Canadian Regulator Mulls Rule Change To Prevent Hedge Fund Sales To Retail Investors

by Carla Johnson, Investors Offshore.com

23 November 2005

The Ontario Securities Commission is considering whether to tighten up provincial securities laws to prevent retail investors from gaining exposure to hedge funds in the wake of the Portus affair.

According to a report in the National Post, the OSC is examining the possibility of removing a regulatory exemption which allows hedge funds to sell to retail investors using principal-protected notes, or PPNs.

PPNs guarantee the investor's principal whilst also passing on any returns made by the underlying hedge fund. However, using something called the 'bank-debt exemption,' large banks or financial institutions can issue debt without filing a prospectus. This exemption also means that PPNs aren't subject to accredited-investor rules, which stipulate that hedge funds must only sell to high-net-worth investors with appropriate investment experience.

Commenting on the possible rule change, OSC vice-chairman Paul Moore told the National Post that: "We're very much aware that this would be a dramatic, but perhaps appropriate, step."

However, he added that: "We just have a concern that the bank-debt exception was never designed to allow hedge funds to be sold."

It is alleged that the Toronto-based hedge fund Portus Alternative Asset Management, which has left some 26,000 investors out of pocket following its collapse earlier this year, used a PPN guarantee by the French banking group Societe General.

The Ontario Securities Commission is also said to be preparing to attack some of the 1,000 financial advisers who put their clients into Portus.

Many of the advisers concerned have said they are willing to return principal amounts to investors, or return commissions to the receivers of Portus, KPMG. Manulife Securities International Ltd, which referred many clients to Portus, has guaranteed the principal investments of those clients, providing C$40m in its accounts for that purpose.

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