R.S.O. 1990, c. S.5, AS AMENDED
IN THE MATTER OF
MARCHMENT & MACKAY LIMITED, AMIT JAMES SOFER,
CHARLES LORNE ORNSTEIN, JERRY MURRAY SALTSMAN,
GREGORY CHARLES OSBORNE AND FRASER JOHN EDWARD PLANT
June 22, 23, 24, 25, July 22, 24, August 24, 25, 31, September 9, 29, October 6, 13, 20, November 16, 20, 25, 26, 27 and December 3, 1998
January 5, 6, 7, February 9, 10, 16, 17, March 15, 16, 23, 26, April 29, 30, May 3, 10, 11 and June 23 and 24, 1999
David A. Brown, Q.C., - Chair
Helen M. Meyer - Commissioner
Derek Brown - Commissioner
Counsel: For the Staff of the Ontario Securities Commission
James D.G. Douglas
Counsel: For Marchment & MacKay Limited
Thomas Dunne, Q.C.
Counsel: For Amit James Sofer
Nigel M. Campbell
Counsel:For Charles Lorne Ornstein
Counsel: For Jerry Murray Saltsman, Gregory Charles Osborne & Fraser John Edward Plant
Brian H. Greenspan
The Notice of Hearing in this matter was issued on August 2, 1996. Copies of theNotice of Hearing and the related amended Statement of Allegations are attached.The hearing commenced on June 22, 1998 and continued during 38 sitting daysuntil June 24, 1999 at which time the receipt of evidence and argument relating tothe matters set out in the Notice of Hearing and amended Statement of Allegationswas completed. At the request of the panel, written argument was filed with thepanel and exchanged among the parties. Written argument was delivered bycounsel for Staff of the Commission on May 28, 1999 accompanied by a three-volume Compendium and a Brief of Authorities; written argument was delivered bycounsel for the Respondents on June 14, 1999 accompanied by a two-volumeCompendium; written reply was delivered by counsel for Staff on June 17, 1999.Oral argument was delivered on June 23 and June 24, 1999.
The evidence phase of the hearing and the delivery of written argument wascompleted without any suggestion by the panel or any of the parties that theproceedings be reopened for the receipt of evidence and argument on the ordersthat might be made by the Commission should the findings by the Commission onthe merits of the case so warrant. The issue was raised for the first time by counselfor the Respondents in the closing minutes of counsel for Staff's oral argument.After hearing submissions by counsel for all parties, the Commission ruled that itwould not reopen the proceedings for that purpose. The following morning, June24, the Respondents filed an application to the Divisional Court for judicial reviewof this Order and obtained an interim order from Matlow J. staying "...allproceedings before the panel of the OSC directed to the issue of any sanction orpenalty that might be imposed on any of the applicants." (endorsement of MatlowJ. dated June 24, 1999). On June 25, 1999, Matlow J. made an order continuingthe stay until disposition of the application by a panel of the Divisional Court.
On June 28, following completion of the oral argument and the delivery by MatlowJ. of his stay order, the Panel reconvened the hearing during which all members ofthe Panel and counsel for all parties participated by conference telephone. At thissession, the Panel advised the parties that it had reconsidered its decision withrespect to reopening the hearing and advised the parties that it would proceed asfollows: the Panel would deliver its Decision on the merits of the issues raised inthe Notice of Hearing and Amended Statement of Allegations not later than Friday,July 16, 1999, without making any findings with respect to any order that may bemade and without giving reasons for its Decision; reasons for the Decision wouldbe delivered at a later date; and, should it be necessary as a result of the Panel'sDecision on the merits, the proceedings would be reopened after the reasons forthe Decision were delivered for the purpose of receiving additional evidence andoral argument on any Orders to be issued. Because the stay of Matlow J. could beconstrued as preventing the Commission from reopening the hearing to permit thereceipt of evidence and argument on the question of remedies or penalties (in otherwords, preventing the Commission from acceding to the Respondents' request tothe Panel, the original denial of which had formed the basis for the application toMatlow J.), the Panel requested that all parties ask Matlow J. to lift his stay on thebasis of the Commission's revised ruling. The hearing was reconvened, again byconference telephone on the same basis, on Wednesday, June 30, 1999 at whichtime counsel for all of the Respondents advised that they would not ask Matlow J.to lift the stay on that basis. Notwithstanding, counsel for the Staff applied toMatlow J. to vary the order made on June 25, 1999. On July 12, 1999, Matlow J.varied the order dated June 25, 1999 to provide that the stay shall not apply toprohibit the panel of the OSC from continuing the proceedings provided that, in theevent of a finding of liability with respect to any of the applicants, a further anddistinct hearing be held with respect to the sanction or penalty to be imposed.
The Decision of the Panel on the merits was delivered on July 16, 1999 withoutgiving reasons for the Decision. For convenience, that Decision has beenincorporated with the Reasons into this single document.
There were a number of other motions brought prior to and during the course of theHearing in relation to which decisions were rendered. These included the followingmotions by the Respondents:
Motion to quash the Notice of Hearing
- November 4, 1996- Motion to quash the Notice of Hearing, or, in thealternative, strike out certain portions of the statement of allegations. Bydecision dated December 4, 1996, the Commission dismissed the motion(published at (1996), 19 OSCB 6637).
- June 26, 1997- The Respondents sought judicial review of the decision ofthe Commission dated December 4, 1996. By decision dated June 26, 1997,Southey J., for the Divisional Court, dismissed an application for judicialreview (reported at 34 O.R. (3d) 284).
- The Respondents brought a motion for leave to appeal the decision of theDivisional Court to the Court of Appeal. The motion for leave to appeal wasdismissed on October 3, 1997.
Motion regarding bias
- September 26, 1996- The Respondents brought a motion arguing that six ofthe nine Commissioners of the Commission should be disqualified fromsitting on the substantive hearing in the proceedings by reason of theexistence of bias or a reasonable apprehension of bias. By decision datedOctober 22, 1996, the Commission found that the Commissioners were notprecluded by actual bias or reasonable apprehension of bias from sitting onthe substantive hearing in the proceedings (published at (1996), 19 OSCB6163).
- May 29, 1997- The Respondents sought judicial review of the decision of theCommission dated October 22, 1996. By endorsement dated May 29, 1997,Southey J., for the Divisional Court dismissed the application for judicialreview.
- The Respondents brought a motion for leave to appeal the decision of theDivisional Court to the Court of Appeal. The motion for leave to appeal wasdismissed on October 3, 1997.
- June 22 and 23, 1998- The Respondents brought a motion for an ordercompelling Staff to make full disclosure to the Respondents of informationand documents relevant to the hearing, an order restricting Staff fromleading evidence in respect of the nature of the securities or product tradedby Marchment & Mackay and a declaration that Staff shall not lead evidencefrom and after the date of the Notice of Hearing and Statement ofAllegations. On June 24, 1998, the Commission dismissed the motions.With regard to the motion for full disclosure, the Commission found that theonly issue was whether the notes of interviews of a person must beproduced in circumstances where a witness statement signed by that personhas been produced. The Commission held that production of such noteswas not required.
Prior to the commencement of the hearing, a settlement was reached by Staff withNorman Frydrych, a salesman who had been employed by Marchment & MacKayLimited ("Marchment"), which was approved by another panel of the Commission.Accordingly, this Decision and Reasons relate only to the remaining Respondents,who will be referred to collectively in this Decision and the reasons to follow as the"Respondents".
II PURPOSE OF THE HEARING
The purpose of the Hearing, as set out in the Notice of Hearing, was to considerwhether it is in the public interest for the Commission to order that the registrationsof Marchment, Charles Lorne Ornstein, Amit James Sofer, Jerry Murray Saltsman,Gregory Charles Osborne and Fraser John Edward Plant be suspended,terminated, restricted or made subject to terms and conditions pursuant toParagraph 1 of subsection 127(1) of the Securities Act and whether, pursuant toParagraph 3 of subsection 127(1) of the Act, any and all of the exemptionscontained in the Act not apply to the Respondents. Staff has also asked theCommission to consider whether pursuant to Subsection 37(1) of the Act it is in thepublic interest to suspend, cancel, restrict or impose terms and conditions upon theright of the Respondents to call at or telephone to any residence in Ontario for thepurpose of trading in any security or in any class of securities. Staff has urged usto make these orders in response to conduct alleged to have been undertaken bythe Respondents commencing in January 1993 and as set out in considerable detailin the amended Statement of Allegations.
In view of the bifurcation of the hearing as described above, this Decision andReasons will not deal with the Orders requested in the Notice of Hearing. ThisDecision and Reasons will deal only with the Commission's findings with respectto the alleged conduct of the Respondents set out in the amended Statement ofAllegations. As a result of our findings, the parties will be given an opportunity onAugust 3, 1999 to introduce evidence and make submissions with respect to Ordersto be issued. Accordingly, we will not deal with any Orders that may flow from ourDecision until after that phase of the hearing has been completed.
1. The Law
The fundamental legal principles have not been contested in this Hearing. However, it isappropriate at this stage to summarize the three main principles on which we base ourfindings. These include (1) a registrant's duty to deal fairly, honestly and in good faith witha client; (2) the "know-your-client" rule and the corresponding duty to ensure the suitabilityof the investment for the client; and (3) the fiduciary duty that may, in the circumstances,be owed by a broker to a client.
The Registrant's Duty to Deal Fairly, Honestly and in Good Faith with a Client
The fundamental requirement of any registrant is to deal fairly, honestly and in good faithwith its clients. This general duty is now imposed by Ontario Securities Commission Rule31-505 Conditions of Registration which came into force on December 23, 1998. Therelevant sections of Rule 31-505 read as follows:
PART 2 GENERAL DUTIES
2.1 General Duties
2. A registered dealer or adviser shall deal fairly, honestly and in goodfaith with its clients.
3. A registered salesperson, officer or partner of a registered dealer ora registered officer or partner of a registered adviser shall dealfairly, honestly and in good faith with his or her clients.
4. A registered salesperson, officer or partner of a registered dealer ora registered officer or a partner of a registered adviser shall not acton behalf of the dealer or adviser in a transaction of the dealer oradviser that is not in compliance with Part XIII of the Regulation andMultilateral Instrument 33-105 Underwriting Conflicts or this Rule.
Rule 31-505 revoked the following sections 221 and 222 of the Regulation that previouslyset out the duties of a registrant:
221.Every registrant shall deal fairly, honestly and in good faith with its customers andclients.
222. (1) Every officer, partner, salesperson and registered director of a registrantshall deal fairly, honestly and in good faith with the customers and clientsof the registrant.
(2) No individual referred to in subsection (1) shall act on behalf of theregistrant in connection with any transaction or other act of the registrantthat is not in compliance with this Part.
The registrant's duty to deal fairly, honestly and in good faith with its client has beenconsistently articulated by this Commission. In E.A. Manning, the Commission found a"failure to observe the obligation of a registrant to deal fairly, honestly, and in good faithwith its customers, which obligation the commission has long considered to be one whicha registrant must be considered to assume with a registration under the act" (E.A. ManningLimited et al. (1995), 9 C.C.L.S. 231 (O.S.C.) at 260). See also Trend Capital Services Inc.et al. (1992) 15 O.S.C.B. 1711 at p. 1763; Rosmar Corporation Limited (1982), 3 O.S.C.B.11C at p. 35C-36C; Adelaide Securities Limited, March 1968, O.S.C.B. 57 at p. 77; andGoldmack Securities Corporation Limited, January 1966, O.S.C.B. 14 at pp. 17-18.
"Know-your-Client" and The Duty to Ensure Suitability
The registrant also has obligations to "know-your-client" and to ensure the suitability of aproposed purchase and sale with respect to that client. The duty to know the client'sinvestment objectives, financial means and personal circumstances, and to recommendonly those investments which are suitable for the client is fundamental to the obligation ofevery dealer and registered representative dealing with the public.
The duty is now imposed by Rule 31-505. Sections 1.5(1) and (2) read as follows:
1.5 Know-your-Client and Suitability
1. A person or company that is registered as a dealer or adviser and anindividual that is registered as a salesperson, officer or partner of aregistered dealer or as an officer or partner of a registered adviser shallmake such enquiries about each client of that registrant as
1. subject to section 1.6, enable the registrant to establish the identityand the creditworthiness of the client, and the reputation of the clientif information known to the registrant causes doubt as to whether theclient is of good reputation; and
2. subject to section 1.7, are appropriate, in view of the nature of theclient's investments and of the type of transaction being effected forthe client's account, to ascertain the general investment needs andobjectives of the client and the suitability of a proposed purchase orsale of a security for the client.
This rule revoked section 114(4)(a) and (b) of the Regulation to the Securities Act thatpreviously set out know-your-client and suitability obligations of a Registrant:
114.(4) For the purposes of subsection (1), but without limiting the requirements of thatsubsection and subject to subsection (7), each dealer, investment counsel and portfoliomanager shall make such enquiries as,
(a) will enable it to establish the identity and, where applicable, the creditworthiness of each client, and the reputation of the client if information knownto the dealer, investment counsel or portfolio manager, causes doubt as towhether the client is of good reputation; and
(b) subject to subsection (5), are appropriate in view of the nature of the client'sinvestment and of the type of the transaction being effected for its accountas to the general investment needs and objectives of each client and thesuitability of a proposed purchase or sale for that client.
Referring to the "know-your-client" and suitability requirements, the Commission in E.A.Manning stated: "These requirements are an essential component of the consumerprotection scheme of the Act and a basic obligation of a registrant, and a course ofconduct by a registrant involving the failure to comply with them is an extremely seriousmatter." E.A. Manning Limited et al., supra, at p. 277. See also; Hodgkinson v. Simms, 3 S.C.R. 377 at p. 425; Trend Capital Services Inc., supra, at p. 1762 and 1765;Harry Ramras, June 1972, O.S.C.B. 123 at p. 127.
A fiduciary relationship between a broker and client is not presumed. Nevertheless, afiduciary relationship between a broker and client may arise out of the particularcircumstances.
... The relationship of an investor and his or her discount broker will notlikely give rise to a fiduciary duty where the broker is simply a conduit ofinformation and an order taker. There are, however, other advisoryrelationships where, because of the presence of elements such as trust,confidentiality, and the complexity and importance of the subject matter,it may be reasonable for the advisee to expect that the advisor is in factexercising his or her special skills in that other party's best interests,unless the contrary is disclosed.
(Hodgkinson v. Simms, supra, at p. 410).
The issue of whether a broker-client relationship gave rise to a fiduciary duty wasconsidered by Keenan J. in Varcoe v. Sterling (1992), 7 O.R. (3d) 204 (Gen. Div.), aff'd(1992), 10 O.R. (3d) 574 (C.A.). At p. 236, Keenan J. stated as follows:
The relationship of the broker and client is elevated to a fiduciary level whenthe client reposes trust and confidence in the broker and relies on thebroker's advice in making business decisions. When the broker seeks oraccepts the client's trust and confidence and undertakes to advise, thebroker must do so fully, honestly and in good faith. In any case where abroker has an interest in a particular transaction, the broker must make fulldisclosure and assumes the onus of proving that no advantage was takenof the client, that the transaction was entered into in perfectly good faith andafter full disclosure. It is the trust and reliance placed by the client whichgives to the broker the power and in some cases, discretion, to make abusiness decision for the client. Because the client has reposed that trustand confidence and has given over that power to the broker, the law imposesa duty on the broker to honour that trust and respond accordingly. If thebroker fails to honour that trust or betrays the trust by taking advantage ofthe client, the broker has breached that fiduciary duty.
This case was cited with approval in Hodgkinson v. Simms, supra at pp. 419-420.
See also Laskin v. Bache & Co. Inc.,  1 O.R. 465 (C.A.) at pp. 472-473 and Burkev. Corey (1959), 19 D.L.R. (2d) 252 (O.C.A.) at pp. 258-260.
It is clear from the evidence that was presented to us at the Hearing, much of which isdealt with in detail in these Reasons, that Marchment and its salespeople invitedunsophisticated investors to place their trust in Marchment and to rely on Marchment andits salespeople for investment advice. Marchment's brochure, its introductory form lettersand much of the sales pitch of its sales force clearly evidence these objectives. It is alsoclear from the customers who testified that they accepted that invitation and placed theirtrust and confidence in Marchment's hands and relied on Marchment and its salespeoplefor investment advice.
In our view, it is not necessary for us to find the existence of a fiduciary relationship inorder to find that the Respondents breached their obligations to their clients. As is set outbelow, there is ample evidence of breaches of the other obligations referred to above. Wefind, however, that Marchment and its clients were in a fiduciary relationship.
2. The Nature of Marchment's Business
Marchment is registered with the Commission as a "securities dealer". As such,Marchment is not a member of a self-regulatory organization such as the InvestmentDealers' Association of Canada or the Toronto Stock Exchange. Accordingly, theCommission is the only body charged with regulatory responsibility over Marchment'ssales and trading practices. Mr. Ornstein testified that Marchment's roots go back to 1939,however, he advised us that under his leadership the focus of Marchment's businesschanged to its current format in the early 1990's.
Marchment operates through a single office located in downtown Toronto. It employsapproximately 95 staff consisting of 40 registered representatives, 30 telemarketers and25 office staff. It is important to note that only five of Marchment's employees or formeremployees have been named in these proceedings and that although we have heardreferences to a number of junior salespersons in the course of the testimony, Staff is notseeking orders in these proceedings against any other Marchment employee. In renderingour Decision, we were conscious that our findings with respect to Marchment's conductand the conduct of Mr. Ornstein may lead to the making of orders by the Commission thatwill affect the livelihoods of these unnamed employees.
Mr. Ornstein testified that throughout its long history, Marchment has never been subjectto discipline by the Commission.
Mr. Ornstein is the president of Marchment and is registered with the Commission as anofficer and a director of the firm. All of the capital of Marchment belongs (indirectly) tomembers of Mr. Ornstein's immediate family. In all respects, Mr. Ornstein is the directingmind of Marchment.
Until his resignation in March of this year, Mr. Sofer was the Vice-President andCompliance Officer of Marchment and was registered with the Commission as an officerof Marchment. At all material times, Mr. Sofer was responsible for the training andsupervision of Marchment's sales staff.
Mr. Osborne has been registered as a salesperson with Marchment for over 12 years andcontinued in that position throughout the period relevant to these proceedings. Mr. Plantjoined Marchment in 1986 and became a registered salesperson approximately six monthslater. He resigned from Marchment in 1998 and, at the time of giving his testimony in Aprilof this year, was employed as a licensed real estate agent with Royal LePage Commercial.Mr. Saltsman has been a registered securities salesperson for approximately 33 years andhas been employed as a salesperson at Marchment for the past 10 years. He wassuspended by Mr. Ornstein early in May of this year. The circumstances giving rise to hissuspension are described later in these Reasons.
4. Marchment Customer Witnesses
Nine Marchment customers gave evidence at the Hearing. They came from different walksof life. These customers dealt with Marchment at different points in time ranging from 1993until late June 1997, long after the Notice of Hearing and amended Statement ofAllegations had been issued. With the exception of Mr. Peltola, each of these customersdealt with one of Messrs. Sofer, Saltsman, Osborne or Plant. They also have varyinglevels of education and business sophistication.
Messrs. Sofer, Osborne, Plant and Saltsman gave evidence that was directly contradictoryto the evidence of their customers. In simple terms, if we accept the evidence of thesecustomers, it would follow that we would also conclude that many of the allegations set outin the amended Statement of Allegations have been proven. Conversely, if we accept theevidence of Messrs. Sofer, Osborne, Plant and Saltsman, such allegations will not havebeen proven. Accordingly, we will deal with the testimony of each of the customerwitnesses in some detail, commencing with Mr. Kowalewski and proceeding in the orderin which the customers testified.
David Kowalewski is a 43 year-old professional engineer who at the time of testifying wasa contracts engineer at Siemens Canada Limited. At the time that he first dealt withMarchment (in 1995), Mr. Kowalewski was a project manager at Foster Wheeler Limitedand had an annual income of about $60,000. His net worth was approximately $200,000(excluding his RRSP). The assets comprising his net worth consisted of his house($150,000), Stelco shares (worth $8,000 or $9,000), some GIC's and two vehicles. Theonly asset that Mr. Kowalewski had available for investment when he was first telephonedby a Marchment salesman was $20,000.
Mr. Kowalewski testified that his propensity for risk was very low. He testified that he isa landlord and that his investment in residential real estate has caused him a lot of"aggravation" in his life. For that reason, he did not want to invest in high risk securities.He testified that in the past he had invested in high risk options but did not enjoy the"aggravation" or the "worry" associated with those investments and therefore, after arelatively short period, no longer engaged in this form of trading.
Mr. Kowalewski testified that he was telephone-solicited by Joe Allen ("Allen"), aMarchment junior salesperson. He said that Allen recommended that he purchase sharesin Raw Creek Resources Inc. ("Raw Creek"). Mr. Kowalewski testified that Allen advisedhim that one of the benefits of investing with Marchment was its low commission rate ofabout $30 per trade. Mr. Kowalewski said that he made it clear to Allen that he was notinterested in purchasing any penny stocks, however Allen assured him that Marchmenttook into account its customers' propensity for risk and would never recommend anythingthat he did not want or did not need.
Acting on the advice of Allen, on August 15, 1995, Mr. Kowalewski purchased 1,000shares of Raw Creek for $1.61 per share. The new client application form that Allencompleted for Mr. Kowalewski stated that his investment objectives for his cash accountat Marchment were 70 per cent speculation.
After his initial purchase of Raw Creek shares on the advice of Allen, Mr. Kowalewskitestified Mr. Saltsman contacted him with the recommendation that he make a moresubstantial investment in Raw Creek. Mr.Kowalewski testified that he distinctlyremembered his telephone call with Mr. Saltsman. He described Mr. Saltsman as being"very, very high pressure; a very show-boaty type of salesman, full of promises aboutmaking [him] money, about how he was going to be guiding [him] through this taking careof [him]..." Mr. Kowalewski also recalled that his telephone call from Mr. Saltsman was a"very high-pressure, sense of urgency type of phone call, where [he had] got anopportunity here. [He] shouldn't miss it."
Mr. Kowalewski also testified that Mr. Saltsman advised him that the Raw Creek shareswere going to "make a move". This phrase became significant later in the proceedingsbecause Mr. Saltsman is recorded as having used similar language during a telephoneconversation with Mr. Newell, another customer witness, in connection with securities thathe was recommending that Mr. Newell buy more than two years later. We accept thatthese words came from Mr. Saltsman.
Mr. Kowalewski testified that he asked Mr. Saltsman whether there was any risk involvedin purchasing additional Raw Creek shares. He said that Mr. Saltsman told him not toworry and that there was very little chance of loss. Mr. Kowalewski testified that he had"reservations" about Mr. Saltsman's tactics and his personality regarding the sale ofsecurities. As a result, he testified that he called Allen about Mr. Saltsman and asked himhow Mr. Saltsman could make the promises that he had made regarding Raw Creek.Mr. Kowalewski said that Allen assured him that Mr. Saltsman had considerableexperience, was very good at what he does and had made people a lot of money in thepast. Based on this assurance, Mr. Kowalewski said that he agreed to purchase 6,500additional Raw Creek shares. He purchased those shares on September 27, 1995 forapproximately $11,470, bringing his total investment to approximately $13,000.
Mr. Kowalewski testified that Mr. Saltsman called him again in November 1995. Accordingto Mr. Kowalewski, this time Mr. Saltsman recommended that he make a substantialinvestment in the shares of Tropika International Limited ("Tropika"). Mr. Kowalewskitestified that in this trade, Mr. Saltsman also created a "high sense of urgency". He saidthat Mr. Saltsman assured him "I have researched this. I have looked into it. We wouldn'tbe proposing it to customers if we didn't think that it was a very good investment".
Mr. Kowalewski testified that he advised Mr. Saltsman that he owned shares in Stelco butsuggested that he sell a portion of his Raw Creek shares to purchase the Tropika shares.He stated, however, that Mr. Saltsman dissuaded him from disposing of the Raw Creekshares and recommended instead that he sell the Stelco shares to finance the transaction.Mr. Saltsman suggested that Mr. Kowalewski ask his other broker (Investors' Edge, CIBC'sdiscount broker) to have the Stelco certificates delivered to him and then to deliver thecertificates to Mr. Saltsman to sell. Mr. Kowalewski testified that Mr. Saltsman also toldhim not to tell his broker why he was selling the Stelco shares. When asked whyMr. Saltsman had asked him not to do so, Mr. Kowalewski said that Mr. Saltsman told himthat some brokerage houses do not like it when you change houses to another companyand they may ask questions. We inferred that Mr. Saltsman was concerned that arepresentative of Investors' Edge might warn Mr. Kowalewski about the wisdom ofexchanging Stelco for Tropika.
On November 16, 1995, Mr. Kowalewski acquired 5,000 Tropika shares at $1.68 per sharefor approximately $8,500. At this point, he had invested over $21,000 with Marchment inspeculative securities.
Mr. Saltsman asked Mr. Kowalewski to write a letter to Marchment indicating hissatisfaction with Mr. Saltsman's services as an "office administration-type matter". TheMarchment Policies and Procedures Manual provides that all trades in securities at thefirm are reviewed by an approved officer or the president of Marchment for suitability. Incases where a question arises as to the suitability of a trade, the manual provides that thesalesperson will be consulted and a request for further documentation will be made. Thisrequest may require a letter from the client stating recognition of the risk in the transactionor a letter from the salesperson stating updated information which may shed light as to whythe trade is suitable.
Mr. Kowalewski was not told that the letter was required because his investment inMarchment speculative securities had exceeded his suitability threshold. The letter thatMarchment received from Mr. Kowalewski reads as follows:
"As requested, I wish to confirm that my approximate net worth is about$300,000 and my annual salary is about $55,000 per year.
I realize that investing in the stock market does carry a certain degree ofrisk, along with the potential for capital gains as well as capital losses. I feelsatisfied that the trades processed so far for me by your company have beencompleted in a timely and professional manner, and feel that with sufficientadvice and guidance by yourself and your researchers, the potential forcapital gains within my account does exist. Please note that my risktolerance is not infinite and I welcome those recommendations which areconsidered to be fairly reliable."
In our view, this letter could not have allayed any concern that Marchment should havehad about Mr. Kowalewski's knowledge of the risks involved in the purchase of speculativesecurities from Marchment's inventory. As well, the statement of net worth in the letter didnot give Marchment any idea about the liquid assets that Mr. Kowalewski had available toinvest in speculative securities. We find that the manner in which the letter was requestedand its content do not contribute to compliance by Marchment with its obligations or withMr. Saltsman's obligations to ensure that all trades are suitable. Instead, the letterappears to be an attempt to obtain a written record that Mr. Kowalewski accepts fullresponsibility for the risk in a series of transactions that may not have been suitable for himin his circumstances.
Shortly after Mr. Kowalewski acquired the Tropika shares, he received a notice advisingthat his Raw Creek shares would be consolidated on a one-to-two-and-one-half basis.Mathematically, this should have produced a trading price of $5 per share after theconsolidation; however, the stock traded only at $3. Mr. Kowalewski testified that he calledMr. Saltsman who advised him not to worry and that the shares would climb in value again.
In March 1996, Mr. Kowalewski noted that his Tropika shares had dropped toapproximately $0.30 or $0.40 per share. He testified that he called Allen and that Allenadvised him that the decline in the trading price was attributable to principals of thecompany dumping the shares. According to Mr. Kowalewski, Allen connected him to Mr.Saltsman who said that "market conditions" can make the shares go down and they wouldincrease again. Mr. Kowalewski testified that, subsequently, his Tropika shares wereconsolidated on a one-for-ten basis and were trading at about $0.20 to $0.30 per share.On that basis, his $8,500 investment in Tropika was worth at most $150.
Mr. Kowalewski stated that it took him two to three years to save the money that he hadinvested in Raw Creek and Tropika and that he will never look at a stock table again.
Mr. Kowalewski is one of four customer witnesses for whom Mr. Saltsman was the seniorsalesperson. Mr. Saltsman testified that he followed the required procedure at Marchmentto ensure that trades were suitable for customers in view of their profile. He reviewed newclient application forms on file and, in his conversations with clients, confirmed theaccuracy of his knowledge by their signature and, where appropriate, obtained furtherdetails. He also testified that he always disclosed the inherent risks of investing in highrisk securities. He stated that he noted disclosure of risk and the basis on whichMarchment sold the shares in the "comments" section of the new client application formand verification of trade information form. He denies that he failed to ensure that hisrecommended trades were suitable in view of his clients' profiles.
Each of these assertions by Mr. Saltsman purported to describe his approach to dealingwith clients generally and were not a recollection by him specifically of his dealings withMr. Kowalewski. In fact, Mr. Saltsman testified that he did not have a specific recollectionof his conversations with Mr. Kowalewski.
As we have set out below, we have ample reason to reject Mr. Saltsman's testimony as aresult of the evidence given by his other customers and, in particular, as a result of theaudiotape made by Mr. Newell of his conversations with Mr. Saltsman. Similarly, we rejecthis evidence as it relates to his dealings with Mr. Kowalewski. In contrast, we have noreason to disbelieve Mr. Kowalewski. He demonstrated to us that he has very specific andreliable recollection of what was said in his conversations with Mr. Saltsman. The fundsthat he invested with Marchment on the advice of Allen and Mr. Saltsman were veryimportant to him and constituted a significant part of the assets that he had accumulated.Although counsel for the Respondents were able to establish some inconsistencies in hisrecollection during cross-examination, we find those inconsistencies to be relatively minorand not of sufficient importance to affect our view of the veracity of Mr.Kowalewski'stestimony. We believe that his recollection of the events which caused him to lose sucha large proportion of these funds were clearly imprinted in his memory. Accordingly, weaccept Mr. Kowalewski's testimony concerning his dealings with Marchment and Mr.Saltsman and reject Mr. Saltsman's version of what likely would have happened.
In his dealings with Mr.Kowalewski, Mr. Saltsman did not deal fairly, honestly and in goodfaith with Mr. Kowalewski and breached his fiduciary obligation to him. He failed to ensurethat trades which he recommended were suitable in view of Mr. Kowalewski's financialcircumstances and investment objectives. He failed to disclose the risks inherent in theinvestments he recommended and misrepresented the prospects for both the Raw Creekand Tropika investments. He used high-pressure sales techniques. He advisedMr. Kowalewski to sell Stelco shares to purchase further speculative stocks fromMarchment's inventory while, at the same time, discouraging the sale of Raw Creekshares.
Mr. Kowalewski testified that he signed and returned to Marchment the new clientapplication form and acknowledged that he reviewed the acknowledgement portion of theform before doing so. He confirmed that he had received a stock risk disclosure letter andreceived confirmation slips for his share purchases. We will deal later in these Reasonswith Marchment's documentary package and the use which Marchment purports to makeof it. We find that these documents, individually and taken as a whole, did not increasematerially Mr. Kowalewski's understanding of the risks he was taking in following Allen'sand Mr. Saltsman's advice.
Ms. Grech was a fifty year-old part-time clerk with London Life Insurance Company. At thetime she dealt with Marchment, her annual income was $16,000 to $17,000 per year. Shehas a high school education. She separated from her husband, a Ford Motor Companyemployee, on March 5, 1997. In 1996, her net worth was about $300,000 made up of thefamily home (about $250,000), payroll funded RRSP's, a mutual fund and about $10,000in a bank account. The funds in the bank account were part of the proceeds of thesettlement of a back injury claim that she had made several years earlier.
Ms. Grech testified that her investment knowledge at the time that she began to deal withMarchment was very minimal. Her previous investment experience was limited to thepurchase of mutual funds through a London firm called the Investment Centre. It isapparent from her evidence that Ms. Grech is a very unsophisticated investor.
Unlike the other customer witnesses, all of whom were first contacted through Marchment'stelephone solicitation campaigns, Ms. Grech contacted Mr. Osborne on therecommendation of her neighbour, Tony Cooper, who had purchased shares of GemstarCommunications Ltd. ("Gemstar") from Marchment. She testified that, at the time shecontacted Mr. Osborne, her tolerance for risk was very minimal because she intended touse her savings to finance her daughter's university education. Ms. Grech testified thatin her first conversation with Mr. Osborne, she told him about her personal situation andhow much money she had available.
Ms. Grech testified that Mr. Osborne told her that the Gemstar shares would "go up"because a component that Gemstar produced was going to be purchased by John Deere.She also testified that she had every faith in Mr. Osborne's representation that Gemstarwould be a good investment. In reality, the only transaction that Gemstar had entered intowith John Deere was a 90-day pilot project in which Gemstar agreed to pay $100,000 totest its technology on the inventory of a single John Deere dealership. Ms. Grech testifiedthat there was no discussion about risk in her dialogue with Mr. Osborne concerning theGemstar shares.
Ms. Grech testified that originally she wanted to purchase only 500 Gemstar shares butthat she ultimately purchased 1,500 because Mr. Osborne told her that they were sold incertain blocks and that she had to buy 1,500 shares. This, of course, would not have beentrue. Ms. Grech testified that she understood that when the price for the shares reachedtheir peak, Mr. Osborne would sell them for her.
Based on Mr. Osborne's advice, Ms. Grech purchased 1,500 shares of Gemstar on July17, 1996 for $2.01 per share, for a total investment of about $3,000.
Upon the completion of the Gemstar transaction, Mr. Osborne completed a new clientapplication form for Ms. Grech that recorded her investment objectives for her account atMarchment to be 80% speculation. Mr. Osborne testified that he provided this breakdown.Ms. Grech gave evidence that this was not a correct statement of her objectives.
Mr. Osborne has acknowledged that he knew that Ms. Grech had only $10,000 to invest.Even with Mr. Osborne's determination that it would be suitable for her to invest 80% ofthis amount in speculation (an objective which she denies), she would have at the most,$8,000 to invest in speculative securities.
Subsequent to her purchase of Gemstar shares, Ms. Grech contacted Mr. Osborne abouta company called Anglo Swiss Industries Inc. ("Anglo Swiss"). Ms. Grech testified that shehad heard about Anglo Swiss from a colleague at work. At about the same time shecontacted Mr. Osborne about another company, Palace Exploration Inc. ("PalaceExploration"), which she heard about from Tony Cooper. Ms. Grech testified thatMr. Osborne was very negative about these securities. Mr. Osborne testified that he toldMs. Grech that he did not know anything about these companies and acted merely as an"order taker" for her. Mr. Osborne also testified that he told Ms. Grech that he could notoffer her advice about whether to buy or sell either Anglo Swiss or Palace Exploration.Notwithstanding this lack of knowledge, however, within about a month after theiracquisition, Mr. Osborne had Ms. Grech out of the Anglo Swiss and Palace Explorationshares and into speculative securities which he sold to her from Marchment's inventory,Racad Technologies Limited. ("Racad") and Triangle Multi-Services Corporation.("Triangle").
Ms. Grech testified that, shortly after her purchase of Anglo Swiss and Palace, shediscussed her mutual fund investments with Osborne. She testified that Mr. Osborne toldher that her CI Pacific mutual fund "was not going to do well at all" and recommended thatshe cash out of the fund and acquire NCE Petrofund, a closed-end royalty trust in whichMarchment participated as part of the selling group. In his evidence, Mr. Osborne deniedthat he advised Ms. Grech to cash out of her CI Pacific to purchase NCE Petrofund units.Mr. Osborne does not know of any reason, however, why Ms. Grech would not tell the truthabout who recommended that she sell her CI Pacific mutual funds. Moreover,Mr. Osborne's evidence is not credible because Ms. Grech only had $10,000 apart fromher mutual fund investments and had already invested $6,000 in securities throughMarchment. Since Ms. Grech invested about $6,600 in the NCE Petrofund, Mr. Osbornemust have known that at least a portion of the funds would come from her mutual fundinvestments. In cross-examination, Mr. Osborne admitted that he had no information aboutthe performance of Ms. Grech's CI Pacific mutual fund at the time that he discussed theNCE Petrofund with her.
In his examination in chief, Mr. Osborne implied that the NCE Petrofund was a growthinvestment and stated that he had recommended this purchase to fulfill the 20% growthinvestment objectives he had provided for Ms. Grech. Nevertheless, he used the fund asa ready source of assets to finance the purchase by Ms. Grech of speculative securitiesfrom Marchment's inventory in the short-term. This was to Mr. Osborne's economicadvantage because no part of the 5% sales commission he received on the sale of theNCE Petrofund units to Ms. Grech would be "clawed back" if she sold them within anyperiod of time. Accordingly, on November 5, 1996 (less than one month after she acquiredthe NCE Petrofund units), Ms. Grech sold 100 NCE Petrofund units and 1000 Anglo Swissunits to finance her purchase of Triangle shares. Ms. Grech testified that she was notinformed about any risk in her investment in the Triangle shares. She acquired theseshares because Mr. Osborne had told her that they would be "good investments". Inconnection with the Triangle purchase, Ms. Grech gave the following evidence:
Q. Did Mr. Osborne ever suggest to you that there was anyurgency about your purchase of Triangle shares?
A. Well, the sooner I purchased the shares, the better it wasbecause he said that the price of the shares were going torise, and if I bought them right at the time we were speaking,then I would get them at a better buy.
Ms. Grech testified that, after she purchased the Triangle shares, she telephonedMr. Osborne because she was concerned about the status of her investments. On thistelephone call Mr. Osborne recommended that she dispose of 500 additional NCEPetrofund units and use the proceeds (about $2,750) to purchase additional Racad shares.At the same time, Ms. Grech testified that Mr. Osborne strongly urged her to hold on to herGemstar shares because "John Deere was still looking at the Gemstar". Ms. Grechtestified that she agreed to acquire the additional Racad shares because Mr. Osborne:
"...kept telling me that everything was going to go and I was already losingso much that I was sort of grasping at straws at this point."
After her purchase of the additional Racad shares, Ms. Grech had invested approximately$10,000 in speculative securities from Marchment's inventory. This represented asubstantial portion of her savings and, with her purchase in NCE Petrofund, was morethan the $10,000 that she had originally identified as being available for investment. Bythat time, (April, 1997) Ms. Grech had separated from her husband. She testified that shewas very fragile emotionally at that time and concerned about her daughter's tuition. Shewas also very concerned about the status of her investments with Marchment. Ms. Grechtestified that she told Mr. Osborne about her changed circumstances. Nevertheless, inJuly 1997, eleven months after the issuance of the Notice of Hearing and accompanyingStatement of Allegations, Mr. Osborne contacted her again to recommend that she acquireshares of Active Control Technologies Inc. ("Active Control"). Ms. Grech testified that, likethe other securities that he recommended to her, there was no discussion about the riskin this transaction. Although she was losing a considerable amount of money at the time,she testified that Mr. Osborne continued to tell her that all the securities that she hadpurchased would do well. On that basis, Ms. Grech agreed to purchase 250 ActiveControl shares at $1.85 per share.
Ms. Grech testified that after the Active Control purchase, all of the securities that she hadacquired from Marchment were "just plummeting". She contacted a representative at RBCDominion Securities who advised her to sell all of her Marchment speculative securities.In all, Ms. Grech made at least eight purchases in the speculative shares of fourcompanies out of Marchment's inventory. She lost most of the $10,000 that she hadavailable for investment.
Ms. Grech was one of two customer witnesses who purchased securities on the advice ofMr. Osborne. Much of Mr. Osborne's testimony is directly contradictory of the evidencegiven by Ms. Grech. Mr. Osborne had several dealings with Ms. Grech not only in orderto effect eight separate sales of speculative securities to her, but also in connection withhis purchases on her behalf of the shares of Anglo Swiss and Palace Exploration and hissale to her of units in NCE Petrofund. It should have been obvious to Mr. Osborne thatMs. Grech was very unsophisticated in financial matters and knew virtually nothing aboutthe stock market or the relative differences in risk between mutual funds and penny stocks.He should have recognized that she was in desperate need of sound, expert investmentadvice.
Mr. Osborne testified that it is his practice always to inform customers about the risk ofinvesting in speculative stock. He did so in every conversation with the client. As well, asa reminder to himself and a check that he had communicated this important information,he would be sure to note that he had done so in the new client application form or theverification of trade information form. Mr. Osborne testified that he used language whichhe felt investors, and particularly less sophisticated investors, could readily understand.For example, he testified that he used the word "gamble" as it plainly communicated therisk of losing all one's money as well as the terms "longshot", "this is a good shot", "it is awin or lose situation", and "we are looking for a needle in a haystack". Specifically, hetestified that he ensured that Ms. Grech was well aware that the investment in Gemstarwas highly speculative in nature. He testified that he pointed out to her that juniorcompanies are the most risky companies in the market. Mr. Osborne denied that he failedto deal fairly, honestly and in good faith or that he did not act in the best interests ofcustomers of Marchment, and in particular, Ms. Grech.
Mr. Osborne's testimony is internally inconsistent in one important respect. WhenMs. Grech called him about purchasing shares of Anglo Swiss and Palace Exploration,Mr. Osborne testified that he told Ms. Grech that he was not knowledgeable about eitherAnglo Swiss or Palace Explorations and that in light of his lack of knowledge he couldneither discourage nor encourage her to invest in these companies. Later in hisexamination in chief, however, he testified that he specifically brought to Ms. Grech'sattention the risk of investing in the Anglo Swiss and Palace Exploration securities but Ms.Grech wanted to go ahead. We find it difficult to understand how Mr. Osborne couldpresume to give this advice given that his lack of knowledge was such that he couldneither discourage nor encourage her to invest in those companies.
More significantly, within about a month after Ms. Grech's purchase of the Anglo Swiss andPalace Exploration shares, Mr. Osborne sold the Anglo Swiss and Palace Explorationshares on her behalf and invested the proceeds in the purchase of securities of Racad andTriangle which were being sold out of Marchment's inventory. Ms. Grech testified that sheagreed to make the switch based on Mr. Osborne's advice. We accept this testimony.Clearly, Mr. Osborne knew that she would have to fund her new purchases in this manner.We find that Mr. Osborne advised Ms. Grech to sell her investments in Anglo Swiss andPalace Exploration and apply the proceeds to the purchase of Marchment inventorysecurities.
Although Respondents' counsel were able to identify in cross-examination minorinconsistencies in Ms. Grech's evidence, we accept Ms. Grech's testimony with respectto her dealings with Mr. Osborne. To the extent that Mr. Osborne's testimony conflicts withMs. Grech's, we reject Mr. Osborne's testimony. We find that Mr. Osborne took advantageof Ms. Grech's lack of sophistication and her vulnerability and used the opportunity tomanipulate her investments so as to earn the maximum return for himself and forMarchment, contrary to her interests as a customer who had reposed her trust in him. Mr.Osborne did not deal fairly, honestly and in good faith with Ms. Grech. He breached hisfiduciary obligation to her. In his dealings with her he failed to ensure that the purchaseshe recommended were suitable; nor did he disclose to her the risks she was incurring infollowing his advice.
Ms. Grech acknowledged that she received the new client application form completed forher by Mr. Osborne as well as the stock risk disclosure letters, although she stated thatshe likely did not read the latter. She also acknowledges signing and returning theverification of trade information form. We find that her receipt of these forms did notcontribute materially to her understanding of the risks inherent in purchasing stock fromMarchment's inventory.
Mr. Anderson was a 33 year-old circulation assistant at the Scott Library at YorkUniversity, earning about $30,000 per year. His net worth was about $50,000 of which$15,000 was invested in an RRSP and about $9,000 was invested in an Altamira mutualfund. He also owned Seagram shares worth about $4,000 and the securities of two otherissuers, Rea Gold and Tecsyn, that had been recommended in financial publications. Hehad about $20,000 on deposit in a bank account. According to Mr. Anderson, the $20,000on deposit in the bank constituted the only assets that he had available for investment.
At the time that he dealt with Marchment, Mr. Anderson was suffering from depression andwas under the care of a psychologist. His psychologist encouraged him to participate inthe capital markets as part of taking a more active interest in his financial affairs. Mr.Anderson testified that he was not a "humongous risk taker". He found his job at the libraryto be "really horrendous" and he was concerned that, if he left his employment, he wouldno longer have insurance coverage for the medication that he took for depression. Mr.Anderson lived with his parents and had hoped to use his savings to purchase acondominium.
In the early summer of 1994, Mr. Anderson received a telephone call from Ray Kawaguchi("Kawaguchi"), a Marchment junior salesperson. Kawaguchi asked Mr. Anderson abouthis occupation and his investment knowledge. In the course of this telephoneconversation, Mr. Anderson advised Kawaguchi about his practice of reading the financialpress. Kawaguchi discouraged him from doing so. He said that investment publicationsare expensive and that it was extremely time-consuming to read financial information. Herecommended that Mr. Anderson would do better to place his faith in a securities dealersuch as Marchment.
In the course of this telephone conversation, Kawaguchi recommended that Mr. Andersoninvest in the shares of Cyber Digital Video Services Limited ("Cyber Digital") whichKawaguchi said was in the CD-ROM business and part of the information highway.Kawaguchi advised Mr. Anderson that Marchment specialized in "getting in on the groundfloor for investors". He told Mr. Anderson that "we want to make you some money" so thatMr. Anderson would have a "long-term" relationship with the firm.
Kawaguchi told Mr. Anderson that he should check the volume of trading in the CyberDigital shares because that showed "how popular" the securities were with investors. Inview of the dominance by Marchment and, another securities dealer, Price WarnerSecurities Limited ("Price Warner") in the trading of Cyber Digital shares, this statementwas very misleading. Mr. Anderson testified that during his conversation with Kawaguchi,there was no discussion about the securities being speculative in nature. Mr. Andersonpurchased 1,000 Cyber Digital shares for $1.32 on July 21, 1994.
Kawaguchi completed a new client application form for Mr. Anderson in which he recordedMr. Anderson's objectives for his account at Marchment as 75% speculative. Mr. Andersontestified that this statement was incorrect.
On September 29, 1994 Mr. Anderson received his first telephone call from Mr. Plant. Bythat time, the trading price for the Cyber Digital shares had increased from $1.32 to about$1.55. According to Mr. Anderson, Mr. Plant emphasized that he should review thevolumes at which the Cyber Digital shares were trading (again misleading in view of themarket dominance of Marchment and Price Warner). Mr. Anderson testified that Mr. Plantrecommended that he purchase more Cyber Digital shares. Mr. Anderson recalledsuggesting 2,000 additional shares and Mr. Plant responding by asking whether he couldtalk Mr. Anderson into acquiring an additional 3,000 shares. According to Mr. Anderson,Mr. Plant emphasized to him that he had his best interests at heart.
Mr. Anderson testified that there was no discussion about the risks involved in making amore substantial investment in Cyber Digital shares. To the contrary, Mr. Plantemphasized that the securities had "nowhere to go but up". Following Mr. Plant'srecommendation, Mr. Anderson agreed to acquire 3,000 additional Cyber Digital sharesfor $1.55 on September 29, 1994. By this time, Mr. Anderson had invested approximately$6,000 in shares of Cyber Digital on the advice of Kawaguchi and Mr. Plant.
Mr. Anderson testified that less than two weeks after he agreed to purchase the additionalCyber Digital shares, he received an urgent telephone call from Mr. Plant at work.Mr. Anderson has a very specific recollection about this discussion. According toMr. Anderson, Mr. Plant apologized for disturbing him but told him that he had a "flashingred light" to purchase the shares of Zlin Aerospace Inc. ("Zlin Aerospace"). Mr. Andersontestified that Mr. Plant advised him that Zlin Aerospace was the distributor of aCzechoslovakian airplane and that the market was reacting unfavourably to anapprehension that its product would not receive government approval. Mr. Andersonrecalled that Mr. Plant told him that Marchment had knowledge that the plane did, in fact,work and that Mr. Anderson should "jump in big" and invest as much money as he couldin Zlin Aerospace shares.
Mr. Anderson told Mr. Plant that he was concerned about being so heavily invested withMarchment. According to Mr. Anderson, Mr. Plant responded by asking Mr. Anderson"Don't you wish you had bought more shares of Cyber Digital when they were at $1.32 or$1.55?". The newspaper quotations for Cyber Digital shares at that time would have giventhe impression that they were then trading at $1.85. Mr. Anderson testified that there wasno discussion about the "downside" involved in an investment in Zlin Aerospace shares.Following Mr. Plant's recommendation, Mr. Anderson purchased 5,000 Zlin Aerospaceshares on October 12, 1994. He testified that he initially suggested purchasing 4,000shares, but Mr. Plant "talked him into" 5,000 shares for a total investment of $4,000. Atthis point Mr. Anderson had spent approximately $10,000 purchasing speculative sharesfrom Marchment's inventory.
Mr. Anderson testified that in November 1994, Mr. Plant recommended he acquire 20,000shares of Weaver Lake Explorations Ltd. ("Weaver Lake") for $2,000. Mr. Andersonrecalled expressing to Mr. Plant at the time of his concern that he was heavily investedwith Marchment and suggesting that he sell his Cyber Digital shares to finance thisacquisition. According to Mr. Anderson, Mr. Plant recommended that he retain the CyberDigital shares. Following Mr. Plant's recommendation, Mr. Anderson purchased 20,000shares of Weaver Lake. At this point, Mr. Anderson's purchases totalled $12,000.
Mr. Anderson testified that in the context of this telephone conversation Mr. Plant told himthat as a "formality" he would have to write a letter to Marchment, the contents of which hedictated to Mr. Anderson. The letter which Mr. Plant dictated was similar to the letter thatMr. Saltsman had asked Mr. Kowalewski to write. It is apparent that Mr. Plant demandedthe letter in an attempt to justify the suitability of this and any subsequent purchases hemight recommend to Mr. Anderson.
Mr. Anderson testified that in the context of dictating the letter to him, Mr. Plant usedphrases like "speculative" and "losses" that had never been mentioned in any previouscalls that Mr. Plant had made to him when he recommended that Mr. Anderson purchaseother securities. Mr. Anderson testified that he was willing to write and send the letterbecause he had no reason not to trust Mr. Plant and was "up to [his] neck already" inMarchment recommended securities by that time.
Mr. Anderson testified that he received independent advice from a broker at ScotiaMcLeod after he purchased the Weaver Lake shares. In March 1995, Mr. Anderson soldhis Cyber Digital and Weaver Lake shares. The Zlin Aerospace shares had fallen to"around a nickle or ten cents" per share so he retained them.
By early December 1995, Mr. Anderson had left his employment at the library and washospitalized for depression. By that time the trading price for his Zlin Aerospace shareshad recovered. Mr. Anderson testified that he contacted Mr. Plant and asked him to sellthe shares and that he informed Mr. Plant about his personal situation. Nevertheless, Mr.Plant did not immediately sell the shares. Ultimately, they were sold for $0.40 a share,exactly half of what he had paid.
Even after Mr. Anderson's episode in the hospital, Mr. Plant called him again in the springof 1996. Mr. Anderson testified that Mr. Plant advised him that he and Kawaguchi feltbadly about what had happened to Mr. Anderson and said "What we would like to do ismake it up to you ". According to Mr. Anderson, Mr. Plant recommended that he acquireadditional securities from Marchment. Mr. Anderson testified that he "couldn't believe [Mr.Plant] actually had the gall to do that."
Mr. Anderson is the only customer witness who dealt with Mr. Plant as the seniorsalesperson. Mr. Plant's testimony directly contradicted much of Mr. Anderson'stestimony. Mr. Plant testified that he informed clients about the risk associated with thestock and that Mr. Anderson was no exception. For example, he testified that Mr.Anderson was made aware that the investment in Cyber Digital was highly speculative.Mr. Plant also testified that he never told Mr. Anderson that Cyber Digital was "on theground floor" and "had nowhere to go but up". He stated that Mr. Anderson was alreadyin on the ground level at a much lower price. He also stated "That would have, you know,been a silly thing to say...[with respect to "no where to go but up"]. It is not true, becausestocks can go anywhere. They can go up, they can go down."
With respect to Mr. Anderson's purchase of 5,000 shares of Zlin Aerospace, Mr. Planttestified that he was cognizant that Mr. Anderson's portfolio of speculative stock hadreached 15 per cent of his net worth, but was satisfied that continued investment of aspeculative nature was suitable for Mr. Anderson. He stated "It didn't create any concernsin my mind. Like I said, again, I took a lot of things into account. His age, he was single,his level of net worth, that type of thing". Mr. Plant also denied that he ever used the term"flashing red light" or said that Mr. Anderson "should jump in big with as much money ashe could afford". Mr. Plant testified that he always ensured that his customers were awarethat they could sell their securities at any time and denied ever making misleading or falsestatements to Mr. Anderson which were designed to induce him to refrain from selling hissecurities. He stated that he sold Mr. Anderson's shares in Weaver Lake and CyberDigital when Mr. Anderson requested that he do so in March, 1995, however, at that timeMr. Anderson decided to retain Zlin Aerospace because he did not feel that he would getenough to make it worthwhile to sell. He also stated that in December 1995, althoughMr. Anderson had possession of his share certificates, he contacted Mr. Plant to sell theshares on his behalf, which Mr. Plant did.
In cross-examination, Mr. Plant admitted that he did not have a specific recollection of hisdiscussions with Mr. Anderson concerning the purchase of Cyber Digital shares. Asidefrom testimony by each of the Respondents about procedures generally followed atMarchment, no evidence was introduced to refute Mr. Anderson's description of hisdealings with Kawaguchi. We accept this part of Mr. Anderson's evidence.
Mr. Anderson told us that he was very uncomfortable giving testimony, that he was a verynervous type of person who did not like speaking in public. He said that when he sent aletter to the Commission identifying himself as a Marchment investor who had lost money,he knew that he would probably be asked to testify and stated that, "I weighed that againstmy own wanting just to forget the whole thing and not put myself through all that, and Iopted to testify against these people because it was worthwhile to do so." Having listenedto Mr. Anderson's testimony and having observed his demeanour, we were convinced thathis description of events that happened almost five years ago, was accurate.
Having listened to and observed Mr. Plant, however, we did not have the same comfortthat he was describing events as he recalled them but rather was reconstructing the eventsas he knew they should or could have occurred. The conflict over the timing of thedisclosure by Mr. Anderson of his hospitalization for depression is illustrative of ourreasons for choosing Mr. Anderson's testimony over that of Mr. Plant. Mr. Andersontestified that he advised Mr. Plant in early December, 1995 that he had left his employmentat the library and was hospitalized for depression. Mr. Plant testified that Mr. Andersonnever informed him that he was in poor health or on medication but acknowledged that hadhe done so, the purchases of speculative securities would have been consideredunsuitable for Mr. Anderson. Mr. Plant testified that it was not until April, 1996 thatMr. Anderson indicated that he was unemployed and that he concluded at that time thatit would not be an appropriate time for Mr. Anderson to be involved in the speculativemarket and did not propose any further trades. In our view, this evidence is not credible.Mr. Anderson was very precise in his recollection that he specifically discussed hishospitalization in late 1995 to appeal to Mr. Plant's "sense of fair play" as he anticipatedthat he would meet with resistance to his request that the Zlin Aerospace shares be sold.Moreover, Mr. Plant's evidence on this issue is not consistent with the witness statementdelivered prior to the hearing, which Mr. Plant admitted having reviewed before givingevidence, in which he said that he first learned about Mr. Anderson's hospitalization whenMr. Anderson wrote a complaint letter to Marchment in August, 1996.
We believe that it is clear from the evidence that Mr. Anderson was never a suitablecandidate for the purchase of speculative securities and this would have been so obviousto anyone dealing with Mr. Anderson that both Kawaguchi and Mr. Plant must have beenaware of it. We believe that Mr. Plant recognized Mr. Anderson's vulnerability andproceeded to exploit that vulnerability to his and Marchment's economic advantage. Heabused the trust that Mr. Anderson clearly had placed in him. He did not deal fairly,honestly and in good faith with Mr. Anderson. He breached his fiduciary duty to Mr.Anderson. In his dealings with Mr. Anderson, Mr. Plant failed to ensure that the purchaseshe recommended were suitable and he failed to disclose to Mr. Anderson the risks he wasincurring by following Mr. Plant's advice. He also discouraged Mr. Anderson from sellingMarchment principal securities to finance the purchase of other securities fromMarchment's inventory.
Mr. Anderson also received the same sequence of documents as Mr. Kowalewski andMs. Grech. Mr. Anderson testified that he "glossed over" part of the new client applicationform to ensure that his name was right and that he had bought the shares that wereindicated but did not read other parts of the document. In addition, Mr. Anderson testifiedthat he never read the print at the bottom of a letter sent by Marchment following thepurchase of the Cyber Digital shares. Lastly, Mr. Anderson testified that he reviewed thesignature card briefly and just "glanced" it over.
As in the cases of Mr. Kowalewski and Ms. Grech, we find that the documents did notcontribute to his appreciation of the risks he was incurring.
At the time of his testimony, Mr. Lombardi was 35 years old and was a self-employed,registered dental technologist. When he was first contacted by Marchment in October1995, his income was about $45,000 per year. His approximate net worth was about$250,000 consisting of his home, his vehicles and the assets of his business. He testifiedthat he had no surplus funds to invest at that time because he had just bought a dentallaboratory. He also testified that he had no investment knowledge or any investmentexperience at the time that he dealt with Marchment. That Mr. Lombardi was not a goodcandidate to purchase speculative penny stocks is obvious.
Mr. Lombardi testified that he received numerous telephone calls from a Marchmentrepresentative. Mr. Lombardi said that the representative spoke to him about purchasingshares of Tropika. Mr. Lombardi testified that he was told that Tropika was a "Canadian-based company, and they were doing really well, and they were selling world wide, andpicking up in the States". Mr. Lombardi testified that there was no discussion about anyrisk involved in the investment. The Marchment representative was identified as HarrisLusher ("Lusher"), a Marchment junior salesperson. Mr. Lombardi testified that he finallyagreed to buy 400 shares because of the constant telephone calls that he received. In thatregard, he said:
Q. Okay, now why did you agree to buy these shares?
A. I guess it was the constant phone calls. I never reallyagreed to buy them honestly, I felt like just to get them off myback, I just said, "Okay, I will just buy 400 shares". I said,"What is the least I could buy?" and he said, "Maybe just gointo buying 400 shares for now," and I did.
Shortly after he acquired the 400 Tropika shares, Mr. Lombardi received a telephone callfrom Mr. Saltsman. By that time, Mr. Lombardi testified Mr. Saltsman told him that hisTropika shares were performing "really well". He said that Mr. Saltsman told him that itwas a good time to buy more stocks because they "are going to be going up". Accordingto Mr. Lombardi, there was no discussion of any risk.
Mr. Lombardi was adamant in his evidence that he did not agree to purchase anyadditional Tropika shares in his discussion with Mr. Saltsman. Nevertheless, he testifiedthat he received a "bill" for $8,200 from Marchment shortly thereafter. Mr. Lombarditestified that he immediately called Mr. Saltsman. According to Mr. Lombardi, Mr.Saltsman told him that he had agreed to purchase additional Tropika shares. Mr.Lombardi said that he stressed to Mr. Saltsman that he was in no position to purchase theshares and that he could not afford the purchase. Mr. Lombardi asked Mr. Saltsman if hehad to pay for the shares. Mr. Saltsman told him that he had to do so because it was "withthe lawyers". Mr. Lombardi said that Mr. Saltsman "kind of scared me so I decided to putmy trust in him". Mr. Lombardi testified that Mr. Saltsman recommended that Mr. Lombardiborrow the money to pay for the shares from the bank or from a family member becausein a few weeks he would be making the money and could repay the loan. Following Mr.Saltsman's advice, Mr. Lombardi borrowed the money to buy the additional Tropika sharesfrom his wife's uncle.
After he paid for the additional Tropika shares, Mr. Lombardi was contacted again byMr. Saltsman. This time Mr. Saltsman recommended that Mr. Lombardi acquireStockguard shares. Mr. Lombardi testified that notwithstanding the difficulties that he hadwith Mr. Saltsman, he agreed to purchase 500 Stockguard shares at $1.38 . He said thatat the time that Mr. Saltsman contacted him regarding Stockguard, he was in debt and feltthat if he made money on these investments, it would ease the financial pressures that hewas under at the time. After he acquired his Stockguard shares, the trading price forTropika and Stockguard declined. He testified that at that time, he had difficulties reachingMr. Saltsman.
Mr. Lombardi summed up his feelings about his dealings with Marchment with the followingtestimony:
"Well my feelings about Marchment & Mackay is that they arejust a very pushy ... they come across as just trying to make asale. I feel pressured when I speak to them. I really don't likedealing with them. I don't want to talk to them, really, on thephone. A lot of times I would like to hang up, but it is just notin my nature to do so. I feel cheated."
Mr. Lombardi was the second of the Marchment customer witnesses who dealt withMr. Saltsman. In the context of Mr. Kowalewski's testimony, we have referred toMr. Saltsman's testimony concerning the manner in which he dealt with clients and hisdenial that he failed to ensure that his recommended trades were suitable in view of hisclients' profiles. When asked about whether he would advise clients to incur debt tofinance an investment in speculative securities, Mr. Saltsman was adamant: "I would nottell the client to go out and borrow money or make... borrow money through any way. Iwould not tell the client to put himself under duress on any gamble." Further, when askedspecifically whether he had suggested that Mr. Lombardi borrow money from a familymember in order to complete the trade, Mr. Saltsman responded, "Absolutely not."
We were impressed with Mr. Lombardi's demeanour and sincerity as a witness and accepthis testimony as an accurate portrayal of his dealings with Marchment and Mr. Saltsman.Mr. Saltsman denied advising Mr. Lombardi to borrow money. The fact that he did borrowmoney from his wife's uncle to pay for the Tropika shares which Mr. Saltsman alleged thathe had purchased was uncontroverted and we find that he did so on Mr. Saltsman'sadvice. On cross-examination, Mr. Saltsman acknowledged the obvious: that no-oneought to borrow money to purchase speculative penny stocks. To the extent that Mr.Saltsman's testimony contradicts that of Mr. Lombardi, we reject Mr. Saltsman's versionof the events. Had Mr. Saltsman attempted to comply with his "know-your-client"obligations, he would have determined that Mr. Lombardi should never have purchasedspeculative securities. We find that Mr. Saltsman employed techniques of intimidation andcoercion to induce Mr. Lombardi to borrow money from relatives to pay for securities. Hebreached the trust that Mr. Lombardi placed in him. Mr. Saltsman clearly failed to dealfairly, honestly and in good faith with Mr. Lombardi and breached his fiduciary obligationto him. He failed to ensure that the purchases he recommended to Mr. Lombardi weresuitable and failed to disclose to him the risks he was incurring in following Mr. Saltsman'sadvice.
In his testimony, Mr. Lombardi acknowledged having signed and returned a "signaturecard" together with a photocopy of his new client application form. It was Marchment'spractice at the time to ask clients to sign and return the signature card along with a chequein payment for the client's first purchase of shares from Marchment's inventory.Notwithstanding its name and the fact that it is designed to look like the signature card onewould use in opening a new bank account, the Marchment "signature card" purported toevidence the acknowledgement by the customer of the complete accuracy of the enclosednew application form, trade confirmation and introductory stock disclosure letter. It alsopurported to evidence the acknowledgement by the customer of his or her fullunderstanding of the risks involved in the security being purchased. Mr. Lombardi testifiedthat he did not even look at the signature card, but signed it as requested. We accept thistestimony. We find that the receipt by Mr. Lombardi of the documents referred to in thesignature card and the signature card itself did not contribute to his appreciation of therisks he was incurring.
Mr. Peltola testified that he was contacted by Daniel Sacke ("Sacke"), a Marchment juniorsalesperson on October 18, 1997, more than a year after the Notice of Hearing was issuedin these proceedings. Sacke recommended that Mr. Peltola acquire shares of Partner JetInc. ("Partner Jet"). Mr. Peltola described Sacke as very aggressive in his sales approach.Sacke sent him some information regarding Partner Jet by fax. Sacke called Mr. Peltolaback later that day at which time Mr. Peltola told Sacke that he was not interested inbuying any Partner Jet shares. Nevertheless, Mr. Peltola received an invoice requiringhim to pay for 250 Partner Jet shares. Mr. Peltola testified that he called Sacke remindinghim that he had not agreed to purchase any Partner Jet shares and that Sacke apologizedto him for the error.
Mr. Peltola then received a package by courier from Marchment which he returnedunopened. Sacke called him back to ask why he had returned the package. Mr. Peltolaagain denied that he had acquired the shares. According to Mr. Peltola, this time Sackedisagreed and advised him that he had in fact agreed to buy the shares. UnlikeMr. Lombardi, Mr. Peltola told Marchment that he had no intention of paying for the shares.In that regard, it is worth noting that Mr. Peltola had received some training in thesecurities industry by taking the Canadian Securities Course.
Sacke completed a new client application form for Mr. Peltola which was filed as an exhibitin these proceedings. The new client application form indicates that Mr. Peltola'sobjectives for his account at Marchment were 100% speculative. This was consistent withMr. Sofer's teachings in the sales training course for junior salespeople where he told thenovices that "this could be full spec". Mr. Peltola testified that he did not discuss hisinvestment objectives with Mr. Sacke.
Marchment did not call any evidence to contradict Mr. Peltola's testimony nor has it offeredany explanation as to why Sacke acted as he did.
In December 1994, Professor Donald Wilson, who has a Ph.D. from Trinity College,Dublin, was teaching French language and literature at the University of Waterloo. Hewas approximately 54 years of age. In 1994, his annual income was approximately$90,000 and his net worth was about $700,000. His assets consisted of a house, car,mutual funds and rental properties. Professor Wilson testified that all his assets wereinvested and that he had no knowledge about the stock market whatsoever. He stated thathis objectives were "steady growth". He testified that he has always avoided investing inequities because he felt that stocks were much riskier than mutual fund investments.
Professor Wilson testified that he was contacted in December 1994 by Kawaguchi.Professor Wilson told Kawaguchi that he had no experience at all in the stock market andthat he was very reluctant to get involved. Kawaguchi told Professor Wilson not to worrybecause Marchment would provide investment advice. Kawaguchi recommended thatProfessor Wilson begin with a small investment to see how it performed. Kawaguchi toldhim that if he was happy, he could either take his profits or reinvest them with the firm.
According to Professor Wilson, Kawaguchi recommended that he buy shares in a companycalled Dimensional Media Inc. ("Dimensional Media"). Professor Wilson said that he wastold that Dimensional Media manufactured computer terminals that would be placed inpharmacies. According to Professor Wilson, he was also told that it was almost a surething that the price for the shares would increase in value. Professor Wilson foundKawaguchi to be very persuasive. Professor Wilson testified that he was not told anythingabout any risk involved in an investment in Dimensional Media shares. Professor Wilsonagreed to purchase 800 Dimensional Media shares at $1.28 in the course of thistelephone conversation (December 2, 1994). Professor Wilson said that he toldKawaguchi that he would have to borrow the funds to purchase these shares from his lineof credit. Kawaguchi did not change his recommendation upon receiving this information.
Kawaguchi completed a new client application form for Professor Wilson. The formrecorded that Professor Wilson's objectives for his account at Marchment were 75 per centspeculation. Professor Wilson testified that this was "absolutely not" a correct statementof his intentions with the assets that he invested with Marchment. Professor Wilson statedthat in December 1994 almost all of his interest was in growth because he had his salaryfrom the University and his rental income from two rental properties.
Professor Wilson testified that, after his initial acquisition of Dimensional Media shares,the trading price for the securities increased. Then he received a telephone call fromMr. Osborne who recommended that he make an additional investment in DimensionalMedia shares. Professor Wilson testified that he advised Mr. Osborne that he wasinterested in purchasing additional Dimensional Media shares because they had done sowell. Professor Wilson also testified that he explained to Mr. Osborne that he would beborrowing the money to finance the acquisition of these shares and that he wantedMr. Osborne to assure him that he would not be making a risky investment. ProfessorWilson testified that Mr. Osborne gave him that assurance. In this telephone conversation,Professor Wilson agreed to acquire a further 4,200 Dimensional Media shares for $6,300on February 1, 1995.
Professor Wilson testified that Mr. Osborne contacted him again in March 1995. This timehe recommended that Professor Wilson acquire Maxill Inc. shares. According toProfessor Wilson, he told Mr. Osborne that he would be borrowing money to invest andwanted to be certain this was not a risky investment. Professor Wilson testified that MrOsborne assured him the risk was minimal. Professor Wilson acquired 5,000 Maxill Inc.shares at $0.75 for about $3,800 on March 27, 1995.
In his evidence, Professor Wilson made it very clear that he was told from the outset thathe could rely on Marchment to advise him when he ought to sell his securities.Nevertheless, Professor Wilson did not receive any further telephone calls from Mr.Osborne (or Kawaguchi). In July 1995, Professor Wilson called Mr. Osborne to ask aboutthe securities. Mr. Osborne recommended that he retain them. Professor Wilson testifiedthat he did not contact Mr. Osborne again. After having read an article in The Globe &Mail regarding penny stocks, by letter dated November 20, 1995, Professor Wilson wroteto Mr. Ornstein complaining about Mr. Osborne and Kawaguchi. The principal complaintsin his letter were that there was inadequate disclosure of risk and that he did not receivethe investment advice that he was promised.
Professor Wilson is the second of the two customer witnesses who purchased shares onthe advice of Mr. Osborne. As was the case with Ms. Grech, much of Mr. Osborne'stestimony is directly contradictory to the evidence given by Professor Wilson. In thesection of these reasons dealing with Ms. Grech's testimony, we summarized Mr.Osborne's evidence as to how he dealt with customers generally. There is no need torepeat that summary here. With respect to Professor Wilson, Mr. Osborne testifiedspecifically in his examination in-chief that Professor Wilson did not tell him that he hadborrowed money to finance his investment. Mr. Osborne was clear that in his view, theborrowing of funds to finance speculative transactions is inappropriate. He testified thathad he known that Professor Wilson had borrowed funds, he would have declined thetrade. Mr. Osborne also stated that he "would" have told Professor Wilson that aninvestment in Dimensional Media would be a gamble. Mr. Osborne also testified that whenhe contacted Professor Wilson, Professor Wilson was eager to increase his position inDimensional Media and explained that he already had been thinking of purchasing moreDimensional Media. Mr. Osborne testified that he told Professor Wilson that because thecompany was junior, it was a highly risky investment. He was certain that he alsodisclosed the risk involved and would never suggest that little risk was involved.
Mr. Osborne was questioned during cross-examination about his specific recollection ofconversations with Professor Wilson in the first few months of 1995. His responses werepunctuated with the word "would" in reference to what he would have told Professor Wilsonin these telephone conversations. Notwithstanding, he maintained that there were certainthings that he did recollect because Professor Wilson, ".....actually probably wasn't quitetypical". Later he said that, "He stood out to me because I remember the man and hisconversation, yes."
That Professor Wilson was averse to risk is obvious from his testimony. Mr. Osbornetestified that his customers invested assets with him to "gamble" and "have fun". Tosuggest that Professor Wilson wanted to "have fun" gambling with his investments withMarchment is simply not tenable.
We accept the testimony of Professor Wilson and, to the extent that it conflicts with suchtestimony, we reject the testimony of Mr. Osborne. We find that Mr. Osborne was awareof the fact that Professor Wilson had to borrow money to finance his purchases ofMarchment principal securities. We find that in his dealings with Professor Wilson,Mr. Osborne failed to disclose the risk inherent to the Marchment principal securities thathe recommended Professor Wilson acquire. We find that Mr. Osborne recommended thatProfessor Wilson acquire speculative securities from Marchment's inventory and ultimatelydiscouraged Professor Wilson from selling such securities without any legitimate basis fordoing so.
We find that Mr. Osborne did not deal fairly, honestly and in good faith with ProfessorWilson. He breached his fiduciary obligations to Professor Wilson. In his dealings withProfessor Wilson, Mr. Osborne failed to ensure that the purchases of shares inDimensional Media and Maxill were suitable in view of Professor Wilson's profile as aninvestor. We also find that Mr. Osborne failed to disclose to Professor Wilson the riskinherent in his investments and discouraged Professor Wilson from selling the shares thathe had acquired from Marchment's inventory. Regarding the documentation he receivedfrom Marchment, Professor Wilson testified, "I felt slightly alarmed at first, and then Iremembered what I had been told on the telephone, and rather disregarded it, because Ihad been told that this was a safe investment. I had made it clear that I was onlyinterested in a safe investment and I believe this is what it was." We find that the receiptof the documentation did not contribute to Professor Wilson's understanding of the riskshe was incurring.
At the time of his testimony, Mr. Duffy was 48 years old and was a self-employed businessconsultant. In the spring of 1993, Mr. Duffy was employed as the vice-president andgeneral manager of AFG Glass Inc.. At the time, his investment experience was limitedprimarily to mutual funds, investments in GICs and money market instruments. He had noinvestments outside his RRSP. His net worth was approximately $500,000 comprised ofhis home and his RRSP and approximately $100,000 cash in a bank account that he hadobtained on the sale of shares of his former employer (Pilkington Glass) to AFG Glass.Mr. Duffy testified that he had not formed any investment objectives in the spring of 1993.
Mr. Duffy testified that in the summer of 1993, he received numerous telephone calls atwork from representatives of Marchment. His reaction to most of these telephone callswas that he was too busy to speak to Marchment. Finally, in July 1993, David Bruce("Bruce"), a Marchment junior salesperson, convinced him to purchase securities. Mr.Duffy testified that Bruce called him with the recommendation that he purchase shares inMaxill. According to Mr. Duffy, Bruce said that he expected the trading price for the sharesin Maxill to double or triple in a short period of time. Mr. Duffy testified that there was nodiscussion about the risk involved in an acquisition of Maxill shares. He agreed topurchase 400 Maxill shares at $2.05 per share on July 29, 1993.
Bruce completed a new client application form that recorded Mr. Duffy's investmentobjectives for his account at Marchment to be 80% speculation. Mr. Duffy testified that thisstatement bore no relation to his actual objectives because he was at the time a "neophytein terms of anything other than just simple RRSP purchases or GICs".
In October 1993, Mr. Duffy received a call from Mr. Sofer who introduced himself asMarchment's vice-president. Mr. Duffy testified that, in this initial telephone call, Mr. Soferwas very pleasant but that in subsequent conversations he became a little bit moreaggressive. He testified that Mr. Sofer advised him that Maxill was doing very well and thathe expected that its shares would continue to generate a very good return. Mr. Duffytestified that Mr. Sofer recommended that he acquire additional Maxill shares. He alsotestified that there was no discussion of risk in that telephone conversation. Mr. Duffyacquired an additional 2,100 Maxill shares for $2.35 per share on October 12, 1993.Mr. Duffy testified that in the same conversation, Mr. Sofer recommended that he acquireshares in Star Group Newspaper Networks ("Star Group"). According to Mr. Duffy,Mr. Sofer advised him that there would be a "huge boom" in the trading price for theshares. Again, Mr. Duffy testified that there was no discussion of risk in the conversationand that he found Mr. Sofer's presentation to be "very persuasive". Mr. Duffy agreed toacquire 10,000 Star Group shares at $1.15 per share, bringing the total that he hadinvested in the course of this single conversation with Mr. Sofer to about $15,000. Mr.Duffy testified that he then advised Mr. Sofer that he had reached the limit of what hewanted to invest with Marchment.
Nevertheless, Mr. Duffy testified that Mr. Sofer called him again at the beginning ofNovember 1993 with another recommendation, Valavaara Environmental TechnologiesLtd. ("Valavaara"). Mr. Duffy recalled that Mr. Sofer advised him that he should act veryquickly to acquire the Valavaara shares. He also testified that, in this conversation, thesales technique stepped up somewhat in pitch and stated that Mr. Sofer became muchmore aggressive explaining that Valavaara was not an opportunity that he could miss andthat he could double his money. Despite Mr. Duffy's reservations about making any furtherinvestments through Marchment, Mr. Duffy acquired 5,000 Valavaara shares for about$7,900 on November 8, 1993.
Mr. Duffy testified that in January 1994, Mr. Sofer called him with another recommendation,this time to purchase shares of Megasol Corporation ("Megasol"). Mr. Duffy could notremember what business Megasol was engaged in but recalled that Mr. Sofer told him thatMarchment had some insider information on the company which would be coming out withsome very exciting news and that this would provide a significant return. On thistransaction, Mr. Duffy testified that Mr. Sofer stepped up his sales presentation in termsof the pressure that he applied. As Mr. Duffy said, "again, he increased one more level interms of the intensity of his sales techniques, even to the point where the whole tone is"You have got to be stupid if you do not buy this" type of thing "You are missing a greatopportunity". On January 12, 1994, Mr. Duffy acquired 10,000 Megasol shares for a totalcost of just under $17,000. By this time, Mr. Duffy had invested about $44,000 withMarchment in the space of about six months.
By this time Mr. Duffy's investment in Maxill had begun to decline. Mr. Duffy testified thathe had a "heated" discussion with Mr. Sofer about his investments. In the course of thisdiscussion, Mr. Duffy recalled Mr. Sofer strongly recommending that Mr. Duffy acquireadditional Maxill shares to "consider averaging down" his acquisition cost for the shares.In the weeks following his Megasol transaction, the stock quotations appearing in the dailynewspaper for most of the shares that Mr. Duffy had acquired from Marchment began toindicate that prices were declining. Mr. Duffy testified that he made several attempts tocontact Mr. Sofer but that he had difficulties reaching him. Mr. Duffy said that he hadformed the firm intention of disposing of the shares that he had acquired throughMarchment. He testified that in February 1994 Mr. Sofer advised him that he could sell hisStar Group shares for what he paid for them. On February 11, 1994, Mr. Duffy sold his10,000 Star Group shares for $1.15 per share.
Mr. Duffy testified that he had a conversation with Mr. Sofer about Megasol in March1994. He recalled that Mr. Sofer told him that he had a "buyer" for 5,000 of his 10,000Megasol shares at $0.85. Mr. Duffy testified that he gave Mr. Sofer an order to sell all ofhis Megasol shares. Mr. Duffy said that he assumed that the "buyer" was an arm's lengthparty who wanted to acquire the shares and that this "buyer" only wanted 5,000 shares.Mr. Duffy testified that his reaction to learning that Marchment was the "buyer" of theseshares was "one of great dismay" and outrage. Mr. Duffy also said that he asked Mr. Soferabout selling his Maxill and Valavaara shares but was told that there were no "buyers".
As the Megasol trading records from the Canadian Dealing Network (" CDN") disclose, inthe weeks following the receipt of Mr. Duffy's order, Marchment bought or sold about19,000 Megasol shares at an average price of $0.90. During the same period, PriceWarner was buying or selling even larger quantities of the securities for the same pricesyet Mr. Sofer never contacted Price Warner to fill Mr. Duffy's outstanding sell order. Mr.Duffy testified that he then contacted Mr. Sofer about a month later and was advised thatMr. Sofer had a "buyer" for the remaining 5,000 Megasol shares. These shares were soldfor $0.50 per share.
Mr. Sofer's testimony was contradictory to Mr. Duffy's testimony in several respects.Mr. Sofer testified that he first contacted Mr. Duffy in approximately September 1993 asa follow-up to one of Mr. Duffy's answers to the client questionnaire which Marchment sentout to all new customers. He testified that during that conversation, which he rememberedas being "a good conversation" and detailed, Mr. Sofer and Mr. Duffy discussed securitiesand investing more generally. Mr. Sofer testified that in particular, in their discussion withrespect to Maxill during that conversation, it was clear to him that Mr. Duffy understood thegamble involved. Mr. Sofer testified that Mr. Duffy was advised and was aware that thesecurities that he was purchasing from Marchment were speculative in nature. Mr. Soferindicated that Mr. Duffy was quite involved with his investments and telephoned Mr. Soferregularly. He took specific exception to the suggestion by Mr. Duffy that his calls were notreturned because Mr. Sofer made a point of calling everyone back within an hour-and-one-half "always". He testified that he called Mr. Duffy back and would always leave amessage for him.
With respect to Mr. Duffy's testimony concerning his attempts to sell his 10,000 Megasolshares, Mr. Sofer testified that because of Megasol being down in price and, possiblybecause Mr. Duffy had a wedding for his daughter to pay for, he wanted funds. He saidthat Mr. Duffy would call regularly and seek price information. Mr. Sofer recalled thatMr. Duffy understood CDN and he understood the bid was $0.50 at that time but made itclear that he wanted $0.85 per share. Mr. Sofer testified that he told Mr. Duffy that if therewere customers who put in a buy order at $0.85, Marchment would cross his order. ThenMarchment accommodated Mr. Duffy's price demand at $0.85 which, according toMr. Sofer, was "a show of good faith". He testified, however, that Mr. Duffy did not leaveany order to sell the balance of his Megasol shares at that time.
Mr. Duffy is the only customer witness who dealt with Mr. Sofer as a senior salesperson.Although Mr. Duffy was not a sophisticated investor, he did appear to have considerablebusiness acumen. He was a senior executive and a shareholder in a large manufacturingcompany and had received substantial proceeds from the sale of his shares following themerger of that company with another glass company. In addition, Mr. Duffy acknowledgedin cross-examination that he knew he was dealing with speculative securities whenpurchasing from Marchment, that he knew there was a chance of losing money and thatit was like the toss of a coin.
Having listened to and observed both Mr. Duffy and Mr. Sofer, we are unable to concludethat the version of events portrayed by either one of them is to be preferred over theversion portrayed by the other. Further, we were not directed to any additional evidencethat would corroborate either's version of events. Accordingly, we find that Staff has notestablished to our satisfaction that with respect to his conduct as a salesperson, Mr. Soferengaged in the activities set out in paragraph B.7 of the amended Statement ofAllegations.
It is worth noting, however, that even accepting Mr. Sofer's version of the acquisition byMarchment of half of Mr. Duffy's Megasol shares, it is evident that Mr. Sofer was not beingperfectly candid with Mr. Duffy. Mr. Sofer testified that he told Mr. Duffy that Megasol wasbid and trading at $.50 per share. The evidence shows that there were no trades at thattime at $.50 per share although the market maker was quoting $.50 bid and $1.00 ask.The evidence also shows that at that time and for a considerable period thereafter,Marchment bought or sold about 19,000 Megasol shares, as principal, at an average priceof $0.90 per share. Given CDN's customer priority rules, Marchment could not sell fromits own inventory without first fulfilling a sell order from a customer at a price not lower thansales from its inventory. Mr. Sofer's suggestion that Marchment accommodated Mr. Duffy'sprice demand as a gesture of good faith is not true. Furthermore, it is apparent that ifMr. Sofer had advised Mr. Duffy that if he were to leave an order to sell the remaining5,000 shares, Marchment would have been required to purchase them before it couldcontinue to sell any additional shares as principal pursuant to its selling campaign.
At the time of giving testimony, Richard Rempel was a 64 year-old history professor atMcMaster University. His annual income in 1993 was about $95,000. His net worth at thattime was about $200,000. About $170,000 of Professor Rempel's net worth wascomprised of the equity in his home. He had furniture and vehicles comprising about $8,000 and GIC's of about $8, 000 to $9, 000.
Professor Rempel was candid about being "very unintelligent" regarding investing in 1993.He said that he only began to invest in his RRSP "belatedly" and was looking for a way tofind out about the market. He was concerned because he would not retire with a fullpension.
Professor Rempel testified that he received a telephone call from Lusher, a Marchmentjunior salesperson, in late May or early June, 1993 According to Professor Rempel,Lusher recommended that he acquire shares in Solex Capital Inc. ("Solex"), which Mr.Lusher explained manufactured "a product that was increasingly used in restaurants whichwere primarily related to pasta cuisine." Professor Rempel testified that Lusher urged himto make an investment in Solex shares because there was a "very good opportunity tomake a strong profit". Professor Rempel stated that there was no discussion of any riskinvolved in investing in Solex.
Following Lusher's recommendation, Professor Rempel agreed to acquire 1,000 Solexshares for $1.45 on June 9, 1993. In connection with the transaction, Lusher completeda new client application form. The form recorded that Professor Rempel had assets ofbetween $500,000-$600,000. Professor Rempel testified that this information could nothave come from him because he did not have any such assets. The form also stated thatProfessor Rempel had "fair" investment knowledge. Professor Rempel testified that thiswas incorrect insofar as he did not know anything about investing.
Professor Rempel's investment objectives for his account at Marchment were recorded as"100 percent spec". Professor Rempel testified that he did not intend to speculate at allin his account at Marchment. Professor Rempel stated that he was too old to speculateand had never speculated. Previously, Professor Rempel had acquired shares of aVancouver Stock Exchange issuer, International Exotic Motors. That was based on advicethat he had received from a colleague at McMaster about the promising prospects of thecompany. He did not believe that he was speculating in International Exotic Motors.
After his initial acquisition of Solex shares, Professor Rempel received a telephone callfrom Mr. Saltsman. According to Professor Rempel, Mr. Saltsman advised ProfessorRempel that his initial investment in Solex was performing very well and that there existedan excellent opportunity at that moment to make a significant profit if he were to acquireadditional Solex shares. Professor Rempel recalled Mr. Saltsman suggesting that he makean immediate commitment to acquire 9,000 additional Solex shares. Professor Rempeltestified that when he advised Mr. Saltsman that he did not have any funds to make theinvestment, Mr. Saltsman suggested that he borrow the funds to purchase the shares.Professor Rempel said that he also advised Mr. Saltsman that he wished to speak toMrs. Rempel about the transaction but that Mr. Saltsman dissuaded him from doing soadvising that there was not sufficient time to speak to his wife and that he would have tocommit to purchasing the securities immediately. Professor Rempel recalled that thereason given was that the Solex shares were so "hot". Professor Rempel testified that hewas not advised about the risk involved in a further acquisition of Solex shares. Based onMr. Saltsman's advice, Professor Rempel bought 6,500 additional Solex shares for $1.90per share on July 19, 1993.
About one week following this acquisition, the quoted price for Solex shares declined andProfessor Rempel testified that he contacted Mr. Saltsman. He said that he was told byMr. Saltsman not to worry and was advised that the share price would rise again.
Subsequently, Professor Rempel read a newspaper article in The Globe and Mail aboutpenny stocks. He testified that the article alarmed him and said that he called Mr.Saltsman who advised him that the statements in the article were incorrect. Followingadvice contained in The Globe and Mail article, Professor Rempel telephoned theCommission and was referred to John Aiken, a Commission employee who requested thathe write a letter to the Commission explaining the nature of his dealings with Marchment.Following the intervention of Mr. Aiken, on September 7, 1993, Mr. Sofer authorized therepurchase by Marchment of Professor Rempel's Solex shares at the then current priceof $1.55 per share.
Professor Rempel was the third of the four customer witnesses who had dealt withMr. Saltsman as a senior salesperson. Mr. Saltsman gave testimony about his generalapproach to dealing with customers that would contradict the specific testimony ofProfessor Rempel. In addition, Mr. Saltsman testified that he was not aware that ProfessorRempel borrowed from his line of credit in order to purchase additional Solex shares.
We accept Professor Rempel's testimony as an accurate portrayal of his dealings withMarchment and reject the portions of Mr. Saltsman's testimony that are inconsistent withProfessor Rempel's version.
On the basis of his age, experience, objectives and his financial needs on retirement,Professor Rempel was clearly a very poor candidate to make a substantial investment inspeculative securities. Contrary to principles which both Mr. Saltsman and Mr. Osborneembraced during their testimony, we find that Mr. Saltsman actively counselled ProfessorRempel to borrow funds to purchase speculative shares from Marchment's inventory. Wefind that Mr. Saltsman did not deal fairly, honestly and in good faith with Professor Rempel.We find that Mr. Saltsman breached his fiduciary duty to Professor Rempel. In hisdealings with Professor Rempel, Mr. Saltsman failed to ensure that the purchases of Solexshares which he recommended to Professor Rempel were suitable in view of ProfessorRempel's circumstances and financial objectives. We also find that Mr. Saltsman failedto disclose the risks inherent in an investment in Solex shares from Marchment's inventoryand we find that he used high pressure sales techniques to convince Professor Rempelto make a hasty decision without the benefit of his wife's counsel.
In section F. of the amended Statement of Allegations, it is alleged that Mr. Sofer andMarchment interfered with the administration of the Securities Act by staff of theCommission, in a manner which is contrary to public interest, by offering reimbursementfor all or part of the trading losses sustained by customers who had complained aboutMarchment to the Enforcement Branch of the Commission, on the express condition thatthese customers withdraw their complaints and write letters to the Enforcement Branchdenying that Marchment had engaged in any inappropriate conduct. At the Hearing, therewas considerable testimony about a letter written by Professor Rempel to Mr. Aiken datedSeptember 3, 1993 essentially withdrawing the complaints set out in his earlier letter toMr. Aiken. Staff urged us to conclude that by soliciting such a letter, Marchment wasattempting to frustrate the regulatory process. Counsel for Mr. Sofer submitted, on theother hand, that Mr. Sofer was merely attempting to satisfy Mr. Aiken's request that thematter be resolved amicably between Professor Rempel and Marchment. He also arguedthat the documents and the sequence of the exchange of correspondence betweenProfessor Rempel, Marchment and Mr. Aiken was highly transparent and reflective ofMr. Sofer's innocent intentions in complying with Mr. Aiken's request.
We do not accept Staff's characterization of these events and accordingly do not find thatMr. Sofer and Marchment engaged in the conduct alleged in section F. of the amendedStatement of Allegations.
At the time of his testimony, Mr. Newell was 59 years old and was a retired productmanager. In March 1997, Mr. Newell's approximate net worth was $500,000 consisting ofhis home worth approximately $250,000 and his and his wife's RSP investments. The onlyliquid asset that Mr. Newell had available for investment was $30,000 in cash. Mr. Newelltestified that at the time that he first dealt with Marchment he was contemplatingretirement.
Mr. Newell testified that in March 1997 he received a telephone call from John Coombes("Coombes"), a Marchment junior salesperson. Coombes suggested that Mr. Newell makea small investment in the shares of Forsys Corporation ("Forsys") which Coombesdescribed as an up-and-coming distributor of restaurant software. Mr. Newell testified thatthere was no discussion of any risk involved in an investment in Forsys. On March 24,1997, Mr. Newell agreed to purchase 500 Forsys shares at $1.83 per share.
Coombes completed a new client application form. The form made no reference toMr. Newell's upcoming retirement. The form also stated that Mr. Newell's objectives forhis account with Marchment were "100 percent spec". Mr. Newell testified that he did notreview that portion of the new client application form. He also gave evidence that it wasnot accurate and that he did not want to speculate. In fact, Mr. Newell testified that, hadhe been asked about his investment objectives, he might have been willing to speculatewith 10 percent of his liquid assets (about $3,000). In cross-examination, however, heacknowledged that during his telephone conversation with Coombes there was somediscussion about speculation and degree of risk.
Mr. Newell received his first telephone call from Mr. Saltsman on May 21, 1997. Accordingto Mr. Newell, Mr. Saltsman asked him whether he had noticed that his Forsys shares hadincreased in value. Mr. Newell testified that Mr. Saltsman advised him that he had a"block" of 7,000 Forsys shares. Mr. Saltsman recommended that Mr. Newell purchasethem. Mr. Newell testified that he understood, based on the information that Mr. Saltsmangave to him, that he could only purchase the block of 7,000 shares and "had to take it asit was". Mr. Newell described Mr. Saltsman's sales presentation as "high-pressured" and"very smooth". Mr. Newell testified that he did not believe that he had much time to reflecton the transaction because Mr. Saltsman told him that the stock was quite popular andwould not be available much longer. Mr. Newell also testified that, not only was there nodiscussion of risk, but that Mr. Saltsman assured him that there would be money to bemade in the transaction. Mr. Newell agreed to purchase 7,000 additional Forsys shareson May 21, 1997 for about $15,500.
After his acquisition of additional Forsys shares, according to Mr. Newell, Mr. Saltsmancontacted him to recommend that he acquire shares of Active Control. Again, Mr. Newellsaid that there was no discussion of risk and that he had no appreciation of the basis uponwhich Marchment was selling these securities. Following his investment in Active Control,Mr. Saltsman contacted Mr. Newell again to acquire shares in Partner Jet.
Ultimately, Mr. Newell invested approximately $30,000 with Marchment. That investmentrepresented all of his liquid assets.
Mr. Newell made tape recordings of two of his telephone conversations with Mr. Saltsmanthat were the subject of much testimony at the Hearing. These recordings and our findingswith respect to the statements made by Mr. Saltsman are dealt with in the next sectionof these Reasons.
Mr. Newell is the last of the four customer witnesses who purchased speculative securitiesfrom Marchment's inventory on the advice of Mr. Saltsman. As with Professor Rempel,Mr. Saltsman's testimony contradicts many aspects of Mr. Newell's testimony at theHearing. We accept Mr. Newell's description of his dealings with Marchment and withMr. Saltsman. In view of Mr. Newell's age and his pending retirement, he clearly was nota suitable candidate for the purchase of speculative securities from Marchment's inventory.We also find that the references in Mr. Newell's new client application form, which hadbeen completed by Coombes, to Mr. Newell's objectives for his account with Marchmentbeing "100 percent spec" were pure fabrication. We also find that Mr. Coombes'completion of the form in this manner was consistent with Mr. Sofer's teachings in thejunior salesperson training programme. We find that in his dealings with Mr. Newell(excluding for this purpose the revelations contained in the recordings), Mr. Saltsmanmade material misrepresentations with respect to the sale of Forsys shares. We find thatMr. Saltsman did not deal fairly, honestly and in good faith with Mr. Newell. We also findthat Mr. Saltsman breached his fiduciary obligations to Mr. Newell. In his dealings withMr. Newell, Mr. Saltsman failed to ensure that the trades that he recommended to himwere suitable in view of Mr. Newell's age, his pending retirement, his financialcircumstances and his investment objectives. Mr. Saltsman failed to disclose to Mr. Newellthe risk inherent in the purchases of speculative securities from Marchment's inventorywhich he was recommending to Mr. Newell. Mr. Saltsman also used high pressure salestechniques in the sale to Mr. Newell of the shares of Forsys.
Mr. Newell gave testimony concerning the documentation that he received. In respect ofthe new client application form, Mr. Newell stated that "it was just a document that camein the mail, a form letter, sort of formality by Marchment & Mackay that, as part of me doingbusiness with them, they needed this thing back, signed, so that is what I did". We findthat the Marchment documents received by Mr. Newell did not contribute to hisunderstanding of the nature of the risks he was incurring.
The Newell Recordings
Mr. Newell's dealings with Marchment began in March 1997, more than seven months afterthe issue of the Notice of Hearing and Statement of Allegations in these proceedings. Thetape recordings were made by Mr. Newell of his conversations with Mr. Saltsman onNovember 28, 1997 and December 18, 1997. Principally, the recordings consist of anumber of arguments being advanced by Mr. Saltsman as to why Mr. Newell should notat that time sell shares that he had purchased from Marchment's inventory. Mr. Saltsman'sstatements range from being merely false and misleading to blatant lies and deceptionwhich, to Mr. Saltsman's knowledge, had no basis in fact. At one point, Mr. Saltsmanadvised Mr. Newell that if he were to sell at that time, he would be "committing financialsuicide" when, as Mr. Saltsman would have known, the opposite was almost certainly thecase.
Mr. Ornstein testified that since the commencement of these proceedings, Mr. Ornsteinhad reviewed copies of transcripts of the recordings, and had listened to the testimony ofMr. Newell and that of Mr. Saltsman. As a result, Mr. Ornstein temporarily suspendedMr. Saltsman, asked him to leave the premises and extracted an undertaking from him thathe will complete the Conduct and Practices Handbook course.
Staff urged us during the Hearing to conclude that there was nothing unique aboutMr. Newell as a Marchment customer (apart from the fact that he made the recordings).Staff submitted that there was no evidence tendered at the Hearing indicating whyMr. Saltsman would be more likely to mistreat Mr. Newell than any of his other customers.Staff further urged us to draw the inference that the recordings corroborate the evidenceof every other customer who testified with respect to their experiences in attempting to sellsecurities acquired from Marchment's inventory.
We have had no difficulty in concluding that the recordings are representative of the wayin which Mr. Saltsman dealt with his customers. Indeed, although the specific words andcircumstances are not identical, the other three witnesses who dealt with Mr. Saltsmanreflected experiences that were not dissimilar to Mr. Newell's experiences, so graphicallyportrayed on the recordings.
We reject Staff's suggestion, however, that we should attribute Mr. Saltsman's conduct tothe other individual Respondents and have therefore been careful not to weigh theirtestimony against the backdrop of the Newell recordings.
We do not have the same difficulty, however, in attributing Mr. Saltsman's conduct toMarchment. Mr. Saltsman was employed as a senior salesperson at Marchment forapproximately ten years. Notwithstanding the ability by Messrs. Ornstein and Sofer tomonitor telephone conversations between Marchment's salespeople and its customers, Mr.Saltsman's practices remained unchecked . The Respondents' suggestion that the Newellrecordings were an aberration is just not credible in light of the testimony of the othercustomer witnesses. We also find it inexcusable that Mr. Ornstein waited until May of thisyear to suspend Mr. Saltsman when he clearly was aware of the content of the recordingsmuch earlier.
4. Marchment's Operations
Marchment portrays itself to its customers as a full-service brokerage firm engaged in thebusiness of providing advice to small and beginning investors. Marchment publishes abrochure entitled "From One Individual Investor To Another" that is mailed to prospectivecustomers and contains the following statements:
Since 1939 it has been our [Marchment's] business to specialize inadministering to the needs of the individual, rather than institutional,investor. You might say we are a retail house where small andbeginning investors are particularly welcomed.
Whatever your investment goals, you are invited, freely, to exploreyour options with a resourceful Marchment & MacKay securitiesrepresentative without obligation, confident you are dealing with aknowledgeable specialist in the securities business.
When your representative calls to offer you a recommendation, feelfree to ask about any investment security or speculation that interestsyou. He or she will be happy to give you advice and information. Wewant you to profit from your relationship with us and recommend usto your friends. (emphasis added)
Mr. Ornstein testified that prior to receiving the first telephone call from a Marchmentsalesperson, a client receives a letter under Mr. Ornstein's signature that containsinformation that is very similar to that contained in the brochure (the "Dear InvestorLetter"). The Dear Investor Letter reads in part as follows:
Since 1939, Marchment and MacKay Limited has specialized inadministering to the individual, rather than institutional investor. Wewelcome all small and beginning investors and are proud to offer ourservices at low commission rates.
Whatever your investment needs, we invite you to take advantage ofour knowledge, experience and resources. A Marchment andMacKay securities representative will gladly help you explore youroptions without obligation. (emphasis added).
In addition to portraying itself to novice investors as a full-service brokerage firm, theabove documents are illustrative of Marchment's invitation to small and beginninginvestors to rely on Marchment and to repose trust and confidence in Marchment. Eventhe title of the brochure, "From One Individual Investor To Another", which is somewhatmisleading given its origins, appears directed to gain the confidence of prospectiveinvestors. The highlighted passages in both the brochure and in the Dear Investor Lettermake it clear that Marchment is seeking reliance by and the trust and confidence ofprospective customers. Donald Wilson testified that the brochure reinforced hisimpression that he was dealing with a firm that would look after his interests as a small andbeginning investor with the confidence that he was dealing with a knowledgeable specialistin the securities business. Daniel Newell testified that the Dear Investor Letter caused himto conclude that Marchment was an all-round brokerage house, dealing with a lot ofdifferent things that he himself was interested in.
Marchment's business is actually much different than that portrayed to potential customers.
Although Marchment may well deal in other facets of the securities business, we find thatin reality its core business is the sale of low cost, high risk penny stocks from its owninventory to members of the public who are contacted by telephone.
Mr. Sofer tried to emphasize aspects of Marchment business that did not involve the saleof penny stocks from its inventory. In his examination in chief, Mr. Sofer attempted to showthat the sale of penny stocks from Marchment's inventory constituted only a small portionof Marchment's business. He testified that Marchment's trading activity in non-principaltransactions accounts for 65% of all trades per dollar volume completed throughMarchment. On cross-examination, however, Mr. Sofer admitted that principal tradingaccounts for very close to 85% of Marchment's net trading profit. Mr. Plant testified asfollows: "My job at Marchment was basically to sell stocks that we had a principal positionin." Mr. Osborne stated in cross-examination: "We are in the speculation business, yes."All nine of the Marchment customers who gave testimony were contacted by Marchmentsalespeople for the specific purpose of selling them penny stocks from Marchment'sinventory.
Further, exhibits 57A and 57B were ledgers introduced by Mr. Sofer depictingapproximately 1,000 customers who had purchased and subsequently sold securitiesoriginally acquired from Marchment's inventory. It is apparent from these exhibits thatvirtually all of these customers were sold relatively small amounts of shares fromMarchment's inventory for purchase prices of less than $2.00 per share. We find thatthese exhibits further support our conclusion concerning the true nature of Marchment'score business.
5. Structure of Marchment's Sales Force
Marchment employs a three-tiered structure in the sale of penny stocks to its clients fromits own inventory. The lowest tier is occupied by the qualifier (or cold caller). Qualifiersare telemarketers who are not registrants under the Act. Their function is to solicitconsents from members of the public whom they contact using telephone and otherdirectories to the receipt of market information from Marchment. The qualifiers record thename and address of the prospect on lead cards that are passed to the junior salesperson.The junior salesperson then attempts to sell a relatively small quantity of whateverprincipal stock Marchment is promoting at the time to the prospects on the lead cards. Thejunior salesperson then completes a new client application form. Although no juniorsalespersons are respondents in these proceedings, Allen, Sacke, Bruce, Coombes,Kawaguchi and Lusher are examples from the evidence of Marchment salespeople whoperformed this role.
Shortly after the initial sale, the customer's account is passed to a senior salesperson whoseeks to trade larger quantities of the shares from Marchment's inventory to the customer.The Respondents, Sofer, Osborne, Saltsman and Plant are all senior salespeople.
In addition to their portion of the brokerage commission charged by Marchment on eachtrade, each salesperson also receives 17.5% of the selling price of all shares sold by thatsalesperson out of Marchment's inventory. A senior salesperson would split this "bonus"50/50 with the junior salesperson.
Russell Gottschalk, a former Marchment junior salesperson, used the term "opener" torefer to junior salespersons and "loaders" to refer to senior salespersons" although theuse of these terms was discouraged by Marchment. Because all parties seemed to usethe word "qualifiers" for the telemarketing group, we will continue in these reasons to usethat term. For the registrants occupying the second and third tiers, we will useMarchment's terms "junior salespeople" and "senior salespeople", respectively.
Mr. Gottschalk testified that it was standard procedure within Marchment that once a juniorsalesperson effected a first sale to a customer, the account would be taken from that juniorsalesperson and assigned to a senior salesperson. Mr. Sofer acknowledged thatMarchment does have a practice of assigning a senior salesperson to an account but onlyat the wish of the junior salesperson. Of the nine former customers of Marchment to testifyat the Hearing, one customer, Al Peltola, did not agree to purchase any penny stocks andanother customer, Genevieve Grech, called a senior salesperson directly. With respectto each of the remaining seven customer witnesses, their accounts were passed on to asenior salesperson after completion of the first sale by a junior salesperson. In his cross-examination, Mr. Osborne also testified that this is the usual procedure at Marchment.
Although Marchment can identify instances where a senior salesperson did notimmediately become involved, we find that the transferring of the account to a seniorsalesperson following the initial sale by a junior salesperson was standard practice atMarchment. In the result, however, we believe that very little turns on this finding. As isset out later in these reasons, we believe that the important issue is the manner in whichthe customer is treated following his or her initial purchase by a Marchment salespersonand not whether such treatment is at the hands of the salesperson who made the initialsale or by another salesperson to whom the account is assigned.
Mr. Gottschalk commenced employment as a qualifier at Marchment in about August 1994.He testified that qualifiers were required to complete between 20-25 lead cards each day.The qualifiers, through their telemarketing campaign, were essentially soliciting consentsby prospects to receive free market information from Marchment. Anyone who gave theirconsent was also asked to supply their mailing address to the qualifier.
A prospective customer who is "qualified" by a Marchment telemarketer begins to receivecopies of the Canadian Market Digest, a Marchment periodical that is produced by externalwriters. The information contained in the Digest relates generally to investment and otherissues but does not contain any information about the over-the-counter market nor doesit provide any information about the speculative stocks that Marchment sells from itsinventory to its customers. The prospect also receives a copy of the Marchment brochure,"From One Individual Investor to Another", and the Dear Investor Letter. In a subsequentmailing, the prospect is sent a glossy brochure published by the issuers of the securitiesthat Marchment is promoting at the time together with a stock introduction form letter thatrefers in very general terms to the securities described in the glossy brochure.
Shortly after receiving the glossy brochure and stock introduction form letter, a juniorsalesperson telephones the prospect for the express purpose of recommending that theprospect acquire a relatively small number of the speculative stocks described in thebrochure and form letter which are being sold by Marchment from its inventory at that time.Both of these materials are highly promotional and fall far short of normal securitiesdisclosure documents or research publications.
Mr. Gottschalk testified that in the training course for junior salespeople (which wasdesigned and taught by Mr. Sofer), junior salespeople were taught a sales pitch that wasto be employed when the salesperson first contacts a prospective client. Staff produceda copy of the handwritten notes kept by Mr. Gottschalk during this portion of the salestraining program. Counsel for Marchment also produced notes taken by Derek Graham,a Marchment sales trainee who attended the same course as Gottschalk.
Staff have made a number of allegations relating to the sales training course. In ourDecision, we stated that we have not concluded that the sales training courses conductedby Mr. Sofer, taken as a whole, were contrary to the public interest and business practice(see paragraph B of these Reasons).
We do find, however, that the selling techniques experienced by all of the customerwitnesses which we have found to be objectionable were very similar to the sales pitchtaught by Mr. Sofer to sales trainees. To this extent, we find that the sales pitch iscorroborative of this part of the evidence of the customer witnesses.
Both Mr. Graham's and Mr. Gottschalk's notes confirm that sales trainees were taught toovercome any objections that a prospective customer might have to purchasing thesesecurities which the junior salesperson was attempting to sell out of Marchment'sinventory. The major thrust of the sales pitch was to attempt to get the prospect to agreeto purchase even a small number of securities as a "test" of Marchment's ability to makemoney for the customer. Indeed, Mr. Plant testified that the average number of sharespurchased by a customer who succumbed to the junior salesperson's sales pitch wasbetween 300 and 500 shares. Because Marchment's selling campaigns for each securitybeing promoted usually started at slightly over $1 per share, it is unlikely that the dollarvalue of such orders would justify the selling effort. It is clear, however, from all of theevidence received, that the junior salespeople were in reality setting up the customer fora call from the senior salesperson after Marchment had created the appearance of anincrease in the market price of the securities through the continuation of its sellingcampaign.
If the junior salesperson succeeded in obtaining an order for a relatively small number ofshares of the stock then being promoted, the junior salesperson was then responsible forcompleting the standardized new client application form. In order to complete a portionof this form, the junior salesperson had to elicit from the customer some personalinformation about the customer's financial circumstances upon which the juniorsalesperson, Marchment and the senior salesperson could base a determination as to thesuitability of that investment and subsequent investments for that client. Mr. Gottschalk'snotes make it clear that this client profile would be elicited only after the customer hadagreed to make the purchase of the stock being promoted. Mr. Graham's notes do notindicate whether the profile information was to be obtained before or after the completionof the first sale. It is clear, however, that the purpose of the first telephone contact with aprospect following the "qualification" of that prospect by the telemarketers is to sell aspecific security to the prospect. The junior salespeople are expected to make those callswithout any knowledge about the prospect other than the fact that he or she has agreedto accept market information materials and has divulged his or her address to thetelemarketer.
We believe that it would be highly unlikely, given the structure of these sales campaigns,that a prospect would divulge the sensitive personal information which would be necessaryto gain an understanding of the financial circumstances and investment objectives of theprospect until the prospect has agreed to make a purchase and is told that some personaldetails are required in order to complete the purchase. In this respect, Marchment'stelephone selling campaign departs significantly from industry practice wherein informationrelating to a client's finances and investment objectives would be expected to be obtainedbefore there is any suggestion that the client purchase any particular security.Furthermore, the most inexperienced registrant in the Marchment hierarchy has beengiven responsibility for obtaining the most important information about the client thatMarchment will require in order to determine suitability for the client of subsequentinvestments which Marchment intends to recommend.
As we have stated, apart from Ms Grech and Mr. Peltola, each of the customer witnessestestified that, after their first acquisition of shares from Marchment's inventory, theyreceived a telephone call from a senior salesperson. Messrs. Osborne and Plant eachtestified that the trading price for the securities that Marchment sells from its inventorygenerally increases between the time that the customer makes his or her initial trade withthe junior salesperson and the time that he or she is contacted by a senior salesperson.This evidence was confirmed by the testimony of the client witnesses. It is also evidentfrom the trading records of many of the stocks which were being sold by Marchment fromits inventory to these customer witnesses that the apparent value of the stocks rosesteadily in an uninterrupted pattern following the commencement of Marchment's sellingcampaign, reached a peak and plateaued for a period of time and then declined equallysteadily to prices well below Marchment's original selling price to its customers.
It is also clear from the trading records that virtually all of the activity in the stocks beingpromoted by Marchment consists of principal trades between Marchment and its customersor between another firm, Price Warner and its customers. In other words, the tradingrecords indicate virtually no agency trades in these stocks in which one client waspurchasing or selling to another client. It was clear from the testimony of several of thecustomer witnesses as well as the testimony of the salespeople, that customers wereencouraged to follow the quotations for their stocks and the trading activity in the financialpress. Clearly, the intention was to foster the impression in the minds of the customers,as the Marchment selling campaign continued, that the customers were making money asa result of an independent, active and rising market for their shares. In reality, theapparent paper gains that the customer was led to believe that he or she had realizedwere attributable only to the fact that Marchment had systematically raised the price atwhich it was selling the stock during the course of its sales campaign. Clearly, those gainsserved to increase the appetite of the Marchment customer to purchase additionalsecurities from its inventory and to build a feeling of trust between the customer andMarchment's sales force.
Mr. Sofer testified that the practice of assigning two brokers to an account was done forthe purposes of providing better client services and to provide stability to an account dueto the high turnover of brokers in the securities industry. We found Mr. Sofer's evidencenot to be credible. Mr. Osborne admitted in cross-examination that as a seniorsalesperson, he has no greater information regarding the securities that Marchment sellsfrom its inventory than the junior salespeople and therefore does not offer any superiorservice to his customers regarding these investments. We also heard testimony fromMessrs. Plant and Saltsman, neither of whom professed to have any more informationabout the stocks being promoted than was available to the junior salespersons, andneither of whom exhibited any particular knowledge or expertise that could be expectedto enhance the service given to Marchment's customers.
Many of the customer witnesses testified that when the trading price for the securities theyacquired from Marchment declined (which happened in almost every case), they contactedtheir senior salesperson. In those conversations, Marchment's senior salespeople stronglydiscouraged their customers from selling the shares. In Mr. Saltsman's case, therecordings made by Dan Newell disclose that Mr. Saltsman used highly manipulative anddeceptive means to prevent Mr. Newell from selling securities that he had acquired fromMarchment's inventory.
The remuneration structure at Marchment provides a strong incentive to its sales staff tosell as many securities as possible from Marchment's inventory. In a trade fromMarchment's inventory, the salesperson receives his or her share of the 2½% commissionwhich is charged to the customer and reflected on the face of the confirmation slip. Inaddition, however, as referred to above, the salesperson receives a "bonus" of 17½% ofthe selling price of the securities to the customer. If a junior salesperson makes an initialtrade of principal securities to a customer whose account is then passed to a seniorsalesperson, then he or she can also expect to receive one-half of the bonus paid to thesenior salesperson for any subsequent sales to that customer. By conventional industrystandards, the total remuneration (almost 20% of the sale price of the security) isexcessive.
In the amended Statement of Allegations, Staff alleged that Marchment and Messrs. Sofer,Saltsman, Osborne and Plant failed to disclose adequately to customers that Marchment'ssalespersons received remuneration on each trade ranging between 16 and 18% of thecustomers' acquisition cost. Although none of the customer witnesses appeared to beaware of the "bonus" that salespeople receive for sales of securities from Marchment'sinventory, the respondents provided us with ample documentary evidence that everyprospective customer and every purchaser of securities from Marchment's inventoryreceived one or more statements in writing which disclosed the size of the bonus beingpaid. While we do not doubt that the customer witnesses may not have been aware of thebonus given the relative lack of prominence in which the bonus was displayed on theconfirmation slip and the context in which customers would have received the otherdocuments containing the disclosure of the bonus, nevertheless, the fact of the bonus andits quantum was available to anyone willing to take the time to read the materials or todecipher the code on the confirmation slip. Accordingly, we have not found that theserespondents failed to disclose adequately to customers the existence or amount of thebonus.
The bonus structure at Marchment also provides an incentive to its salespeople todiscourage customers from disposing of the stock that they have purchased from the firm'sinventory. This is as a result of Marchment's reservation of the right to "claw back" the17½% bonus from the salespersons if the customer sells the stock within a 3-month period.According to Mr. Sofer, the claw-back was only discretionary and was rarely employed.In our view, the mere understanding by the salespeople that a claw-back policy existed,not the frequency with which it was employed, would be sufficient to affect their behaviour.In their evidence, Messrs. Osborne, Plant and Saltsman each referred to the claw-back butdid not say that it was in any way discretionary. Mr. Sofer attempted to convince us thatthe claw-back policy was put in place by Marchment to discourage registeredrepresentatives from churning their accounts. He suggested that the policy was to addressconcerns in the industry that registered representatives "flip" or move a client in and outof stocks simply to accumulate commissions. He stated that the claw-back policy wasspecifically developed to address this concern.
We do not find these statements of Mr. Sofer to be credible. The implication in histestimony is that without the claw-back policy, there would be excessive turnover ofcustomers' stock through trading in the market. As we have noted, however, there isvirtually no auction market for the stock sold out of Marchment's inventory. In fact, inpractice, Marchment itself was the only buyer for its principal stock which customersinsisted on selling. As a result of the requirement of the CDN of which Marchment was auser and on whose facilities virtually all of Marchment's principal stock was quoted, so longas Marchment continued to sell stock from its inventory to its customers, whenever acustomer wished to sell stock, Marchment was required either to buy the stock itself or sellit to another of its customers at a price not less than the price then being charged byMarchment for its own stock. In our view, the principal motive for the claw-back policy wasto motivate salespersons to discourage customers from placing sell orders for their stockwith Marchment with the consequence that Marchment would be required to repurchaseit.
During the Hearing, we were advised by Mr. Ornstein that given the concerns raised byStaff regarding the claw-back policy, he is prepared to eliminate the claw-back. Clearly,it should never have been implemented in the first place.
Each of the Respondent salespeople denied that the claw-back caused them to discouragecustomers from disposing of their securities that they had purchased from Marchment'sinventory. As we have stated earlier in these reasons, we have concluded that bothMessrs. Saltsman and Plant did indeed discourage customers from reselling principalsecurities. Although we did not make that specific finding against Mr. Osborne, there wassome evidence that he may also have discouraged such sales. We believe that there islittle doubt that the claw-back policy contributed to this course of conduct by Marchment'ssenior salespeople.
In the amended Statement of Allegations, Staff also alleged that Marchment and Messrs.Sofer, Saltsman, Osborne and Plant failed to disclose the claw-back policy to customersor potential customers. In our Decision, we did not conclude that Mr. Sofer had acted inthis manner. It stands to reason that if none of the Marchment customers were aware ofthe 17½% bonus, they would also not be aware of the claw-back policy. However,although we have found that the existence and quantum of the bonus was set out in writingin documents delivered to these customers, we have found no evidence that the customerswere made aware of the fact that their salesperson would lose the lion's share of thecompensation which he received on the sale of the principal stock should the customer sellthe stock within 90 days of the original purchase. Indeed, on cross-examination, Messrs.Osborne, Saltsman and Plant each testified that they did not disclose the claw-back totheir customers and Mr. Plant acknowledged that it would have been preferable if thisinformation had been disclosed.
In our view, the existence of the claw-back policy was a significant component of the totalrisk facing the customers who purchased Marchment principal securities and ought to havebeen disclosed to the customers. In our Decision, we concluded, therefore, that each ofMarchment and Messrs. Saltsman, Osborne and Plant failed to deal fairly, honestly andin good faith with customers and potential customers of Marchment, did not act in the bestinterests of customers, and otherwise acted contrary to the public interest , in part,because they failed to disclose that Marchment's salespersons could lose their entitlementto the bonus if customers sold the securities they acquired within a certain period of time.
Many of the customer witnesses testified to their difficulties in convincing Marchmentsalespeople to sell their Marchment principal securities. No customer witness testified thathe or she had been advised by a Marchment salesperson to sell Marchment principalsecurities. The Respondents attempted to dispute the allegation that it was Marchment'spolicy to discourage sales of principal securities by customers. Exhibits 57A and 57B,referred to earlier in these Reasons, are ledgers depicting approximately 1,000 customerswho had sold principal securities originally acquired from Marchment's inventory. Theseledgers were submitted as evidence that Marchment willingly executed sale orders andthat hundreds of customers made money. We are not convinced that these ledgersnecessarily demonstrate the Respondents' assertion. Mr. Sofer's instruction to theMarchment computer operator was only to run ledgers of customers who had made onepurchase, followed by one sale and who had turned a profit. We were told that Marchmenthad thousands of customers during the period relevant to this proceeding.
We were not offered a list of customers who had sold securities at a loss or who were stillholding securities for which there is no market or for which the trading price is far belowtheir cost; nor did any of the customers whose names appear on Exhibits 57A or 57Btestify before us. We are unable to conclude, therefore, that Exhibits 57A and 57B disputethe evidence of the customer witnesses on this issue.
It is instructive at this stage of our Reasons to comment on the credibility of Mr. Sofer'stestimony on issues relating to Marchment's operations. We find that Mr. Sofer did notgive evidence pertaining to Marchment's business structure in a forthright manner. In hisexamination in chief he misrepresented the nature of Marchment's business by attemptingto show that the sale of penny stocks from Marchment's inventory constituted a relativelysmall part of its business. On cross-examination, however, Mr. Sofer admitted that sellingspeculative penny stocks from its inventory is the bread and butter of its business. Mr.Sofer also denied that Marchment's junior salespeople engage in a telephone campaignfor the purpose of selling prospective customers securities from Marchment's inventory.This is in spite of the fact that each prospect receives a glossy brochure published by theissuer of the securities that Marchment is promoting together with a stock disclosure letterrelating to such securities before the prospect receives his or her first telephone call froma junior salesperson. Mr. Ornstein testified that a few days after the stock disclosure letteris mailed to prospects, the salespeople will call them "to see if they have any interest inspeculating". Mr. Sofer's testimony is also contrary to the actual experiences of the clientwitnesses.
Mr. Sofer also denied that he instructed Marchment's sales trainees on how to pitchMarchment's principal stocks in their initial telephone call to a prospect. This is in spiteof the detailed notes regarding such a pitch as it related to Stockguard securitiescontained in both Mr. Gottschalk's and Mr. Graham's notes. Mr. Sofer's testimonyconcerning passing customers' files from junior to senior salespeople was inconsistent.In his examination in chief, Mr. Sofer testified that from time to time management asks itsjunior sales staff whether they have any accounts to which a senior salesperson ought tobe assigned, but that no junior salesperson was required to have his accounts passed toa senior salesperson. In cross-examination, after he was shown a lengthy series ofexamples in which this occurred, Mr. Sofer finally admitted that in virtually every instancewhere a client has shown an appetite to purchase speculative penny stocks, the client'saccount is assigned to a senior salesperson. Mr. Sofer also admitted in cross-examinationthat, apart from their years of experience, there is nothing different in the training orqualifications of a senior, as opposed to a junior, salesperson.
6. Marchment Principal Securities
As stated above, we have concluded that Marchment's core business is the sale of lowcost, high risk penny stocks from its own inventory to members of the public who arecontacted over the telephone. We have also concluded that these sales are made withoutadequate regard to the suitability of the investments for such clients or adequatedisclosure of the risks involved in these transactions. Although Marchment's clients areled to believe that they can count on the firm to provide investment advisory services tothem, in reality, Marchment's real interest lies in disposing of large positions that it hasacquired in low-cost stocks to its customers at a substantial markup and then ensuring thatthe customers hold on to these securities until the selling campaign is over.
To understand the enormity of the risks that a customer takes when he or she decides toacquire such securities from Marchment, it is important also to understand the nature andattributes of the securities that Marchment sells to its customers and the manner in whichMarchment acquires and trades these securities. Furthermore, the pattern of trading inthe securities is also a necessary ingredient in understanding how Marchment customerswere induced to make substantial investments in Marchment's inventory product. Set outbelow is a discussion of these issues with particular reference to Stockguard, a companywhose shares Marchment acquired and sold from its inventory. Although the evidencepresented with respect to the pattern of selling the shares of most of the companies inMarchment's inventory was quite general, we were provided with a detailed review of theStockguard example. We find that the Stockguard example is fairly representative of theprocess by which shares were acquired by Marchment.
In aggregate, the Marchment customers who testified at the hearing were sold shares byMarchment from its inventory of 21 speculative entities. With one exception (Maxill Inc.),the securities that the customer witnesses acquired from Marchment's inventory weretraded over-the-counter and were quoted on CDN. All of the securities were the productof reverse takeover transactions pursuant to which dormant Ontario reporting issuersacquired "start up" private companies. In these transactions, the shareholders of theprivate companies normally enter into share exchange agreements with the dormant publiccompanies. Under the terms of the share exchange agreements, the shareholders of theprivate companies obtain a very substantial majority of the shares of the resurrected publiccompanies. The shares of the dormant public companies are then consolidated. Pursuantto the terms of the share exchange agreements, the members of the private companies'management groups generally agree to place the shares that they obtain in the reversetakeover transactions in voluntary escrow. The remaining shareholders have beendescribed as "wholesalers" who generally acquire a significant minority stake in the capitalof the private companies before the reverse takeover transaction is effected. The majorityof the shares obtained by the wholesalers are free-trading. Evidence was given at thehearing that, at least in the case of Stockguard, the party that arranges the reversetakeover transaction introduces the wholesalers to the private companies.
The wholesalers then enter into option agreements with Marchment and, it would appear,with at least one other securities dealer that also intends to sell from its inventory positionto retail customers in a telephone campaign. Upon the exercise of these options, thewholesalers will thus have disposed of their holdings in the newly resurrected publiccompanies for a quick profit. In many of the cases in evidence, the other securities dealerthat is apparently participating in these transactions alongside Marchment, is PriceWarner. Price Warner was formed by Ian Rolin, who, until 1993, was the Vice-Presidentand Compliance Officer of Marchment.
The reverse takeover transactions require approval by the shareholders of the dormantpublic companies. A valuation of the private company which is to be "acquired" by thedormant public company is performed for the benefit of the shareholders of the dormantpublic company. Most of the valuations in evidence were performed by one of twobusiness valuators: Rex McCafferty (who gave evidence on behalf of the Respondents)and James Catty. The valuations about which Mr. McCafferty testified were usuallyprepared on the basis of projections of the private companies' earnings prepared bymanagement of the private companies.
The shareholders of the public company would then approve a resolution changing thename of the reorganized enterprise at the meeting called to consider the reverse takeovertransaction.
Shortly after the reverse takeover transaction is approved, the newly reorganized publiccompany seeks a quotation on CDN. Immediately following the quotation approval, thereusually follows a series of low-volume trades at prices that are multiples of the share priceindicated by the valuation reports described above. An approved market marker posts amarket around the trading prices of these initial trades. The market maker's bid price is,therefore, also substantially higher than the value for the shares indicated by the valuationreports. In the cases about which we heard testimony, no material change in the businessor affairs of the issuer was reported between the completion of the reverse takeovertransaction and the date that the market maker calls a market.
We were provided with trading records produced by CDN for several newly reorganizedpublic companies which had completed steps similar to those referred to above. Ananalysis of those records, indicates that the market maker accounts for a very smallproportion of the trading in the securities.
In the ordinary course, Marchment begins to sell its inventory in the shares at pricesbetween the market marker's bid and ask price. The prices move upward in a series ofsteps (as Marchment and Price Warner raise the prices that they offer the shares to theircustomers). During the selling campaign, Marchment and Price Warner account forvirtually every reported trade in the securities. In this period, few, if any, trades aretransacted between Marchment and Price Warner or between either of these firms and themarket maker. Invariably, as the prices that Marchment offers the securities to itscustomers approach the market maker's asking price, the market maker adjusts its quotedmarket upward.
This process continues until the selling campaign is over. When the selling campaignends, the trading price declines. Unless an independent market can be established for theshares, the shares settle at a very low trading price.
In his evidence, Mr. Gottschalk testified that he and all other sales people at Marchmentwere aware that the trading prices of the securities that Marchment sold to its customersfollowed the pattern described above. The Respondents, Osborne and Saltsman, alsotestified that they were aware of this pattern.
Customers of Marchment who acquire these securities from Marchment's inventory andhold them until after its telephone sales campaign has ended have virtually no chance ofprofiting and almost certainly will lose most or all of their investment.
Staff, in its written argument, provided us with an analysis of the per share value andaverage monthly trading prices of five of the companies in which Marchment acquiredpositions which it then, through a telephone campaign, sold to customers including thosewho testified at the Hearing. This analysis was not contested by the Respondents eitherin their written submissions or in oral argument. In each case, Mr. McCafferty valued theshares of the private company forming part of the reverse takeover. The values rangedfrom a low of $0.05 per share of one of the restructured public companies to a high of$0.17 per share of another of the restructured public companies. When Mr. McCaffertyapplied to his calculations price earnings multiples applicable to publicly tradedcompanies, his per share values ranged from a low of $0.07 to a high of $0.25 per shareof the restructured public company. Marchment began selling shares of the company withthe lowest valuation at more than $1.25 per share approximately two-and-one-half monthsfollowing the McCafferty valuation. Marchment began selling shares of the company withthe highest McCafferty valuation at prices in excess of $1.29 per share approximately two-and-one-half months after the McCafferty valuation. The opening prices for the Marchmentsales campaign for the remaining companies in these examples ranged from a low of $1.10per share to a high of $1.39 per share. The peak at which Marchment traded these sharesin these five examples ranged from a low of $1.73 per share to a high of $2.29 per share.
It is clear from the above, that the companies would need to perform exceptionally well fortheir intrinsic values to rise even to the levels at which Marchment begins its salescampaign. As is discussed elsewhere in these reasons, we were presented with severalinstances where Marchment sales persons continued to recommend that customers holdonto their shares long after they began to come off their high and, indeed, we werepresented with evidence that a number of clients were unsuccessful having Marchmentsalespersons sell their shares notwithstanding their strongly expressed desires to do so.
Considerable attention was directed during the hearing to the process by which shares ofStockguard were acquired by Marchment and sold from its inventory to its customers. Ananalysis of the Stockguard promotion provides valuable insights into the nature of the riskswhich clients of Marchment were incurring by following Marchment's recommendation topurchase shares from its inventory. Although clearly no two transactions developed in anidentical manner, we have concluded that the Stockguard example is fairly representativeof the many other promotions implemented by Marchment.
The Respondents called Herb Marshall the President of Stockguard, to give evidence atthe hearing. The Respondents also called Mr. McCafferty who prepared a valuation of thecompany that was transformed into Stockguard in the reverse takeover transaction. Mr.Sofer gave evidence as to the "due diligence" that Marchment performed in connectionwith Stockguard.
Mr. Marshall testified that the private company that ultimately became Stockguard required$400,000 in startup capital to commence operations in Canada, but that he had beenunable to obtain commitments for that financing. Through an acquaintance, Mr. Marshallwas introduced to Martin Cole ("Cole") a principal of Hayes Bustin Securities Limited("Hayes Bustin") a securities dealer. Cole advised Mr. Marshall that Hayes Bustin wouldraise $500,000 for Stockguard if it were willing to surrender 25% of its capital. Mr.Marshall testified that Hayes Bustin was willing to proceed right away with the financing.Mr. Marshall understood that his private company would enter into a reverse takeovertransaction with a reporting issuer. Ultimately, the transaction was completed with BaitexMedical Corporation ("Baitex"). Mr. Marshall never met with any of the principals of Baitex.
Mr. Marshall testified that the process moved forward quickly after his first conversationwith Cole. On September 21, 1994, Mr. Marshall's private company issued 500,000common shares to three off-shore companies for $50,000. Mr. Marshall understood thisto be a down payment on the $500,000 that Cole had promised to Stockguard. Mr.Marshall testified that he never met nor was he aware of the identity of the principals of thethree off-shore companies, but he understood that they would be involved in thearrangements made for a subsequent $450,000 private placement of Stockguard's shares.
Cole introduced Mr. Marshall to Mr. McCafferty who performed a valuation of Stockguardto be included in the proxy materials delivered to the shareholders of Baitex. Mr.McCafferty concluded that the fair market value of Stockguard on an en bloc basis was$2,510,000. Mr. McCafferty's valuation of Stockguard was based upon projections ofearnings supplied to him by Stockguard management. According to his valuation,Stockguard's fair market value as a public company would be approximately $0.18 pershare after completion of the reverse takeover transaction.
At the special meeting of Baitex (held on October 31, 1994) a share exchange betweenBaitex and the shareholders of Stockguard was approved. The shares of Baitex wereconsolidated on a one-for-ten basis and twenty million Baitex shares were issued to theStockguard shareholders. As a result, the members of Stockguard's management groupobtained 15,000,000 shares which, under the terms of the share exchange agreement,were placed in escrow for 18 months. The three off-shore companies who had acquiredthe interest in Mr. Marshall's private company obtained an aggregate of 5,000,000Stockguard shares on the reverse takeover. Most of these shares were freely tradeable.Mr. Sofer and Mr. McCafferty each testified that Marchment acquired its Stockguard sharesfrom one of the three off-shore companies. We were provided with evidence thatMarchment acquired these shares for $0.40 per share. It is also apparent that PriceWarner must have acquired Stockguard shares from one or more of the three off-shorecompanies.
Following the Baitex special meeting, Stockguard applied for quotation approval on CDN.Mr. Marshall testified that he was not involved in this process nor was any other memberof Stockguard's management group.
It is clear that Mr. Marshall was oblivious to what was happening. He was not part of theprocess by which his company was being groomed to form the basis of a money-makingscheme for Hayes Bustin and Marchment. He did not select the public vehicle (Baitex)which would acquire his private company, nor did he meet its principals. He did notparticipate in the listing on CDN of the company of which he was the CEO. He never metthe parties who could provide the $500,000 financing he was promised. In the end, healso did not get a widespread public float with a real auction market that would provide himwith possible access to additional capital. He and Stockguard were just convenient pawnsin the scheme in which Marchment was a key player.
On November 14, 1994 (two weeks after the Baitex special meeting) CDN reported a tradeof 1,000 Stockguard shares at $1.00 per share. Mr. Marshall testified that no member ofStockguard's management made this trade (or any other trade reported on CDN). Therefollowed a series of low-volume trades at $1.00 and $1.15. The last of these trades was$1.25. Mr. Marshall testified that (apart from the reverse takeover transaction) there wasno material change in the business and affairs of Stockguard from the date ofMr. McCafferty's valuation (September 15, 1994) to the date of the first trade on CDN(November 14, 1994) that would account for the trades in the securities at over five timestheir appraised value as a public company. From the CDN records , it appears that therewere only two trades during the month of November 1994 (on November 14 and November16) for a total of 1,500 shares, there were eight trades during the month of Decembertotalling 4,486 shares and no trades during the month of January 1995.
Marchment reported its first trade in Stockguard shares on February 1 , 1995 at a price of$1.10 per share. During the month of February, CDN records indicate that 890,478Stockguard shares changed hands, and during the month of March 1,075,600 Stockguardshares were traded. In Staff's submissions, not challenged by the respondents, it is statedthat Marchment and Price Warner accounted for 95.3% of the trading in Stockguardshares during the period beginning November 14, 1994 and ending September 30, 1996.
The trading price for Stockguard shares moved up in a series of steps reaching its highof $1.90 in or about September 1995. By that time, Stockguard's market capitalization was$38 million and was trading at over 9 times Mr. McCafferty's valuation of the shares of thepublic company a year earlier. After September 1995, the price began to declinesubstantially. In May, 1998 Stockguard announced that its wholly-owned British subsidiarywas placed into receivership. Thereafter, CDN halted trading in Stockguard shares.
The Due Diligence Exercise
In paragraph B.7(k) of the Amended Statement of Allegations, it is alleged that Marchmentand Messrs. Sofer, Saltsman, Osborne and Plant sold securities to clients without makingany bona fide independent verification or investigation regarding the nature of thebusiness or financial condition of the issuers of those securities. Mr. Ornstein and Mr.Sofer addressed this allegation in their testimony with references to the due diligencereview which Mr. Sofer usually performed with respect to the business, affairs andprospects of companies to be used by Marchment in its sales campaign. They testifiedthat a visit to the premises and facilities and meetings with the principals of thesecompanies formed part of the review. By way of example, we were presented with adetailed description of Mr. Sofer's due diligence review of Stockguard.
In addition, Mr. Ornstein and Mr. Sofer testified that they relied on the fact that each issuer(with the exception of Maxill Inc.) whose stocks were sold to customer witnesses hadwithstood the scrutiny of the due diligence performed by CDN before the issuer wasapproved for quotation on CDN. Mr. Ornstein referred to the CDN policy and, specifically,the section dealing with the requirements for quotation on CDN. He referred to thefollowing considerations of CDN including the financial position of the issuer, share capitalof the issuer, the directors, officers, major shareholders and promoters of the issuer, thesize of the public float, the business or proposed business of the issuer and other relevantfactors. It is interesting to note, however, that CDN did not have a formal process in placeregarding requirements for quotation prior to 1997.
Staff have not satisfied us that Marchment and Messrs. Sofer, Saltsman, Osborne andPlant sold securities to customers without making any bona fide independent verificationor investigation regarding the nature of the business or financial condition of the issuersof those securities. In our Decision, therefore, we stated that we have not concluded thatthese Respondents have engaged in such conduct. Our findings, however, should betaken in the context of the following findings.
In reality, the due diligence performed by Mr. Sofer was irrelevant to the customer'sinvestment experience because the actual business, affairs and prospects of thecompanies were irrelevant to the selling campaign. The due diligence process does notappear to have had any effect on the price at which Marchment began its sellingcampaign, nor the incremental increases in those prices or the timing of implementingthose increase. The Stockguard example is instructive. It is obvious from the prices atwhich Marchment sold Stockguard shares to its customers that Mr. Sofer was notinfluenced at all by the documents that he says he reviewed pertaining to Stockguard. Inparticular, Mr. Sofer apparently had no regard to the McCafferty valuation of those shares.On May 24 , 1995 Mr. Marshall met with Mr. Sofer at Marchment's offices and providedMr. Sofer with projected sales figures that were substantially lower than the projectionsused by Mr. McCafferty in arriving at a valuation which ascribed a value of $0.18 per shareof Stockguard as a public company. Mr. Sofer ought to have realized that these newrevenue projections could substantially diminish the value of Stockguard shares as aninvestment. Nevertheless, in May 1995 and thereafter, Marchment continued torecommend that its customers acquire these shares at steadily increasing prices reaching$1.90 per share in September 1995.
We will not speculate why Mr. Sofer conducted his due diligence exercise. We find,however, that aside from ensuring that Stockguard existed as a commercial enterprise, theexercise provided no protection to Marchment's customers.
We also find that the purported reliance on CDN does not bear scrutiny. None of theissues which CDN considers addresses the per share value of an entity or, moreimportantly, the relationship between such a value and the price at which a dealer sellsquoted shares to its customers. We find Mr. Sofer's and Mr. Ornstein's purported relianceon CDN's policies in this respect to be disingenuous.
Counsel for Marchment submitted that based upon the review by Marchment and the duediligence performed by CDN, each issuer whose stocks were sold to the customerwitnesses had a good opportunity for growth and a reasonable opportunity of providing areturn on the investment. For the reasons stated above, we find this proposition to becompletely untenable.
It should not be surprising that the due diligence performed by Mr. Sofer was irrelevant toMarchment's customers' investment experience. The prices and timing of price increasesfor the sale of its inventory to its customers were dictated solely by Marchment's sellingcampaign. In his evidence, Mr. Sofer stated that the markup that Marchment applied onthe Stockguard shares was reasonable. Primarily, he offered two justifications for themarkup. The first justification was that Marchment did not set the market for theStockguard shares but that Latimer, the market maker, set the trading price for thesecurities. In his evidence, Mr. Sofer referred to Latimer's bid and ask as the "street price"of the securities. Mr. Sofer's second principal justification for the markup was that the15,000,000 Stockguard securities held in escrow were subject to an "illiquidity discount".
We do not accept Mr. Sofer's testimony on this issue. It is obvious from the trading datathat there was no depth behind Latimer's bid price and asking price (or the bids posted bythe market makers in any other Marchment principal securities). In the circumstances,there was no "street price" to the securities that Marchment traded from inventory to itscustomers. Any dealer of Marchment's experience would know this. In fact, Marchmentcould have moved the market maker's bid or ask price by offering to the market maker thesale or purchase of a relatively small number of securities. Had Marchment thought thatthere was any depth to the bid price posted by the market maker (in the Stockguardexample a price that was two-and-one-half times Marchment's acquisition cost) Marchmentwould have attempted to sell some of its inventory to the market maker before embarkingon an expensive campaign to sell these securities to a large number of retail investorscontacted by telephone. The CDN records illustrate that in none of the securities in issuein this proceeding were there any substantial trades by Marchment to the market makerin the periods that Marchment was selling shares from its inventory.
On cross-examination, Mr. Ornstein confirmed that Marchment did not know how strongLatimer's bid was in the Stockguard shares and never asked. Contrary to Mr. Sofer'sevidence as to the importance of the market maker's bid, Mr. Ornstein testified on cross-examination that, even if there were no market maker, Marchment would still mark up itsprincipal stock by more than 100 per cent.
Mr. Sofer's second principal justification for the mark up simply makes no sense. Putsimply, the illiquidity discount can have little or no bearing on the value of the free-tradingshares of Stockguard because the discount does not result in a corresponding liquiditypremium on the free-trading shares.
We find that Marchment recommended that its clients acquire Stockguard's shares atprices that were dictated solely by its own selling campaign and which bore no relation atall to the appraised value of the securities or to any independent market price.
7. The Nature of the Risk
In the amended Statement of Allegations (B.7.(a)), it is alleged that Marchment andMessrs. Sofer, Saltsman, Osborne and Plant failed to disclose adequately to customersthe risks associated with investing in the securities offered by Marchment. Although wehave not concluded that Mr. Sofer personally failed to disclose adequately these risks, wehave concluded that Marchment and Messrs. Saltsman, Osborne and Plant failed todisclose adequately to customers these risks.
The Respondents rely heavily on the documentary disclosure made by them to customersbefore, during and after their purchase of speculative securities in responding to this andseveral other of the allegations contained in Paragraph B.7. In our analysis ofMarchment's use of these forms set out in section 9 below, and in our findings relating tothe experiences of the customer witnesses, however, we have concluded that Marchment'suse of these documents did not contribute to its customers' understanding of the risks theywere incurring.
We have not found that Marchment failed to advise customers that the securities beingsold to them were speculative. In our view, in the context of the Marchment telephonecampaigns, however, the fact that the securities of the company are speculative is onlyone feature of the risk profile faced by a prospective purchaser and it is by no means themost significant one. At a minimum, customers who succumb to a Marchment telephonesales campaign incur risks that are the sum of many factors, including the following:
(a) the shares have been valued at pennies per share based on management'sprojections of their company's ability to achieve its business plan;
(b) most, if not all, of the freely-traded shares have been acquired by Hayes Bustinand optioned to Marchment and one or more other brokers who intend also toembark on a telephone sales campaign;
(c) Marchment's price for the shares is substantially less than the price at which itsselling campaign starts (in the Stockguard example, Marchment's selling campaignstarted at over 2½ times its acquisition cost and reached a peak of over 4½ timesits acquisition cost);
(d) after the selling campaign has gained some momentum, Marchment will, byincrements, increase the price at which it is selling shares from its inventory, givingan appearance in the daily newspaper stock quotes that the shares have increasedin value;
(e) there will be no attempt by Marchment (or the other dealer or dealers operatingsimilar campaigns) to develop a trading market for the shares;
(f) Marchment's salespeople earn almost 20% of the selling price of the shares ascommissions or bonuses;
(g) Marchment has the discretion to "claw back" the 17½% bonus component of thesalesperson's remuneration if the customer sells within ninety days of the purchase;
(h) Marchment salespeople will not offer advice about the proper time to sell the sharesand will actively discourage the customer from selling as long as the telephonecampaign is continuing; and
(i) when the Marchment selling campaign ends (when Marchment has sold all or asmuch of its inventory as it believes it can sell), the indicated value of the shares willdecline very rapidly and, because there never was a market for the shares, thecustomer will be unable to sell at any price.
With the exception of the references to the speculative nature of the securities, none ofthese risks were described to the customers and several of them were misrepresented.In our view, it is likely that very few investors who are apprised of all of these risk factorswould succumb to the Marchment telephone sales campaign. Accordingly, we find thatMarchment and the Respondents, Osborne, Saltsman and Plant, failed in a very materialway to disclose adequately to clients the risks associated with investing in the securitiesoffered by Marchment.
8. The Marchment Sales Training Program
Section D of the amended Statement of Allegations makes a number of allegationsconcerning sales training courses which were developed by Mr. Sofer for prospectivemembers of Marchment's junior sales staff. The allegations list a number of objectionablefeatures which are said to be part of the sales training program and, as a result, thetraining program is alleged therefore to be contrary to the public interest.
Apparently the sales training course was developed by Mr. Sofer although it has beenchanged from time to time. The course usually takes place two or three nights per weekover a six to eight week period. Although much of the attention at the Hearing wasdirected to one or two components of the training program, the evidence indicates that itcovers an extensive range of subjects that would be important to a person training to bea securities salesman. The portion of the training program on which our attention wasfocussed related to the sample "sales pitch" that formed the basis of one of the salestraining sessions. We have already referred to notes taken by Mr. Gottschalk and Mr.Graham at that session which were entered into evidence. We also found that some of thestatements attributable to Mr. Sofer and recorded in those notes corroborate the salespractices adopted by Marchment junior salespersons as related by the customer witnessesin their testimony.
We accept that the instruction by Mr. Sofer with respect to selling techniques wasdesigned in part to enable Marchment salespeople to close sales of securities beingpromoted without adequate regard for the customer's own investment experience, incomelevels, assets or investment objectives. We also accept that trainees were taught how toovercome any reservations that a customer might express about purchasing the securitiesbeing offered.
We have also found that junior salespeople were taught in the training program to elicit theinformation necessary to complete the new client application form after the initial sale ofspeculative securities had been made. As a result, we have found that these aspects ofthe sales training program were corroborative of some of the elements of the Marchmenttelephone sales campaigns which we have found to be its core business.
Mr. Gottschalk testified extensively about his experiences in the sales training programand as a junior salesman at Marchment. Much of Mr. Gottschalk's testimony is notcorroborated convincingly either by his notes or the notes kept by Mr. Graham. In addition,much of Mr. Gottschalk's testimony is specifically contradicted by Mr. Sofer.
Having listened to the testimony and examined the documentary evidence presented tous, we do not find the sales training program, other than those elements specificallyreferred to above, to be offensive or significantly different from programs at otherinvestment firms to which we were referred. Nor, on balance, do we find the trainingprogram taken in its entirety to be contrary to the public interest. Accordingly, it is notnecessary for us to choose between the competing versions of events presented byMr. Gottschalk and Mr. Sofer.
9. The Marchment Forms
A significant portion of the Hearing was occupied with a detailed analysis of the documentsused by Marchment in its dealings with its customers. These materials included formletters and brochures routinely sent to prospective customers (and in some cases, re-sentto customers after purchases were made), new client application forms, signature cardsand verification of trade information forms that were completed by the salespersons andsent to customers for signature and return, confirmation slips sent to customers followingeach trade and client questionnaires.
The Respondents sought to rely on this pattern of documentation to demonstrate that theyadequately disclosed to clients the risks associated with investing in Marchment principalsecurities; that they properly satisfied their obligations to ensure that securities sold tocustomers from Marchment's inventory were suitable; that they adequately disclosed toclients that Marchment was selling securities as principal at a price substantially higherthan Marchment's acquisition costs and that Marchment's salespersons received a bonusof 17½% of the customers' acquisition cost; and that the confirmation slips delivered tocustomers did not mislead them about the gross profits earned by Marchment and theremuneration received by Marchment salespeople on trades.
Mr. Ornstein testified that he personally reviewed all new client application forms to ensurethat the trade disclosed on the form was suitable for the particular customer. During thecourse of the Hearing we examined the new client application forms and had anopportunity to assess the suitability of the trades made by each of the customer witnesses.In virtually every case, a reasonable person easily would have concluded that none ofthese trades were suitable for these customers. Furthermore, it was admitted by Mr.Ornstein and Mr. Sofer that an assessment of a customer's liquid assets (in other words,cash or cash equivalent available for investing in speculative securities) is not identifiedon the form.
Although Mr. Ornstein may have reviewed the new application forms, we seriously doubtwhether his review had anything to do with suitability. If he did, it was clearly a fruitlessexercise as it would appear that every client who agreed to purchase a test amount ofspeculative securities from Marchment's inventory was deemed to be interested inspeculating in the stock market and therefore eligible to be sold additional speculativesecurities.
We have already referred to evidence about the procedures used by the salespeople tocomplete the forms and, in particular, evidence that they, rather than their customers,provided the breakdown between income, growth and spec. in the investment objectivessection. We also saw from Mr. Graham's notes that Mr. Sofer taught trainees never to put"nil" in the investment knowledge box of the form. Instead, Mr. Sofer is quoted as saying"educate them a little". None of the forms filled out for customer witnesses showedinvestment knowledge as "nil" in spite of the fact that several of them clearly had little orno investment knowledge.
The senior salespeople took the position that once an account had been assigned to anyof them, the suitability of the client had already been approved, presumably on the basisof the information elicited by the junior salesman and the purported review of the newclient application forms by Mr. Ornstein. Nevertheless, the three senior salesmen, Messrs.Saltsman, Osborne and Plant, testified that they reviewed the information on the new clientapplication form, noting in particular such pertinent factors as age, net worth and income.They also stated that in their conversations with customers, they confirmed the informationon the client application form, gathered additional or other soft data in subsequentconversations and continued to enquire whether changes to the client's financial situationhad occurred.
In our view, these assertions are not credible. They are inconsistent with the testimonyof the customer witnesses, many of whom testified that the senior salespersons paid littleattention to their personal circumstances and appeared to disregard changes incircumstances that were specifically communicated by these customers to them. Thesesalespeople must be taken to have been aware of the cavalier approach taken by theMarchment organization to the completion of these forms (Mr. Osborne had been a juniorsalesperson) and to have fully appreciated their short-comings. As well, given the quantityand levels of risk inherent in the investments which the senior salespeople urged thesecustomers to purchase, it is hard to understand what use these salespeople purported tomake of the information which they say they obtained by their review of the forms andconversations with customers.
In our view, the apparent disregard by the senior salespeople for the information containedon the new client application form is further confirmed by their treatment of the section ofthe form purporting to describe the customer's investment objectives. The formscompleted for many of the customer witnesses showed under the heading "investmentobjectives (this account)" some allocation to "growth" investments. (For example, the formcompleted for Mr. Anderson showed "Growth 25% spec. 75%".) None of the Respondentsalespeople made any recommendations to the customer witnesses to fulfill the "growth"portion of their objectives. Mr. Osborne testified that he had this in mind when he advisedMs. Grech to buy units in NCE Petrofund. However, as we have already observed, hequickly had her out of that investment and into speculative securities from Marchment'sinventory.
As set out above, the Respondents attempted to answer allegations that Marchmentsalespersons were recommending investments to customers who were unsuitable bydescribing their process for forwarding copies of the new client application form and, at alater stage in the development of their process, a form entitled, verification of tradeinformation, to their customers with a request that the customers review thedocumentation, sign an acknowledgement that it is correct and return the documentationto Marchment. They also testified that they expected customers to contact them ormanagement, and, in particular, Mr. Ornstein, to report any discrepancies between the oralrepresentations made and the disclosures contained in the written documentationreceived.
We reject this attempt to rely on these procedures as an effort to transfer to the customersthe burden of determining whether the high risk investments being recommended to themby Marchment salespersons were suitable for purchase by them. The obligation todetermine suitability clearly rests with the registrant. Although the co-operation of thecustomer is necessary to enable the registrant to discharge his or her obligation, aregistrant cannot transfer this obligation to the customer by expecting the customer tohighlight discrepancies between the assessments recorded by the junior salesmen on anew client application form and the customer's own risk tolerance. Nor can the customerbe expected to relate the verbal representations made by a salesperson in the course ofan aggressive selling campaign of Marchment's principal stock out of its inventory to hisor her own investment objectives and tolerance for risk.
Counsel for the Respondents provided us with detailed analyses of the number of timesin which references to "speculative" appears in the documentation that would have beensent to a customer in the normal course. Further, we were told of the number of times thatsuch a customer would have been warned in the documentation of the risk associated withhis or her investment in Marchment principal securities. We note, however, that incounsel's analysis, virtually all of the references to risk are either references to thespeculative nature of the securities or to consequences which flow from the fact that thesecurities are considered to be speculative.
We were also referred by counsel to the numerous references in the documentation to thefact that Marchment was selling as principal, that Marchment's salespersons would receiveremuneration on each trade either of 17½% or within a range of 16% and 18% of acustomer's acquisition cost and of references to Marchment's average acquisition cost orto the fact that its acquisition cost may have been significantly lower than current marketprices.
Most of the customer witnesses demonstrated that they had almost no understanding ofthe messages which Marchment alleges it intended to convey through its documentaryprocesses. We find that these documentary references fall far short of satisfyingMarchment's obligations and those of its salespersons to apprise customers of the risksthey are incurring by purchasing penny stocks from Marchment's inventory during one ofits telephone sales campaigns. In the securities industry, the speculative nature of acompany or its securities usually refers to factors affecting the company and its businessor prospects such as the fact that its business plan may not have been tested, its productmay not perform as anticipated, there may not be sufficient demand for its product at pricesthat are viable considering its costs of development and production, its capitalization maybe inappropriate, and so on. In an active market, these speculative factors influence themarket price of the shares. Here, references to the word "speculative" or to the fact thatinvestment in speculative securities is risky do not adequately inform Marchment'scustomers of the risks that they were incurring.
We also find that the documentary exercise was not sufficient to rectify the blatantdisregard by Marchment's salespersons of the suitability of Marchment principal securitiessold to its customers. Similarly, we find that Marchment and the Respondents, Saltsman,Osborne and Plant, cannot rely on this documentary exercise to demonstrate theircompliance with their "know-your-client" obligations. We find it difficult to conceive thatit would be possible to draft a series of forms that could, in and of themselves, overcomethe serious deficiencies in complying with the suitability and know-your-client rules evidentin the telephone sales campaign.
We have concluded, however, that the documents sent to customers contained amplewarnings that Marchment was selling the securities as principal and contained adequatedisclosure of the amount of the salesperson's remuneration and of the extent of the mark-up at which Marchment was selling shares from its inventory as compared to its acquisitioncost. Accordingly, we have not concluded that Marchment failed to disclose adequatelythe information identified in paragraph B.7.(h) of the amended Statement of Allegations.Similarly, we have not concluded that Marchment delivered misleading confirmation slipsas alleged in sub-paragraph (i) of paragraph B.7. of the amended Statement of Allegations.
Much was made by the Respondents of Marchment's request to the Commission forpermission to reproduce the Commission's Penny Stock brochure and provide a copy ofthe brochure to its customers. We are not persuaded that Marchment was in any wayfrustrated by this refusal from communicating the elements of risk contained in thatbrochure to its customers. Marchment could have reproduced the risk disclosurestatements contained in the brochure in its own materials and ensured that they werereceived, read and understood by prospective customers before selling them speculativesecurities.
Mr. Sofer also made much of Marchment's practice of delivering the new client applicationform, verification of trade information form, confirmation slips and stock risk disclosureletter to most customers by way of Loomis Courier. He implied that this practice wasfollowed as a way of ensuring that customers received this information. We were notconvinced that this was the sole or even material reason for adopting this practice. Mr.Sofer also testified that the Loomis Courier package included a return Loomis Courierenvelope into which the customer was required to deposit a cheque in payment for thesecurities purchased together with the signed documentation. It was apparent to us thatthe use of the courier would imply a sense of urgency to less sophisticated customers thatthere was an obligation to return the cheque and signed documentation without delay.
Respondents also relied very heavily on the fact that customers were asked to verify theinformation contained in the new client application form and, at a later stage, theverification of trade information form and to acknowledge the accuracy of the informationcontained by signing and returning either a signature card or, at a later stage, anacknowledgement printed on the forms themselves. In almost all of the cases, thecustomers testified that they did not remember having read the forms or, if they did readthem, they do not remember appreciating the significance of the acknowledgement whichthey had signed. We accept this testimony by the customer witnesses. When pressed oncross-examination to explain their actions, the customers gave a wide variety ofexplanations. Many of them were embarrassed by the fact that when forced to focus ontheir acknowledgement of the correctness of information which was clearly untrue, theywere hard-pressed to explain their actions. Counsel for the Respondents urged us to viewthis written record as undermining the credibility of these witnesses.
In the context of what these customer witnesses had been told by Marchment salespeopleduring the selling campaign, we do not think it fair to expect Marchment's customers toappreciate the significance of the documents. In our view, the mere acknowledgement byMarchment customers on these forms cannot absolve Marchment or its salespeople fromtheir obligations to their clients.
The Respondents emphasized that a client questionnaire had been developed, for "checksand balances", so that Marchment was able to follow-up with customers to ensure thatregistered representatives were following the policies and procedures at Marchment. Mr.Sofer testified that there was an earlier version of the questionnaire and a later versionwith only one change (question 13). Interestingly, in the earlier version of thequestionnaire, question 13 stated: "At the time of purchase did the RegisteredRepresentative make a specific price projection?". There was evidence that Marchmentreceived a number of forms in which question 13 was answered in the affirmative. Indeed,it was an affirmative response to question 13 (as well as concerns with one other question)that prompted Mr. Sofer to contact Mr. Duffy. The later version of question 13 was revisedto read: "Did you make your decision to purchase based upon an expected general upwardmovement as opposed to a very specific target price and/or date".
The Respondents' provided a summary of responses to the questionnaire. The responsesare categorized according to which principal security was purchased by a customer. Thereis a breakdown provided of eight different principal securities. The summary of responsesindicates an average of 81% responded in the affirmative to question 13. Counsel advisedthat the summary of responses reflects approximately equal numbers of the earlier versionof the questionnaire and the later version. The statistic indicates that a very substantialproportion of the responses to the earlier version must have answered question 13 in theaffirmative.
We find it strange that the original question was eliminated in view of the fact that itobviously enabled Marchment to determine whether its salespeople were in compliancewith the policies and procedures at Marchment. We find it particularly strange given thatthey had received answers indicating that their salesperson had made specific priceprojections.
We find that the revision of question 13 casts doubt on Marchment's assertion that thequestionnaire was intended to be used as follow-up and ensure compliance with thepolicies and procedures at Marchment.
We have incorporated in each section of these Reasons our findings on the issuesdiscussed in those sections. For clarity, however, we set out below our findings withrespect to the specific allegations in the amended Statement of Allegations. Thesefindings were released separately on July 16, 1999.
We have concluded that Marchment has, since January 1993, engaged in extensivecampaigns to sell speculative penny stocks from its inventory by telephone throughnumerous salespeople without regard to the suitability of the trades to the needs of itsclients. These campaigns have been conducted in a manner intended to induce thecustomer to make a hasty decision to buy the security being offered without disclosure ofthe risks inherent in the investment or disclosure that an integral part of Marchment'sselling campaign is the establishment by Marchment from time to time of the trading priceof the securities. We have also concluded that the individual Respondents, Charles LorneOrnstein and Amit James Sofer conceived and implemented this aspect of Marchment'sbusiness and in so doing failed to deal fairly, honestly and in good faith with Marchment'sclients, did not act in the best interest of clients, permitted Marchment and its salespeopleto breach their "know your client" obligations and otherwise acted contrary to the publicinterest. We have also concluded that the individual Respondents, Jerry Murray Saltsman,Gregory Charles Osborne and Fraser John Edward Plant were each knowing and willingparticipants in these campaigns. In so doing, these three Respondents failed to act fairly,honestly and in good faith with their clients, did not act in the best interest of clients,breached their "know your client" obligations and otherwise acted contrary to the publicinterest.
Staff have not established, to our satisfaction, however, that each and every of the itemsof specific conduct alleged in the amended Statement of Allegations was engaged in bythe Respondents, or all of them, or that the effect of every one of the alleged businesspractices was as set out in the amended Statement of Allegations.
The allegations in Section A of the amended Statement of Allegations were notcontroverted in any material respect. Our specific conclusions with respect to each of theallegations in the amended Statement of Allegations, commencing with Section B.,"Allegations Relating to Trades in Securities to Clients of Marchment" are set out below.The letters and numbers of headings and paragraphs correspond to the equivalentdesignations in the amended Statement of Allegations.
B.7. We have concluded that Marchment and the individual Respondents,Saltsman, Osborne and Plant failed to deal fairly, honestly and in good faithwith clients and/or potential clients of Marchment, did not act in the bestinterests of clients, and otherwise acted contrary to the public interest. Wehave not concluded that the individual respondent, Sofer, engaged directlyin such conduct. With respect to the specific allegations set out insubparagraphs (a) to (m), our conclusions with respect to Marchment andthe individual Respondents, Saltsman, Osborne and Plant are set out belowwith the word "yes" denoting our conclusion that these Respondentsengaged in the conduct as alleged and the word "no" denoting that we havenot concluded that these Respondents have engaged in such conduct. Inview of the fact that we have not found that Mr. Sofer engaged directly in theconduct alleged generally at the beginning of the paragraph, it follows thatwe make no findings with respect to Mr. Sofer's alleged participation in theconduct specifically alleged in these subparagraphs.
1. Yes -- with respect to Marchment, Saltsman, Osborne and Plant
2. Yes -- with respect to Marchment, Saltsman, Osborne and Plant butonly with respect to that part of the allegation relating to failure todisclose that the securities traded by Marchment were of limitedliquidity or marketability; No -- with respect to all Respondents withrespect to the remainder of this allegation.
3. Yes -- with respect to Marchment, Saltsman, Osborne and Plant
4. Yes -- with respect to Marchment, Saltsman, Osborne and Plant
5. Yes -- with respect to Marchment, Saltsman, Osborne and Plant
6. Yes -- with respect to Marchment, Saltsman, Osborne and Plant
7. No -- with respect to all Respondents
8. No -- with respect to all Respondents
9. No -- with respect to all Respondents
10. Yes -- with respect to Marchment, Saltsman, Osborne and Plant
11. No -- with respect to all Respondents
12. Yes -- with respect to Marchment, Saltsman, Osborne and Plant
13. Yes -- with respect to Marchment and Saltsman; No -- with respect toOsborne and Plant.
C.8. We have not concluded that the sales training courses for prospectivemembers of Marchment's junior sales staff conducted by Mr. Sofer andMarchment, taken as a whole, were contrary to the public interest andprudent business practice. Consequently, it is not necessary for us toaddress the specific allegations contained in subparagraphs (a) to andincluding (h).
D.9. We have concluded that, during the period in issue, Marchment engaged inactivity consisting of an extensive selling campaign by telephone to offersecurities to clients through numerous salespeople without regard to thesuitability of the investments to the needs of the client, in such a manner asto induce a hasty decision to buy the security being offered withoutdisclosure of the material facts relating to the issuer, contrary to publicinterest. We have also concluded that other very important material factsrelating to the investment decision also were not disclosed to prospectiveinvestors, contrary to the public interest.
E.10. As stated above, we have concluded that the individual RespondentsOrnstein and Sofer conceived and implemented the activities of Marchmentreferred to above and in so doing failed to deal fairly, honestly and in goodfaith with Marchment's clients, did not act in the best interests of clients,permitted Marchment and its salespeople to breach their "know your client"obligations and otherwise acted contrary to the public interest. We havealso concluded that the Respondents, Ornstein and Sofer, as senior officersof Marchment, were aware of, permitted, acquiesced and participated in thesales activity which we have concluded was conducted by Marchment andmore particularly set out in our conclusions under paragraph B7(a), (b), (c),(d), (e), (f), (j), (l) and (m), in each case contrary to the public interest. Inview of our conclusions with respect to the allegations set out in Section Crelating to the sales training courses taken as a whole, we do not make anyfinding with respect to the allegation in paragraph E10 as it relates to theactivity alleged in Section C of the amended Statement of Allegations.
E.11. We have concluded that the respondent, Sofer, as the Compliance Officerof Marchment, and the respondent, Ornstein, as the President of Marchment,failed to establish and enforce procedures for dealing with clients thatconformed with prudent business practice. We have also concluded thatsuch procedures would have reduced the likelihood of the activity describedin Section D of the amended Statement of Allegations as well as theimproper selling scheme referred to in Section B of the amended Statementof Allegations, contrary to the public interest. We do not find that suchprocedures necessarily would have prevented such activities as alleged inparagraph E11 of the amended Statement of Allegations.
F.12. We have not concluded that the Respondents, Sofer and Marchment, haveengaged in the activities alleged in this paragraph.
The hearing will be reconvened on Tuesday, August 3, 1999 at 10:00 a.m. for thepurposes of receiving any evidence which parties wish to adduce and any submissionswhich parties wish to make with respect to any Orders to be issued imposing remedies orpenalties as a result of the Decisions which we have made. We would ask counsel for theStaff and each of the Respondents to advise the Secretary to the Commission before 5:00p.m. on Thursday, July 29 whether or not they intend to call further evidence and/or makesubmissions on this issue.
DATED at Toronto this 27th day of July, 1999."David A. Brown"
"Helen M. Meyer"
R.S.O. 1990 c.S.5 AS AMENDED
IN THE MATTER OF
MARCHMENT & MACKAY LIMITED, AMIT JAMES SOFER, CHARLES LORNE ORNSTEIN, JERRY MURRAY SALTSMAN, NORMAN FRYDRYCH, GREGORY CHARLES OSBORNE AND FRASER JOHN EDWARD PLANT
NOTICE OF HEARING
(Section 37 and 127 of the Securities Act)
TAKE NOTICE that the Commission will hold a hearing pursuant to sections 37and 127 of the Securities Act, R.S.O. 1990 c.S.5 as amended (the "Act") at its officeson the 8th Floor, 20 Queen Street West, Toronto, Ontario, commencing on September6, 1996 at 9:30 o'clock in the forenoon;
(a) whether, pursuant to paragraph 1 of subsection 127(1) of the Act, it is in thepublic interest to order, that the registrations of Marchment & Mackay Limited,Amit James Sofer, Charles Lorne Ornstein, Jerry Murray Saltsman, NormanFrydrych, Gregory Charles Osborne, and Fraser John Edward Plant (collectively,the "Respondents") should be suspended, terminated, restricted or be madesubject to conditions;
(b) whether, pursuant to paragraph 3 of subsection 127(1) of the Act, it is in thepublic interest to order that the exemptions contained in Ontario securities lawdo not apply to the Respondents;
(c) whether, pursuant to subsection 37(1) of the Act, it is in the public interest tosuspend, cancel, restrict or impose terms and conditions upon the right of theRespondents to call at or telephone to any residence in Ontario for the purposeof trading in any security or in any class of securities; and
(d) such further and other order as the Commission considers appropriate.
BY REASON OF the allegations as set out in the Statement of Allegations madeby staff of the Enforcement Branch of the Commission that the conduct of theRespondents was not in the public interest;
AND TAKE FURTHER NOTICE, that any party to the proceedings may berepresented by counsel if that party attends or submits evidence at the hearing;
AND TAKE FURTHER NOTICE, that upon failure of any party to attend at the timeand place aforesaid, the hearing may proceed in the absence of that party and suchparty is not entitled to any further notice of the proceeding.
August 2nd, 1996.
"Daniel P. Iggers"
R.S.O. 1990 C. S. 5 AS AMENDED
IN THE MATTER OF
MARCHMENT & MACKAY LIMITED, AMIT JAMES SOFER, CHARLES LORNEORNSTEIN, JERRY MURRAY SALTSMAN, GREGORY CHARLES OSBORNE ANDFRASER JOHN EDWARD PLANT
STATEMENT OF ALLEGATIONS OF STAFF OF
THE ENFORCEMENT BRANCH OF THE
ONTARIO SECURITIES COMMISSION
Staff of the Enforcement Branch of the Ontario Securities Commission allege that:
A. THE PARTIES
1. Marchment & MacKay Limited ("Marchment") is, and was at all material times,registered with the Commission as a securities dealer pursuant to Part XI of theSecurities Act, R.S.O. 1990 c.S.5 as amended (the "Act").
2. Charles Lorne Ornstein ("Ornstein") is, and was, at all material times, the Presidentand a principal shareholder of Marchment. Ornstein is registered with theCommission to trade in securities as an officer and director of Marchment pursuantto Part XI of the Act.
3. Amit James Sofer ("Sofer") is, and was at all material times, a Vice-President andthe Compliance Officer at Marchment as well as a salesperson. Sofer is registeredwith the Commission to trade in securities as an officer and director of Marchmentpursuant to Part XI of the Act.
4. Jerry Murray Saltsman ("Saltsman") is, and was at all material times, a salespersonof Marchment and is registered as such with the Commission pursuant to Part XIof the Act.
5. Gregory Charles Osborne ("Osborne") is, and was at all material times, asalesperson of Marchment and is registered as such with the Commission pursuantto Part XI of the Act.
6. Fraser John Edward Plant ("Plant") is, and was at all material times, a salespersonof Marchment and is registered as such with the Commission pursuant to Part XIof the Act.
B. ALLEGATIONS RELATING TO TRADES IN SECURITIES TO CLIENTS OFMARCHMENT
7. Between January 1993 and the present Marchment, Sofer, Saltsman, ^ Osborneand Plant have failed to deal fairly, honestly, and in good faith with clients and/orpotential clients of Marchment (collectively "clients"), did not act in the best interestsof clients, and otherwise acted contrary to the public interest and prudent businesspractice. Among other things, these respondents:
(a) failed to disclose adequately to clients the risks associated with investing inthe securities offered by Marchment;
(b) failed to disclose in particular that the securities traded by Marchment werehighly speculative, of limited liquidity or marketability, and that an investmentin these securities could result in a loss on the original capital invested;
(c) failed to take adequate steps to ensure that securities sold to clients weresuitable or appropriate in view of the clients' net worth, income, investmentknowledge and experience and objectives;
(d) otherwise failed to trade in securities in conformity with their"know-your-client" obligations;
(e) adopted and used high-pressure sales techniques;
(f) made incorrect, misleading or unjustifiable statements regarding the futuretrading price of the securities offered by Marchment and/or the prospects ofthe issuers of those securities, for the purpose of completing trades ofsecurities to clients;
(g) made representations to clients based upon purported knowledge of insideinformation;
(h) failed to disclose adequately to clients that:
(i) Marchment was selling the securities as principal;
(ii) Marchment was selling the securities at a price that was substantiallyhigher than their initial acquisition costs; and
(iii) Marchment's salespersons received remuneration on each traderanging between 16 and 18 percent of the clients' acquisition cost;
(i) delivered confirmation slips to clients that misled them about the grossprofits earned by Marchment and the remuneration received by Marchmentsalespeople on trades;
(j) failed to disclose that Marchment's salespersons would lose their entitlementto the remuneration referred to in clause 7(h)(iii) above, if clients sold thesecurities they acquired within a certain period of time;
(k) sold securities to clients without making any bona fide independentverification or investigation regarding the nature of the business or financialcondition of the issuers of those securities;
(l) resisted or refused to sell securities when clients instructed them to do so;and
(m) made unjustifiable, misleading and/or false statements to clients designedto induce them to refrain from selling their securities.
C. ALLEGATIONS RELATING TO SALES TRAINING
8. Sofer and Marchment conducted sales training courses for prospective membersof Marchment's junior sales staff. These courses were designed to instruct thesales trainees to use highly manipulative and promotional techniques to sellsecurities over the telephone. These sales techniques were designed to closesales without adequate regard to the attributes of the securities being promoted orthe client's own investment experience, income, assets or objectives. The trainingprogramme was therefore contrary to the public interest and prudent businesspractice. In particular Sofer and Marchment taught sales trainees:
(a) that the sales trainees should use the uniform sales pitch that Soferdemonstrated during the training course in all sales regardless of the client'scircumstances or the particulars of the securities sold to the client;
(b) that, by using the sales pitch described in subparagraph 8(a) above, thetrainees could foster a sense of urgency and excitement in the minds ofclients so as to facilitate the closing of sales of securities to them;
(c) to advise clients that favourable news regarding the securities then beingpromoted would be forthcoming, and that a positive impact on the tradingprice for the securities would result regardless of the actual prospects of theissuers of the securities traded by Marchment;
(d) to advise their clients that they, as ^ junior salespeople, intended to foster along-term relationship with their clients, although they were not permitted tomaintain any relationship after the first trade of securities to their clients;
(e) to advise clients that the securities they were selling constituted a "specialopportunity" offered only to a select few clients when these securities were,in fact, being offered to each and every prospect that junior salespeoplecontacted over the telephone;
(f) to adopt high-pressure sales techniques designed to dismiss and discountany reservations that a client might have about purchasing the securitiesoffered;
(g) to place no or inadequate emphasis on the speculative nature of thesecurities offered; and
(h) to avoid advising clients about the actual remuneration received byMarchment salespeople and to avoid disclosure of the profits earned byMarchment on trades of securities.
D. HIGH-PRESSURE SELLING ACTIVITY
9. In substance, during the period in issue, Marchment has been engaged in ^ activityconsisting of an extensive selling campaign by telephone to offer securities toclients through numerous salespeople without regard to the suitability of theinvestments to the needs of the client, in such a manner as to induce a hastydecision to buy the security being offered without disclosure of the material factsrelating to the issuer, contrary to the public interest and prudent business practice.
E. ALLEGATIONS REGARDING KNOWLEDGE AND PARTICIPATION OF SENIORMANAGEMENT
10. The respondents Ornstein and Sofer, as the senior officers of Marchment, wereaware of, permitted, acquiesced and participated in the sales activity referred to indivisions B and C above, contrary to the public interest and prudent businesspractice.
11. Furthermore, Sofer, as the Compliance Officer of Marchment, and Ornstein, as thePresident of Marchment, failed to establish and enforce procedures for dealing withclients that conformed with prudent business practice. Such procedures wouldhave prevented the activity described in division D above as well as improperselling scheme referred to in division B above, contrary to the public interest andprudent business practice.
F. ALLEGATIONS REGARDING INTERFERENCE WITH COMPLAINTS TO THEONTARIO SECURITIES COMMISSION
12. Sofer and Marchment have interfered with the administration of the Act by staff ofthe Commission in a manner that is contrary to the public interest. In particularMarchment and Sofer:
(a) offered reimbursement for all or part of the trading losses sustained byclients who had complained about Marchment to the Enforcement Branch ofthe Commission, on the express condition that these clients:
(i) withdraw their complaints; and
(ii) write letters to the Enforcement Branch denying that Marchment hadengaged in any inappropriate conduct in the sale of securities tothem;
(b) offered reimbursement to clients for all or part of the losses that theysustained as a result of their trades in securities through Marchment on thecondition that they not proceed with any proposed complaint to theEnforcement Branch; and
(c) required as a term of settlement with clients who had sustained tradinglosses that the client not disclose any matter relating to their dealings withMarchment with any other person including any representative of staff of theCommission; and
(d) required as a term of settlement with clients who had sustained tradinglosses that the client deliver up to Marchment all documents in the client'spossession relating to the client's dealings with Marchment.
G. OTHER ALLEGATIONS
13. Staff also relies upon such further and other allegations as staff may advise and theCommission may permit.
August 2nd, 1996.