Posted on the Globe & Mail by Andrew Willis:
Regulators finally laid out their case against failed ABCP creator Coventree on Monday, and it's dynamite.
Market watchdogs allege Coventree and the country’s largest investment dealers knowingly dumped toxic investments on their clients. The Ontario Securities Commission is out to make a case that when it came to ABCP, there was grim but realistic information available to market insiders, while a shiny, happy picture was painted for the rest of the investing world.
Canada’s third-party asset-backed commercial paper market fell apart in August, 2007, and Coventree was the biggest creator of this short-term debt. The ABCP meltdown counts as one of the darkest episodes in the history of the country’s capital markets.
More than two years later, the OSC is after Coventree and two of its top executives, Dean Tai and Geoff Cornish, for misleading markets. The OSC is also close to an expected $200-million settlement with banks that were active in the ABCP market.
Coventree and its executives deny any wrongdoing.
In the more sensational element of this case, the OSC alleges that on July 24, 2007, Coventree sent an email to investment dealers that sold its ABCP detailing holdings of U.S. subprime mortgages. It was the first time Coventree had set out exposure to these assets: Three of its creations had more than 15 per cent of assets invested in subprime mortgages. The information was not widely released.
The OSC says that based on Coventree’s unexpectedly high exposure to subprime debt, “certain dealers reduced or temporarily eliminated their market-making lines and adjusted their inventory holdings of Coventree-sponsored ABCP, in order to minimize their exposure to losses in the third-party ABCP market.”
At the same time, in late July, the OSC said credit rating agency DBRS “advised Coventree that it was getting daily calls on US subprime exposure in Canadian conduits and stated that Coventree’s funding capacity might be affected.”
The market continued to function for three more weeks, in part because the Caisse de depot et placement du Quebec stepped up as a major buyer of ABCP. The Quebec fund owned a stake in Coventree, and was the dominant player in this corner of the commercial paper market.
On August 13, the ABCP market collapsed, as investors refused to buy new issues of Coventree ABCP to replace paper that was maturing – exactly the problem DBRS warned was building.
Coventree and its executives intend to fight the regulator’s allegations.
“We are extremely disappointed with OSC staff's decision to commence these proceedings. Led by the Special Committee, Coventree cooperated fully and completely with OSC staff and took significant steps – at a substantial cost to the Company – to cooperate with their investigation,” said Wes Voorheis of Coventree’s Special Committee. “Most significantly, the Special Committee engaged independent legal counsel and other experts and undertook its own investigation into the issues identified by OSC staff. Based on our investigation, we believe the Company and the individuals complied with their obligations under the Ontario Securities Act and that these allegations are unwarranted and unfair in the circumstances.”
For legal junkies, here are the guts of the OSC’s allegations, released late Monday:
(a) Coventree failed to make full, true and plain disclosure in its prospectus by failing to disclose the fact that DBRS had adopted more restrictive credit rating criteria for ABCP in November 2006;
(b) Coventree failed to meet its continuous disclosure obligations by failing to disclose that DBRS’s decision in January 2007 to change its credit rating methodology resulted in a material change to Coventree’s business or operations;
(c) Coventree made misleading statements in April 2007 by telling the market that the total U.S. subprime exposure in its sponsored conduits was 7.4 percent, but failing to provide investors with a breakdown of that exposure by conduit and ABCP note series. The exposure was higher than 15 percent in three conduits, and higher than 40 percent in one note series;
(d) Coventree failed to meet its continuous disclosure obligations by failing to disclose liquidity and liquidity-related events and the risk of a market disruption in the days leading up to the market disruption on August 13, 2007.