Re: 1/25/02 - Financial Post: And yet another one bites the dust, TK merges with Research Capital, and none too soon; Research Capital to merge with Thomson Kernaghan, $3B in customer assets
And yet another one bites the dust
TK merges with Research Capital, and none too soon
Derek DeCloet
Financial Post
[picture]
Mount Sinai Hospital
(MARK) VALENTINE: not aboard at RCC
And so another small independent brokerage disappears from Bay Street. It would be easy to lament the demise of Thomson Kernaghan & Co. Ltd., which will be merged into Research Capital Corp. TK, while small, has a lineage that predates the First World War; it was one of the longest-running independent firms on the Street.
More recently, the firm became known for trading and underwriting speculative technology stocks, which is no place to be in this market. So, chalk up TK as just another helpless victim of the tech crash, you know, it's just so sad ....
Or is it?
Yesterday's announcement by the two firms called it a merger. It looks more like a rescue of a firm drowning in a morass of self-inflicted problems.
Rumours began circulating almost two years ago that Thomson Kernaghan was operating on the knife-edge of financial trouble. By last spring, it was under attack on several fronts from unhappy clients. It has faced at least eight lawsuits in recent years over its financing of small companies, most particularly over TK's use of so-called "death spiral" deals. Death spirals are convertible debenture financings in which the debenture holders receive an increasing number of shares as the stock price falls. In practice, they are designed so the financier can profit even if other shareholders get crushed by a plummeting stock. Which is what usually happens.
Meanwhile, a private hedge fund run by Mark Valentine, TK's cocksure chairman, was besieged by investors who wanted to get their money out. The fund plunged in value after the tech crash, but was so illiquid that Mr. Valentine could meet only a fraction of the redemption requests.
(The hedge fund, too, was being sued because of convertible debentures.)
Then there's the sorry tale of Chris Morgis, a former TK client who claims that someone at the firm took US$20,000 from his account without authorization and has never returned it. Mr. Morgis, a wealthy investor who says he lost 70% of his money in two months following the advice of a TK broker, has filed a $5.75-million lawsuit against the firm; it alleges, among other things, that the firm had little or no grasp of the margin position in his account at times -- allowing him to continue trading when his margin debt levels were far above the regulatory limit.
Mr. Morgis notified the authorities about the missing money, but the police have laid no charges. TK has filed a statement of defence in which it says it did nothing wrong; it calls Morgis "the author of his own misfortune."
But Mr. Morgis's case has prompted an investigation by the Investment Dealers Association of Canada into TK's supervision of the broker, according to documents obtained by the Financial Post.
Plenty of brokerage firms get sued and investigated by the IDA. It's part of the business. But Mr. Valentine's obstreperous denials merely added to the impression that Thomson Kernaghan was in turmoil. (He did not return phone calls yesterday.)
Perhaps that's why Research Capital made a point yesterday of assuring the Street that the new firm will be a paragon of virtue -- and why the insolent Mr. Valentine will not be joining it.
"Research Capital will possess the financial strength to continue making the investments in technology and regulatory compliance now required by investors and regulatory agencies," the company said in a statement. "Our goal is to create an organization ... that will attract the best investment advisors to a culture founded on the highest standards of ethics, integrity and regulatory compliance."
These things usually don't need to be so explicitly stated. Who would want to do business with a brokerage firm that aspired to low standards of ethics and integrity?
Without question, after the Yorkton Securities Inc. debacle, the cost of compliance is growing. No one feels the pinch more than small independent dealers like Research and TK. The independents are already suffering from a prolonged market malaise and the major banks' rising clout in the securities business.
Investors need alternatives to keep the banks honest, and there is still a place in Canada for independent brokerage firms. You could argue, perhaps, that good independents are needed more than ever.
But after Yorkton, they've got to play clean. Thomson Kernaghan played with its elbows up. Now it's gone, and it's hard to imagine anyone will miss it.
ddecloet@nationalpost.com
nationalpost.com
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Research Capital to merge with Thomson Kernaghan
$3B in customer assets
Sinclair Stewart
Financial Post
Research Capital Corp. has agreed to merge with rival brokerage Thomson Kernaghan & Co. in a bid to become one of Canada's largest independent investment dealers.
The new company, which will retain the Research Capital name, brings together two firms of roughly equal size with a combined $3-billion in customer assets and 180 retail advisors.
A spokesman for the companies said the marriage was driven by the need to devote greater resources to increasingly costly compliance practices and to invest more heavily in technology.
"You don't have to be a dummy to realize that [with] Enron and the various Yorkton [Securities Inc.] issues, the investing public and the regulatory agents are going to require firms to invest more in regulatory compliance," said Pat Howe. "I think part of where they're driving at is to get some more scale so that you can do more things and so that you can be more responsive to the marketplace."
Mr. Howe declined to offer details on the executive structure of the merged entity but confirmed that Mark Valentine, chairman of Thomson Kernaghan, will not join the company.
Instead, he will continue to oversee Thomson Kernaghan's Nasdaq trading operation, which is not being folded into the new structure and will now operate independently. Mr. Valentine could not be reached for comment.
Mr. Valentine, a youthful executive who joined Thomson Kernaghan in 1994, has witnessed his share of controversy at the firm over the past year. After his hedge funds tumbled during the market meltdown, unitholders began scrambling for redemptions at a pace the fund could not maintain. Other investors took the firm to court, while the Investment Dealers Association of Canada has launched an investigation into allegations money was taken out of a client's account without authorization.
"It's a weird mix," remarked one observer, who described Research Capital as a mainstream small-cap broker, while Thomson Kernaghan has a reputation of being more willing to dabble in speculative plays. "Who's who in the zoo is going to be interesting to watch."
Neither Patrick Walsh, chief executive of Research Capital, nor Lee Simpson, CEO of Thomson Kernaghan, could be reached for comment yesterday. In a joint statement, the two executives said they aimed to focus their efforts on "the under-served corporate mid-market" with a combination of private client, investment banking, research, and institutional sales and trading capabilities.
Peter Brown, chief executive of Canaccord Capital Corp., Canada's largest independent dealer with 673 licensed brokers, attributed the merger to the increasing market penetration of the country's five major banks, and suggested the dwindling numbers of privately owned shops could ultimately strangle the small-cap market.
Groome Capital Inc. and Rampart Securities Inc. were each swallowed last year by Desjardins Securities Inc., a subsidiary of the Mouvement des caisses Desjardins, Quebec's largest financial institution. Vancouver-based Goepel McDermid Inc. was purchased by U.S.-based Raymond James in 2000. Yorkton Securities Inc., in a rebuilding phase after ousting its chief executive and striking a settlement with securities regulators, is also said to be seeking an investment partner, although its principals have insisted they are not looking to sell the firm.
"It's marginalizing all these small retail firms and forcing consolidation and mergers. There may be too few participants to have a viable small-cap market in Canada," said Canaccord's Mr. Brown. "Complicating it also, and one of the barriers to entry, is the massively complex regulatory burden that has been created in Canada -- it's just a nightmare. Only big banks and big-cap companies can deal with that regulation."
Given that the markets have been slow to rebound from their doldrums this past fall, it does not appear that the pace of consolidation will ebb any time soon.
"It confirms what we predicted would happen," said Ian Russell, senior vice-president of capital markets at IDA. "The trend will continue toward further consolidation in the industry and it will continue for some time."
In a recent report, the IDA suggested many of its smaller members may be forced to sell or merge because of an economic downturn that has riven brokerage revenue and crimped profit margins. He pointed out that smaller firms with an emphasis on retail sales are particularly vulnerable when capital markets are weak, since they lack the scale to absorb significant fixed costs in such areas as compliance.
sstewart@nationalpost.com
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