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Reasons For Decision

Re:

Reasons For Decision

Reasons for Decision
File No. 200827


IN THE MATTER OF A SETTLEMENT HEARING
PURSUANT TO SECTION 24.4 OF BY-LAW NO. 1 OF
THE MUTUAL FUND DEALERS ASSOCIATION OF CANADA


Re: Colin Michael Corner, Heather Darlene Halladay, John Joseph
Hanson, Richard Gerald Moore and James Edward Rainbird


Heard: July 6, 2010 in Toronto, Ontario
Reasons for Decision: July 20, 2010

REASONS FOR DECISION

Hearing Panel of the Central Regional Council:

The Hon. Edward Saunders, Q.C.
Chair

Jeanne E. Beverly
Industry Representative

Linda J. Anderson
Industry Representative

Appearances:

Michelle Pong
)
For the Mutual Fund Dealers Association of

Charles Toth
)
Canada

Neil Gross
)
For the Respondents, Corner, Halladay,
Moore and Rainbird

)

John Joseph Hanson
)
Via Teleconference

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1.
This is a settlement hearing pursuant to Section 24.4 of By-law No. 1 of the
Mutual Fund Dealers Association of Canada (the “MFDA”). There are two settlement
agreements to be considered. The first is between the MFDA and the Respondents
Corner, Halladay, Moore and Rainbird, represented by Mr. Gross, and the second is
between the MFDA and the Respondent Hanson. The parties agreed that the agreements
be considered together.

2.
By Notice of Hearing dated October 21, 2008 the MFDA alleged the following
violation of the By-laws, Rules and Policies of the MFDA.

Allegation #1: Between June 25, 2003 and April 1, 2007, the Respondents, in
their capacity as Approved Persons of Farm Mutual Financial Services Inc.
(“Farm Mutual”), sold an exempt product to approximately 300 Farm Mutual
clients without ensuring that:
a) the investments were suitable for the clients and in keeping with the
clients’ investment objectives, contrary to MFDA Rules 2.2.1(a), (b), (c)
and (d), and 2.1.1(c); and
b) the clients qualified as accredited investors in accordance with Ontario
Securities Commission Rule 45-501 and subsequently National
Instrument 45-106, contrary to MFDA Rule 2.1.1(c), thereby engaging
the jurisdiction of the Hearing Panel to impose a penalty on the
Respondents pursuant to s. 24.1.1(h) of MFDA By-law No. 1.

Allegation #2: Between June 25, 2003 and April 1, 2007, the Respondents, in
their supervisory capacity with Farm Mutual, failed to ensure that all business
conducted on behalf of Farm Mutual by Approved Persons under their
supervision at their respective branch office, including the sale of exempt
products to Farm Mutual clients, was in compliance with MFDA Rules and
Policies and applicable securities legislation, contrary to MFDA Rules 2.5.3(b)
and 2.1.1(c) and MFDA Policy No. 2.

3.
All the Respondents had at least 14 years experience in the industry and at the
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relevant times were the Managers or Co-Managers of a branch of Farm Mutual. None of
the Respondents had any disciplinary history throughout their years in the industry.

4.
The allegations against the Respondents have their source in the sale of
debentures issued by FactorCorp Financial Inc. (“FactorCorp”). There is agreement on
the following facts:

(1) FactorCorp held itself out as being in the business of extending credit to
companies which purchased accounts receivable from other companies at a
discount and then attempted to collect the accounts in full.
(2) On June 25, 2003, and again on December 18, 2003, Farm Mutual entered
into a distribution agreement with FactorCorp pursuant to which Farm Mutual
agreed to promote and distribute debentures issued by FactorCorp (the
“Debentures”) to Farm Mutual clients through its Approved Person.
(3) The Debentures offered investors a fixed rate of interest of 6%, 7% or 8%
based on one-, two- or three-year terms, respectively.
(4) The Debentures were offered to investors in Ontario in reliance on the
“accredited investor” exemption set out in section 2.3 of Ontario Securities
Commission Rule 45-501 and subsequently National Instrument 45-106.
(5) In June 2003, Farm Mutual permitted Approved Person at the Respondent
Rainbird’s branch offices to sell the Debentures. In October 2003, Farm
Mutual approved the Debentures for sale by Approved Person at all of its
branch offices.
(6) In September 2003, Farm Mutual’s Manager of Compliance & Audit had
distributed materials to Farm Mutual’s branch managers describing the
Debentures as “highly-secured” and stating that the Debenture funds were “at
significantly less risk than typical investments in the equity markets”. In
October and November 2003, Farm Mutual’s President sent emails to the
branch managers updating them on Farm Mutual’s due diligence review of
FactorCorp, stating that Farm Mutual’s legal counsel had assessed the
Debentures, and describing them as “an outstanding investment opportunity”.
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(7) On November 5, 2003, Farm Mutual's Manager of Compliance & Auditing
began approving advertisements describing the Debentures as “fully secured”,
with “guaranteed rates” and “no market correlation or volatility”.

Subsequently, from November 2003 through July 2005, Farm Mutual's
Manager of Compliance & Auditing approved at least 8 additional similar
advertisements, including advertisements describing the Debentures as
“secured”, as combining attractive growth “with reduced risk versus equity
investments”, and as “a better alternative to GICs.”
(8) It is agreed that based on the aforementioned materials, emails and approved
advertisements, the Respondents concluded that Farm Mutual had rated the
Debentures as either a low or medium-low risk product
(9) On November 11, 2003, Farm Mutual’s Manager of Compliance & Auditing
sent an email message to all Farm Mutual branches, the purpose of which
was, among other things, to clarify the definition of “accredited investor” in
OSC Rule 45-501. This email was not sent directly to all branch managers,
however, and one of the Respondents (Moore) never received it.
(10) In the same email message, the Manager of Compliance & Auditing stated the
following:
“Please make sure that any training that is provided to your
sales associates stress the proper definition of an accredited
investor under OSC Rule 45-501. Any misinterpretation of
this rule/definition could result in a non-compliant sales of
an exempt product to our clients and leave the agent, the
branch and FMFS the dealer exposed to large financial
losses and also put our licensing under review. All exempt
products fall in a high risk category as they require more
than the basic knowledge for selling mutual funds. There
must be a clear understanding by the sales associate of what
they are selling and extra due diligence in supervision by
the branch manager in reviewing and approving, first of all
the account set up for the investor based on the KYC
information and secondly the sale of the product supported
by the information obtained by the associate from the
investor.”

The Respondents state that they read this email as a caution, first, that the sale
of any exempt product, including the Debentures, carried significant risk for
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Farm Mutual if proper procedures for exempt product sales were not
followed; and second, that extra due diligence was required by branch
managers in the supervision of the sale of such products. The said
Respondents state that they did not read it as a statement that the Debentures
were high risk securities suitable only for investors with a high risk tolerance,
since such an interpretation of the email was inconsistent with statements
contained in the aforementioned emails, materials and advertising approvals
distributed by Farm Mutual
(11) Between June 25, 2003 and April 1, 2007, 35 Approved Persons of Farm
Mutual sold approximately $52 million of the Debentures to approximately
680 Farm Mutual clients.
(12) The Respondents either sold, or were responsible for the supervision of
Approved Persons who sold, approximately $50.3 million of the Debentures
to 656 Farm Mutual clients.
(13) At the time the Debentures were sold, Farm Mutual clients were asked to
complete a Farm Mutual new account application form, a FactorCorp
Subscription Agreement, and a FactorCorp Accredited Investor Status
Certificate (collectively, the “Sales Documentation”). In accordance with
specific instructions from Farm Mutual, clients were directed to make all
cheques payable to FactorCorp.
(14) For each sale, the Approved Person provided the Sales Documentation, along
with the client’s cheque in payment for the Debentures, to the Approved
Person’s branch manager whose responsibility it was to ensure that the Sales
Documentation was complete. In accordance with specific instructions from
Farm Mutual, the branch manager then forwarded the Sales Documentation,
along with the client’s cheque, directly to FactorCorp.
(15) In their capacity as branch managers, the Respondents conducted first-tier
reviews of these purchases upon receiving the Sale Documentation. In
Corner’s branch, some of the first-tier reviews were conducted by him and
some were conducted by his co-branch manager. All of the Respondents’
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first-tier reviews included reviews for suitability, however those reviews were
based on:
(a) the Respondents’ aforementioned belief that Farm Mutual had rated
the Debentures as low or medium-low risk; and
(b) the Respondents’ specific training, by Farm Mutual, that the portfolios
of clients with low risk tolerance or medium risk tolerance could
suitably hold some higher risk investments provided the clients’ other
assets were predominantly low risk. (However, Staff’s investigation
did not reveal any evidence that the Respondents had used any
calculations or methodology to apply a “portfolio” approach to
suitability or any documentary evidence in the client files to this
effect.)
Further, Farm Mutual’s President had instructed the branch managers in
November 2003 that the onus lay on investors who purchased the Debentures
to determine whether or not they qualified as accredited investors, and
accordingly the Respondents did not conduct detailed reviews to determine
this. Instead, the Respondents considered the clients’ assets as part of their
first-tier review, however that review was based on advice from Farm Mutual
that assets such as shares in private farm corporations and farm product quotas
could be included as securities for purposes of the accredited investor
qualification criteria, and Farm Mutual did not clarify that this advice was
incorrect until September 2006
(16) In accordance with specific instructions from Farm Mutual, the Respondents
sent the Sales Documentation, including the Know-Your-Client forms (the
“KYCs”), to FactorCorp and the Respondents did not forward copies of the
Sales Documentation or KYCs to Farm Mutual’s head office, but instead, in
accordance with Farm Mutual's specific instructions, the Respondents retained
copies of the Sales Documentation and KYCs at the branch offices. At no
time did Farm Mutual conduct second-tier suitability reviews of any of the
Debentures transactions.
(17) On October 31, 2005, the MFDA issued Member Regulation Notice MR-0048
“Know-Your-Product” the purpose of which was to set out Staff’s
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interpretation and to assist Members and Approved Persons with respect to
the approval and sale of investment products. The Notice states, among other
things, that “Approved Persons are required to ensure that each order accepted
or recommendation made for any account of a client is suitable for the client
and in keeping with the client’s investment objectives. Know-your-client
requirements are a fundamental part of meeting basic suitability obligations.
However, these obligations can only be properly discharged if Approved
Persons…also fully understand the products that are being recommended to
clients.”
(18) FactorCorp suspended redemptions in May 2007. On July 6, 2007, the Ontario
Securities Commission issued a temporary cease trade order. Eventually
FactorCorp became bankrupt, as did Farm Mutual.
(19) Of the approximately $52 million invested by Farm Mutual’s clients in the
FactorCorp Debentures, approximately $49 million remained outstanding and
unredeemed at the time of the cease trade order.

5.
Farm Mutual has been disciplined for deficiencies in its due diligence assessment
of FactorCorp debentures, deficiencies in its approval of FactorCorp debentures for sale
to clients, and deficiencies in its supervision of such sales, including its failure to conduct
second-tier supervisory reviews. The Respondents’ admitted contraventions referred to
below, occurred in the context of those deficiencies and, in large part, as a result of those
deficiencies.

6.
The Respondents admit that between June 25, 2003 and April 1, 2007, the
Respondents, in their capacity as Approved Persons of Farm Mutual, conducted sales of
exempt securities – specifically FactorCorp debentures – using training and information
provided by the Respondents’ Member, Farm Mutual, and as a result of deficiencies in
that training and deficiencies in that information the Respondents sold FactorCorp
debentures to clients who did not qualify as accredited investors in accordance with
Ontario Securities Commission Rule 45-501 and subsequently National Instrument 45-
106 and to clients whose risk tolerance was less than high, thereby contravening MFDA
Rule 2.1.1 (c) and thereby engaging the jurisdiction of the Hearing Panel to impose a
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penalty on the Respondents pursuant to s. 24.1.1(h) of MFDA By-law No. 1. In effect,
the Respondents admit Allegation #1.

7.
In making these admissions, the Respondents acknowledge that their regulatory
obligations as mutual fund salespersons and branch managers were not limited to the
training and information they received from Farm Mutual with respect to the risks
associated with the FactorCorp debentures but extended to include a knowledge of the
essential framework associated with the sale of exempt securities.

8.
Turning to Allegation #2, the Respondents admit that between June 25, 2003 and
April 1, 2007, the Respondents, in their supervisory capacity as branch managers of Farm
Mutual, complied with a directive from Farm Mutual to send all FactorCorp debenture
sales Documentation, including KYCs, directly to FactorCorp and not to Farm Mutual’s
head office, and in so complying the Respondents failed to discern that Farm Mutual’s
Compliance department and its senior management were rendering themselves incapable
of conducting second-tier reviews necessary for Farm Mutual to properly supervise client
accounts, thereby contravening MFDA Rule 2.5.3(b)(i) and thereby engaging the
jurisdiction of the Hearing Panel to impose a penalty on the Respondents pursuant to s.
24.1.1(h) of MFDA By-law No. 1.

9.
MFDA Rule 2.5.3(b)(i) provides as follows:
It is the responsibility of a branch manager to:
(i) ensure that the business conducted on behalf of the Member by an
Approved Person and other employees and agents at the branch is in
compliance with applicable securities legislation and the By-laws and
Rules;

10.
The Farm Mutual head office directed branch managers to send FactorCorp
documents directly to FactorCorp and not the Farm Mutual head office. It would be a
bold manager that would not comply with such a direction. In complying with the
direction, the Respondents admit that they failed to discern that Farm Mutual’s
compliance department and the senior management were rendering themselves of
incapable of conducting second-tier reviews necessary for Farm Mutual to properly
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supervise client accounts. The second-tier review was a head office responsibility not a
branch responsibility. In our view, Rule 2.5.3(b)(i) is confined to the business conducted
by Approved Persons and other employees and agents at the branch and does not extend
branch manager responsibility to the supervision of head office responsibilities.

11.
The Respondents have agreed to the terms of the settlement as set out in the
respective Settlement Agreements. After consideration, we find the settlement terms fall
well within a reasonable range even if the admissions with respect to Allegation #2 are
ignored. The Settlement Agreements are therefore accepted.

DATED this 20th day of July, 2010.

“Edward Saunders”
The Hon. Edward Saunders, Q.C.,

Chair

“Jeanne Beverly”
Jeanne E. Beverly,

Industry Representative

“Linda Anderson”
Linda J. Anderson,

Industry Representative

Doc 220418
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