INVESTMENT INDUSTRY REGULATORY ORGANIZATION OF CANADA IN THE MATTER OF: THE DEALER MEMBER RULES OF THE INVESTMENT INDUSTRY REGULATORY ORGANIZATION OF CANADA AND TERRY NORMAN DYCK NOTICE OF HEARING TAKE NOTICE that pursuant to Part 10 of Dealer Member Rule 20 and Section 1.9 of Schedule C.1 to Transition Rule No.1 of the Investment Industry Regulatory Organization Canada (IIROC), a set date hearing will be held before a hearing panel of IIROC (Hearing Panel) on July 11, 2011 at 121 King Street West, Toronto, Ontario, Boardroom #1, at 10:00 a.m., or as soon thereafter as the hearing can be heard. TAKE FURTHER NOTICE that, pursuant to Rule 6.2 of the Dealer Member Rules of Practice and Procedure, the hearing shall be designated on the: The Standard Track The Complex Track THE PURPOSE OF THE HEARING is to determine whether Terry Norman Dyck (Dyck or the Respondent) has committed the following contraventions alleged by staff of IIROC (Staff): From about January to December 2009, the Respondent, while a Registered Representative: (i) (ii) failed to use due diligence to learn and remain informed of the essential facts relative to every order accepted, contrary to IIROC Dealer Member Rule 1300.1(a); and failed to use due diligence to ensure that recommendations were suitable for his clients, contrary to IIROC Dealer Member Rule 1300.1(q).
- 2 - PARTICULARS TAKE FURTHER NOTICE that the following is a summary of the facts alleged and to be relied upon by Staff at the hearing: A. Overview 1. Dyck learned of certain leveraged exchange traded funds (LETFs) as early as 2006. He recommended them to his clients and started purchasing them in client accounts in 2006. In 2009, 141of Dyck s clients held the LETFs in 186 accounts, representing more than half of his client base. 2. Dyck assessed the LETFs as medium risk. The funds, however, use high risk trading strategies and extensive leverage. The prospectuses for the funds indicate that they are highly speculative and involve a high degree of risk. To nevertheless conclude that they are medium risk, Dyck failed to review, disregarded or failed to undertake a careful analysis of the information available to him in relation to the LETFs. He failed to know his product. 3. Dyck had an obligation to take reasonable steps to know the products that he recommended to his clients, in order to engage in a proper suitability analysis for his clients. By recommending the LETFs without learning essential facts about the product, Dyck failed in his most basic obligation to his clients. His failure caused his clients to take on higher risk than was indicated on their account documents. 4. The LETFs were not suitable for the majority of his clients as they had little or no tolerance for risk. In at least 186 instances, Dyck failed to use due diligence to ensure that recommendations of LETFs were suitable for his clients. B. Registration History 5. Dyck first became a registrant in 1995. He was a Registered Representative (RR) at the Thunder Bay, Ontario branch of Wellington West Capital Inc. from 2006 until he
- 3 - resigned on or about December 21, 2009. Dyck is no longer a registrant with an IIROC firm. C. The Leveraged ETFs 6. The LETFs are investment funds that use leverage and high risk trading strategies to try to achieve either a multiple or an inverse multiple of the daily performance of an index of a reference exchange. 7. Dyck solicited purchases of the following nine Horizons BetaPro LETFs in his client accounts : Bear LETFs S&P/TSX 60 Bear Plus ETF S&P 500 Bear Plus ETF US Dollar Bear Plus ETF S&P/TSX Global Gold Bear Plus ETF S&P/TSX Capped Financials Bear ETF NYMEX Crude Oil Bear Plus ETF Bull LETFs S&P/TSX 60 Bull Plus ETF S&P 500 Bull Plus ETF US Dollar Bull Plus ETF 8. The Bear LETFs are designed to achieve an inverse multiple of the daily performance of an index, i.e., to rise or fall in value in the opposite direction from which the market is moving, at two or more times the rate that the market is moving. 9. The Bull LETFs are designed to achieve a multiple of the daily performance of an index, i.e., to rise or fall in value in the same direction in which the market is moving, at two or more times the rate that the market is moving. 10. The LETFs are described in their prospectuses as highly speculative and as involv[ing] a high degree of risk. 11. The LETFs include the following characteristics, among others, as described in their prospectuses:
- 4 - (a) (b) (c) the securities underlying the funds include equity and/or fixed income securities, currencies, commodities and/or financial instruments including derivatives, such as options, swap agreements and futures and forward contracts; their use of leverage could magnify market movements and provide greater investment exposure than in an unleveraged investment; and they are designed to provide daily investment results and are rebalanced daily, which could magnify gains or losses. 12. The prospectuses for the LETFs identify a number of inherent risks, including: active investor risk; leverage risk; volatility risk; derivatives trading risk; restrictive effect of speculative position limits; commodity risk; aggressive investment technique risk; correlation and inverse correlation risk; counterparty risk; and risks associated with the underlying securities. D. Dyck Failed to Use Due Diligence to Know the LETF Product 13. Dyck first learned of the LETFs when he was approached by representatives of their manager. Dyck took some steps to learn about the LETFs, including meeting with representatives of the LETFs manager, conducting seminars for clients with those representatives, and consulting with and relying upon a third party portfolio manager about the LETFs. Based on what he learned about the LETFs, Dyck concluded that they are medium risk products and, as such, appropriate for his clients. 14. Dyck, however, incorrectly believed that the LETFs held the securities of the reference indices rather than trading other high risk securities in order to achieve a multiple or inverse multiple of those indices. In believing that the LETFs held the index securities as their underlying assets, Dyck failed to use due diligence to know the essential facts in relation to the true nature of the LETFs underlying assets. 15. Further, in assessing the LETFs as medium risk products despite their use of leverage, Dyck either did not understand the risks associated with that leverage or disregarded those risks.
- 5-16. There is no objective basis for Dyck s belief or understanding about the LETFs. 17. The information about the assets underlying the LETFs and the risks inherent in their use of leverage was readily available to Dyck in the prospectuses. He therefore failed to review the prospectuses, disregarded the information in the prospectuses or failed to undertake a careful analysis of the information in the prospectuses. In any of these instances, Dyck failed to use due diligence to learn essential facts relative to the LETFs. E. Dyck Failed to Use Due Diligence to Ensure LETFs were Suitable for His Clients 18. Dyck failed to use due diligence to learn essential facts relative to the LETFs; as a consequence, he did not ensure that his recommendations were suitable for his clients and in keeping with his clients objectives. In at least 186 instances in 2009, Dyck failed to use due diligence to ensure that such recommendations were suitable. Dyck Recommended LETFs to Clients 19. Dyck recommended the LETFs for his clients as medium risk investments and solicited his clients investment in the funds on that basis. 20. Dyck s clients purchased LETFs in their accounts starting in June 2006. Dyck continued recommending the LETFs for his clients and soliciting these investments. By 2009, 141 of Dyck s clients held LETFs in 186 accounts, representing approximately representing more than half of his client base. 21. Of Dyck s 186 accounts that held LETFs in 2009, only 10 or approximately 5% indicated the investment knowledge as sophisticated on the account forms while 107 or approximately 58% indicated the investment knowledge as poor or limited. 22. Further, approximately 71% of the 186 accounts in which Dyck s clients held the LETFs in 2009 had no or little capacity for high risk trading as indicated on the account documents. In particular 84 of the account documents [or approximately 45%] indicated a 0% high risk component on the account forms; while 48 of the account documents [or approximately 26%] indicated a risk tolerance of up to only10%. The balance of the account documents indicated a higher tolerance for high risk trading.
- 6 - Dyck s Clients Complained about LETF Investments 23. Fifteen of Dyck s clients who held LETFs in their accounts in 2009 (the Complainants) complained to IIROC about those investments. 24. Dyck failed to adequately explain the LETFs to the Complainants, including the risk inherent in the funds, the funds use of leverage and the volatile nature of the underlying securities. 25. Dyck recommended that the Complainants continue to hold the LETFs even when they started to experience losses in 2009. 26. Subsequent to Dyck s departure from the firm, all of the LETFs in the Complainants accounts were liquidated. The 15 Complainants held a total of 23 accounts with Dyck. Although six of these accounts made a profit from the LETFs trading, 17 of these accounts sustained losses. The total net losses for those accounts, over the entire period that the accounts held the LETFs, are in excess of $270,000. GENERAL PROCEDURAL MATTERS TAKE FURTHER NOTICE that the hearing and related proceedings shall be subject to IIROC s Rules of Practice and Procedure. TAKE FURTHER NOTICE that pursuant to Dealer Member Rule 13.1, the Respondent is entitled to attend and be heard, be represented by counsel or an agent, call, examine and crossexamine witnesses, and make submissions to the Hearing Panel at the hearing. RESPONSE TO NOTICE OF HEARING TAKE FURTHER NOTICE that the Respondent must serve upon Staff a Response to the Notice of Hearing in accordance with Rule 7 of the Rules of Practice and Procedure within twenty (20) days (for a Standard Track disciplinary proceeding) or within thirty (30) days (for a Complex Track disciplinary proceeding) from the effective date of service of the Notice of Hearing.
- 7 - FAILURE TO RESPOND OR ATTEND HEARING TAKE FURTHER NOTICE that if the Respondent fails to serve a Response or attend the hearing, the Hearing Panel may, pursuant to Dealer Member Rules 7.2 and 13.5: (a) (b) (c) proceed with the hearing as set out in the Notice of Hearing, without further notice to the Respondent; accept as proven the facts and contraventions alleged by Staff in the Notice of Hearing; and order penalties and costs against the Respondent pursuant to Dealer Member Rules 20.33, 20.34 and 20.49. PENALTIES & COSTS TAKE FURTHER NOTICE that if the Hearing Panel concludes that the Respondent did commit any or all of the contraventions alleged by Staff in the Notice of Hearing, the Hearing Panel may, pursuant to Dealer Member Rules 20.33 and 20.34, impose any one or more of the following penalties: Where the Respondent is/was an Approved Person: (a) (b) a reprimand; a fine not exceeding the greater of: (i) $1,000,000 per contravention; and (ii) an amount equal to three times the profit made or loss avoided by such Approved Person by reason of the contravention. (c) (d) (e) (f) (g) (h) (i) suspension of approval for any period of time and upon any conditions or terms; terms and conditions of continued approval; prohibition of approval in any capacity for any period of time; termination of the rights and privileges of approval; revocation of approval; a permanent bar from approval with the Association; or any other fit remedy or penalty.
- 8 - Where the Respondent is/was a Member firm: (a) (b) a reprimand; a fine not exceeding the greater of: (i) $5,000,000 per contravention; and (ii) an amount equal to three times the profit made or loss avoided by the Member by reason of the contravention; (c) (d) (e) (f) (g) suspension of the rights and privileges of the Member (and such suspension may include a direction to the Member to cease dealing with the public) for any period of time and upon any conditions or terms; terms and conditions of continued Membership; termination of the rights and privileges of Membership; expulsion of the Member from membership in the Association; or any other fit remedy or penalty. TAKE FURTHER NOTICE that if the Hearing Panel concludes that the Respondent did commit any or all of the contraventions alleged by Staff in the Notice of Hearing, the Hearing Panel may, pursuant to Dealer Member Rule 20.49, assess and order any investigation and prosecution costs determined to be appropriate and reasonable in the circumstances. DATED at Toronto, this 16 th day of June, 2011. JEFFREY KEHOE VICE-PRESIDENT, ENFORCEMENT INVESTMENT INDUSTRY REGULATORY ORGANIZATION OF CANADA 121 KING STREET WEST, SUITE 1600 TORONTO, ONTARIO M5H 3T9