Regulation Services has released a Settlement Agreement between itself and Scotia Capital regarding the continuing David Berry Saga:
Specifically, in the Relevant Period, Berry and McQuillen solicited 39 client orders in 16 new issues during the distribution period at the distribution price. In respect of 15 of the solicitations, on or about the first day of trading, Berry and McQuillen conducted off-marketplace trades in the newly listed shares by selling them short from the Inventory Account at the distribution price. In respect of 24 of the solicitations, the trades to clients from the Inventory Account took place before the security was listed, in the “grey market.” Berry and McQuillen covered their short positions in the Inventory Account by buying shares in the marketplace. The majority of the new issues shares involved in the trading traded in the secondary market at prices lower than the distribution price paid by clients and never reached the distribution price before the short positions in the Inventory Account were covered. The profit to the Inventory Account from shorting the shares was $731,959.00, of which Berry received 20% ($142.792.00) and Scotia Capital received 80% ($571,161.00).
Because the syndication process was by-passed, clients purchased newly listed shares from the secondary market through the Inventory Account. They were therefore not afforded the inherent rights of purchasers pursuant to a prospectus. In addition, the off-marketplace trades were not transparent to other market participants and may have misled other participants as to the true nature of the demand for the shares and affected their subsequent investment decisions.
Specifically, for instance:
Solicitations 4, 5 and 6 – March 2005 – CIBC Series 30 (“CM.PR.H”)
4. On February 24, 2005, Berry and McQuillen solicited an order to purchase from client 1 to buy 100,000 CM.PR.H @ $25.00 per share.
5. On February 24, 2005, Berry and McQuillen solicited an order to purchase from client 2 to buy 15,000 CM.PR.H @ $25.00 per share.
6. On February 24, 2005, Berry and McQuillen solicited an order to purchase from client 3 to buy 75,000 CM.PR.H @ $25.00 per share.
4. On March 10, 2005, client 1 bought 15,000 shares of CM.PR.H @ $25.00 per share in a principal trade with the 08 account.
5. On March 10, 2005, client 2 bought 100,000 shares of CM.PR.H @ $25.00 per share in a principal trade with the 08 account.
The trades were not printed over the TSX.
Feb 24, 2005
Press Release.
Berry and McQuillen solicited orders @ $25.00 per share from client 1 to buy 100,000 shares of CM.PR.H, from client 2 to buy 15,000 shares of CM.PR.H and from client 3 to buy 75,000 shares of CM.PR.H.
Client 3 is the same client referred to in trade 3 above. See Berry’s February 24, 2005 statements to the client in trade 3 regarding the source of the shares.
March 1, 2005
Final prospectus receipted.
March 7, 2005
A buy ticket for client 2 was prepared without quantity, price or symbol by McQuillen. The trade to client 3 was transacted in the grey market and confirmed to client 3 as transacted on this date.
March 9, 2005
A buy ticket for client 1 for 100,000 CM.PR.H @ $25.00 was time-stamped.
CM.PR.H was listed.
March 10, 2005
The buy ticket for client 1 was stamped a second time by McQuillen.
A buy ticket for client 2 to buy 15,000 CM.PR.H @ $25.00 was time-stamped by McQuillen.
The 08 account sold 100,000 CM.PR.H to client 2 @ $25.00.
The 08 account sold 15,000 CM.PR.H to client 1 @ $25.00.
CM.PR.H began trading on TSX; it opened @ $24.00 and closed @ $24.05 with a high of $24.10.
The trades with the clients 1 and 2 did not appear on the TSX trading data.
Profit/Loss
The 08 account was short 190,000 CM.PR.H shares as of March 10, 2005 as a result of selling to these 3 clients.
Throughout the day on March 10, 2005, McQuillen sold short 2,000 CM.PR.H for the 08 account and also bought a total of 249,700, on the TSX, leaving the account with a long position.
The profit to the 08 account on the trading of CM.PR.H was $188,100.
Now, perhaps this just shows my evil nature, but I can’t see what harm was done in this instance that was worth destroying a man’s career. Rules are rules, and it certainly seems from the agreement that RS & Scotia have agreed that they have been broken, but when we look at the Section titled “Effect of the Trading Strategy on Scotia Capital’s Clients and Market Integrity, we see:
In the 15 instances of off-marketplace trades, the syndication process was by-passed and, as a consequence, clients purchased newly listed shares from the secondary market through the 08 account. Because clients did not receive new issue shares from the primary market through the Syndication Desk, pursuant to a prospectus, they were deprived of all the inherent rights afforded to such purchasers.
OK, there’s the right of recission. Big deal. Are there any others? I quite honestly don’t know.
Some clients were aware that they would be receiving shares in the new issue at the distribution price from a transaction with the 08 account which might result in a profit to the 08 account. Some were not.
They got their shares at the price they agreed to pay, which was the same price as the syndication price. There are problems here with the difference between acting as broker and acting as principal, which in some cases can be meaningful … but the harm done in this case seems pretty minor.
The majority of the new issue shares involved in the Trading traded in the secondary market at prices lower than the distribution price paid by the clients and never reached the distribution price before any short positions in the 08 account were subsequently covered. Accordingly, the 08 account profited from its short positions in these shares.
OK. And?
By filling client orders by means of the Trading, Berry was not restricted to the allocation formula or guidelines used by Scotia Capital in the normal syndication process. This increased Berry’s opportunity for profit and generated goodwill from clients.
OK. And?
The overall profit to the 08 account from shorting the shares was $713,959. Berry received 20% of the profit or $142,792. Scotia Capital’s profit was therefore $571,167.
OK. And?
The off-marketplace trades precluded other market participants from seeing those trades printed on a marketplace or organized regulated market and resulted in a lack of transparency to other market participants. Transparency is a cornerstone of the maintenance of market integrity.
Not a good thing. I am not clear on the grey-market rules (I just buy things when I think they’re cheap and sell when I think they’re expensive, but I’m kind of old fashioned that way). It is not clear to me whether a grey-market transaction was possible in such a situation, and what the implications of alternatives are, but I see no real harm arising from this particular case.
Market participants had no knowledge of Berry and McQuillen selling shares in the new issue to clients once the shares opened for trading. They only saw Berry and McQuillen buying the shares, which is consistent with an accumulation strategy. This had the potential to mislead other market participants as to the true nature of the demand for the stock, and affect their subsequent investment decisions.
If there were, in fact, market participants who nodded wisely to each other about ‘Scotia’s accumulation strategy’ and slapped dollars down on the table as a result of this, then the faster those market participants go bankrupt and lose their licenses on grounds of boneheadedness, the better.
David Berry is facing a “Contested Hearing” on this matter (essentially, the same thing as the Scotia Settlement, but re-labelled). It will be most interesting to hear further arguments as to the actual harm caused.
Update : Perhaps somebody with more familiarity with the trading and syndication rules than I can comment on how Berry could have accomodated his clients without falling afoul of the rules … if indeed he did, which has been agreed to by Scotia, but not yet by Berry in his contested hearing.
And, to clarify a bit: my point in not taking umbrage at the conflict is that the clients purchased their shares at the same price everybody else did. There is a definite problem with Berry acting as principal if the client thought he was acting as broker … but on the other hand, Berry was in fact taking on market risk in confirming a sale in the expectations of covering on the market later. It’s not quite the same thing as telling a client that, as broker, you bought shares for him at $25, when in fact you had already bought them as principal at $24.
Another Update: It should be remembered that my background is bonds. Good old fixed income bonds, where it’s understood that everybody deals as principal and if you can make a nickel by bankrupting somebody, your boss will ask you why you didn’t make a dime. There’s one story I particularly remember, from the Euromarket in the late eighties … Merrill Lynch bought more of a new issue than existed and the other dealers, who had gone short in expectations of covering in the open market (just like Berry!) found out they had … er … something of a problem, what with Merrill insisting on either delivery, or a buy-in at a ridiculous price.
Yet another update: I really don’t want anybody to think I’m a scofflaw! I would be much more upset about this situation if, for instance, Berry had sold to his client at $25.10 while I or anybody else was dutifully following the rules and publicly trying to sell at $25.05. But there’s no indication in the settlement that Berry was trading at a price that ignored an extant market … the short was done at $25.00 while every other transaction was done at $25.00 and covered on the open market later on at a lower price. It is possible (and has been agreed by Scotia & RS) that there was some rulebreaking. It’s not clear to me that this is anything other than “Gotcha Regulation” – at least, to the extent that Scotia is taking umbrage at the (alleged) misconduct.