questionnaires[8];
    2. between 2012 and 2016, the Respondents submitted Membership Questionnaires to the MFDA in which the Respondents failed to disclose the sale of Energentium Notes; and
    3. during compliance examinations conducted at ICM’s office in 2009, 2012 and 2015, John and Javier participated in interviews with Staff during which they:
       1. were asked about the full range of products that they offered through ICM, outside of the Member, and through referral arrangements with third parties and did not disclose their roles, relationships or activities in respect of IPS or Energentium or their efforts to solicit investments by ICM clients in IPS Notes or Energentium Notes; and
       2. stated that they were not engaged in any outside business activities.

55. At all material times, the Respondents knew or ought to have known that they were providing misleading statements to MFDA Compliance Staff.

B) Misleading Statements to MFDA Enforcement Staff

56. In April 2011, in response to inquiries from MFDA Enforcement Staff about the extent of their continuing involvement with IPS, the Respondents falsely denied that they had an existing relationship with IPS, and denied that they were receiving compensation in connection with the distribution of IPS Notes.

57. John and Javier provided false or misleading statements to MFDA Enforcement Staff during an interview on November 18, 2016 including the following:
    1. the IPS Notes were secured notes;
    2. Javier stated that ICM clients who purchased IPS Notes were provided with a disclosure letter informing them that:
       1. IPS was a high risk investment;
       2. the Respondents had a non-arm’s length relationship with IPS; and
       3. the Respondents received compensation for soliciting money for the purchase of IPS Notes;
    3. John stated that ICM clients who purchased Energentium Notes were provided with a disclosure letter informing them that:
       1. the Respondents had a non-arm’s length relationship with Energentium; and
       2. the Respondents received compensation for soliciting money for the purchase of Energentium Notes; and
    4. John substantially understated the extent of the losses that Energentium was generating on a monthly and annual basis.

58. At all material times, the Respondents knew or ought to have known that they were providing misleading statements to MFDA Enforcement Staff. 

C) Removal of Emails During On-Site Inspection by Staff

59. On November 15, 2016, after receiving reports that the Respondents had been soliciting investments in IPS Notes and Energentium Notes from clients of ICM, Staff attended at the office of ICM to conduct an on-site inspection to investigate whether the Respondents were engaged in undisclosed securities related business that had not been recorded on the books and records of ICM. Staff retained a third party forensic digital technology expert firm to participate in the on-site inspection and copy ICM’s electronic records in order to facilitate Staff’s investigation.

60. Staff arrived at the office of ICM shortly after 9:00 a.m., and informed the Respondents that, among other things, Staff required access to John’s and Javier’s computers in order to copy their respective hard drives. Between 9:00 a.m. and 12:30 p.m., the Respondents refused to facilitate access to John’s and Javier’s computers and simultaneously took steps to conceal or destroy certain electronic records of ICM prior to the copying of those records by the forensic digital technology expert retained by Staff.  In particular, the Respondents withheld, concealed and potentially destroyed (or arranged for employees or agents of ICM to withhold, conceal or destroy) electronic records concerning the involvement of John and Javier with IPS and Energentium, including their efforts to solicit investments by clients of ICM in IPS Notes and in Energentium Notes.

61. The files that the Respondents or their agents withheld, concealed or destroyed from ICM’s computers or network included email archives from 2009 to 2015. Approximately 30 gigabytes of electronic records, including emails, were removed before the Respondents consented to the copying of their electronic records.

62. By providing false and misleading statements to the MFDA and withholding, concealing and/or destroying records relevant to matters under investigation, the Respondents failed to cooperate with Staff’s investigation into their conduct, contrary to section 22 of MFDA By-law No. 1 and MFDA Rule 2.1.1. 

Allegation #7 – Repeat Trade Supervision Deficiencies

63. In the first quarter of 2012, Staff conducted a compliance examinationof ICM, in order to assess the Respondents’ compliance with MFDA Rules, By-laws and Policies (the “2012 Compliance Examination”).  The results of the 2012 Compliance Examination were summarized and delivered to the Respondents in a report dated July 27, 2012 (the “2012 Compliance Examination Report”).

64. The 2012 Compliance Examination identified, among other things, the following deficiencies:
    1. ICM supervisory staff did not maintain evidence of trade inquiries, responses received and resolutions achieved; and
    2. ICM had not implemented adequate procedures to identify or detect trading trends or patterns of concern, in accordance with MFDA Policy No. 2. Specifically, the following reviews were not being conducted:
       1. accounts generating commissions greater than $1,500 within the month;
       2. AUA reports on a quarterly basis comparing current AUA to AUA at the same time the prior year; and
       3. commission reports on a quarterly basis for the previous twelve-month period comparing them to the same period the prior year.

65. In their response to Staff regarding the reported deficiencies dated August 27, 2012, the Respondents informed Staff that commencing no later than December 31, 2012, they would:
    1. implement the use of an electronic module available through ICM’s back office system that was designed to facilitate trade review and the creation and retention of records of the supervision and approval of daily trading, the opening of new accounts and the recording of KYC updates;
    2. implement the use of a compliance email account in order to document compliance inquiries and follow up, and to retain records of trade supervision queries on ICM’s back office system; and
    3. implement the creation and review of reports to identify all accounts generating commissions greater than $1,500 within the month; quarterly commissions; and, quarterly AUA reports.

66. In the first quarter of 2015, Staff conducted a follow up compliance examinationof ICM, covering the period from February 1, 2012 to November 30, 2014, in order to assess the Respondents’ compliance with MFDA Rules, By-laws and Policies (the “2015 Compliance Examination”). The results of the 2015 Compliance Examination were summarized and delivered to the Respondents in a report dated May 28, 2015 (the “2015 Compliance Examination Report”).

67. The 2015 Compliance Examination Report identified, among other things, the following repeat deficiencies that had previously been identified in the 2012 Compliance Examination Report:
    1. the Respondents did not maintain records of trade supervision such as evidence of trade inquiries, responses received and resolutions achieved; and
    2. ICM had not implemented adequate procedures to identify or detect trading trends or patterns of concern, in accordance with MFDA Policy No. 2 with respect to:
       1. accounts generating commissions greater than $1,500 within the month;
       2. AUA reports on a quarterly basis comparing current AUA to AUA at the same time the prior year; and
       3. commission reports on a quarterly basis for the previous twelve-month period comparing them to the same period the prior year.

68. Contrary to their representations to Staff on August 27, 2012, the Respondents:
    1. had not implemented the use of an electronic module on their back office system to facilitate trade review and the creation and retention of records of the supervision and approval of daily trading, the opening of new accounts and the recording of KYC updates;
    2. did not maintain evidence of compliance queries and follow up including trade queries; and
    3. did not implement the use of trend reports to detect concerning changes in trading patterns, commission spikes or significant changes in AUA, as required by MFDA Policy No. 2.

69. By virtue of the foregoing, between July 27, 2012 and May 28, 2015, the Respondents failed to establish, implement and maintain policies and procedures which ensured adequate trade supervision in accordance with MFDA Policy No. 2, contrary to representations that were made to Staff at the conclusion of the 2012 Compliance Examination, and to MFDA Rules 2.1.1, 2.5.1, 2.5.7, and MFDA Policy No. 2. 

NOTICE is further given that the Respondents shall be entitled to appear and be heard and be represented by counsel or agent at the hearing and to make submissions, present evidence and call, examine and cross-examine witnesses.

NOTICE is further given that MFDA By-laws provide that if, in the opinion of the Hearing Panel, the Respondents:

• have failed to carry out any agreement with the MFDA;
• have failed to comply with or carry out the provisions of any federal or provincial statute relating to the business of the Member or of any regulation or policy made pursuant thereto;
• have failed to comply with the provisions of any By-law, Rule or Policy of the MFDA;
• have engaged in any business conduct or practice which such Regional Council in its discretion considers unbecoming or not in the public interest; or
• are otherwise not qualified whether by integrity, solvency, training or experience,

the Hearing Panel has the power to impose any one or more of the following penalties:

1. a reprimand;
2. a fine not exceeding the greater of:
   1. $5,000,000.00 per offence; and
   2. an amount equal to three times the profit obtained or loss avoided by such person as a result of committing the violation;
3. suspension of the authority of the person to conduct securities related business for such specified period and upon such terms as the Hearing Panel may determine;
4. revocation of the authority of such person to conduct securities related business;
5. prohibition of the authority of the person to conduct securities related business in any capacity for any period of time;
6. such conditions of authority to conduct securities related business as may be considered appropriate by the Hearing Panel;

NOTICE is further given that the Hearing Panel may, in its discretion, require that the Respondents pay the whole or any portion of the costs of the proceedings before the Hearing Panel and any investigation relating thereto.

NOTICE is further given that the Respondents must serve a Reply on Enforcement Counsel and file a Reply with the Office of the Corporate Secretary within twenty (20) days from the date of service of this Notice of Hearing.

A Reply shall be served upon Enforcement Counsel at:           

            Mutual Fund Dealers Association of Canada

            121 King Street West, Suite 1000

            Toronto, ON M5H 3T9

            Attention: Shelly Feld, Manager, Litigation

            Fax:  416-361-9073

            Email: sfeld@mfda.ca

 

a Reply shall be filed by:

1. providing four (4) copies of the Reply to the Office of the Corporate Secretary by personal delivery, mail or courier to:

The Mutual Fund Dealers Association of Canada

121 King Street West, Suite 1000

Toronto, ON M5H 3T9

Attention: Office of the Corporate Secretary; or

b. transmitting one (1) copy of the Reply to the Office of the Corporate Secretary by fax to fax number 416-361-9781, provided that the Reply does not exceed 16 pages, inclusive of the covering page, unless the Office of the Corporate Secretary permits otherwise; or

c. transmitting one (1) electronic copy of the Reply to the Office of the Corporate Secretary by e-mail at corporatesecretary@mfda.ca.

A Reply may either:

1. specifically deny (with a summary of the facts alleged and intended to be relied upon by the Respondent, and the conclusions drawn by the Respondent based on the alleged facts) any or all of the facts alleged or the conclusions drawn by the MFDA in the Notice of Hearing; or
2. admit the facts alleged and conclusions drawn by the MFDA in the Notice of Hearing and plead circumstances in mitigation of any penalty to be assessed.

NOTICE is further given that the Hearing Panel may accept as having been proven any facts alleged or conclusions drawn by the MFDA in the Notice of Hearing that are not specifically denied in the Reply.

NOTICE is further given that if the Respondents fail:

1. to serve and file a Reply; or
2. attend at the hearing specified in the Notice of Hearing, notwithstanding that a Reply may have been served,

the Hearing Panel may proceed with the hearing of the matter on the date and the time and place set out in the Notice of Hearing (or on any subsequent date, at any time and place), without any further notice to and in the absence of the Respondents, and the Hearing Panel may accept the facts alleged or the conclusions drawn by the MFDA in the Notice of Hearing as having been proven and may impose any of the penalties described in the By-laws.

 

END.

 

[1] Formerly MFDA Rule 1.2.1(c) and before that Rule 1.2.1(d);

[2] MFDA Rule 2.2.1 was amended in December 2010 and in February 2013.  In this Notice of Hearing, all references to the MFDA Rule 2.2.1 concern the version of the Rule that was in force prior to December 2010.

[3] In September 2009, National Instrument 31-103 changed the registration category “mutual fund salesperson” to “dealing representative”.

[4] Not including interest payable.

[5] The IPS Notes sold between fiscal years 2011 and 2015 (September 1, 2010 to August 31, 2015) totalled approximately $22,622,762.

[6] Not including interest payable.

[7] Whereas the promissory notes issued to clients of ICM typically purported to pay an interest rate of 7% per year, the promissory notes that were issued to Non-Arm’s Length Investors including Javier, Javier’s wife, corporations controlled by John and Javier, other relatives of John and Javier, GS (the President of IPS) and employees of IPS bore an interest rate of 10% per year.

[8] The Respondents had disclosed in ICM’s 2005 response to a Membership Questionnaire that holdings of IPS Notes comprised part of ICM’s AUA and that the promissory notes that had been issued were an example of a type of investment sold by ICM.