Globe and Mail article
See globeinvestor.com :
When brokers are promoters
by Jacquie McNish and Richard Blackwell - Saturday, April 29,
2000
Toronto -- Bay Street's leading technology financier Scott Paterson
has built a fortune for himself and a close group of associates by
privately investing in stocks ahead of his clients at Yorkton
Securities Ltd.
His practices have sparked a vigorous debate in the investment
community over whether officials such as Mr. Paterson, Yorkton's
chief executive officer and vice-chairman of Canada's venture
exchange, the CDNX, can play multiple roles as investors,
investment advisers and corporate insiders without damaging
investor confidence in the stock markets. More seriously, Mr.
Paterson's aggressive promotion of a company in which he is a
stockholder has brought him under regulatory scrutiny.
Mr. Paterson and his lawyers say his transactions with seven
companies fully comply with applicable securities regulations. "I
have zero tolerance for anyone who breaks the law," he said.
There is no suggestion that Mr. Paterson has broken the law with his
private investments. But his transactions in some of the seven
companies indicate that the line between his role as an investment
banker and personal investor can sometimes be blurry.
An investigation by The Globe and Mail reveals that Mr. Paterson,
other Yorkton officials including research director Roger Dent,
family, friends and an assortment of influential businessmen began
privately buying stock in shell companies for pennies a share in the
mid-1990s. Each of the seven companies tracked by The Globe
were named after Mr. Paterson or a family member.
Mr. Paterson and some of his associates played multiple roles in
some of these ventures as directors, executives and investment
advisers. As the ventures matured into publicly traded companies,
they directed most of their lucrative underwriting and advisory fees
to Yorkton. In turn, Yorkton blessed the companies by
recommending the stock to clients and issuing glowing research
reports, sometimes the only available analysis on the companies.
Yorkton gave an added boost to their stock prices in the early days
by dominating trading in their shares.
Some regulators and other industry leaders oppose such extensive
involvement by brokerage staff in publicly traded companies
because it raises questions about a firm's regulatory obligation to act
in the best interests of investors.
"Where you have a firm which is in control of the entire piece from
start to finish. . . . There are just so many personal and corporate
interests that are conflicted in these circumstances that we think it
creates a dangerous vehicle for the creation of any public company,"
said Michael Watson, director of enforcement at the Ontario
Securities Commission.
At the centre of the debate is Mr. Paterson, a brash, raspy-voiced
dynamo who at the age of 36 is determined to buck establishment
standards. If he is unable to motivate staff with personal investments
in client stocks, he says Canada will lose the race to finance
technology startups. So far, his practices have transformed Yorkton
from a marginal brokerage firm into a high-tech financial powerhouse
by raising seed money for such winners as Open Text Corp. and
Certicom Corp.
For example, securities and corporate documents show Mr.
Paterson bought 460,000 penny stock units in a nearly dormant shell
the same month that Yorkton helped the shell initiate merger
discussions with video games reseller GTR Group Inc. When the
merger was announced three months later, the value of Mr.
Paterson's stock soared.
In some of the companies, Yorkton officials, research staff or
former executives became corporate insiders when they were named
directors or executives. John McMahon, chairman of EcomPark
Inc. since 1998, is one of Mr. Paterson's closest friends and until
last year a senior Yorkton official. The former roommates now sit a
stone's throw from each other in glass offices on the 31st floor of
Toronto's BCE Place.
Last month, a subsidiary of EcomPark paid Yorkton a variety of
finders and advisory fees for helping to arrange a merger with a shell
company. Mr. Paterson was a large shareholder in the shell.
Mr. Paterson says he is above criticism because he discloses his
holdings when he is required to do so by securities rules and he still
owns most of his shares. In addition, Mr. Paterson says, personal
investments by brokerage officials are the way of the future in the
technology sector because they motivate staff to back risky startups.
"This is where the world is heading. Our business model is that we
have to be aggressive as it relates to our ability to be a principal," he
says. "I can't motivate [my staff] to focus on small transactions
unless [they have] the opportunity to participate as a principal."
Indeed he is so convinced he's right that he is lobbying regulators at
Canada's five-month-old venture exchange to ease recent restrictions
against personal investments by brokerage staff in junior capital
pools.
While other mid-sized firms such as Vancouver's Canaccord Capital
Corp. allow personal investments by staff in private stock issues in
which the firm is an underwriter, most major brokerage houses ban
employees from such purchases.
"We would not allow our people to be private equity investors in a
company ahead of an initial public offering that RBC Dominion has
a role in," said Chuck Winograd, president of RBC Dominion
Securities and chairman of the Investment Dealers Association of
Canada. "Under no circumstances can our people be buying or
selling stock ahead of our clients."
Added Jeff Orr, chief executive officer at BMO Nesbitt Burns:
"There is an explicit policy against our professionals making any
type of equity investment in a client company ahead of a financing."
Some industry leaders say the controversy over employee purchases
at such firms as Yorkton could undermine confidence in a stock
market that has already been severely shaken by overheated
technology stocks.
"People who are outside the Yorktons, as we are, are concerned
about the perception," says Dan Sullivan, deputy chairman of Bank
of Nova Scotia's investment arm and chairman of the Toronto Stock
Exchange.
Any perceived conflicts, he says, "erode investor confidence in our
markets and it hurts all of us across the board."
Despite his conviction that Yorkton is in the right, Mr. Paterson
conceded the controversy is prompting the brokerage firm to tighten
its disclosure rules and reconsider policies relating to personal or
so-called "pro-trading" in client stocks. Last month Yorkton hired
Alan Schwartz to oversee the changes.
"I've become the poster boy for pro-trading," laments Mr. Paterson.
"I hadn't thought through the degree to which we might be
criticized."
Fuelling the debate about Yorkton's practices is the mixed
performance of some of the six companies he has promoted. The
stock prices of Book4Golf.com Corp. and EcomPark have
plunged 72 and 70 per cent respectively in the past six weeks. Part
of the decline can be attributed to the investor stampede from
Internet stocks, but another factor is failed expectations.
Book4Golf, an Internet golf reservation portal that at its peak had a
total market capitalization of $315-million, has several times delayed
its promise to offer on-line reservations at golf courses in the United
States and Canada. It now says it can't deliver on-line golf
reservations until next month. Despite EcomPark's rapid ascent -- at
one point it was CDNX's most valuable company -- it's just one of
many players in a field crowded with dozens of so-called Internet
incubators, which raise capital for Web-based startups.
Securities regulators began to enquire about Mr. Paterson's activities
last month when he boasted to a Vancouver Sun reporter that
Book4Golf's stock, which he personally owns, would soar above
$100 a share. At the time of Mr. Paterson's comments, Book4Golf's
stock price had fallen 80 per cent from its high of $21.10 on the
CDNX.
Investment officials are prohibited by securities laws from making
promises about the future direction of a stock price. Mr. Paterson
confirmed that he has been approached by regulators about his
comments to the newspaper and sources said the British Columbia
Securities Commission (BCSC) is reviewing the matter.
Sasha Angus, the BCSC's director of enforcement, would neither
confirm nor deny an investigation was under way, but he said Mr.
Paterson's comments about Book4Golf "causes us great concern."
Mr. Paterson is unrepentant about his stock boast and at times
seems to be daring regulators to stop him.
In an interview with The Globe two weeks ago, Mr. Paterson said he
was justified in promising a higher stock price for Book4Golf
because he is convinced it will come true.
"I believe that stock is going to $100 a share and if I had four hours,
I'd tell you why," he said. As of yesterday, Book4Golf was still a
long way from Mr. Paterson's lofty target. It closed at $4.15.
Disclosure is seen by the industry as an important vehicle in
protecting the public.
Four years ago, securities regulators raised alarms about conflicts of
interest within brokerages when it was revealed that a group of
investors at Cartaway Resources Corp., a high-flying penny
mining stock that crashed in 1996, played multiple roles as brokers,
investors and promoters.
A key issue in the scandal was brokerage officials' failure to disclose
their personal investments.
In the wake of the scandal, First Marathon Securities Ltd. paid a
record $4.75-million in fines for failing to supervise employees who
participated in the Cartaway promotion. Several First Marathon
employees were also personally disciplined and two former brokers
and some Cartaway officials are still waiting for Alberta and B.C.
securities commissions to rule on charges that they violated
securities laws.
Mr. Paterson says his activities bear no relation to the Cartaway
story because, unlike many of the First Marathon brokers, he
publicly discloses his personal investments. And indeed, a number
of fund managers canvassed by The Globe say they are not overly
troubled about brokerage staff conflicts as long as their interests are
clearly disclosed.
"Yorkton has made a good business out of bringing junior
companies to the market, so the question is when do they step over
the line between profiting from their business and profiting from their
own investments," said Robert Bertram, senior vice-president with
the Ontario Teachers Pension Plan Board.
"If they are acting in more of their own interests as principals when
they are trying to sell something to me and I don't know about it,
then they are crossing the line."
Disclosure, however, can take many forms. Personal investments of
brokerage staff are sometimes buried in the fine print of securities
documents. Even then, individual positions can be difficult to
discern because they are lumped together as total employee
investments.
In other cases, the names of the purchasers of private stock sales are
only available through years-old prospectuses and filings that have to
be ordered from various provincial regulators. Indeed, more than a
year ago the Ontario Securities Commission made it even harder for
investors to track brokerage staff investments in stocks when it
pulled lists of private placement purchasers from the public files.
Some of Mr. Paterson's purchases were made through holding
companies. In April, 1997, securities filings show Ontario-based
Starpat Inc. purchased 600,000 special common share warrants of
EcomPark's predecessor company for 25 cents each. In November,
1997, Alberta-based Patstar Inc. purchased one million common
share units at 15 cents each in Luxmatic Technologies NV,a shell
company that Yorkton guided to a merger with a subsidiary of
EcomPark.
Until it was revealed by The Vancouver Sun last month, few
outsiders knew Mr. Paterson had personally acquired a large block
of Book4Golf's shares. The only prior clue was a one-sentence
footnote in the company's prospectus that said Yorkton employees,
including one executive, had purchased 585,500 shares.
In response to criticism about Yorkton's disclosure, Mr. Paterson
said in an interview that the company intends to tighten its internal
disclosure policies. For example, when Yorkton issues a research
report about companies in which its staff collectively own more than
5 per cent, their holdings will be revealed in the report. "We'll make
that happen immediately," he says.
Although Mr. Paterson says he still holds most of the stock he
purchased through the corporate shells, some of his friends have
scored big by selling their cheap stock at substantially inflated
prices.
"It was nice when it was way up there," says Harry McCullough,
who made hundreds of thousands of dollars by selling more than
30,000 Book4Golf shares at prices ranging between $5 and $15
apiece. "Now," he says, "it's on a losing streak."
Mr. McCullough, a friend of Mr. Paterson and a frequent director on
a number of Yorkton shell companies, including the predecessor to
Book4Golf, paid between 10 and 20 cents a share for his stock. Mr.
McCullough says he would like to have sold more of his remaining
60,000 shares, but as an early insider in the company he is required
by securities rules to hold a portion of his shares in escrow.
Mr. Paterson's relationship with the seven companies dates back to
the early 1990s when he was struggling to build a name for himself
as an investment banker at Midland Walwyn. One of his first
ventures nearly wiped him out.
Using an Alberta Stock Exchange-listed shell company he called
PatCor Capital Inc., Mr. Paterson and a group of investors
acquired cheap stock and raised money from other investors in the
early 1990s to launch a bingo and gambling company called Dion
Entertainment Corp. When the company lost a bid in late 1993 to
run a casino in Windsor, Ont., the company's stock price suffered a
meltdown.
Although Mr. Paterson continued to dabble in Alberta-listed shell
companies, by the mid-1990s his main focus was on Bay Street
where he was attracting attention by helping to advise such
successful technology startups as Leitch Technology Corp. and
Rand A Technology Corp.
When he moved to Yorkton in 1995, he devoted most of his efforts
to building up a team of investment bankers and research analysts to
specialize in emerging technology and biotechnology stocks. At the
time, few investment houses were focused on these so-called
"special situations," but when the Internet craze swept financial
markets, Yorkton was one of the few firms positioned to deliver
coveted technology startups to investors.
When Mr. Paterson was named Yorkton's CEO in 1998, his priority
was to rid the company of its notorious past as a financier of penny
mining companies. Yorkton had been badly tainted by its
involvement with Timbuktu Gold Corp., an Alberta-listed company
that saw $600-million of stock value wiped out in 1996 when it was
revealed that gold assays had been tampered with.
Initially, he said, he planned to terminate Yorkton's use of shells and
pools on the Vancouver and Alberta exchanges as financing vehicles
for companies seeking to raise money to go public. He says he
changed his mind after he had an "epiphany" on a business trip to
Vancouver.
"I woke up in the middle of the night and I called my voice-mail and
left a message. I said, 'Oh my god we are sitting on a gold mine. We
have people that have a skill set that are very unique. They know
how to create these shells, they know how to raise half a million to a
million dollars.' "
And so it was that Yorkton's past as a breeder of penny mining
stocks became the building blocks for a new future raising capital
for pint-sized technology companies. Yorkton's most common
method to raise money for emerging clients is to arrange reverse
takeovers or mergers with shell companies listed on the CDNX. In
conjunction with these transactions, Yorkton earns underwriting fees
by selling new company shares to its growing base of retail
investors.
These days Mr. Paterson says he is "too bloody busy" to invest or
become personally involved in the new ventures Yorkton is
financing. The only shell he has launched into a public company
since he was named CEO in 1998 was Somerville Capital Inc., the
predecessor to Book4Golf.
Despite his busy career, Mr. Paterson has been directly involved in
at least one of his former shell companies. His activities at Patch
Ventures Inc. in recent years illustrates the various roles he plays.
Like most of his shell companies, Patch Ventures started life as a
junior capital pool listed on the Alberta Stock Exchange. Mr.
Paterson and his first wife Karen Albrektsen acquired one million
shares in Patch for pennies each.
A few years after Patch Ventures was launched, it appeared the
company was headed down the same unhappy path as Dion
Entertainment. The company, renamed Legacy Storage Systems
Corp., bet millions of dollars on acquisitions of companies that
specialized in tape-based computer storage systems. As digital
computer technology rendered tape systems obsolete, Legacy found
itself stuck with a white elephant.
By 1998, the company, renamed again as Xencet Investments Inc.,
was still publicly traded, but it had no operations and a large cash
reserve of nearly $10-million from asset sales. The company's luck
changed in May, 1998, when, according to securities documents,
Yorkton introduced a group of investors in video game reseller
Games Trader, the predecessor to GTR, to the management of
Xencet.
Twelve days before Xencet announced on June 3 that it was in
merger discussions with an unidentified company, Yorkton earned
an underwriting fee of $128,037 from Xencet by raising $747,000 for
the cash-rich company by privately selling 1.2 million units including
warrants and shares at 65 cents each. Mr. Paterson purchased 40 per
cent or 460,000 of the units.
When Xencet announced in early August that it was merging with
Brampton-based Games Trader through a reverse takeover, Xencet's
stock soared to 90 cents, giving Mr. Paterson a paper profit of
nearly $200,000. Eight months later that paper profit soared to nearly
$4-million when GTR's stock rose to $5 a share.
Mr. Paterson says he had no prior knowledge of the merger when he
bought the Xencet shares in 1998. He said he had approached the
board of Xencet weeks before the merger discussions were initiated
because "I had lost money" on prior investments in the company
and "I wanted an opportunity to invest again."
Making a killing on cheap stock is only part of the Yorkton story.
Mr. Paterson's complex ties with a number of publicly traded
companies raise troubling questions about his involvement with
some of the companies for which Yorkton acts as a financial
adviser.
Since 1998, Xencet has grown into a successful company with
$32-million in annual sales to a variety of North American retailers
including Blockbuster Entertain- ment Group and Toys "R" Us
Inc. Over the years Yorkton has acted as an adviser and underwriter
in a number of GTR's transactions, but the relationship has been
strained in the past year.
A source close to GTR, who declined to be identified, said Mr.
Paterson became upset in recent months when management did not
agree with his suggestions for two strategic changes. In the past
month, GTR executives watched in horror as the company's stock
price plummeted more than 50 per cent to $2.25 after Yorkton sold
nearly two million of the company's share.
There have been no material corporate changes at GTR, and indeed
shortly before the selloff Yorkton reaffirmed its long-standing
"strong buy" recommendation on the stock, targeting a price of
$7.50 a share over the next year.
Mr. Paterson said he often has clashes with client executives
because "I am very emphatic and vehement about my views and I try
to encourage people to take my advice." However he says Yorkton's
heavy selling of GTR stock is unrelated to the disagreements with
company officials.
Instead he says the firm sold so many shares because its retail
brokers lost interest in the company. "Some of our retail brokers
viewed it as dead money relative to other technology stocks," he
said.
According to sources, GTR's board of directors this week severed
its relationship with Yorkton. Company officials declined to discuss
their relationship with Yorkton, but last night the company issued a
press release stating it had retained RBC Dominion Securities Inc. as
its financial adviser.
A salesman to the end, Mr. Paterson refuses to let any criticism
about him or his company weaken his unyielding conviction that
Yorkton's financial methods are building a bridge to a stronger
economic future for Canada.
"This debate is about Canada and about financing early stage
companies," he says.
"I'm crossing my fingers that it's as big a success story as I think it
will be. I'm very confident that this is one of the best management
teams, one of the best technology stories I've ever seen. I'm
exuberant."
With research assistance from Celia Donnelly.
SOME EARLY STAGE INVESTORS IN YORKTON
PROJECTS
Benjamin Swirsky
Former CEO of multinational steel company Slater Steel Inc.; former
CEO of real estate developer Bramalea Ltd., and former CEO of
commercial real estate firm Horsham Properties Inc. Now chairman
and CEO of Zconnexx Corp. Bought 200,000 special warrants of
Storage One (now EcomPark) at 25 cents each in 1997.
Steve Landry
Marketing executive at Daimler/Chrysler. University friend of Scott
Paterson, served on some Paterson company boards. In 1998
received options for 66,000 shares of Storage One Inc. (now
EcomPark). Mr. Landry said he was asked by Mr. Paterson to get
involved in his companies because of Mr. Landry's business
knowledge. He said he was never a big shareholder in any of the
companies, and he believes he's "probably broken even" on the
investments.
Stanley Beck
Bay street lawyer and former chairman of the Ontario Securities
Commission. Bought 120,000 special warrants of Legacy Storage
systems, now GTR Group Inc., at $1.25 a share in 1995. Mr. Beck
said he purchased the shares through a friend who was working at
Yorkton. He can't recall his profits, but said "it wasn't very much."
Mr. Beck has since closed his Yorkton account.
Brent Belzberg
Chief executive of Toronto merchant bank Horrowston Inc. Bough
100,000 special warrants in Storage One (now EcomPark) at 25
cents each in 1997.
Max Ward
Former bush pilot and businessman. Founder of Wardair which was
absorbed by Canadian Airlines in 1989. Bought 97,000 special
warrants in Storage One In. (now EcomPark) through his
Rockhaven Holdings Ltd. at $1 in April, 1999, and a further 50,000
special warrants at $2.50 in March, 2000.
Joseph Rotman
Chairman and chief executive Clairvest Group Inc. University of
Toronto's school of management is named after him. Amaranth
Resources Ltd., Mr. Rotman's personal holding company, bought
600,000 special warrants in Storage Onc. Inc. (now Ecompark) for
25 cents each in 1997. It held 166,666 shares in Aastra Technologies
as of June, 1999. Mr. Rotman's director of investment strategy said
he would not comment on any personal investments Mr. Rotman has
made. The investments may have been suggested by advisers, or by
Mr. Rotman himself, he said.
PAT WORLD
Scott Paterson's corporate galaxy
DION ENTERTAINMENT - 1992
Formerly: PatCor Capital - 1987
KEYWEST ENERGY
Formerly: Biopat Capital - 1996
AASTRA TECHNOLOGIES
Formerly: Patseek Capital - 1996
GTR GROUP
Formerly: Patch Ventures - 1993
ECOMPARK
Formerly: Storage Express - 1993
EVERYWARE DEVELOPMENT - 1995
Formerly: Patshare Capital - 1996 sold in 1998
BOOK4GOLF.COM
Formerly: Somerville Capital - 1997 (named after Paterson's
daughter) |
