King, Lois Doreen - Settlement Agreement
IN THE MATTER OF
THE SECURITIES ACT
R.S.O. 1990 C.s.5, as amended (the "Act")
AND
IN THE MATTER OF
LOIS DOREEN KING
SETTLEMENT AGREEMENT
I. INTRODUCTION
1. By Notice of Hearing dated February 12 2001, (the "Notice"), the Ontario Securities Commission (the"Commission") announced that it proposed to hold a hearing to consider, pursuant to section 127(1) of theAct, whether it is in the public interest for the Commission to make an order that the Respondent, Lois King(the "Respondent"), have her registration with the Commission terminated and whether she cease trading insecurities permanently or for such time as the Commission may direct.
II. JOINT SETTLEMENT AGREEMENT
2. Staff of the Commission ("Staff") agree to recommend settlement of the proceedings against theRespondent initiated by the Notice in accordance with the terms and conditions set out below. TheRespondent consents to the making of an order against her in the form attached as Appendix A on thebasis of the facts set out below.
III. AGREED STATEMENT OF FACTS
3. The Respondent and Staff agree to and acknowledge the following facts.
4. The Respondent was at all material times registered under the Act as a portfolio management investmentcounsellor with Boulder Management Inc. ("Boulder"), which was in turn registered with the Commission asa Securities Dealer, Investment Counsel and Portfolio Manager. Boulder's chief business was themanagement of four closely held investment funds distributed by private placement (the "Funds"), thesubscribers to which were all sophisticated, high net worth investors. The Respondent owned 51% ofBoulder, and had two other partners in the business, Louise Morwick ("Morwick") and Denise Flick ("Flick").The Respondent was a director of Boulder, and, with Morwick, was primarily responsible for the portfoliomanagement side of the business. Flick was the chief administrator of the firm.
5. The Funds managed by Boulder were intended to profit from "convertible hedging". As the people primarilyresponsible for Boulder's trading, the Respondent and Morwick would cause the Funds to (a) purchaseconvertible debentures and (b) sell short the underlying common stock for those debentures in an amountequal to the face amount of the debentures. At worst, for the Funds, this strategy would result in a profit tothe Funds roughly equal to the amount paid by the debenture less the costs of borrowing the common stocksold short, since the Funds' liability (the common stock), was fully offset by their asset (the debentures),which were exercisable at the option of the Funds. However, the Funds tended to perform best in volatileor bear markets, while they did less well during bull markets.
6. Units in the funds were priced at the close of each month. Subscribers were permitted to purchase orredeem units at month-end only. The market price of the units in the Funds was determined by the value ofthe debentures and the value of the underlying common stock. In general, if the value of the commonshares was high relative to the value of the debentures, the unit values in the Funds would drop.
7. Pricing the Funds at month end was the responsibility of the Respondent. After the close of business onthe last day of each month, the Respondent would get market prices for both the debentures and thecommon shares from a broker at Forum Capital Markets ("Forum"), one of the New York-based dealersused by Boulder. She would then input the prices in two places: Boulder's accounting system andBoulder's inventory cash management system. Morwick would check the prices in the inventory cashmanagement system on the first day of each month, i.e. the morning after the Respondent had input theprices. Morwick did not check the prices in the accounting system (although she and Flick had at all timesaccess to the information), and assumed that the Respondent input the same prices in each system. Theunit prices of the Funds were calculated by Boulder's accounting system.
8. The market price of the common stock was easily ascertainable by Forum since the price at which sharesin those issuers had traded on the various exchanges was easily ascertainable. Determining a marketprice for the debentures was more difficult, since these securities trade on no exchange. Accordingly,Forum would use their expertise and experience, and their knowledge of the market in convertibledebentures, to provide to the Respondent their best estimate of both "bid" and "ask" prices for thedebentures. After the close of business on the last day of each month, Forum would fax a handwritten"pricing sheet" to Boulder, which sheet stated the closing price for the underlying common shares, and thebid and ask price for the debentures.
9. In the normal course, Boulder used the mean between these bid and ask estimates in order to arrive at amarket value for the debentures, which value was used to calculate the market value of units in the Funds.However, for illiquid securities, Boulder policy permitted the Respondent to exercise a discretion to departfrom the mean in setting the market price, given the imprecise nature of the method used for determiningthat value. There were times when some of the debentures might have been described as "illiquid".Accordingly, on occasion, when it was believed by virtue of this illiquidity that the mean of the bid and askprices supplied by Forum did not truly reflect the market, in setting the market price for the debentures (and,ultimately, for the price of units in the Funds), Boulder would depart slightly from the mean of the bid andask and ascribe another value to the debentures which value Boulder reasonably and truly believed betterreflected the market.
10. Many of the common shares which Boulder had sold short were traded on NASDAQ. In the fall of 1999,NASDAQ was particularly bullish. Meanwhile, the market for debentures was flooded with new issues.Accordingly, the market value of units in the Funds dropped dramatically so that they reflected large losses,which losses were unrealized in the Funds owing to the fact that the debentures were fully hedged againstthe underlying securities and could be held until their redemption date. In setting the month end prices forthe debentures (and ultimately for the units in the Funds) in October, 1999, the Respondent departed fromthe mean of the bid and ask prices supplied by Forum and set the market value close to or at the ask pricesupplied by Forum. She did so without consulting or informing her partners or any of the subscribers to theFunds. In November, 1999, the Respondent again departed from the mean and valued the debenturesclose to or at the ask price supplied by Forum. Again, she did so without consulting or informing herpartners or any of the Funds' subscribers. In December, 1999, the Respondent again departed from themean, and for a number of the debentures in the portfolio, set the market value at a price above the askprice supplied by Forum. Again, she did so without consulting or informing her partners or any of theFunds' subscribers. Accordingly, in each of these three months, the value of units in the Funds wasoverstated. These overstatements did not reflect an appropriate exercise of the discretion described in theprevious paragraph.
11. During these three months, the Respondent input the true market prices into Boulder's inventory cashmanagement system and the incorrect prices, which departed from the mean, into the Boulder's accountingsystem. Accordingly, the prices which Morwick checked were accurate. The unit prices produced byBoulder's accounting system were overstated.
12. In January 2000, the Funds' auditors, PricewaterhouseCoopers ("PWC") began their annual audit of theFunds. As part of their work, PWC sought to confirm the market value of the various securities held by theFunds. To the Respondent's knowledge, PWC wished to get a copy of the December 1999 pricing sheetfrom Forum. The Respondent knew that Forum's December 1999 pricing sheet would not conform with thevalues she had attributed to the debentures held by the Funds. The Respondent telephoned Tracy Evert("Evert"), the broker with whom she dealt at Forum, and told her that PWC wanted the December 1999pricing sheet to be sent directly to PWC from Forum. The Respondent told Evert that she had a copy of itin hand and that she would fax it to Evert so that Evert could fax it to PWC. Evert agreed with thisprocedure. She waited for the Respondent to fax the pricing sheet to her and then had her assistant fax itdirectly to PWC. However, the pricing sheet which the Respondent sent to Evert, and which was forwardedto PWC, had been altered by the Respondent before she faxed it to Evert. The Respondent altered thesheet so that it would reflect the prices she had ascribed to the debentures, which was not reflective of thevalue ascribed by Forum or by the market. Evert was not told by the Respondent that her pricing sheet hadbeen altered, nor, apparently, did she or her assistant notice that it had been altered. Evert sent the alteredsheet on to PWC unaware that it was intended by the Respondent to mislead PWC.
13. In addition to checking the prices from Forum, PWC approached another dealer in the United States inorder to confirm that Forum's estimates of the market values of the debentures in December 1999 wereaccurate. It became apparent from the market prices supplied by this second dealer that the numbers onForum's December 1999 pricing sheet did not properly reflect the market.
14. On February 9, 2000, The Respondent overheard representatives from PWC discussing the discrepanciesbetween the market prices supplied by Forum and the second dealer. At that time she realized that herdeception had been or would be discovered. The Respondent immediately wrote a note for her twopartners which reads as follows:
February 9, 2000
Denise and Louise,
- see attached letters. Please send out as soon as possible.
- Sept 30 Pricing - OK - you might want the auditors to check it.
- Need to revalue Oct, Nov, Dec/99 for all funds
*- watch MMGR/AES conversions
I'm so sorry. I really panicked. I don't know how I'm going to live with myself. I may decide not to.
Lois
[Staff and the respondent are agreed that the fourth point in this note (A*- watch MMGR/AES conversions@) isirrelevant to this proceeding.]
15. The note's reference to "attached letters" was a reference to letters written by the Respondent to thesubscribers in the Funds explaining the overstatement. There were three such letters, which togetherapplied to all of the Funds. The letters are dated February 11, 2000 and are essentially identical. Their textreads as follows:
I deeply regret to inform you that the preliminary December 31, 1999 net asset values of [the Funds] havebeen overstated by approximately 20%.
The overstatement has resulted from an error in judgement in the marking to market of unrealized losses inthe portfolio since October 1, 1999. The unprecedented surge in NASDAQ over the past three months hascaused convertible premiums on most positions in the Boulder portfolios to contract sharply. Theunrealized losses have also been impacted by the large number of new convertible offerings, which resultsin the "older" convertible issues becoming less attractive to potential buyers (and hence cheaper).Compounding these two effects is the natural leverage in the portfolio where a 1 point change per $100 pardebenture across all of the fund's positions impacts the bottom line by approximately 10%. Despite theincrease in the unrealized losses during the past few months, I truly believe that any future sharp reversal inNASDAQ will result in the fund recouping these unrealized losses.
I take full responsibility for the under-valuation of these unrealized losses and am resigning from Bouldereffective immediately. I want to state that no other employee or partner of Boulder was aware of the extentof these losses and there were no unauthorized trades.
You have my deepest apology. I will regret my poor judgement forever.
16. The Respondent left the note and the letters for her partners Morwick and Flick. She then left the office.Morwick and Flick immediately informed the auditors and the largest investor in the Funds, and then sentthe letters described and quoted in the previous paragraph to all the Funds' subscribers, subsequentlycalling each of them to explain the situation. The Funds' largest subscriber conducted extensive duediligence on the books and records of Boulder in an effort to understand the depth of the problem createdby the Respondent. PWC engaged in the same kind of investigation.
17. It was discovered that the Funds had been overvalued in the manner described by the Respondent in hernote and letters. No other problems were discovered by the investigations into these matters. PWC wasretained by Boulder to determine whether any subscribers to the funds had paid too much for units in theFunds, or been paid too little on redemptions, on the basis of the overstated unit prices. PWC determinedthat 14 purchasers of units in the funds paid too much for their units. Those investors either acceptedcompensation in the form of more units in the Funds, or rescinded their purchases. These rescissions costBoulder $479,888. Four investors were paid too much on redemptions of their units. Boulder has beenunable to recover all of this money, of which $144,774 is still outstanding. Boulder has had to bear thisloss. Boulder also incurred substantial professional and other costs as a result of the Respondent'sactions, totalling $143,732. In total, Boulder's losses as a result of the overstatement of the units of theFunds was $768,394. In addition, after the Respondent's misconduct was revealed, the value of Boulder'sgoodwill, the number of clients and the amount of funds under management by Boulder all decreasedsignificantly.
18. The Respondent owned units in the Funds. These were redeemed by Boulder in order to cover some ofthe losses described in the previous paragraph. Through this redemption, Boulder retained $393,666 and,by way of settlement agreement, the remainder, $60,000, was paid to the Respondent. The Respondentalso sold her 51% interest in Boulder to her two former partners for 1 dollar. As a result, the Respondentwas released by Boulder from any liability arising from the overstatement of the value of the units in theFunds.
19. The sale of her interest in Boulder at this price, and the redemption of her units in the Funds, represented alarge financial loss for the Respondent. The Respondent estimates her losses as a result of hermisconduct at approximately $800,000.00.
20. In the course of the investigation of this matter, the Respondent was interviewed by Staff. She co-operatedwith Staff's investigation. She admitted her misconduct and expressed deep remorse for it. She instructedher counsel at the earliest stage to engage Staff in settlement discussions of this matter.
IV. ADMISSION
21. By engaging in the conduct described in Part III of this settlement agreement, the Respondent admits thatshe acted in a manner contrary to the public interest.
V. TERMS OF SETTLEMENT
22. The Respondent agrees to the following terms of settlement:
(i) pursuant to paragraph 1 of subsection 127(1) of the Act, the Respondent's registration will be terminated;
(ii) pursuant to paragraph 2 of subsection 127(1) of the Act, the Respondent will cease trading in securities fora period of three years effective February 9, 2000, with the exception of trading in personal accounts held inher name only or for the account of her registered retirement savings plan (as defined in the Income TaxAct (Canada)); and
(iii) pursuant to paragraph 6 of subsection 127(1) of the Act, the Respondent will be reprimanded by theCommission.
VI. CONSENT
23. The Respondent hereby consents to an order of the Commission incorporating the provisions of theparagraph 22 above in the form of an order annexed hereto as Appendix A.
VII. STAFF COMMITMENT
24. If this settlement is approved by the Commission, Staff will not initiate any complaint to the Commission orrequest the Commission to hold a hearing or issue any other order in respect of any conduct or allegedconduct of the Respondent in relation to the facts set out in this agreement.
25. If the Respondent reapplies for registration with the Commission at any time after February 9, 2003, Staffwill not oppose the Respondent's application by reason only of the facts set out in this agreement and/orthe Commission's order resulting from this agreement.
VIII. WAIVER
26. If this settlement is approved by the Commission, the Respondent waives her right to a full hearing of themerits of this matter and waives her right to any rights of judicial review or appeal of order made by theCommission in accordance with this agreement.
IX. PROCEDURE FOR APPROVAL OF SETTLEMENT
27. Approval of the settlement set out in this agreement shall be sought at a public hearing of the Commissionscheduled for February 19, 2001, or such other date as may be agreed to by Staff and the Respondent inaccordance with the procedures described in this agreement.
28. Staff and the Respondent agree that if this agreement is approved by the Commission, it will constitute theentirety of the evidence to be submitted to the Commission in this matter.
29. Staff and the Respondent agree that if this settlement is approved by the Commission, no party to thisagreement will make any public statement inconsistent with this agreement.
30. If, at the conclusion of the settlement hearing, and for any reason whatsoever, this settlement is notapproved by the Commission or an order in the form attached as Schedule 'A' is not made by theCommission:
(a) each of Staff and the Respondent will be entitled to all available proceedings, remedies and challenges,including proceeding to a hearing respecting the facts set out in this agreement, unaffected by thisagreement or the settlement negotiations;
(b) the terms of this agreement will not be referred to in any subsequent proceeding, or disclosed to anyperson, except with the written consent of Staff and the Respondent or as may be required by law; and
(c) the Respondent agrees that she will not, in any proceeding, refer to or rely upon this agreement or thenegotiation or process of approval of this agreement as the basis for any attack on the Commission'sjurisdiction, alleged bias, appearance of bias, alleged unfairness or any other remedies or challenges thatmay otherwise be available.
X. DISCLOSURE OF AGREEMENT
31. Counsel for Staff or for the Respondent may refer to any part or all of this agreement in the course of thehearing convened to consider this agreement. Otherwise, this agreement and its terms will be treated asconfidential by all parties to the agreement until approved by the Commission, and forever if, for any reasonwhatsoever, this settlement is not approved by the Commission, except with the written consent of allparties or as may be required by law.
32. Any obligations of confidentiality shall terminate upon approval of this settlement by the Commission.
XI. EXECUTION OF AGREEMENT
33. This agreement may be signed in one or more counterparts which together shall constitute a bindingagreement.
February 12, 2001.
_________________________________
LOIS DOREEN KING
_________________________________
MICHAEL WATSON
DIRECTOR, ENFORCEMENT
FOR STAFF OF THE ONTARIO SECURITIES COMMISSION
APPENDIX A
IN THE MATTER OF
THE SECURITIES ACT
R.S.O. 1990 C.s.5, as amended (the "Act")
AND
IN THE MATTER O
LOIS DOREEN KING
ORDER
(Subsection 127(1))
WHEREAS on February 12, 2001, the Ontario Securities Commission (the "Commission") issued a noticeof hearing pursuant to subsection 127(1) of Act in respect of Lois Doreen King (the "Respondent");
AND WHEREAS the Respondent entered into a settlement agreement dated February 12, 2001 (the"Settlement Agreement") in which she agreed to a proposed settlement of the proceeding, subject to the approval ofthe Commission;
AND UPON reviewing the Settlement Agreement, and upon hearing submissions from counsel for theRespondent and for Staff of the Commission;
AND WHEREAS the Commission is of the opinion that it is in the public interest to make this Order;
IT IS ORDERED THAT:
(1) the Settlement Agreement dated February 12, 2001, attached to this Order, is hereby approved;
(2) pursuant to paragraph 1 of subsection 127(1) of the Act, the Respondent's registration is terminated;
(3) pursuant to paragraph 2 of subsection 127(1) of the Act, the Respondent will cease trading in securities fora period of three years effective February 9, 2000, with the exception of trading in personal accounts held inher name only or for the account of her registered retirement savings plan (as defined in the Income TaxAct (Canada)); and
(4) pursuant to paragraph 6 of subsection 127(1) of the Act, the Respondent is hereby reprimanded.
February 19, 2001.
"Howard I. Wetston" "J. A. Geller" "Theresa McLeod"