BCSC paints PI as a cornucopia of client crooks
B.C. Securities Commission *BCSC
Wednesday October 9 2002 Street Wire
Also National Bank of Canada (The) (NA) Street Wire
by Brent Mudry
British Columbia Securities Commission enforcement director Sasha Angus delivered a scathing regulatory indictment of Pacific International Securities in his opening remarks on day three of the commission's landmark hearing into the controversial Howe Street brokerage. Beneath the facade of respected management and a credible compliance department, Pacific International was little more than a massive stock and money laundering conduit which attracted and serviced scores of criminals, securities violators and other dubious American clients to circumvent American regulations and laws, if Mr. Angus is to be believed.
The BCSC launched its prosecution against Pacific International on July 10, 2001, capping an extensive two-year investigation with a notice of hearing alleging the brokerage attracted far more than its Howe Street share of stock crooks, accommodated numerous securities violators and felons, including Sholam Weiss, recently extradited from Austria to Florida after fleeing an 845-year prison sentence, did too little to review their trading and failed to kick them out or take other reasonable steps to protect the public.
The respondents included nine officers or directors of Pacific International, led by chairman Max Meier, Larry McQuid and Germain Carriere, the president and chief operating officer of parent National Bank Financial. Mr. Carriere settled with the BCSC on Sept. 6, agreeing to a $5,000 fine and several admissions, conceding that the brokerage's compliance deficiencies and "some" of the OTC Bulletin Board trading by its non-resident clients gave a black eye to Howe Street's "reputation."
Mr. Angus minced few words in his opening. "This case is a sorry example of what can happen when a firm and its directors care more about money than ethics. It is a case about what happens when a firm and its directors care more about credit than compliance. In short, this is a case about greed creating a culture of non-compliance."
In response, defence counsel Don Sorochan suggested that nothing could be farther from the truth. Mr. Sorochan praised his clients: Pacific International, founder and chairman Mr. Meier and five other current and former officers and directors. (Senior executive and former compliance head Larry McQuid is represented by defence lawyer Mark Skwarok.)
"In this case we have people (P.I.'s directors) who have demonstrated impeccable judgment in other areas," Mr. Sorochan told the hearing. "These people, the respondents are well respected in the community."
Mr. Sorochan stressed that his fine clients followed, and must be judged by, only the laws of Canada. "Not the laws of the United States or the laws of Korea or the laws of the Taliban." (Despite Mr. Sorochan's facetious suggestion Tuesday that 22-1/2 boxes of missing evidence might have been found in a cave in Afghanistan, there is no suggestion that Pacific International had any clients among the Taliban.)
Continuing with this peculiar terrorism theme, Mr. Sorochan repeatedly invoked the case of shoe bomber Richard Reid, without mentioning the Al Qaeda sympathizer by name, arguing it is totally unfair to hold Pacific International to any new standard of vigilance in hindsight. "Prior to the man getting on the plane with the running shoes to blow up the plan was it reasonable to have airport screeners tell everybody to take off their shoes?" Mr. Sorochan asked. (Prosecutor Mr. Angus is placing a strong emphasis on KYC, or know your client, expectations.)
According to Mr. Sorochan's defence scenario, Pacific International and its senior management had not the faintest clue their firm was such a popular magnet for U.S. rogues, they were shocked and appalled when they belatedly found out their best clients, who generated the lion's share of the firm's trading and commissions were anything but fine upstanding people, and they did everything they could to prevent or shut down abusive promotions laundered through scores of accounts at their firm.
"It was not an operation that was run in some chaotic way," Mr. Sorochan told the hearing. "It was a highly organized regime where the board of directors met regularly." Mr. Sorochan pointed out that an inscrutable local regulator, the much maligned former Vancouver Stock Exchange, passed muster on Pacific International and rival Howe Street brokerages in annual operations audits, and never sniffed out the rot that the BCSC now claims permeated his brokerage client.
Wednesday's hearing kicked off with a heated but ill-fated bid by Mr. Sorochan to shut down the whole case because of the alleged abuse of process by commission staff in settlement discussions this summer. This motion, the final prehearing application mounted by defence counsel, quickly evolved into a highly personal sparring between Mr. Sorochan and Mr. Angus, capped by the latter's reference to a Monty Python comic character, Spiny Norman, a "homicidal hedgehog" with which Mr. Sorochan was unfamiliar. Mr. Angus also expressed frustration that he only received full notice and materials on this abuse-of-process attack from Mr. Sorochan after 7:30 Tuesday night, two days after the hearing was set to start.
Although the terms of the proposed summer settlement were never disclosed, Mr. Sorochan's submissions suggested the BCSC was seeking total fines of several million dollars and unspecified suspensions. Mr. Sorochan repeatedly told the panel that commission staff sought fines "substantially in excess of the maximum penalties" set down in the Securities Act, either the old fine cap of $100,000 per person or the new cap of $250,000 per person and $500,000 per company.
Under the new caps, the total tab could be $2.25-million, based on a $500,000 fine for Pacific International and $250,000 each for the seven remaining individual defendants. Although Mr. Angus stressed that he holds Mr. Meier and Mr. McQuid to be the directors most responsible for Pacific International's debacle, the panel did not hear if equal, or scaled fines, were contemplated for all the defendants.
Mr. Angus vigorously argued that all settlement discussions, by their nature and enshrined in case law dating back to the 1830s, are without prejudice, and thus protected from disclosure. The BCSC enforcement head also argued that the panel would obviously be tainted if they heard or reviewed any evidence on the settlement negotiations.
Mr. Sorochan was prepared to tender an affidavit sworn by Richard Thomas, a Pacific International in-house lawyer, recounting the negotiations, but he conceded he had not yet sought a privacy waiver from Gary Snarch, counsel for National Bank Financial executive Mr. Carriere, who reached an individual settlement last month and is no longer part of the case.
Mr. Sorochan vigorously argued that no without-prejudice protection applies, as commission staff negotiated in bad faith by demanding fines in excess of statute. In a peculiar choice as his sole bad-faith case precedent, Mr. Sorochan cited a case in which one party threatened to reveal the illegitimacy of a child during some sort of settlement negotiations.
Mr. Angus wasted little time setting waste to Mr. Sorochan's application by subjecting it to ridicule. "That is the threat? If you don't settle with us (for a higher amount) we will take you to a hearing which will fine you less?"
"This reminds me of a famous Monty Python skit about a homicidal hedgehog named Spiny Norman," Mr. Angus told the hearing. In this skit, Mr. Norman and his bumbling gang of misfit hoodlums first held a gun to the head of passersby, demanding they take all the gang's money. "This didn't work too well, as they lost a lot of money," Mr. Angus recounted.
In the second attempt, the hedgehog gang threatened passersby not to take the gang's money. This was also a flop. The gang finally got it right on their third try, when they threatened passersby to hand over their own money, and got rich.
"Mr. Sorochan's arguments are in the nature of the first two of Spiny Norman's threats. Take our money or we'll kill you. Then don't take our money or we'll kill you. Finally, give us money or we'll kill you," Mr. Angus told the panel.
The prosecutor further attacked the defence lawyer's arguments. "It is like a dandelion blowing across the field. It is nonsensical."
Mr. Sorochan rose to defend his quickly-crumbling abuse-of-process motion. "My friend talks about Prickly something or other -- I don't know what that was all about," he told the hearing. Across the aisle, the helpful prosecutor lightly whispered, "Spiny Norman."
After hearing this rare repartee of comic relief between the jousting lawyers, the panel summarily dismissed Mr. Sorochan's abuse-of-process motion. "Those settlement discussions are not relevant to the hearing before us and we will not hear Mr. Sorochan's applications," stated panel chairwoman Adrienne Salvail-Lopez.
With this final defence motion shot down in flames, prosecutor Mr. Angus at last launched his opening remarks, which were hardly flattering.
"In the spring of 1996, Jean Claude Hauchecorne, one of the top revenue producers at Pacific International, was summoned to New York by two of his biggest clients. They met in a hotel room and what happened there was shocking.
The two clients, Phil Abramo and Phil Gurian, entered the room with two other men. These men were armed. Gurian and Abramo accused Hauchecorne of stealing $1.7-million. They threatened to kill him if the money wasn't returned.
Hauchecorne was quite rightly scared for his life. Abramo and Gurian were apparently high-ranking members of the Mafia," stated Mr. Angus in his opening. (All figures, like most of P.I.'s numerous dubious client accounts, are in U.S. dollars.)
Mr. Hauchecorne returned to Canada, waited a few weeks while he tried to resolve his pickle with his offshore-account Mafia clients, and then told his boss Mr. Meier about the hotel room encounter.
"At this point you might have expected Mr. Meier, the president and CEO of a brokerage firm, to stop and wonder how one of his top brokers could be involved with the Mafia and to do all he could to root it out and stop it. (BCSC) Staff would have expected Mr. Meier to order a firm-wide investigation immediately of the situation to determine if any other similar non-resident accounts were linked to persons with unsavoury backgrounds," Mr. Angus told the hearing.
Instead, no one at P.I. did anything to beef up compliance until much later. "No one thought to look into other similar non-resident accounts to check the background of the people P.I. was dealing with, or the activity which was going on in the accounts. If they bothered to look, they would have discovered that many of their clients were criminals and that they appeared to be laundering money through accounts at P.I.," Mr. Angus told the panel.
The figures the BCSC enforcement head presented demonstrated just how deep this client rot extended, and how crucial these dubious clients were to the firm's profits.
According to a BCSC analysis, the commissions earned by Pacific International from accounts trading in U.S. stocks grew from $2.3-million in 1993 to about $19.2-million by Dec. 31, 1999, including trading done on a spread basis by brokers Dirk Rachfall and Michael Patterson, who were lured to Seattle by the Federal Bureau of Investigation, arrested, convicted and jailed for dealing with other Mafia-linked clients.
"This increase in commissions grew over the years and was concentrated in a few brokers in P.I. Approximately 15 out of P.I.'s then 85 registered representatives generated 82 per cent of that increase. By December 31, 1999, approximately 67 per cent of P.I.'s total commission revenue came from this source. Of this $19.2-million, 80 per cent came from non-resident accounts. P.I. as a firm and those who worked there, including the directors and officers, profited handsomely from this trading," stated Mr. Angus.
The BCSC prosecutor notes that P.I.'s clients attracted an amazing amount of interest from regulators. Between Feb. 9, 1995, and May 12, 1999, there were 77 formal investigation inquiries made by the BCSC for information on client accounts. An additional 35 inquiries were made by VSE personnel between Dec. 1, 1995, and Nov. 5, 1998. BCSC staff also made "numerous inquiries" since June, 1999. This was the second pivotal date for P.I., when Mr. Rachfall and Mr. Patterson were arrested.
In addition, a total of 19 American criminal indictments, dated between October, 1996, and April, 2001, targeted P.I. clients, and five of these indictments specifically mentioned P.I. as a stock or money laundering conduit. Six of the indictments were issued after June, 1999, relating to a handful of dubious Pacific International clients: Wolf Weisse, Richard Gladstone, Hunter Adams, Marka Yagalla, Gerald Burns and Wayne McMullen.
P.I. was also closely watched by the United States Securities and Exchange Commission. The U.S. regulator issued complaints against 18 P.I. clients between February, 1996, and August, 2001.
"Many of the accounts which we will be reviewing with the panel in this case were owned, operated by, or were associated with persons who had unsavoury backgrounds, either because they had been charged or were convicted of fraudulent behaviour or securities offences, or they had other regulatory histories," Mr. Angus told the panel.
"There were some 55 accounts associated with 41 different individuals with criminal or regulatory histories."
Mr. Angus also notes that almost all of these dubious accounts were cash accounts, not margin accounts, yet Pacific International allowed its clients to run significant debit balances, largely for early settlement.
"Staff reviewed 11 particularized accounts for significant debit balances. The maximum debit balance in three of these accounts exceeded $1-million. The maximum debit balance in four of the accounts exceeded $700,000. The maximum debit balance in the other four accounts exceeded $390,000. These 11 accounts were, on average, in a significant debit balance 50 per cent of the time. That is only 11 out of all the accounts at P.I.," stated Mr. Angus.
The prosecutor notes that these U.S. clients circumvented American rules, in which brokerages carrying client debits must subtract this from their regulatory operating capital.
Stock transfers in and out were also a highlight at Pacific International, particularly in OTC Bulletin Board issues. BCSC staff picked a sample of 28 accounts for review. "The occurences of this behaviour was a staggering 1,073. The total dollar value of the stock was $175-million. This, we say, is highly suspicious activity, which could not and should not have gone unnoticed by P.I.," Mr. Angus told the panel.
Another problem area involved stock sales proceeds transferred to third parties. "In other words, the proceeds were not being sent to the persons who supposedly sold the shares. Staff reviewed 22 particularized accounts for third-party sale proceeds and found an amazing 777 such occurrences totaling an incredible $66-million. This, we say, is highly suspicious activity which could not and should not have gone unnoticed by P.I.," Mr. Angus told the hearing.
The prosecutor also raised the spectre of money laundering, citing examples of cash being transferred in and out of accounts with little intervening trading activity. "There would be no economic reason for opening an account to do this, except, of course, to hide the transaction in some way. To launder the money."
BCSC staff reviewed seven sample accounts for this type of activity and found 97 transactions totaling over $12-million. "Again, this is conduct which the staff say is highly suspicious and which could not and should not have gone unnoticed by P.I. It is, in our submission, apparent evidence of money laundering. The evidence will show that these issues were brought to the attention of a number of directors, particularly Mr. McQuid and Mr. (Jean Paul) Bachellerie, but nothing was done," stated Mr. Angus.
Account screening deficiencies are another area of concern. The BCSC claims Pacific International sometimes opened accounts lacking important information including client verification procedures required by Proceeds of Crime legislation and by the account opening rules of the stock exchange and the Investment Dealers Association of Canada. In some cases, accounts were opened, trading took placed, and the accounts were closed before the client verification procedures were completed.
"In fact, by June, 1999, when the merry-go-round came to an end and a series of indictments were issued which embarrassed even P.I. into action, there were over 3,000 unverified accounts at P.I. P.I. seeks to reduce this number by saying that some were inactive and some had merely minor information not required. But the fact is that P.I. took almost a year after June, 1999, to reduce the unverified accounts to a manageable level, even though they had four people working on the problem for a substantial period of time," Mr. Angus told the panel.
Stock distributions were yet another focus of BCSC investigators, as Pacific International clients frequently disposed of U.S. shares back into the U.S. market. In 18 sample accounts, staff found 39 million shares sold back into the U.S., valued at about $24-million. "P.I. failed to consider whether the shares that were coming up into the accounts either by physical certificates or by being journaled in electronically, had not come from distributions in the U.S., and were being illegally sold, because the shares were subject to restriction," stated Mr. Angus.
"There will be evidence from P.I. about how poor the transfer agent system is in the U.S. and how it can be manipulated. Notwithstanding that, P.I., without regard to these problems, of which it appears to have been aware, allowed this kind of trading to occur without reviewing it," the prosecutor told the panel.
(Mr. Sorochan later described one unrelated case he worked on, in which a U.S. transfer agent "run out of a strip mall next to a used hubcap operation purported to cancel millions of shares," causing a short squeeze.)
The last major focus of alleged abuses was in the field of short selling. "Many of P.I.'s U.S. clients were heavily involved in short sales. Staff reviewed ten particularized accounts for short sales. The total dollar amount of the month-end short positions in these accounts was approximately $72-million. In the month of June, 1999, alone there were 669 short sale trades totaling over $23-million," Mr. Angus told the hearing.
"The evidence will show that the short sales done in U.S. markets from the P.I. accounts were naked shorts. That is, they were not covered in any way at the time the short sale was entered into. The evidence will also show that short selling of that nature is illegal in the U.S. and was a major reason why many of P.I.'s clients were trading at P.I. They were there, to the knowledge of P.I., to trade into the U.S. in defiance of American trading rules. They assisted knowingly in a breach of American trading rules. P.I. condoned that and grew fat on it."
After detailing this litany of suspicious account activities, Mr. Angus then blamed Pacific International's officers and directors for doing nothing to intervene.
"By not acting properly as gatekeepers, they put B.C.'s capital markets fundamentally at risk. At best, the evidence will show, the directors hid their heads in the sand. At worst, they ignored every warning sign they saw."
"It is our position that the persons who bear the greatest responsibility here were Messrs. McQuid and Meier. Mr. McQuid was the senior officer most directly responsible for compliance at P.I. Mr. Meier, to whom Mr. McQuid reported, was the chief executive officer at the material time and was the person who truly ran the firm," stated Mr. Angus.
In opening rebuttal, Mr. Sorochan defended Pacific International and its directors, especially compliance head Mr. McQuid.
"It (P.I.) is proud to have hired Larry McQuid, whose expertise was nationally recognized. This is man who served in the RCMP Commercial Crime squad, and also served with Vancouver Stock Exchange enforcement," Mr. Sorochan told the panel.
"If a brokerage wanted a patsy, is this the man you would hire?" Mr. Sorochan praised Mr. McQuid, a former cop, as "someone who has seen crooks in action."
bmudry@stockwatch.com
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