JANET MCFARLAND , BOYD ERMAN and KAREN HOWLETT AND TARA PERKINS

From Monday's Globe and Mail

August 11, 2008 at 4:00 AM EDT
In the two years before the asset-backed commercial paper market collapsed, the investment was
undergoing a transformation, morphing not only into a much riskier product but one that would
start to look less out of place on the shelf among a broker's range of products on offer to ordinary
clients.
Regulators failed to notice the change in structure and seemed completely unaware that the asset
class had even found a new market with retail investors.
Susan Wolburgh Jenah, who heads the Investment Industry Regulatory Organization of Canada
(IIROC), said she and her staff had no idea last year that any individuals even held ABCP. To
their minds, it was still a sophisticated product with large institutional buyers as target customers.
It took disaster to strike before they knew what was really happening.
"Back in August, I had no clue," Ms. Wolburgh Jenah says. "I didn't know there were retail
investors, or how many retail investors. Nobody here knew, either ... It took us a long time to
start getting answers to those questions."
Yet IIROC, the regulator for the brokerage industry, now joins the Ontario Securities
Commission and its other provincial counterparts in trying to find their own conclusions to how
it happened. They are soon expected to reveal a proposal to curtail the sale of ABCP to retail
investors.
At the same time, a federal Parliamentary committee has launched hearings, talking to federal
banking regulators and provincial securities regulators as well as numerous angry investors to
understand what went wrong with ABCP and what should be done to prevent it from recurring in
the future.
In the process, the saga's history will be written and lessons offered on how it can be avoided in
the future. What's clear from an investigation by The Globe and Mail, however, is that the
regulators must share the blame and, in fact, may have inadvertently made matters worse.
"My impression is that all of these different agencies are treating this like a hot potato, trying to
pass it to the next agency and saying that they themselves are blameless," says John McCallum,
the senior Liberal on the finance committee in Ottawa.
"With hindsight, there are probably many things that could or should have been done to avoid
this crisis."

Opening the door

Regulators can be accused of more than benign neglect in this story: They helped to open the
door for ABCP to become a retail product, thanks to a quiet rule change in late 2005. That's when
six provinces, including Ontario, removed a long-standing threshold limiting the ABCP market
to investors who could afford at least $50,000 of paper - a standard that was intended to keep
relatively unsophisticated investors out of the sector. All of a sudden, small investors were able
to buy commercial paper created by so-called "third-party companies" like Coventree Inc., which
specialized in the ABCP market and ultimately was destroyed by its collapse.
By last August, industry sources say, many of the least-sophisticated buyers caught in the ABCP
crisis had holdings below the former $50,000 minimum investment limit.
James Turner, vice-chairman of the OSC, said the change was made because regulators felt the
$50,000 threshold was so low that it was not a meaningful restriction for many investors anyway.
The OSC felt the new requirement to have a high credit rating would be a better protection and
with so many ABCP trusts receiving high ratings by DBRS Ltd., the flood gates were opened.
"That was a much more appropriate exemption than just [requiring] units of $50,000," Mr.
Turner said. The rationale for the change was never publicly discussed in 2005. The rule change
was part of a move by provincial securities regulators to have uniform rules across the country.
But to do so, Ontario and five other provinces lowered their standard to match the other
provinces that never had a minimum investment level. The threshold was also lifted in Alberta,
Manitoba, Quebec, Nova Scotia and Prince Edward Island.
In essence, the regulators decided to treat commercial paper issued by special purpose trusts as if
it were similar to more-traditional commercial paper notes issued by blue chip, publicly traded
Canadian companies. Investors were supposed to rely on the rating of an unregulated agency. But
what no one appeared to focus on at the time was that DBRS was the only agency that rated
these notes. Both Moody's Investors Service Inc. and Standard & Poor's Corp. refused to rate
them.
"I know it sounds like all the regulators are ducking responsibility," Mr. Turner said. "But in
terms of what would have prevented this from happening, it was a whole bunch of different
factors. If the subprime problem in the U.S. had never happened, then we probably wouldn't be
here."
Indeed, the ABCP problem was not entirely foreseeable. But there was a pattern that should have
merited closer monitoring.
The OSC was aware by 1999, for example, that there was a rampant trend emerging for simple
debt instruments to evolve into far more risky derivative-backed products. In a report that year, a
high-level task force set up by the commission recommended that investors be given more
information about products that were backed by derivatives.

"The types of debt instruments sold by these issuers have evolved over the years and ... certain
risk and other disclosure is required for investor protection," the report recommended.
ABCP was exempted from the recommendations because it was not seen as a similar derivativebacked product in that era. But within a few years, it too had evolved from plain vanilla
commercial paper sold by creditworthy companies into the same sort of complex derivative
instrument the committee was trying to address in its report.
As it turned out, much of the non-bank paper that froze up during the credit crisis last summer
was the most complex and derivative-based product that existed.
Ms. Wolburgh Jenah, who was previously a vice-chairwoman at the OSC and worked on the
derivatives task force, says in hindsight the task force demonstrated that many exemptions in
securities law need to be regularly re-examined as markets and products change from their
original conception.
She said when ABCP was created as an "exempt" product, no one was thinking it would be
backed by complicated derivatives such as credit default swaps. Regulators, she says, have to
watch how products "morph" along the way.
"Did anybody think about these products when they created that exemption? Are you kidding?
These didn't exist back then." Following a flurry of opposition, some of it coming from the
Canadian Bankers Association which argued the OSC did not have jurisdiction to regulate bank
debt products, the task force's recommendations on debt-like derivatives were not implemented.
Never again
On Bay Street, there is already speculation that new independent ABCP originators similar to
Coventree will emerge fairly soon to fill a gaping hole left in the market.
While big banks are still selling their own brands of ABCP, which never froze up like the
independent paper, the demand for new versions of Coventree comes because there are many
small lenders who need a place to sell assets such as loans. With independent creators like
Coventree gone, there is no way to do that.
The more complicated ABCP - the paper backed by derivatives - is less likely to return any time
soon. In whatever form ABCP returns, the question now is: What will be different next time?
There's no doubt market discipline will play a key role in the future. Investors have been burned
and will demand improvements: clearer disclosure, better-quality assets, clearer guarantees from
banks pledging to support the paper, and better credit ratings.
But for retail investors in particular, a critical part of the solution will also lie in the work of
regulators which are now considering new rules to restrict the retail market.

The Canadian Securities Administrators (CSA), an umbrella group representing all the provincial
securities commissions, is weighing new restrictions for retail investors buying ABCP, in essence
narrowing the wide-open market that was created with the 2005 rule change.
Mr. Turner says one possible solution would be imposing the so-called "accredited investor" rule
for ABCP. That would mean ABCP could only be sold to individual investors if they meet
criteria (such as having up to $5-million in total assets) designed to limit a product's sale to those
people with a greater level of financial sophistication.
Despite the work under way to tighten up the sale of ABCP, however, the OSC is making no
admissions that it was a mistake to have removed the $50,000 threshold in 2005.
When asked whether the decision was wrong in hindsight, OSC vice-chairman Larry Ritchie
repeatedly stressed that it was the role of the brokerage firms to determine whether ABCP was
suitable for each client.
"The more complicated a product, the more there is an obligation for the people selling and
recommending it to fully understand what it is," he said.
The final response to the ABCP crisis, however, may prove the most frustrating for some
investors. While IIROC has launched some investigations of how ABCP was sold to retail
investors, no individual or firm has so far faced any disciplinary action for improperly selling
ABCP to people for whom it was an unsuitable investment.
And it is unclear whether anything will emerge. Ms. Wolburgh Jenah warns it may be difficult to
pursue cases once retail investors are repaid their funds.
"One of the practical issues we have is that, historically, when people get their money back,
sometimes they lose interest in pursuing the complaint. You want to go to a hearing and have a
witness say, 'This is what the broker told me or this is what happened to me.' It's hard when you
don't have that."
PROPOSED REFORMS
Canadian Securities Administrators will soon propose new rules requiring more disclosure of
details about ABCP products for investors, and is mulling an accredited investor rule that would
make their purchase impossible for many investors. As well, the committee is also planning to
seek new powers giving securities commissions the ability to regulate credit rating agencies.
IIROC has conducted its own "compliance sweep" to consider whether new rules or standards
are needed for ABCP sales. A key issue to be addressed is the product review process that goes
on within brokerage firms to assess whether new or evolving investments such as ABCP are
being adequately reviewed before being sold to retail clients. Brokerages such as Canaccord say
the industry itself will have to be diligent to rely on more than ratings before selling a product to
retail investors. "If you can't get the level of disclosure that you may need," says Canaccord CEO
Mark Maybank, "you may not be able to sell that product."

Purdy Crawford, chairman of the Pan-Canadian Investors Committee for the Third-Party ABCP,
says he would like to see more co-operation between the Office of the Superintendent of
Financial Institutions and IIROC, which could combine their expertise in reviewing financial
products, and such areas as capital and liquidity requirements. "These meetings probably need to
happen at a more senior level."
Globe and Mail Update
August 8, 2008 at 9:18 PM EDT
Ordinary ABCP investors told The Globe and Mail their stories of investing in the ABCP market
that seized up a year ago. Here is a sampling of their comments:
...
I was told T-bills of this size were not always available, but these investments were just as good
and always available. This was seasonal money that was needed for the farm bills during the
year.
- D.F. McIvor
...
My 73-year-old illiterate mother got invested into ABCP unbeknownst to her or myself, as a
Canaccord broker placed her safe' money into it without checking or explaining.
- Serge Biln
...
I recently sold my property and had approximately $600,000 to invest. I was looking for
something that was 100 per cent guaranteed and was liquid on short notice. I cannot stress
hard enough how many times I asked him and was assured that my funds were 100 per cent
guaranteed.
- Jack Swann
...
ABCP has been a huge nightmare for my husband Todd and me, to put it mildly. This is all
of our life savings. I am 40 years old and I have been putting money into RRSPs since I was
about 24 or 25. I started out at $50 per month and gradually built from there. My husband and I
don't have much, but this is all we have.
- Keri Lukacs

...
My experience with ABCP started in May, 2007, when my broker at Canaccord Securities
suggested we put our house cash in it for a few months until our new house purchase was
completed.
- Reid Moseley
...
I am 61 years old. This is my life savings. I now have to get a job. This money was for me to
make up my income. My choices to buy a car, take a vacation, do repairs to my house have been
taken from me.
- Iris Pearce
...
I was told ... that this type of investment was just like a T-bill, with the highest credit rating and
fully cashable at any time. When I returned [from a trip] and had the time to invest this cash with
more detailed study, I tried to cash this investment and was told I could not cash it. I soon found
out why.
- Susan Anastas
...
They were sold to me by Canaccord Capital and described very briefly as a safe and secure
investment similar to, and as safe as, a GIC.
- Emanuel Valder
...
If you were say investing in a mutual fund or something like a bank stock, and you knew what
you were buying, you'd know the possibility that it was going to lose money. But in this case, we
weren't informed.
- Alan Jones
...
Forty-one years we have been married, and this was all our savings. Our children depend on it.
Our RRSPs, our savings, everything was in this.