Notice to Public. Contested Hearing. Northern Securities Inc., Victor Alboini, and Christopher Shaule. October 20, 2005 No.

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1 Notice to Public Contested Hearing October 20, 2005 No Suggested Routing Trading Legal and Compliance Northern Securities Inc., Victor Alboini, and Christopher Shaule Relevant UMIR Provisions 5.2(1) 6.2(1) (4) Summary At a date to be determined, a contested hearing will be held at RS, 145 King Street West, 9 th floor, Toronto to determine whether Northern Securities Inc. (NSI); Victor Alboini, Chairman, President and Chief Executive Officer of NSI; and Christopher Saule, former Chief Compliance Officer at NSI, contravened the Universal Market Integrity Rules. The hearing will be open to the public. The date of the hearing will be published once it is determined. Links Notice of Hearing Statement of Allegations Schedule A Questions / Further Information For further information or questions concerning this notice contact: Jane P. Ratchford Chief Counsel, Eastern Region Telephone: Fax: jane.ratchford@rs.ca

2 NOTICE TO PUBLIC Northern Securities Inc., Victor Alboini, & Christopher Shaule October 20, 2005 IN THE MATTER OF THE UNIVERSAL MARKET INTEGRITY RULES AND IN THE MATTER OF NORTHERN SECURITIES INC., VICTOR ALBOINI AND CHRISTOPHER SHAULE NOTICE OF HEARING TAKE NOTICE that commencing on a date to be determined, Market Regulation Services Inc. ( RS ) will hold a hearing pursuant to Part 9 of Policy 10.8 of the Universal Market Integrity Rules ( UMIR ) at the offices of RS, at145 King Street West, 9 th Floor, Toronto, Ontario. The hearing is open to the public. THE PURPOSE OF THE HEARING is to determine whether Northern Securities Inc. ( NSI ), Victor Alboini ( Alboini ) and Christopher Shaule ( Shaule ) (Hereinafter collectively referred to as the Respondents ) have contravened the following Requirement of UMIR, by reason of the allegations set out in the Statement of Allegations annexed as Appendix A hereto and such additional allegations as counsel may advise and the Hearing Panel permit: 1. NSI RS alleges that: (a) Between January 2003 and August 2005, NSI failed in numerous respects to comply with its trading supervision obligations, contrary to UMIR 7.1(1) and Policy 7.1 of UMIR. (b) On several occasions between March 2004 and August 2004, NSI made purchases of the shares of Transglobe Corporation and Ontzinc Corporation while these securities were on NSI s grey list, in violation of NSI s own policies and procedures, contrary to UMIR Rule 7.1(2)(b) and Policy 7.1 of UMIR. NP Northern Securities Inc., Victor Alboini &Christopher Shaule, October 20, 2005

3 NOTICE TO PUBLIC Northern Securities Inc., Victor Alboini, & Christopher Shaule October 20, 2005 (c) On December 22, 2003, NSI conducted an improper off-marketplace trade, contrary to UMIR 6.4. (d) On December 22, 2003, NSI failed to comply with its best price obligation to a client, contrary to UMIR 5.2(1). (e) On 37 occasions in the period October 2003 to October 2004, NSI failed to properly mark trades to identify them as client or inventory trades, as the case may be, contrary to UMIR 6.2(1). 2. Alboini RS alleges that: (a) Between January 2003 and August 2005, Alboini failed in numerous respects to comply with his trading supervision obligations as President and Chief Executive Officer of NSI, contrary to UMIR 7.1(4). (b) Between April 28, 2003 and August 2005, Alboini, as the sole member of the NSI Board of Directors, failed in numerous respects to comply with the trading supervision obligations of a board of directors, contrary to UMIR 7.1(1) and Policy 7.1. (c) Between March 2004 and August 2004, Alboini engaged in conduct which resulted in NSI contravening UMIR 7.1(2)(b) on several occasions, for which he is liable pursuant to 10.3(4). NP Northern Securities Inc., Victor Alboini &Christopher Shaule, October 20, 2005

4 NOTICE TO PUBLIC Northern Securities Inc., Victor Alboini, & Christopher Shaule October 20, Shaule RS alleges that: (a) Between November 2003 and May 2005, Shaule failed to comply with his trading compliance obligations in numerous respects, contrary to UMIR 7.1(4). AND TAKE FURTHER NOTICE that if the Hearing Panel finds that the Respondents have contravened the Requirement above, the Hearing Panel may impose one or more of the following orders under UMIR 10.5: 1. a reprimand; 2. a fine not to exceed the greater of: (a) (b) $1,000,000 per contravention of a Requirement; and, an amount equal to triple the financial benefit which accrued to the Respondent as a result of committing each contravention. 3. a restriction, suspension or revocation of access to the marketplace for such period and upon such terms and conditions, if any, considered appropriate; and 4. any other remedy determined to be appropriate under the circumstances. AND TAKE FURTHER NOTICE that under UMIR 10.7 the Hearing Panel may assess the expenses incurred by RS as a result of the investigation and proceedings resulting in the order. AND TAKE FURTHER NOTICE that the Respondents have the right to appear and be heard at the hearing. Under Section 9.1 of UMIR Policy 10.8, the Respondents are required to serve a Reply. If the Respondents fail to serve a Reply, or to attend or participate at the hearing, the Hearing Panel may proceed with the hearing on the matter on the date and at the time and place set out in this Notice of Hearing without further notice to the Respondents and in their absence, and the Hearing Panel may accept the facts alleged or conclusions drawn in the Statement of Allegations as having been proven and the Hearing Panel may impose any one or more of the penalties or remedies authorized by UMIR and assess expenses as authorized by UMIR. NP Northern Securities Inc., Victor Alboini &Christopher Shaule, October 20, 2005

5 NOTICE TO PUBLIC Northern Securities Inc., Victor Alboini, & Christopher Shaule October 20, 2005 DATED at Toronto, Ontario this 20 th day of October, Market Regulation Services Inc. 145 King St. W. Suite 900 Toronto, Ontario M5H 1J8 Jane P. Ratchford Chief Counsel and Manager of Investigations Investigations and Enforcement, Eastern Region Telephone: Facsimile: To: Northern Securities Inc, Victor Alboini and Christopher Shaule c/o Jeffrey Kaufman Fasken Martineau DuMoulin LLP TD Bank Tower P. O. Box 20 Toronto-Dominion Centre Toronto, Ontario M5K 1N6 Telephone: (416) Fax: (416) NP Northern Securities Inc., Victor Alboini &Christopher Shaule, October 20, 2005

6 APPENDIX A IN THE MATTER OF THE UNIVERSAL MARKET INTEGRITY RULES AND IN THE MATTER OF NORTHERN SECURITIES INC., VICTOR ALBOINI AND CHRISTOPHER SHAULE STATEMENT OF ALLEGATIONS I. REQUIREMENTS CONTRAVENED 1. RS alleges that Northern Securities Inc. ( NSI ) contravened Rules 5.2(1), 6.2(1), 6.4, 7.1(1) and 7.1(2)(b) and Policy 7.1 of the Universal Market Integrity Rules ("UMIR"). 2. RS alleges that Victor Alboini ( Alboini ) contravened Rule 7.1(1) and Policy 7.1 of UMIR in his capacity as the sole member of NSI s Board of Directors between April 28, 2003 and August 2005, Rule 7.1(4) and Policy 7.1 in his position as President and Chief Executive Officer of NSI in the Relevant Period (defined below) and that in 2004, he engaged in conduct which resulted in NSI contravening Rule 7.1(2)(b) of UMIR, for which he is liable pursuant to Rule 10.3(4) of UMIR. 3. RS alleges that Christopher Shaule ( Shaule ) contravened Rule 7.1(4) and Policy 7.1 of UMIR between November 2003 and May The text of the relevant Requirements is set out at Schedule A. Page 6 of 46

7 II. THE FACTS RELIED UPON Overview 5. In the period January 2003 to August 2005 (the Relevant Period ), NSI failed to implement an effective trading supervision and compliance system as required under Rule 7.1 and Policy 7.1 of UMIR. 6. NSI failed to make the implementation of such a system a priority for most of the Relevant Period. Instead, NSI s priorities were focused on the integration of two other securities dealers which NSI purchased in late 2002 and early 2003, and on dealing with serious member regulation issues. In addition, in the spring of 2004, NSI began building an institutional sales division. 7. RS conducted trade desk reviews ( TDR ) in the fall of 2003 and 2004, which found: insufficient supervision of trading practices and procedures and compliance testing practices; UMIR deficiencies, most notably related to audit trail and order entry designation; and, trading by the firm in securities when such securities were on the firm s grey list, in contravention of the firm s own policies. Many of the 2004 TDR findings were repeat findings from the 2003 TDR. 8. On October 15, 2004, after the completion of the 2004 TDR, NSI was informed that the findings would be referred to RS Investigations and Enforcement. 9. RS s investigation of NSI began in November 2004 and NSI was informed of the investigation by letter dated November 2, In August 2005, RS conducted its 2005 TDR at NSI. While the 2005 TDR found some improvement in NSI s testing procedures and other compliance and supervision issues, several notable deficiencies identified in the previous TDRs remain including: Page 7 of 46

8 insufficiently documented compliance testing procedures and the failure to adequately document internal testing; and, continued UMIR deficiencies relating to audit trail and order entry designation. 11. RS s investigation disclosed that during the Relevant Period, NSI failed to undertake several important supervision and compliance duties required by Rule 7.1 and Policy 7.1 of UMIR and violated several other UMIR Rules, as follows: (a) (b) For the period January 2003 to July 2003, NSI failed to conduct compliance testing for purposes of Policy 7.1. For the period August 2003 to August 2005, NSI has provided inadequate evidence of compliance testing for purposes of Policy 7.1. The results of the reviews that were conducted by NSI were not quantified or summarized and there is limited backup material kept on record to evidence how the reviews were conducted and whether there was follow up on issues identified during testing. This is of particular concern for the Vancouver office where the evidence of testing is extremely limited and fails to establish that sufficient compliance testing was being conducted. (c) NSI failed to conduct the required quarterly testing under Policy 7.1. (d) (e) (f) NSI did not have a proper training program in place during most of the Relevant Period nor was Shaule, who became Chief Compliance Officer in October 2003 or Gary Mulder and George Magill, who conducted the majority of the compliance testing for purposes of Policy 7.1, sufficiently trained in relation to UMIR Requirements to adequately and effectively carry out their respective duties. There was confusion between Shaule and Mulder concerning Mulder s responsibilities for compliance testing. There was no formal process to escalate compliance issues found during compliance testing. Page 8 of 46

9 (g) (h) (i) (j) There was no annual review of the supervision system and no formal reporting of compliance and supervision issues to NSI s Board of Directors, which was comprised primarily of Alboini during the Relevant Period. There was a serious wash trading problem created by several of NSI s proprietary traders from October 2003 to October 2004, all of which went undetected by NSI s compliance department because it was not testing for possible wash trading in proprietary accounts in this time period. There were instances where NSI violated the firm s policies relating to grey list trading, contrary to Rule 7.1(2)(b). There were also compliance failings regarding follow-up where potential grey list trading was detected. NSI violated UMIR 5.2(1), 6.2(1) and 6.4, relating to best price, order entry designation and an off-marketplace trade, respectively, all of which went undetected by NSI s compliance department. 12. During the investigation, Alboini, the President, the Chief Executive Officer and sole member of the Board of Directors of NSI since April 2003, admitted he was the steward of NSI and in charge of detecting and preventing violations. The facts herein establish that he failed to fulfill these roles, contrary to UMIR 7.1(1), 7.1(4) and Policy 7.1. Alboini also engaged in conduct which resulted in NSI contravening Rule 7.1(2)(b) regarding grey list trading for which Alboini is liable pursuant to Rule 10.3(4). 13. Furthermore, because Alboini has been the only member of the Board of Directors of NSI since April 2003, the firm lacked the ability to address deficiencies in the firm s trading supervision and compliance system through the actions of other Board members when Alboini falied to fulfill his duty as steward of the firm. 14. Shaule was Chief Compliance Officer from November 2003 to May He had no prior experience in market-related compliance. He was not conversant with NSI s own policies and procedures or UMIR, and demonstrated a lack of knowledge as to the type of testing his compliance staff was conducting and which staff was responsible for what testing. As such, he failed to fulfill his compliance supervision obligations, contrary to UMIR 7.1(4) and Policy 7.1. Page 9 of 46

10 Corporate structure 15. NSI is a Participant and is a wholly owned subsidiary of Northern Financial Corporation ( NFC ), which is a publicly listed company. 16. On December 20, 2002, NFC purchased all of the assets of Georgia Pacific Securities Corporation ( GP ) and by February 1, 2003, all of the operations of GP were combined with those of NSI. 17. On March 31, 2003, NFC acquired IPO Capital Corp. ( IPO ). The operations of IPO were combined with NSI s during April and May Prior to the acquisition of GP and IPO, NSI was only located in Toronto. With these acquisitions, NSI added branch and sub-branch offices in Calgary and Vancouver. 19. Both GP and IPO had regulatory enforcement records relating to both the firm and certain employees concerning supervisory and trading issues. 20. NSI s Toronto office was initially involved in retail and investment banking, but in the spring of 2004, it began building an institutional sales division. The Vancouver office is involved primarily with retail sales, but also has a group of proprietary traders. Calgary is involved in investment banking, retail sales and has one proprietary trader. 21. NSI also offers discount direct access brokerage services through enorthern. 22. During the Relevant Period, Alboini was the only member of the NSI Board of Directors except during the period January 2003 to April 2003, when there was one other individual in addition to Alboini. As such, Alboini has been the sole member of the NSI Board of Directors since April 28, The NFC Board of Directors oversees Alboini s role as Chief Executive Officer of NSI and his compensation. 24. During the Relevant Period, the NFC Board of Directors consisted of Alboini, who is also Chairman and Chief Executive Officer of NFC, and two independent directors. Page 10 of 46

11 NSI Previous Disciplinary History 25. NSI has a previous regulation enforcement history. In particular, by way of settlement agreement with the British Columbia Securities Commission dated May 10, 2004, NSI admitted that it changed its internal systems on April 25, 2003 and as a result of deficiencies in the new system, executed trades on eight days in 2003 in the shares of Solucorp Industries Ltd. ( Solucorp ) while Solucorp was under a Cease Trade Order ( CTO ). NSI was fined $10,000 which included costs of $2,500. NSI was also required to maintain its internal systems to prevent further cease trade order violations. NSI Personnel Alboini 26. In addition to his role as NSI s Board of Directors, Alboini has been the President, Chief Executive Officer, Chairman and Ultimate Designated Person of NSI since July 1999 and the Chairman, Chief Executive Officer and President of NFC since August Prior to his involvement with NSI, Alboini was employed in the securities industry from Prior to this, he practiced securities law. Shaule 28. Shaule joined NSI as Chief Financial Officer in October Shaule took over the additional role of Chief Compliance Officer in November Prior to joining NSI, Shaule worked in the securities industry, primarily in finance related positions, including as a Chief Financial Officer, since As of May 24, 2005, Shaule ceased to be the Chief Compliance Officer and returned to the sole role of Chief Financial Officer. Page 11 of 46

12 Other Chief Compliance Officers in the Relevant Period 31. NSI had two other Chief Compliance Officers in the Relevant Period: one between January and June 2003 and one between June and October Compliance/Supervision Structure 32. For most of the Relevant Period, Gary Mulder ( Mulder ) was the individual responsible for conducting UMIR compliance monitoring and testing for the Toronto office for purposes of Policy 7.1 of UMIR. Mulder was also responsible for UMIR compliance monitoring and testing for the Calgary branch, including the grey and restricted list, high closing and manipulative and deceptive trading (which was supposed to include wash trading). 33. Mulder joined NSI on March 31, He came to NSI from IPO Capital as part of that acquisition. Prior to March 2003, Mulder had worked in the securities industry, but had not been responsible for compliance testing in reference to UMIR or the previous TSE rules relating to trading. He has never taken a securities related course such as the Canadian Securities Course or the Trader Training Course. 34. The Branch Manager for the Calgary office, Robert Fong ( Fong ) was responsible for the balance of compliance testing under Policy 7.1 for Calgary which was not conducted by Mulder. 35. The Vice-President Compliance for NSI, George Magill ( Magill ) was responsible for compliance testing for purposes of Policy 7.1 for the Vancouver branches. Magill did not receive any training by NSI related to Rule 7.1 or Policy 7.1 of UMIR until May From November 2003 to May 23, 2005, all three of these individuals reported to Shaule in relation to their compliance monitoring under Policy 7.1. Page 12 of 46

13 The Trade Desk Review Process RS s 2003 Trade Desk Review ( 2003 TDR ) 37. In October 2003, RS conducted its 2003 TDR at NSI. As of that date, Policy 7.1 of UMIR had been in effect since April The predecessor policy introduced by the TSE came into effect March 28, By letter dated October 14, 2003, addressed to Alboini with a copy to the then Chief Compliance Officer, NSI was provided by RS with its 2003 TDR findings. 39. The 2003 TDR findings were: A. Supervision of Trading NSI s compliance policies and procedures needed further development to meet the requirements of UMIR Policy 7.1; NSI had not documented written methodologies on how the firm conducts each of the tests as required by the Policy; Testing results were not quantified and summarized for RS review; NSI had not documented how it would address problems that were found during their reviews; and, There was no evidence that compliance issues were reported to the Board of Directors. NSI was required to: Adopt written policies and procedures to ensure compliance with UMIR rules and policies; Conduct the Minimum Compliance Procedures as set out in UMIR Policy 7.1, Part 3, and document its testing procedures and results; Specifics were given as to what the policies should encompass; and, Page 13 of 46

14 A copy of the revised policies and procedures was to be submitted to RS with their response to the 2003 TDR findings. B. Client Priority NSI did not have written policies and procedures which set out how the exemptions included in the client priority rule were to be used. NSI was required to: Develop and implement policies and procedures which set out how the exemptions in the client priority rule were to be used; and, A copy of these polices and procedures were to be submitted to RS with a response to the 2003 TDR findings. C. Completeness of Audit Trail Testing revealed problems with the completeness of the audit trail including missing information on tickets, such as time stamps, quantity of shares and sale price. NSI was required to: Take steps to comply with the requirements for audit trail completeness and document them. D. Order Entry Designation Testing revealed problems with order entry designations relating to improper marking of non-client, principal and jitney trades. NSI was required to: Take steps to comply with the requirements for order designation and document them. 40. When Shaule became Chief Compliance Officer in November 2003, it was his responsibility to draft the necessary policies and procedures and to otherwise respond to the 2003 TDR findings from RS. Page 14 of 46

15 41. On November 28, 2003, RS issued Market Integrity Notice entitled Guidelines on Trading Supervision Obligations (the Notice ). The Notice reminded Participants, among other things, that a failure to develop and implement appropriate policies and procedures in accordance with the requirements of Policy 7.1 may result in disciplinary action against the firm, its management and directors. 42. NSI s written response addressing these issues was to be provided to RS by December 15, On or about the due date, RS agreed to extend the date for delivery of NSI s response to January 15, As of January 20, 2004, RS had not received NSI s written response to the 2003 TDR. An inquiry was made by RS on January 20, 2004 concerning the status of the response. 44. On January 22, 2004, RS spoke with Alboini who advised that RS should contact Shaule. That same day, two voice mail messages were left for Shaule, but the calls were not returned. 45. By letter dated January 23, 2004, RS advised NSI that it must respond to the 2003 TDR findings by January 30, 2004 and that any failure to do so could result in an enforcement action. 46. On February 19, 2004, NSI provided a response including revised policies and procedures, which RS found to be inadequate. 47. On April 1, 2004, a meeting was held between representatives of NSI and RS to discuss NSI s response to the 2003 TDR findings. As a result of the meeting, RS requested by letter dated April 4, 2004 that NSI submit a revised supervision policy by April 8, NSI was also required to submit summary reports of monthly compliance testing for April, May and June On June 4, 2004, RS received a revised supervision policy from NSI. It contained no substantial changes from the report submitted on February 19, In addition, testing for April 2004 which was due on May 21, 2004, was provided with the policy. 49. NSI provided testing for May 2004 on its due date, June 18, Page 15 of 46

16 50. On July 16, 2004, RS was provided with a revised supervision policy from NSI. RS was advised that the wrong file had been provided to RS on June 4, The TDR group determined that it would review NSI s revised supervision policy during the next TDR which was to be conducted later that summer. 51. On the due date, July 23, 2004, RS received NSI s testing for June RS s 2004 Trade Desk Review ( 2004 TDR ) 52. In September 2004, RS conducted its 2004 TDR at NSI. 53. By letter dated October 15, 2004, addressed to Alboini and copied to Shaule, NSI was provided by RS with its 2004 TDR findings. 54. The 2004 TDR findings were: A. Supervision of Trading There was no evidence of a report to the Board of Directors on compliance issues or a review of the supervision system as required under Part II, subsection 9 of Policy 7.1. This was a repeat finding from the 2003 TDR; Compliance testing procedures were inadequate in relation to manipulative and deceptive trading (there were no procedures to test for wash trading, double printing and off-exchange trades), sales from control block, order handling rules, order markers, trade disclosure, as required under Part II, subsections 2 and 5 and Part III of Policy 7.1. This was a repeat finding from the 2003 TDR; and, The evidence of internal compliance testing was not adequately documented as required by Part II, subsection 8 of Policy 7.1. This was a repeat finding from the 2003 TDR. NSI was required to: advise its Board of Directors of this report; Page 16 of 46

17 develop, implement and document policies and procedures that meet or exceed the requirements of Policy 7.1; ensure NSI adheres to all of its documented policies and procedures; and, develop and document procedures for evidencing internal compliance testing. B. Order Entry Designation RS found that proprietary trades were marked incorrectly as non-client and that there were additional problems with proprietary order designation; In addition, the review found that trades for the account of NSI s parent, NFC, were being marked incorrectly as non-client; and, This was a repeat finding from the 2003 TDR. NSI was required to: take steps to comply with the requirements for order designation and document them. C. Completeness of Audit Trail The tickets reviewed were missing the quantity of shares, price, time stamp or had late timestamps; This was a repeat finding from the 2003 TDR; and, There was no improvement in respect of audit trail compliance from the 2003 TDR. NSI was required to: D. take steps to comply with the requirements for the completeness and accuracy of the audit trail and document them. Page 17 of 46

18 Short Sale Finding RS s review found thirteen instances of unmarked sales through the proprietary inventory accounts, eight of which were done below the last sale price. Ten of the thirteen should have been marked short and the remaining three should have been marked short exempt. NSI was required to: take steps to comply with the requirements for short sales; and, take steps to ensure that the traders know how to use the relevant markers and document them. E. Grey List Trading Issues RS s review raised concerns with trading activity in two grey listed securities, OTZ Corporation and TransGlobe Energy Corporation; With respect to OTZ Corporation, the review raised concerns that NSI did not follow or have in place adequate internal supervision policies for reviewing trading in grey listed securities; and, NSI did not provide a complete response to RS s request for information for the trades related to TransGlobe Energy. F. Principal Disclosure/Related Issuer/Average Price Disclosure The Review identified concerns in these areas. 55. The 2004 TDR findings and covering letter from RS advised NSI that given RS s concerns with supervision and other findings, as well as past findings, the 2004 TDR findings were being forwarded to the Investigations and Enforcement Division for further review. 56. The 2004 TDR findings also noted that there were numerous delays in NSI s response to RS s 2003 TDR. RS advised NSI that its delays in responding to RS raised additional concerns with NSI s supervision. Page 18 of 46

19 57. RS s investigation of NSI began in November 2004 and NSI was informed of the investigation by letter dated November 2, On December 9, 2004, NSI provided RS with a revised policies and procedures manual in response to the 2004 TDR findings which, on its face, appeared to address the 2004 TDR findings. NSI was advised that RS would determine if the policies and procedures had actually been implemented effectively at the next TDR 59. On May 24, 2005, NSI hired a new Chief Compliance Officer and Shaule resumed his sole role as Chief Financial Officer. 60. In late March 2005, NSI retained the law firm of Fasken Martineau DuMoulin LLP ( Fasken ) to conduct a review of NSI s supervisory and regulatory compliance practices and procedures. 61. The Fasken report was delivered to RS on August 10, 2005 and highlighted many of the same deficiencies in NSI s trading supervision system, which were listed in RS s 2004 TDR. 62. As of this date, some, but not all of the recommendations in the Fasken Report, have been implemented by NSI. RS s 2005 Trade Desk Review ( 2005 TDR ) 63. In August 2005, RS conducted its 2005 TDR at NSI. The 2005 TDR findings were consistent with previous TDR findings. They include: A. Supervision of Trading This is a repeat finding from the 2003 and 2004 TDRs. NSI s documented compliance testing procedures lack specific detail in the following sections: audit trail; order designation testing including short sales marking; testing for average price and principal disclosure; manipulative and deceptive testing for wash trading, double printing and off-exchange trades; order handling testing for order exposure, watch list review and client priority review; Page 19 of 46

20 Evidence of internal compliance testing was not adequately documented. There is no discernable way to determine what specific daily review is being performed nor are there monthly or quarterly summaries detailing specific testing results. Evidence of detection, escalation and prevention is lacking; and, NSI s policies and procedures do not identify many of the actual beneficial practices of the trading and compliance staff. For example, the newly created short sale report tool used daily by compliance is not detailed in NSI s policies and procedures. Furthermore, NSI s policies and procedures detail some practices of the compliance staff that are not being done. For example, NSI s policies and procedures state that compliance in Calgary, Vancouver and Toronto shall conduct a monthly trade desk review of at least 20 order tickets per month. Evidence of this review will be maintained on an Excel spreadsheet with documents attached, if necessary. No evidence of this can be found at NSI. B. Order Entry Designation This is a repeat finding from the 2003 and 2004 TDRs; Testing revealed that some proprietary trades were marked incorrectly as non-client; and, Testing revealed that trades for the account of NSI s parent company, NFC, were being marked incorrectly as non-client. This was specifically detailed in the 2004 Trade Desk Review as a practice to be abolished. C. Completeness of Audit Trail This is a repeat finding from the 2003 and 2004 TDRs; and, Testing found that some tickets were missing either quantity, price or time stamp and that some tickets had late time stamps. Page 20 of 46

21 D. Principal Disclosure/Average Price Disclosure The review identified concerns in this area; and, This is a repeat finding from the 2004 TDR. Findings of the Enforcement Investigation Insufficient Policies and Procedures/Failure to Test/Lack of Evidence of Compliance Testing at NSI Toronto and Calgary Offices of NSI January 2003 July 2003 Period 64. The 2003 TDR found that NSI s compliance policies and procedures needed further development, including documenting written methodologies on how the firm conducts each of the tests under Policy For the period January 2003 to July 2003, NSI failed to conduct compliance testing for purposes of UMIR 7.1. August 2003 September 2004 Period 66. RS s 2004 TDR found that compliance testing procedures were inadequate in several areas including manipulative and deceptive trading, order handling and order markers. 67. In August 2003, NSI began using a compliance chart which listed the requirements found in the matrix for minimum compliance procedures for trading supervision in Policy 7.1. The chart was to be used by Mulder, or other applicable staff, who were to conduct the testing. The chart had an area to confirm (usually by check mark) if the review for each requirement was conducted and a place for notes. 68. In August 2003, the compliance chart was used daily for the first week and thereafter, it was filled out on a weekly basis until September 22, The chart was not used again until October 20, 2003, after which time it was used daily, although some days were missed in December, 2003 and January and February Page 21 of 46

22 69. On most days, the compliance chart contained only checkmarks, with the occasional notation on some. In addition, the section for signatures evidencing testing was never used. 70. The results of the testing documented on the chart were not quantified or summarized and limited supporting material has been kept by NSI to demonstrate what was reviewed to conduct the testing or to evidence follow-up on issues noted on the chart. October 2004 August 2005 Period 71. As noted in the RS 2005 TDR findings, the lack of detail in NSI s policies and procedures regarding compliance testing and insufficient evidence of compliance testing remained unrectified in the period October 2004 to August Vancouver Office of NSI January 2003 August 2005 Period 72. The documentation provided by NSI to evidence compliance monitoring and testing for purposes of Policy 7.1 for NSI s Vancouver offices fails to establish that sufficient compliance testing was being conducted. The Vancouver reviewer, Magill, did not use the NSI compliance chart utilized for Toronto until May 2005 (8 months after the 2004 TDR and after the commencement of this investigation) nor was there any other form of summary evidencing such review. 73. Prior to May, 2005, Magill s testing for purposes of Policy 7.1 consisted of scrolling through pro and client account activity he received in electronic form for anything suspicious. He did not review trading blotters, commission reports or trade tickets unless he found something he thought was suspicious. No one at NSI reviewed his testing procedures. 74. Magill began testing for artificial pricing and correct order marking in May The inadequacies in the compliance testing in Vancouver is of particular concern because of the previous regulatory enforcement records of the former firms GP and IPO in respect of their Vancouver operations and which were assumed by NSI. Page 22 of 46

23 NSI s Supervision Policies Frequency of Testing 76. The various manuals provided by NSI to RS during the TDR process provided for daily and monthly testing to be conducted to test for violations of certain UMIR Requirements which, on their face, exceeded the quarterly review mandated by Part 3 of Policy 7.1 for some Requirements: for example, testing for audit trail and order handling violations and frontrunning. NSI did not conduct quarterly testing for these particular Requirements. 77. The purpose of quarterly testing is to provide a Participant with the opportunity to take a snapshot of trading in the firm over several days and look for patterns of abusive trading or other rule violations that might not be evident from a daily review. 78. However, if a firm wishes to exceed the minimum compliance procedures set out in Part 3 of Policy 7.1 by conducting daily testing, this would be encouraged by RS, as long as the daily testing results are sufficiently summarized to allow the firm, on a periodic basis, to review these summaries for such patterns over time. 79. As stated above, to the extent NSI was conducting daily testing, it was not summarized in any manner which would allow the firm to carry out a review comparable to a quarterly review. As such, the lack of summarization of daily testing combined with the lack of quarterly testing fails to meet the minimum requirements for an effective trading supervision and compliance system under Policy 7.1. Confusion at NSI Concerning Who Had Testing Responsibilities 80. The investigation disclosed confusion between Shaule and Mulder as to Mulder s responsibilities for compliance testing and illustrates that certain testing was not being conducted, as follows: (a) Audit Trail Requirements According to Mulder, he conducted testing for the Toronto office only. Shaule believed Mulder was responsible for testing for both Toronto and Calgary. In fact, Fong was testing for audit trail requirements in Calgary. (b) Manipulative and Deceptive Trading Page 23 of 46

24 According to Mulder, although he did some testing for manipulative and deceptive trading for both Toronto and Calgary, in the period September 2003 to November 2004, Mulder only tested for possible wash trading by retail customers. He did not test for wash trading in institutional or proprietary trading, nor did he test at all for double printing. As noted below, several NSI traders engaged in undetected wash-trading in NSI proprietary accounts in this time period. Shaule was unaware of this and only became aware of this issue as a result of the RS investigation. (c) Grey List Shaule believed Mulder was testing for possible improper trading of securities on NSI s grey list for all NSI branches on a daily basis. According to Mulder, he tested for grey list trading for Toronto only. Mulder did not in fact have all the necessary trading information to conduct such testing for the Vancouver and Calgary trading. No Formal Escalation Process for Compliance Issues at NSI 81. NSI did not have any written guidelines or requirements concerning when and how Mulder and the other reviewers should escalate matters to Shaule and then Shaule to Alboini. 82. Meetings between Shaule and Mulder and Shaule and Magill were event driven and rarely documented. 83. Likewise, contact between Mulder, Fong and Magill on compliance related issues were rarely documented. Lack of Evidence of Reporting to the Board of Directors 84. Policy 7.1 requires that a summary of compliance reviews and results of the supervision system must be provided at least annually to the Board of Directors of the Participant. This requirement was implemented so the Board would review the trading supervision and compliance system to ensure that it is adequate and there is accountability within the firm if it is not. Page 24 of 46

25 85. At NSI neither a summary of any compliance reviews nor a review of the supervision system were reported to the Board of Directors in the Relevant Period. NSI s explanation for the lack of reporting is that Alboini is the sole Board member and as such, it was not required. 86. This unsatisfactory explanation underscores the risk NSI assumed for itself and its clients when it structured its business affairs so that the only member of the Board of Directors is the Chief Executive Officer of the firm. In this case, the Chief Executive Officer did not make the implementation of an effective trading and supervision and compliance system a priority and as a result of the corporate structure, he was accountable to no one for that failing. Lack of Training Initiatives at NSI 87. Policy 7.1 imposes an obligation upon a Participant and its supervisors to ensure that employees are properly trained and knowledgeable about UMIR Requirements. 88. In the Relevant Period, NSI had no formal training program. Employees were provided with the firm s manual regarding compliance and credit issues and essentially were expected to learn by doing the job. 89. As noted earlier, neither Shaule, Mulder nor Magill (until May 2005) were properly trained in relation to UMIR compliance matters. 90. Shaule did not read Market Integrity Notice prior to drafting the supervision manual in February Wash Trading Violations by NSI Traders and Deficiencies in Compliance Testing for Wash Trading 91. The 2004 TDR found that NSI s policies and procedures manual had not outlined compliance testing for wash trading. As a result, RS undertook a review of crosses executed on the TSX and TSX-V by NSI in the period October 2003 to October 2004 involving the same user ID and/or same account identifier on both sides of the trade. NSI was then asked to provide the name of the account on both sides of the trade. Page 25 of 46

26 92. This process identified 78 crosses as potential wash trades that were previously undetected by the firm. NSI then reviewed these trades and subsequently acknowledged that there was no change of beneficial ownership and that these trades were in fact wash trades. 93. Thirty-three of the trades were conducted by one trader. The balance of the trades was conducted by eight other traders, two of whom conducted fifteen and seventeen trades, respectively. A review of these trades did not uncover a planned pattern of wash trading but in fact the wash trades appear to have occurred as a result of reckless and sloppy trading. 94. NSI did not detect any of this wash trading because NSI was not testing for wash trading by proprietary traders in the period October 2003 to November As a result, none of the 78 wash trades was cancelled. 95. In February 2005, as a result of this investigation, NSI implemented a new monitoring tool in the form of a proprietary software program which watches in real time for potential wash trades at the firm. Grey List Trading at NSI 96. In the 2004 TDR, RS identified potential problems with grey list trading in the shares of TransGlobe Corporation ( TLG ) and Ontzinc Corporation ( OTZ ). 97. In addition to the 2004 TDR, which reviewed the period May 1, 2004 to June 9, 2004, RS conducted further testing of the grey list trading for the period December 2003 through April 2004 and July 2004 through October In these time frames, NSI s policies and procedures regarding the grey list provided that NSI employees with access to the list are subject to the same trading, advising and research restrictions as restricted securities on the Restricted list. 99. NSI s policies for restricted securities prohibit principal trading for NSI s account (except for normal market making activities), solicited and/or discretionary trading for client accounts, personal trading for accounts of directors, officers and employees of NSI, and, the preparation and dissemination of research materials. Normal market- Page 26 of 46

27 OTZ Trading making activities include trading approved in advance by the Chief Compliance Officer for the securities in question The 2004 TDR referred a number of possible non-client trades in OTZ while it was on NSI s grey list. RS was concerned that NSI did not follow its internal policies relating to the trading of grey listed securities OTZ appeared on NSI s grey list for the period March 11, 2004 to June 24, On 3 occasions during that timeframe, Alboini instructed a proprietary trader to make the following purchases of OTZ for an NSI inventory account: June 9, June 11, June 14, million shares 220,000 shares 15,000 shares 102. Alboini was one of the individuals who received the grey list. Alboini s explanation with respect to this trading is that NSI had erred on the side of caution by leaving it on a grey list for longer than necessary According to Alboini, he originally purchased the OTZ shares into inventory hoping he would be able to sell them to a client. However, he was unable to reach the client and subsequently sold them Such conduct by NSI and Alboini was a breach of NSI s policy restricting grey list trading On June 10, 2004, Mulder, when reviewing employee trading in reference to the grey list, noted the June 9, 2004 purchase of OTZ. Mulder asked Alboini by why NSI was purchasing shares of an issuer on the grey list Alboini advised that NSI was expecting to be selling this block of stock and that it was part of the possible transaction being discussed. Page 27 of 46

28 107. This explanation was not satisfactory and should have been further pursued by NSI s compliance department On June 24, 2004, Mulder noted the other OTZ trading of June 11 and 14, 2004 and sent an to Mark Stableforth, a NSI trader who was the head of trading at the firm at that time. NSI has been unable to provide a response from Stableforth s report to this inquiry No further follow up to resolve these issues has been provided Alboini made a profit of approximately $8, from the sale of OTZ s shares from NSI s inventory account by trading a grey list stock during the grey list period, contrary to NSI s own policies and procedures. TGL Trading 111. TGL was on NSI s grey list for the period March 2, 2004 to August 6, During this period, NSI made a number of purchases for pro-accounts and inventory accounts. Most of the trading through the inventory accounts was incorrectly marked as non-client. The majority of these trades were entered at the direction of Alboini Alboini was a recipient of the grey list for TGL NSI was asked to provide evidence of compliance reviews for the purposes of UMIR including but not limited to, all notes, s and correspondence, of trading in TGL during the grey list period. NSI provided no evidence that the trading in TGL was reviewed adequately by NSI s compliance It is NSI s position that the trading in question was to assist the company in question in providing market liquidity By directing trading in the accounts in question, even for the purpose of creating market liquidity, NSI and Alboini breached NSI s own policy which prohibits any such trading (except for normal market-making activities approved by the Chief Compliance Officer) when a security is on the grey list. Page 28 of 46

29 Conclusions Regarding Grey List Trading 117. NSI s grey list trading described above violated its own policies and procedures, contrary to Rule 7.1(2)(b) It was Alboini s conduct described above which resulted in NSI contravening Rule 7.1(2). He is liable pursuant to Rule 10.3(4) for NSI s conduct in this regard NSI s compliance failings described above are a violation of Rule 7.1(1) and Policy 7.1. Other Violations of UMIR at NSI UMIR 6.4 Off Marketplace Trade 120. On December 22, 2003, NSI conducted an improper off-marketplace trade when purchasing a block of 5 million shares of Precision Assessment Technology ( PDT ) NSI purchased, from Canadian Client A over the counter, 5 million shares of PDT at a price of $0.125 for its house inventory account. At 13:28:41, the NSI inventory account sold 5 million shares to various clients. These sales had been previously arranged. These trades to the clients were printed on the TSX at $0.160 per share NSI failed to conduct the take on portion of the trade from Canadian Client A into NSI s inventory account on a marketplace or pursuant to one of the exemptions provided for in UMIR 6.4, in violation of UMIR 6.4. UMIR 6.2 Designations and Identifiers 123. In addition, NSI originally marked the printed trade above as a client/non-client cross and then corrected the trade as a non-client/non-client cross. Both of these were incorrect. The trade that was printed should have been marked as inventory on the sell side and client on the buy side. This incorrect marking of the trade is a violation of UMIR 6.2(1) Two of the wash trades noted in the wash trading section above were executed for US brokers. NSI incorrectly marked the trades executed on behalf of these brokers Page 29 of 46

30 as inventory when they should have been marked as client. This incorrect marking is a violation of UMIR 6.2(1) On March 27, 2003, RS had issued Market Integrity Notice entitled Order Marking to assist Participants in complying with Requirements of UMIR. The Notice specifically discussed marking orders from foreign dealers and stated that when orders originating from a US securities dealer are executed as agent on the marketplace, these orders should be marked client The thirty-three wash trades executed by the same trader referred to above were marked non-client when they should been marked inventory. Such incorrect marking is a violation of UMIR 6.2(1) NSI s various failures to adhere to UMIR 6.2 raises serious concerns about it ability to maintain a proper audit trail and to conduct reviews for such possible UMIR violations as frontrunning, client priority and best execution. UMIR 5.2 Best Price Obligation 128. With reference to the off-marketplace trade above, NSI knew when it arranged buyers for the portion of the trade which was printed that it was paying Canadian Client A $0.125 per share for the stock NSI took the spread between the $0.125 and the $0.160 as payment for the transaction. In addition, NSI charged the clients who paid $0.160 per share a commission in addition to taking the spread In failing to give Canadian Client A a better price than $0.125 per share, NSI failed to provide the best price to this client, contrary to UMIR 5.2(1). Alboini 131. Throughout this investigation, Alboini consistently portrayed himself as responsible for the stewardship of NSI. Alboini was aware of the findings from both the 2003 and the 2004 TDR and the required dates for NSI to respond to these findings. As the President, Chief Executive Officer and Chairman of NSI and the sole member of Page 30 of 46

31 the NSI Board, he was solely responsible for ensuring that the RS TDR findings were addressed and that the deadlines were met Alboini did not seriously begin to address the issues outlined by RS in the 2003 and 2004 TDR reports until months after he was advised of the commencement of this investigation in November 2004 and after the receipt of RS s 2004 TDR findings Alboini also violated NSI s internal policies with his trading in OTZ and TLG while it was on the grey list. In his position as Chief Executive Officer and as steward of the firm, Alboini has a responsibility to set a standard for the firm by adhering to the firm s internal policies All of the foregoing establishes that Alboini failed to fulfill his obligations under UMIR 7.1(1), 7.1(4) and in the case of grey list trading, that he is liable pursuant to Rule 10.3(4) for causing NSI to violate Rule 7.1(2)(b). Shaule 135. Shaule did not fully understand UMIR 7.1 and UMIR Policy 7.1 and his responsibilities in relation to them. By his own admission, he had very limited experience with UMIR in general prior to joining NSI and did not rely on UMIR 7.1, the related Policy or the MIN when drafting his February 19, 2004 version of NSI s Policies and Procedures. Furthermore, he was unable to give RS assurances as to when or if he had read MIN at the time of the investigation Shaule was also not conversant with NSI s own internal policies and procedures, nor did he know what exactly Mulder and the other staff charged with the testing under Policy 7.1 were doing on a day to day basis even though they reported to him and he was responsible for their supervision. He and Mulder gave conflicting evidence as to what monitoring Mulder was doing for the Calgary and Vancouver branches Shaule was directly responsible for responding to RS s findings letter for the 2003 TDR and subsequent related requests. RS had to pursue Shaule for these responses. RS also attempted to work in partnership with NSI, meeting Shaule on subsequent occasions after the 2003 TDR to clarify concerns. Even given this Page 31 of 46