IN THE MATTER OF THE SECURITIES ACT
R.S.O. 1990, c. S.5, AS AMENDED
IN THE MATTER OF
RT CAPITAL MANAGEMENT INC., K. MICHAEL EDWARDS, TIMOTHY K. GRIFFIN, DONALD E. WEBSTER,JENNIFER I. LEDERMAN, PETER B. LARKIN, PETER A. RODRIGUES, GARY N. BAKER, PATRICK SHEA AND MARION GILLESPIE
STATEMENT OF ALLEGATIONS OF STAFF OF THE ONTARIO SECURITIES COMMISSION
Staff of the Ontario Securities Commission (the "Commission") makes the followingallegations:
1. RT Capital Management Inc. ("RT Capital") is an indirectly, wholly owned subsidiary ofRoyal Bank of Canada and was established in 1986. RT Capital is registered as an InvestmentCounsel and Portfolio Manager and provides investment management services for approximately700 client accounts, the majority of which are institutional pension funds. RT Capital currentlyhas approximately $34 billion in assets under its management in both pooled and segregated funds,as well as cash funds. Of that $34 billion in assets, approximately $13.5 billion is held inCanadian equities.
2. During the period October 30, 1998 to March 31, 1999 (the "material time"), there weresix members of the Board of Directors of RT Capital, each of whom was also an officer of thecompany. The Directors were:
(a) K. Michael Edwards ("Edwards"): appointed as a director and as the Chairmanand CEO on December 7, 1998. Edwards is also the President and CEO of RTInvestment Management Holdings Inc. ("RTIM"), the principal commonshareholder of RT Capital. RTIM is itself, indirectly, a wholly owned subsidiaryof Royal Bank of Canada. Edwards is a former Chairman of the Toronto StockExchange (the "TSE") who has extensive experience in all aspects of the securitiesindustry. Edwards is approved as a Non-Trading Officer of RT Capital.
(b) Timothy K. Griffin ("Griffin"): appointed as a director on January 1, 1991. Griffinhas been an employee of RT Capital or its predecessor since its inceptionapproximately 15 years ago. Griffin was appointed President of RT Capital onJanuary 17, 1996. Prior to being appointed President, he held the position ofExecutive Vice-President, and before that, Vice-President. Griffin is approvedas a Non-Counseling Officer of RT Capital.
(c) Donald E. Webster ("Webster"): appointed as a director on August 22, 1990.Webster was an employee of RT Capital or its predecessor since its inception in1986 until his retirement on March 31, 2000. During the material time, Websterwas the Senior Vice-President, Fixed Income and a portfolio manager in thatdepartment. Webster was registered as an Investment Counsel and PortfolioManager.
(d) Jennifer I. Lederman ("Lederman"): appointed as a director and officer on August30, 1994. Lederman is a lawyer and is the Senior Vice-President, Compliance andthe Corporate Secretary. Lederman is the officer designated by RT Capital as thecompliance officer responsible for discharging the obligations of RT Capital underOntario securities law. Lederman is also an officer of RT Capital's principalshareholder, RTIM. Lederman is approved as a Non-Trading Officer of RTCapital.
(e) Peter B. Larkin ("Larkin"): appointed as a director on August 22, 1990. Larkinhas also been an employee of RT Capital or its predecessor since its inception in1986. Larkin is the Senior Vice-President, Canadian Equities. Larkin is thesenior portfolio manager in the Canadian Equities section to whom the six otherportfolio managers in that section report. Larkin has been employed in thesecurities industry in one capacity or another in excess of thirty years. Larkin isregistered as an Investment Counsel and Portfolio Manager.
(f) Peter A. Rodrigues ("Rodrigues"): appointed as a director on August 22, 1990.Rodrigues is the Vice-President, Finance and Operations. Rodrigues has also beenan employee of RT Capital or its predecessor since its inception. Rodrigues wasresponsible for the administrative aspects of the management and operation of RTCapital's trading activity, including the taping system used to record calls to andfrom RT Capital's order executioners. Rodrigues is approved as a Non-Counselling Officer of RT Capital.
3. Gary N. Baker ("Baker") is a Vice-President of Canadian Equity. Baker has been anemployee of RT Capital for approximately ten years. Baker is registered as an InvestmentCounsel and Portfolio Manager. During the material time, Baker was solely responsible formanaging RT Capital's Canadian Equity Small Capitalization Fund, in addition to managingapproximately 16 to 17 regular Canadian Equity portfolios. After Larkin, Baker is the longestserving Canadian Equities portfolio manager at RT Capital.
4. Patrick Shea ("Shea") is an "order executioner" at RT Capital. Shea's job title is that of"Senior Equity Trader" but he is not a registrant. Shea has been an employee of RT Capital forapproximately 13 years.
5. Marion Gillespie ("Gillespie") is also an "order executioner" at RT Capital. Like Shea,Gillespie's job title is that of "Senior Equity Trader" and she is not a registrant. Gillespie hasbeen an employee of RT Capital for approximately 12 years.
6. Between them, Shea and Gillespie were responsible for carrying out all of the tradingactivity of the portfolio managers in the Canadian Equities section of RT Capital, including Larkinand Baker, during the material time.
High-Closing Trading Activity Engaged in by RT Capital
7. RT Capital intentionally engaged in trading activity on 53 occasions designed to create ormaintain an uptick in the closing price of a security; or, alternatively, to prevent or rectify a"downtick" in the closing price of a security. A total of 26 different Canadian equity securities,all listed on the TSE, were the subject of this high-closing activity on at least one occasion.
8. The high-closing activity occurred on the following dates:
- Friday, October 30, 1998
Monday, November 30, 1998
Wednesday, December 30, 1998
Thursday, December 31, 1998
Friday, January 29, 1999
Friday, February 26, 1999
Tuesday, March 30, 1999
Wednesday, March 31, 1999
9. Each of the foregoing dates was the last trading day of a month, with the exception ofWednesday, December 30, 1998 and Tuesday, March 30, 1999, which were the next-to-lasttrading days of the month. Nineteen of the 53 high-closings occurred on December 30 and 31,1998 (year-end); ten of the high-closings occurred on March 30 and 31, 1999 (quarter-end).
10. Of the fifty-three high-closings identified, Larkin was responsible on forty-three occasionsfor instructing either Shea or Gillespie to carry out a trade, or engage in a trading strategy,designed to create or maintain an uptick, or prevent or rectify a downtick, in the closing price ofa security.
11. Of the remaining ten high-closings, Baker was responsible for instructing either Shea orGillespie to carry out a trade, or engage in a trading strategy, designed to create or maintain anuptick, or prevent or rectify a downtick, in the closing price of a security.
12. On each of the fifty-three occasions, either Larkin or Baker discussed the high-closingwith either Shea or Gillespie, who was then responsible for contacting a broker and orchestratinga trade, or a trading strategy, designed to create or maintain an uptick, or prevent or rectify adowntick, in the closing price of a security. On several occasions, the trading strategy involvedexecuting cross-trades involving RT Capital client accounts in order to effect the desired closingprice. These cross-trades had no legitimate investing purpose for the client.
13. The total increase in the value of the Canadian Equities component of RT Capital'sportfolios as a result of Larkin's high-closings was $30,186,168, more or less.
14. The total increase in the value of the Canadian Equities component of RT Capital'sportfolios as a result of Baker's high-closings was $8,376,110, more or less.
16. The monthly increases in the market capitalization of the 26 issuers affected by RTCapital's high-closings are summarized in Schedule "C" appended hereto.
17. The high-closings carried out by way of cross-trades involving RT Capital client accountsare summarized in Schedule "D" appended hereto.
The Model Portfolio
18. Almost all of RT Capital's Canadian Equities portfolios were run on the basis of a "modelportfolio". The model portfolio comprised in excess of 200 securities, selected from all sectorsof the economy, each of which was assigned a specific weighting within the model portfolio. TheCanadian Equities Small Capitalization Fund was a pooled fund managed exclusively by Bakerand was not subject to the constraints of the model portfolio.
19. Larkin was responsible for determining which securities were included in the modelportfolio and the weighting to be assigned to each. Larkin updated the model portfolio every twoweeks, either adding or deleting securities from the model portfolio, or changing the weightingof a given security. The revised model portfolio was then distributed to the other six portfoliomanagers in the Canadian Equities section.
20. Each of the Canadian Equities portfolio managers was required to re-balance the portfoliosunder his management to ensure that they were consistent with the composition of the revisedmodel portfolio, in terms of both content and weighting, subject to a narrow discretion:approximately 7% of the value of any portfolio was permitted to be composed of securities notcontained in the model portfolio.
21. All of the securities which were the subject of Larkin's high-closing activity were in themodel portfolio. As a result, Larkin's high-closings affected all of RT Capital's CanadianEquities portfolios which followed the model portfolio, whether or not those funds were directlyunder Larkin's management.
22. Several of the securities which were the subject of Baker's high-closings were in the modelportfolio. The remaining securities were in the Canadian Equities Small Capitalization Fundmanaged exclusively by him.
Fund Valuation and Performance Measurement
23. RT Capital determined the value of the Canadian equity component of any given portfolioby multiplying the number of shares of a particular security in the portfolio by the closing priceof the security as posted on the TSE, for each of the securities held in the portfolio.
24. RT Capital measured the performance of its Canadian Equities portfolios by comparingthe portfolios' performance against certain benchmark indices, most commonly the TSE 300index. The portfolio managers were expected to match or better the index.
25. RT Capital distributed monthly reports to each of its Canadian Equities portfolio managerssetting out an analysis of the performance of the portfolios under his control.
Reporting to Clients and Invoicing for Management Fees
26. RT Capital operated on a calendar year for the purpose of: (i) calculating its annualportfolio performance measures, which were provided to existing clients and were also publishedgenerally; (ii) reporting to its clients quarterly on portfolio performance; and (iii) invoicing itsclients quarterly for management fees.
27. The management fees which RT Capital charged its clients each quarter were calculatedon the basis of agreed upon percentages of the average value of the client's assets undermanagement, as set out in an "Investment Counselling Agreement" executed by RT Capital andits clients. The percentages charged were usually subject to a "sliding scale", such that thepercentage charged increased as certain thresholds of asset value were crossed. Subject to anyspecific terms which may have been negotiated between RT Capital and a client, the InvestmentCounselling Agreement provided that the average value of a client's assets during any givenquarter was calculated by taking the average of: the value of the client's assets on the first day ofthe quarter and the value of the client's assets on the last day of the quarter.
Compensation and Incentives
28. The Canadian Equities portfolio managers and order executioners at RT Capital eachreceived a base salary and participated in a profit sharing plan based on the company'sprofitability. Each portfolio manager was allocated a certain number of "phantom equity" sharesannually, which entitled him to a proportionate share of the company's profits. The allocationof phantom equity shares was based on, among other factors, the portfolio manager's performancein the preceding year. The order executioners were not allocated "phantom equity" shares butreceived an annual bonus based on the company's profitability.
Trading Activity Not Monitored
29. The Compliance Manual (March 1999) of RT Capital provided that:
The President and RT Capital's Directors are responsible forensuring that investments for client accounts are appropriately madeand that practices within the organization do not violatesecurities regulations. In addition, they are responsible forensuring that the Compliance Manual and Employee Code ofConduct and Privacy Code are adhered to in all respects. (emphasisadded)
30. The Compliance Manual further provided that every employee of RT Capital was requiredto sign a consent form on an annual basis acknowledging his or her agreement to comply with theterms of the Compliance Manual and to confirm his or her compliance for the previous year. InMarch 1999, Griffin, Rodrigues, Larkin, Baker, Shea and Gillespie each executed the consentform applicable to the material time.
31. Despite the terms of the Compliance Manual and the requirement that every employee ofRT Capital was required to agree to comply with its terms, RT Capital did not in fact monitor thetrading activities or practices of its Canadian Equities portfolio managers and order executionersto ensure their conduct was in compliance with applicable securities regulations and was notcontrary to the public interest. Nor did RT Capital have any systems or protocol in place formonitoring the trading activities and practices of its portfolio managers and order executioners.
32. As a result, Larkin, Baker, Shea and Gillespie were able to intentionally, repeatedly andopenly (within RT Capital) effect high-closings of securities on significant month-, quarter-, andyear-end dates for the purpose of improving the appearance of portfolio performance. On nooccasion did they attempt to conceal, alter or destroy the internal records of their trading activity.They acted without fear of detection by anyone at RT Capital and/or safe in the knowledge that RTCapital impliedly condoned their activity or was wilfully blind to it. None of the fifty-three high-closings was ever "red flagged" or made the subject of scrutiny by RT Capital to ensurecompliance with applicable securities regulations.
33. During the entire periods of their respective employment at RT Capital, none of Larkin,Baker, Shea or Gillespie ever had the propriety of any of their trades questioned by RT Capital.
34. Contrary to the statements in the Compliance Manual, the Board of Directors of RTCapital (the "Board") performed a largely ceremonial function, mostly relating to the passing andsigning of resolutions and the execution of other corporate documents as needed from time totime. The Board did not convene on a regular basis and rarely, if ever, met in person. Larkinwas not aware that he was a director of RT Capital and was unable to identify the other membersof the Board, beyond speculating that Edwards and Griffin presumably held positions on it. TheBoard did not monitor, or ensure that systems were in place to monitor, the trading activities andpractices of RT Capital's portfolio managers and order executioners.
35. During the material time, Griffin, Webster, Larkin and Rodrigues, all four of whom arefounding members of RT Capital, also sat on the "management committee" of RT Capital. Themanagement committee met once every two weeks, more or less, to deal with matters pertaining tothe management, operation and performance of RT Capital. The management committee did notmonitor, or ensure that systems were in place to monitor, the trading activities and practices of RTCapital's portfolio managers and order executioners. Edwards and Lederman did not attend themeetings of the management committee.
Deceptive Trading Practices
36. Larkin, Baker, Shea and Gillespie were aware that TSE Market Surveillance wasmonitoring end of day trading for the purpose of detecting high-closing activity. Larkin, Baker,Shea and Gillespie authorized, permitted or acquiesced in strategies designed to avoid detectionby TSE Market Surveillance. Shea and Gillespie had discussions with the brokers engaged bythem to effect the high-closings. In those discussions, the brokers advised Shea and Gillespie thatthey had misled TSE Market Surveillance, or would mislead TSE Market Surveillance if the needarose, to ensure that RT Capital's trades were processed before the close of trading.
Response of RT Capital to Investigation
37. Prior to September 1999, as a matter of routine business practice, RT Capital recorded alltelephone calls between Shea and Gillespie and the brokers engaged by them to carry out tradeson behalf of RT Capital. The RT Capital taping system also recorded, however, all internaltelephone calls of Larkin and Baker to and from Shea and Gillespie. In September 1999, after RTCapital became aware that its trading activity was under review, RT Capital re-configured itstaping system so that the telephone calls of Larkin and Baker to and from Shea and Gillespiewould no longer be recorded. RT Capital permitted Larkin, Baker, Shea and Gillespie to continueto perform their normal duties.
38. During the course of Staff's subsequent investigation, Larkin and Shea denied carryingout any trades, or engaging in any trading strategies, designed to create or maintain an uptick, orprevent or rectify a downtick, in the closing price of a security during the material time, with theexception of two securities. Larkin and Shea admitted that they established the closing price atmonth end of "Multibank" and "Dia Met A", two securities which Larkin felt were undervaluedby the market. Gillespie admitted that numerous of the trades carried out by her on behalf ofboth Larkin and Baker which Staff was investigating were in furtherance of an attempt todetermine the closing price of securities. Baker denied that he engaged in any high-closingactivities.
39. On June 23, 2000, Royal Bank Financial Group and RT Capital issued a press release inrespect of Staff's investigation which acknowledged that "....these transactions had the effect ofoverstating the value of certain portfolios for the quarters in question" and further that "Althoughthe impact on portfolio values and fee revenues was small, RT Capital and Royal Bank FinancialGroup regard the matter as very serious".
Conduct Contrary to the Public Interest
40. The conduct alleged above contravened Ontario securities law and constituted conductcontrary to the public interest for the following reasons:
(a) by engaging in trading activity designed to create or maintain an "uptick", orprevent or rectify a "downtick", in the closing prices of publicly traded securities,RT Capital was interfering with the market forces of supply and demand to setartificially high prices in those securities on specific month-, quarter- and year-enddates. Trading activity of this nature undermines the integrity of the capitalmarkets and erodes investor confidence.
(b) the high-closing activity occurred on, or immediately before, month-, quarter-, andyear-end dates. To the extent that these artificially high prices were used by RTCapital in representing or calculating monthly, quarterly and annual portfolioperformance, RT Capital misled its existing and prospective clients as to the truelevel of investment returns and RT Capital's portfolio management performance.By so doing, RT Capital, Larkin and Baker failed to deal fairly, honestly and ingood faith with RT Capital's clients.
(c) by carrying out cross-trades involving client accounts without a legitimate investingpurpose, RT Capital failed to deal fairly, honestly and in good faith with itsclients;
(d) the high-closings which occurred on a quarter- or year-end date resulted in anartificially high valuation of any client account holding one or more of thosesecurities. As a result, the management fees charged to those clients, which werebased on the average value of the assets under management during the quarter,were overstated. The high-closings which occurred on a month-end within aquarter contributed to this phenomenon by sustaining or increasing the valuationof the securities in the client accounts over the course of the quarter. By chargingunwarranted management fees, RT Capital failed to deal fairly, honestly and ingood faith with its clients.
(e) to the extent that the month-end closing prices of the securities at issue were usedby dealers and brokers to establish capital and margin requirements, the artificiallyhigh closing prices set by RT Capital resulted in inaccurate calculations of thesecapital and margin requirements; and
(f) the issuers of the securities which were the subject of the high-closings were misledas to the true market value of their securities as at these month-, quarter- and year-end dates, which are frequently used for reporting purposes. Any shareholders ofthose issuers, including other pension and mutual funds and their unit holders,were similarly misled as to the true market value and performance of the securitiesduring the material time. As a result of the high-closings, other pension andmutual funds and their unit holders may also have been charged excessivemanagement fees by their respective portfolio managers.
41. Staff reserves the right to make such further and other allegations as Staff may submit andthe Commission may allow.
|Schedule "A": Trades Initiatedby Peter Larkin
|Schedule "B": Cross Trades Made
|Schedule "C": Increase in Market Capitalization
|Schedule "D": Cross Trades Made