The Canadian Investment Regulatory Organization (CIRO) is sanctioning both Yujie (Jared) Liu and BMO Nesbitt Burns Inc., after Liu failed to determine the suitability of a strategy he used with clients and after the firm failed to implement supervisory controls to govern trading in certain client accounts.

In the settlement agreement with both parties, CIRO enforcement staff agreed to an $80,000 fine for Liu. It ordered he disgorge some fees and commissions that were not already paid out to affected clients, amounting to $63,258, and ordered him to successfully complete the Conduct and Practices Handbook course before reapplying for registration with the regulator. (Liu is currently employed by the firm in a non-registered capacity.) Liu also agreed to pay costs in the amount of $5,000.

BMO Nesbitt Burns, meanwhile, agreed to a fine of $1.5-million, a disgorgement of fees and commissions in the amount of $146,876 and costs in the amount of $50,000.

Strategy involved short selling bonds 

Beginning in 2015, Liu engaged in a trading strategy that involved clients investing in preferred shares, which evolved into clients borrowing to invest in preferred shares. “Instead of using conventional margin, this strategy involved short selling government of Canada (GOC) bonds – in many cases, 30-year bonds – and using the proceeds of shorting the GOC bonds to invest in preferred shares,” the settlement agreement with Liu and BMO Nesbitt Burns states.

Liu reportedly failed to explain to clients the incremental risk created by shorting the long-term bonds to invest in preferred shares. “Further when prevailing interest rates declined in October and November 2018, Liu failed to advise his clients in a manner that was adequately responsive to the change in market conditions.” 

BMO Nesbitt Burns, meanwhile, permitted the accounts to be overweight in fixed income investments, relative to the asset allocations reflected in know-your-client (KYC) documentation. “Further, BMO Nesbitt Burns failed to consider the risk of the portfolio as a whole and failed to give due consideration to the increased risk associated with the combination of the two constituent elements of the strategy.” 

In addition, they say the firm’s system allowed a significant buffer before requiring supervisory action, in some cases requiring risk tolerances to be off by more than 20 per cent before requiring action.

Accounts declined in value 

The 16 client accounts engaged in the strategy experienced an aggregate decline in value of approximately $38.7-million from October 2018 to May 2019. Supervisors did not perform calculations to determine the suitability of leverage in the client accounts; in at least 10 instances, the supervisors approved KYC updates when the account’s holdings exceeded at least one of the leverage ratios the firm’s policies cautioned against exceeding. The settlement agreement documents a series of other instances where supervisors did not implement or follow up with plans for dealing with identified risks.

Of the 16 accounts identified, all suffered losses ranging from 31.5 per cent, up to 79.8 per cent. 

“Prior to March 2019, 15 of the 16 client accounts were consistently overweight in fixed income securities by more than 20 per cent compared to the account’s targets,” they state, adding that although exceptions appeared on monthly reports, these were not queried by supervisors.

“In short, BMO Nesbitt Burns failed to implement a system of supervision and controls in respect of the trading activity in the client accounts that was adequate.” 

Clients received compensation 

The settlement agreement notes that owners of 12 of the client accounts have received compensation for their losses as a result of civil litigation. The disgorgement amounts ordered include the fees and commissions paid by owners of the four remaining accounts which did not commence litigation or receive compensation.