OSC probing Bay Street dealsShares may have been sold early
Special warrants under scrutiny
RICK WESTHEAD
BUSINESS REPORTER
Opening a new front in its crusade against abusive stock trading practices, Canada's main securities regulator has begun probing several hundred cases involving large Bay Street investors who bought discounted shares before they were offered to the general public.
The Ontario Securities Commission is looking at nearly 400 cases dating back to Jan. 1, 2000, in which companies have raised millions of dollars through the sale of so-called special warrants - discounted shares that are available to a limited group of large institutional investors.
Proceeds from the cut-rate share deals are often used by the companies to pay down debt that's coming due or to finance an acquisition. The eventual sale of the new shares floods the market and typically drives down a company's stock price.
Michael Watson, the OSC's director of enforcement, said the regulator is investigating whether money managers who were offered the chance to buy special warrants used information gleaned from sales presentations to trade shares in the company trying to raise money.
Some fund managers, the OSC alleges, sold the companies' stock before the private-placement deals were finalized and disclosed publicly.
"It shouldn't come as a surprise that when you have information that guarantees you a profit, that is insider trading," Watson said in an interview.
He said there are several ways fund managers may have used inside information to take advantage of special warrant offerings. For instance, a company with shares trading at $10 and needing to raise money might offer recipients the chance to buy special warrants at $9 a share.
Fund managers could sell their existing shares of the company for $10 each, realizing they could replace their current allotment with $9 shares, making a profit of $1 a share. Portfolio managers could also use inside information from so-called road shows even without agreeing to buy into the special-warrant offering, Watson said.
The fund manager could borrow shares of the money-raising company from a third party. In a practice known as short selling, the fund manager would sell the borrowed shares at the current market rate, replacing them with lower-cost shares from the special-warrant sale.
Joe Groia, the OSC's former director of enforcement who's now in private practice, said trading abuses involving special warrant offerings can be tied to the prolonged six-month time frame involved in gaining regulatory approval.
Yet Groia contends the OSC may have a hard time proving that trading on the knowledge of a special warrant offering constitutes insider trading.
"If you know that Air Canada is going to file for bankruptcy protection, that's a serious material change," Groia said. "But if you only know that they're going to do a financing, you don't know how the market will react."
In at least some instances, fund managers agree to subscribe to special warrant offerings before they know the per-share price, Groia said.
The OSC is trying to winnow down the number of special warrant offerings it will probe. Watson said the regulator is focusing on offerings in excess of $250,000 and only on those involving institutional investors. The OSC also plans to look for unusually high volume trading of companies in the days immediately before they've announced special warrant offerings, he said.
Watson said the OSC hasn't sent out any requests for documents from fund companies because the investigation is in "its early stages." The OSC has already discovered several instances of "suspicious trading" but wouldn't name targets of its investigation.
Watson wouldn't say how many investigators have been assigned to the probe. He said investigators plan this week to present their case against a mutual fund firm he declined to name, and another case is as many as three months away from being disclosed.
The OSC has the ability to bar fund managers and their respective firms from trading again and can levy fines of up to $1 million. The regulator can also file a quasi-criminal charge if the allegation is serious enough.
The sale of special warrants is relatively common.
In the past year, for instance, Ivanhoe Energy Inc. raised $15.8 million through the sale of the security, while Samsys Technologies Inc. garnered $13.2 million and Bolivar Gold Corp. raised $53.3 million. No fund managers who hold a stake in those companies have been accused of wrongdoing.
Frequently criticized because it appears the OSC is less aggressive in pursuing securities abuse than the U.S. Securities and Exchange Commission, Watson noted this is an instance when Canada's main securities regulator is ahead of the Americans.
Last week, the Wall Street Journal reported the SEC is several months into a probe of hedge funds that may have used insider information to profit from pending stock offerings, similar to the allegations the OSC is probing.
"We're often criticized for riding on their coattails, so it was nice to tell my boss this was a case where we were actually ahead of the Americans."
Watson's comments come a month after the OSC reached a settlement with a salesman at investment dealer Paradigm Capital, the dealer itself, and a portfolio manager at the Royal Bank's mutual fund arm, RBC Global Investment Management.
The OSC alleges that in October, 2001, Paradigm was hired to sell $10 million worth of special warrants in Bioscrypt Inc., which makes devices that read fingerprints. Paradigm official Patrick McCarthy allegedly contacted RBC portfolio manager Eden Rahim, who already controlled 1.5 million shares in the Mississauga-based company.
Rahim subsequently agreed to buy $2 million of the offering, and allegedly agreed to sell $1.02 million worth of RBC's existing position to Paradigm, which had other funds prepared to buy at that price. RBC would be guaranteed a quick $60,000 profit, by selling a block of shares for more than it would pay to replace them. Paradigm stood to earn trading commissions.
According to settlement terms reached with the OSC last month, Paradigm, McCarthy and Rahim were reprimanded and fined a collective $145,755.