Securities Law & Instruments




In the Matter of Staff’s Recommendation
for the Refusal of Reactivation
of Registration of John Kodric

Opportunity to be Heard by the Director under
Section 31 of the Securities Act




Decision

  1. For the reasons outlined below, my decision is to refuse the reactivation of registration of John Olojz Kodric (Kodric).

Overview

  1. On May 4, 2015, staff of the Compliance and Registrant Regulation Branch (CRR) of the Ontario Securities Commission (OSC) (Staff) recommended to the Director that the application for reactivation of registration under the Securities Act (Ontario) (Act) by Kodric in the category of mutual fund dealing representative be denied.  Under section 31 of the Act, Kodric is entitled to an opportunity to be heard (OTBH) before a decision is made by me, as Director. 
  1. My decision is based on:
    1. the verbal and written arguments of Staff, Victoria Paris (Legal Counsel, CRR), on behalf of the OSC,
    2. the verbal and written arguments of Janice Wright and Greg Temelini of Wright Temelini LLP on behalf of Kodric, and
    3. the evidence of Jennie Alley of Wright Temelini LLP, Kodric, Lisa Pielbags (Accountant, CRR), “AB” (client of Kodric), and “CD” (client of Kodric).      

Suitability for registration generally

  1. Subsection 25(1) of the Act requires any person that trades in securities to be registered in accordance with Ontario securities law as a dealing representative of a registered dealer and to only act on behalf of the registered dealer.  As set out in numerous prior decisions, a registrant is in a position to perform valuable services to the public, both in the form of direct services to individual investors and as part of the larger system that provides the public benefits of fair and efficient capital markets.  A registrant also has a corresponding capacity to do material harm to individual investors and to the public at large.  Determining whether an applicant should be registered (or whether registration should be reactivated) is thus an important component of the work undertaken by the OSC. 
  1. Subsection 27(1) of the Act provides that, on receipt of an application, the Director shall register the person unless it appears to the Director that the person is not suitable for registration or that the proposed registration is otherwise objectionable.  In the recent case of Re Ittihad Securities Inc.(2010), 33 OSCB 10458, I, as Director, stated that:

The OSC has, over time, articulated three fundamental criteria for determining suitability for registration – integrity (which includes honesty and good faith, particularly in dealings with clients, and compliance with Ontario securities law), proficiency, and solvency.  These three fundamental criteria have been codified in subsection 27(2) of the Act…  The determination of whether an applicant’s registration may be otherwise objectionable goes beyond the three suitability criteria above.  Prior OSC decisions have held that registration is “otherwise objectionable” if it is determined… that it is not in the public interest for the person or company to be registered.

The issues at hand are Kodric’s integrity and proficiency.  Staff also argued that Kodric’s reactivation of registration was otherwise objectionable. 

Background information

  1. Kodric was registered as a mutual fund dealing representative with Manulife Securities Investment Services Inc. (Manulife) or other related entities from 1998 to 2014.  His employment was terminated in September 2014.  The notice of termination indicates that Kodric was dismissed in good standing from Manulife and that Kodric was subject to an open investigation by the Mutual Fund Dealers Association (MFDA) and client complaints.

Issues discussed during the OTBH

  1. Although there were many important issues raised during the OTBH, this decision focuses on what in my view were the three primary issues – trading outside category of registration, failure to meet the suitability obligation by recommending a leveraging strategy, and pre-signed forms in client files. 

Trading outside category of registration

  1. Staff argued that Kodric acted outside of his registration with respect to various activities related to Sakha Enterprises Corp. (Sakha), a company involved in gold and timber production in Russia.  Staff also argued that because Kodric’s brother in law worked for Sakha and because he had a personal investment in Sakha, that Kodric was in a conflict position with his clients with respect to Sakha.     
  1. The activities carried on by Kodric with respect to Sakha or Sakha securities (which in my view were all proven) included: 
    1. Putting clients (including AB and CD) in contact with representatives of Sakha for the purpose of investing in Sakha (after calling his brother in law to see if they could purchase securities of Sakha),
    2. Advising clients of his personal investment in Sakha
    3. Informing clients of the ability to sell their securities back to Sakha,   
    4. Delivering client cheques to Sakha for the purpose of purchasing securities of Sakha,
    5. Delivering Sakha share certificates to clients,
    6. Providing client names and phone numbers to Sakha,
    7. Informing clients of a presentation by Sakha and attending that presentation with them,
    8. Providing periodic updates to clients as to the status of their Sakha investment, and
    9. Asking clients if they wanted to purchase additional securities of Sakha or if they knew of anyone that would be interested in buying securities of Sakha
  1. Staff argued that the activities listed in the previous paragraph were outside Kodric’s category of registration and that therefore his conduct was contrary to subsection 25(1) of the Act.  Staff also argued that his acts in furtherance of a trade in the Sakha securities constituted “trading” under subsection 1(1) of the Act.
  1. Kodric’s counsel argued that:
    1. only a small number of Kodric’s clients learned about Sakha through him,
    2. Kodric was clear in his testimony that he neither promoted nor recommended Sakha,
    3. Kodric told his clients that he was not licensed to talk about Sakha nor was he recommending an investment in Sakha,
    4. Kodric’s clients were well aware that his brother in law worked for Sakha, and
    5. Kodric himself had made a personal investment in Sakha.   
  1. In my view, Kodric’s acts as set out above constituted trading under subsection 1(1) of the Act.  Kodric was, at the time, registered as a mutual fund dealing representative which permitted him to trade defined categories of securities only.  Since the Sakha securities were not any of these types of permitted securities, my conclusion is that, by trading in Sakha securities, Kodric acted outside of his category of registration contrary to subsection 25(1) of the Act.  This finding is consistent with the finding in Re Burdo (2014), 37 OSCB 7829.
  1. AB and CD testified that Kodric told them that the Sakha securities would be listed and communicated specific values and time frames for which the values would be met.  Staff argued, and I concur, that these representations were contrary to section 38 of the Act. 
  1. Staff further argued that Kodric did not deal fairly with his clients by facilitating client investments in Sakha at a time when Kodric was personally invested in Sakha and his brother in law was an employee of Sakha.  Staff argued that this conduct demonstrated a failure by Kodric to deal fairly, honestly and in good faith with his clients, contrary to subsection 2.1(2) of OSC Rule 31-505 Conditions of Registration (OSC Rule 31-505), and that Kodric lacked the integrity required for registration under the Act.  I agree.
  1. Both counsel argued about whether Kodric’s activities with respect to the Sakha securities were “outside business activities” which were required to be disclosed to Manulife, under its policies and procedures, and to the MFDA.  I was referred to precedent decisions by Staff and Kodric’s counsel.  Since my decision is that the activities described above were outside of Kodric’s category of registration (and that Kodric therefore violated subsection 25(1) of the Act), my conclusion is that these activities were outside business activities and that they were required to be disclosed.    

Failure to meet the suitability obligation by recommending a leveraging strategy

  1. Staff submitted that Kodric recommended a leveraging strategy to many of his clients (including AB and CD) which involved borrowing against their home equity in order to invest in mutual funds.  In AB’s case, the leveraging strategy involved borrowing $100,000 from his Manulife One account, using those borrowed funds to obtain what is sometimes called a two-for-one loan from a bank (both loans are interest only loans), and then investing the resulting $300,000 in mutual funds.  The mutual fund distributions are used to pay the interest on the loans and any excess distributions (or tax refunds from the strategy) are invested in additional mutual funds.
  1. Staff argued that there was insufficient documented evidence to support that the strategy was suitable for AB and CD in light of their net worth and household income, or that the risks of the leveraging strategy (including what would happen in a declining market or what would happen if the client needed to withdraw from the strategy earlier than predicted) were adequately explained to clients.   In addition, the leveraged amounts for these two clients far exceeded the suitability guidelines set out by the MFDA and Manulife’s policies and procedures. 
  1. Staff argued that Kodric failed to meet the suitability obligation in subsection 13.3(1) of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. Staff also argued that Kodric lacked knowledge and proficiency with respect to Manulife’s policies and procedures and relevant MFDA rules and guidelines with respect to suitability.
  1. Kodric’s counsel argued that Kodric did, in fact, understand the risks of leveraged investing, that he explained the risks of leveraging to his clients, that he had a number of meetings with all clients proposing to use the leveraging strategy, that he employed the leveraging strategy discriminately with his clients, and that Staff inappropriately relied on the evidence of two of Kodric’s 225 clients to support its position.
  1. I agree with Staff’s position on this issue and believe it is supported by the evidence.  For example, it is clear to me that the leveraging strategy was not suitable for AB if, according to a previous voluntary interview provided by Kodric, AB would use his line of credit to make payments in the event that the distributions from the investment were insufficient to fund the loan.  In my view, for at least two of Kodric’s clients (AB and CD), the leveraging strategy was not appropriate, despite any discussions Kodric may or may not have had with these clients regarding the risks of the strategy or the number of meetings Kodric may or may not have had with these clients.  In addition, I do not think that the number of clients Kodric may have put in the leveraging strategy is an important consideration for me to take into account.  The high risk leveraging strategy (as it was described by Kodric) was either appropriate for the clients that were put into it or it was not.  In my view, at least for AB and CD, the leveraging strategy was not appropriate for them based on their net worth, income level, investment experience, investment knowledge, or the ability (or willingness) to lose 100% of the money invested in the strategy.
  1. Staff further argued that Kodric asked clients to sign an indemnity letter with respect to the leveraging strategy in an attempt to shift the responsibility for assessing suitability from Kodric to his clients.  Kodric’s counsel argued that the indemnification language was included to ensure that clients understood the risks of leveraging and that it was not an attempt by Kodric to shirk his responsibilities as a registrant.  With respect, I disagree.  In my view, the indemnification language is clear on its face and Kodric cannot now claim that he was not intending to shirk his responsibilities as a registrant. 

Pre-signed forms in client files

  1. Staff argued that there were six pre-signed signed forms in Kodric’s client files including order entry authorizations, a KYC form and client information change forms.  Staff argued that this was a further example of Kodric’s failure to deal fairly, honestly and in good faith with his clients contrary to subsection 2.1(2) of OSC Rule 31-505 and that this also meant that Kodric lacked the integrity required for registration under the Act.
  1. Kodric’s counsel accepted that “those documents were found in his files” and did not take issue with the fact that “the use of blank forms is prohibited” or with the fact that “blank forms create serious issues for the integrity of the regulatory system”.  Kodric’s counsel argued that Kodric never intended to use pre-signed forms and that it was not his practice to obtain them.  She also argued that when a pre-signed form was inadvertently signed, it was Kodric’s practice to shred the document or to mark it “void”.  Lastly, Kodric’s counsel indicated that the limited instances of pre-signed signed forms does not suggest a pattern of conduct, that Kodric’s testimony demonstrated a clear understanding of the importance of not using pre-signed forms, and that the limited instances of pre-signed forms is not sufficient to justify a permanent refusal of reactivation of registration. 
  1. Both counsel acknowledged that pre-signed forms were found in Kodric’s files and that the use of pre-signed forms is problematic.  What was at issue with respect to the pre-signed forms (and the other two issues discussed above) was whether this misconduct justified a permanent refusal of reactivation of registration.  My views on this point are set out below. 

Reasons

  1. For the reasons set out elsewhere in this decision, my decision is to refuse the reactivation of registration of Kodric. It is my view that, at this time, Kodric lacks the necessary proficiency and integrity to be registered and his registration is otherwise objectionable.  
  1. Kodric’s counsel argued that Staff bears the onus of demonstrating that Kodric is not suitable for registration.  I agree.  In my view, Staff clearly demonstrated that Kodric is unsuitable for registration because he lacks the necessary proficiency and integrity, because he did not act fairly, honestly and in good faith with his clients, and because he did not comply with various provisions of Ontario securities law. 
  1. Kodric’s counsel also argued that Staff did not provide sufficient evidence to support a finding by me that Kodric’s application for reactivation of registration should be permanently refused.  With respect, that was not the question that was before me.  The question before me was whether Kodric’s application for reactivation of registration should be refused at this time.  My decision is that it should be refused at this time for the reasons set out elsewhere in this decision.  The next question is if Kodric again applies for reactivation of registration whether, in my view, that application might be approved by Staff.  My view is that should Kodric decide to apply for reactivation of registration after a period of at least twelve months from the date of this decision, Kodric may be suitable for registration subject to:
    1. terms and conditions (including strict supervision by his sponsoring firm and prohibiting the use of leverage),
    2. Kodric demonstrating remorse for the misconduct set out in this decision, and
    3. Kodric demonstrating that he has taken courses to better understand his obligations as a registrant. 
  1. For clarity, my view is that if Staff is asked to consider a subsequent reactivation of registration application from Kodric (after the twelve month period mentioned above), and the enumerated conditions in the previous paragraph are complied with, Staff should only consider matters or issues that arise subsequent to the date of this OTBH in assessing Kodric’s application. 

 

 

“Marrianne Bridge”, FCPA, FCA
Deputy Director, Compliance Strategy and Risk
Compliance and Registrant Regulation
Ontario Securities Commission
September 22, 2015