Investors Scrutinizing the Regulators

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Fox Guarding the Hen House

   
John Gray

2004-10-11

On guard for you

A new squad of scam busters is fighting to crack down on stock swindlers and other white-collar crooks. But in a country that some say is too soft on corporate crime, can the new cops on the Street get the job done?

 

RCMP Supt. Craig Hannaford had been waiting more than four years for this day. On a cold October morning, Hannaford sat inside a cavernous courtroom in downtown Toronto waiting to hear how much jail time Alan and Elliot Benlolo would receive for their role in an elaborate stock swindle that stole millions of dollars from victims in Canada, the United States, Australia and more than a dozen other countries around the world. The brothers had pleaded guilty to the scam in July and agreed to jail time. But Hannaford was anxious to find out just how much time they were looking at and what fine they'd be forced to pay--if any. The Benlolos were also facing sentencing for their part in a phony telephone-invoice scam they ran with their younger brother, Simon, and another accomplice. They'd been convicted on that charge earlier this year, after a two-month trial. The scheme resulted in more than 4,400 complaints to the federal Competition Bureau.

Investigators dubbed the stock-swindle case Project Opulence--a fitting title since Alan Benlolo, 36, and his 38-year-old brother Elliot lived so lavishly off the proceeds of their scams. By the time they were arrested, in February 2001, the brothers and five accomplices (three of them pleaded guilty; one fled the country with one case still pending) had scammed more than 77 investors out of almost $3 million. When police searched the Benlolos' mansions in the Toronto suburb of Thornhill, they found more than $25,000 in cash stuffed into a cedar chest, and a fleet of leased luxury cars that included a Mercedes Benz SUV, a Ferrari 360 Spyder, a Lamborghini, a Jeep Cherokee and a Yukon Denali. To make matters worse, the Benlolos targeted their victims from a list of investors they had purchased from another gang who had already robbed the same people in a previous pump-and-dump scam.

This was not the first time the Benlolo brothers had run afoul of the law. In 1993, Elliot was sentenced to nearly two years in a Canadian prison for hispart in a cocaine trafficking conspiracy.

 

Hannaford heads up IMET in Toronto

Alan got 18 months in a U.S. jail for mail fraud in 1998. He was returned to Canada in March 1999 and released shortly thereafter. Almost immediately upon his return, he joined his brother in the Canadian scam. The U.S. Securities and Exchange Commission is still trying to collect a US$1-million fine levied against him.

Given Canada's aversion to sending white-collar criminals to jail, would the fraudsters get as much jail time in Canada as they did in the States? For Hannaford, a 23-year veteran of the RCMP who is also a certified general accountant, seeing the Benlolo brothers behind bars would be more than just a reward for helping to unravel one of the most complex stock scams he's seen. It would hopefully be a sign of things to come. The case was cracked by a team of RCMP investigators working closely with agents from the Federal Bureau of Investigation and the Ontario Securities Commission. The team effort worked so well on the Benlolo case that it was used as a model for the RCMP's new Integrated Market Enforcement Team, an elite fraud squad made up of experienced RCMP investigators, forensic accountants and securities market experts. In the past year IMET has opened branches in Toronto and Vancouver, with offices in Calgary and Montreal currently hiring staff. Their mandate: to work with Canada's securities enforcement community to crack down on corporate crime and restore confidence in Canada's financial markets. "Whether you steal your money with a knife and a gun, or a pen and a cellphone," says Hannaford, who heads up IMET's Toronto branch, "you are still a criminal."

IMET agents are the new cops on the Street. But they're under a lot of pressure. Canada has developed a reputation as a haven for stock-market hucksters, money launderers and other corporate criminals. None of the Canadian executives behind such notorious flame-outs as Bre-X and YBM Magnex has ever been charged with a criminal offence. Even when criminal charges are laid, the process moves at what some observers consider a glacial pace. Just look at Livent, the theatre company founded by Toronto impresario Garth Drabinsky, which collapsed in 1998 under the weight of allegations of accounting fraud. Hannaford spent more than two years investigating Livent before charges were filed against Drabinsky and three other executives in 2002. It could be another year before the trial begins. Meanwhile, in the United States, New York state attorney general Eliot Spitzer has been working overtime to bust executives who ripped off shareholders and analysts that touted stocks they knew were worthless. And Spitzer's not alone. Courts across the U.S. have already convicted executives from Enron and Adelphia, along with the masterminds behind a host of other corporate scandals.

IMET has some catching up to do if it wants Canada to shed its reputation as a good place for fraudsters to do business. So far, the Toronto unit has made just one arrest: in May, charges of theft and money laundering were laid against Steve McRae, a 39-year-old former HSBC Canada employee who allegedly stole $370,000 worth of stock certificates from unclaimed client accounts at its Toronto brokerage. That's pretty small stuff for the new corporate flying squad, but Hannaford says the charges sent a message to the financial community that there's a new sheriff in town. "We wanted the Street to know that we are out there watching," says Hannaford, the son of a Montreal stockbroker. "And your chances of getting caught doing something wrong just went up."

It took two years of meticulous police work to unravel the Benlolo scam. The RCMP started sniffing around the brothers in July 1999, after TD Bank passed on complaints from scammed investors. According to court documents, the Benlolos preyed on victims who had already been duped into buying overpriced microcap stocks that turned out to be virtually worthless. The brothers enticed investors by offering to swap that stock for shares in blue-chip companies like Royal Bank and Compaq--they were trying to take the tiny companies private, they told their victims. But there was a catch: to complete the deal, investors would have to make up some of the difference in share price, wiring cash to Toronto mail drops or offshore banks. In some cases, that added up to $15 or $20 per share. One investor lost $675,000. Only when they tried to sell their phony stock did they realize they'd been taken again.

For more than a year, the RCMP followed the Benlolos' accomplices to and from mail drops and even searched the brothers' garbage for evidence. Their fingerprints showed up on the fake documents mailed to investors. The Mounties received vital assistance both from an FBI agent who was temporarily transferred to Canada to work on the case and from an OSC investigator who helped untangle the complex web of fraudulent stock transactions. "Without the strong team of investigators from the different agencies coming together and working so well," says Hannaford, "we would not have been able to make this case."

The Benlolos are just the tip of the corporate-crime iceberg. A much greater danger comes from the accounting fraud, earnings manipulations and outright theft from companies and shareholders in massive corporate scandals at Enron and WorldCom. When these companies imploded, they dragged down the entire stock market and proved that white-collar crime could jeopardize not just the pensions of individual investors, but the entire economy. "The Department of Finance came to us and asked, 'Could this happen in Canada? Is this a threat?'" says Superintendent John Sliter, who heads up the national IMET program, headquartered in Ottawa. "And the police said, 'Yes, it is a very real threat.'" In 2002, the feds agreed to set aside $120 million over four years to fund IMET. The program would radically alter how the RCMP investigates white-collar crime and how it manages its force nationwide.

Hannaford's Toronto IMET team is headquartered in a modern but non-descript office building in north Toronto. It looks less like a traditional cop shop and more like a boutique accounting firm. But make no mistake, the cops hope that any numbers crunched here will lead to criminal charges. And they've been busy so far. One of the office's three massive evidence rooms is already filled with documents related to a case. Affixed to the room's locked door is the note: "Project Nebula: Authorized Access Only." A bulletin board in the coffee room is filled with newspaper stories about recent corporate shenanigans involving Conrad Black, Nortel Networks' Frank Dunn and Martha Stewart. Just down the hall are two interview rooms. The "hard interview" room is a tiny windowless box furnished with a single Spartan table and hardback chairs; it's reserved for the grilling of suspects. The "soft interview" room is for co-operative witnesses and fraud victims--it's bright and airy, with a plush couch and comfortable chairs arranged around a coffee table. Both rooms are wired with tiny cameras and microphones. Hannaford's team might have only one minor arrest under its belt, but it is also investigating transactions between Toronto-based Royal Group Technologies (TSX: RYG) and a St. Kitts resort controlled by chairman Vic De Zen, as well as possible criminal behaviour at Nortel Networks (TSX: NT).

Across the country, in Vancouver, Insp. Bill Majcher, a 20-year veteran of the RCMP, is working the Howe Street beat for IMET. While Toronto concentrates on large-scale blue-chip corporate fraud, Majcher's unit is targeting the relatively smaller--but no less damaging--stock swindlers who have tarnished the reputation of the Vancouver equity markets. "The Bay Streeters seduce you with nice manners, fancy dinners and fancy degrees," says Majcher. "In B.C., they don't waste your time with all that--they just screw you."

A former Eurobond trader in London, Majcher has spent much of his career working undercover to break up corporate fraud and money-laundering rings. He's perhaps best known for his role in the so-called Bermuda Short sting, a joint effort of the RCMP, FBI and U.S. Department of Justice that helped bring money-laundering charges against Martin Chambers, a Vancouver lawyer with underworld connections who was often described as the Lex Luthor of Canada's West Coast. The Vancouver office officially opened last December, with its full team in place by February. Three weeks later, investigators there served their first search warrant. They're now focusing on two cases while keeping a close watch on half a dozen more. One is a potential mining scam, and Majcher has used IMET resources to recruit an RCMP officer with a master's degree in geology to work on the case.

RCMP veteran Majcher works the Howe Street beat


The goal of all the IMET teams is to speed up the investigation process. Even in cases like the Benlolos and Livent that ultimately led to charges, it took more than two years for cops to complete their investigations. IMET aims to cut that in half, bringing charges in most cases within 12 months. According to Sliter--whose Simon Fraser University MBA thesis examined the internal management hurdles that hindered the RCMP from bringing corporate criminals to justice--the process went much slower under the old RCMP system because of what cops call the 1:5 ratio: "We would lock an investigator in a room with a bunch of files for five years, and then he would come out and say whether we should press charges. By then, the public interest was just about zero, and the prosecutorial interest, if there ever was one, had diminished to just about nil." The new ratio is 10:1--10 detectives on each case and a year to wrap it up, while it's still fresh in the public's mind and prosecutors are willing to take the case before a judge.

To fast-track investigations, each 11-person IMET team includes experienced fraud detectives, on-site forensic accountants, legal and market experts, as well as special investigative assistants to help them sort through reams of paper these investigations generate. And to manage that deluge of documents, IMET has invested in a sophisticated computerized file management system that allows them to quickly scan the material into a central searchable database. To ensure cops quickly identify possible scams, IMET has formed alliances with local securities commissions, the Canada Revenue Agency and other market administrators. A joint team of cops and securities regulators scores each potential case out of 100 to determine whether IMET will investigate. Companies with a large market cap, shares that trade on more than one exchange, or ongoing frauds score high; smaller bulletin board scams that went on several years ago are lower priority.

IMET is also recruiting local market experts to act as guides through Bay and Howe streets. IMET Vancouver has already hired Brent Mudry, a veteran reporter with Stockwatch, the bible of Canada's venture exchange. Mudry's scoops helped lead to the arrest of fugitive Thai financier Rakesh Saxena, who was accused of embezzling more than $88 million from the Bangkok Bank of Commerce. The Toronto office is currently interviewing candidates and has received resumés from several former high-flying Bay Streeters, including the now-retired division head of a Toronto brokerage firm.

Recruiting qualified RCMP officers--and keeping them--is also critical. To that end, the Mounties have revamped the way they promote and compensate detectives to keep skilled investigators on the job, says Sliter. This is still a paramilitary force, where pay and responsibility are based on rank rather than skill and experience. Before, many experienced detectives opted to leave the force for a more lucrative post at an accounting firm in the private sector. A veteran fraud investigator who wanted to stay and move up in the ranks, on the other hand, often had to transfer out of commercial crime and into, say, the bomb squad or dog-handling unit. While that created well-rounded officers, it made it all but impossible to find the skills needed to unravel the increasingly complex web of financial fraud the RCMP is facing. "We realized we shouldn't necessarily be moving people across the organization," says Sliter. "The skills that make you a good fraud investigator are not the same skills that make you a good dog handler."

IMET now operates under a "flexible rank" structure that has actually lured some cops who left the force to return to the RCMP, says Sliter. An officer can now conceivably remain at IMET for his entire career, building up knowledge of the capital markets. Even if there are no openings for, say, a new sergeant in the unit, an officer with commercial-crime skills can be designated an "acting sergeant" and given the corresponding pay raise. Rank and years of service are less important in IMET than formal business or legal training and a proven track record investigating commercial fraud.

Hannaford, for instance, is a certified general accountant who completed the Canadian Securities Course by correspondence while working as an RCMP patrolman in rural Manitoba nearly 20 years ago. He still remembers the odd looks he got from locals in Crystal City, a tiny outpost 150 kilometres outside Winnipeg, while trudging through the snow to the post office to pick up a week's worth of Wall Street Journals.

In Vancouver, Bill Majcher often relies on the experience he gained as a bond trader in London and working undercover as a commodities trader in the United States and Canada. One undercover operation was aimed at Colombia's Cali cocaine cartel, which tried to use McDonald's and Burger King to launder money using a huge sesame-seed franchise. "I was nearly the sesame-seed king of Canada," says Majcher. "The Colombians wanted me to undercut the current suppliers of sesame seeds to Burger King and McDonald's, and I would have got the business, too, because it was all just a money-laundering scheme."

Keeping such experienced cops on the IMET squad is essential to saving it from the fate of other RCMP corporate-crime crackdowns. In 1995, the RCMP and the British Columbia Securities Commission announced, with great fanfare, the formation of the Securities Fraud Office. It was an attempt to bring RCMP officers, BCSC investigators and Crown prosecutors under one roof to co-ordinate a cleanup of the Vancouver Stock Exchange.

Within the first year, there was nearly 100% turnover in the ranks, says Sliter, the first RCMP officer to head up the unit. Despite the BCSC's sinking $3 million into the program, it got only a handful of convictions. The office was quietly closed shortly after the BCSC withdrew its funding, in 1998. Without that money, RCMP officers resorted to sending letters to bilked investors telling them that, although their complaints warranted investigation, the cops didn't have the resources to investigate. The letters advised victims to complain to their member of Parliament. "We learned a lot of lessons from the Securities Fraud Office," says Sliter. "We know what doesn't work. Now it's up to us to show that we can do what will work."

No matter how hard IMET tries, however, not everyone is convinced it will manage to put more corporate criminals behind bars. The RCMP has removed many of the hurdles in its own organization that have allowed some crooks free rein. But it has no control over Crown prosecutors who don't want to file charges or judges who don't consider white-collar crime to be serious. There are also legal barriers that hamper cops from getting access to the information they need to file charges, says Sasha Angus, director of enforcement for the BCSC. "We are dealing with dice that are loaded," he says.

In the United States, the SEC can force companies to turn over reams of documents, and it has much more latitude to share what it finds with the cops. That's forbidden here. "When we talk to the SEC investigators," says Angus, "they wonder how we get anything done up here."

In Canada, police must jump through legal hoops to get search warrants for those same documents. Even then, companies routinely challenge the validity of warrants. Last month, the Vancouver IMET investigators were forced to raid its own offices and serve itself with a search warrant to retain possession of documents and computer hard drives seized during a February raid on the offices of SilverStar Energy Inc. The second warrant was required after a B.C. judge agreed with a lawyer representing the junior oil-and-gas exploration company (which trades on the over-the-counter bulletin board market in the United States) that the cops did not have reasonable grounds to suspect fraud had been committed.

The RCMP hopes federal Bill C-13, which went into force in September, will alleviate some of the problem. Besides giving police more power to execute search warrants, the bill includes new protection for corporate whistle-blowers and increases the maximum sentence for fraud to 14 years in prison from 10--the longest sentence that can be imposed short of life in prison. It also adds insider trading to the Criminal Code. Until now, it's been merely an administrative violation of provincial securities acts.

Criminalizing insider trading won't make much of a difference if judges don't care, however. David Brown, chairman of the Ontario Securities Commission, says many judges simply don't take white-collar crime seriously. At a speech at Toronto's Schulich School of Business in April, he told the audience about one recent case: "Our lawyer was in mid-sentence when the judge jumped in and said, 'Excuse me, counsel, but insider trading--that's a victimless crime, isn't it? What's all the fuss about?' When a judge asks that kind of question, it gives you an idea of the challenge ahead for us."

You can't blame investors for wondering if Canada is really serious about protecting them from financial predators. At least the victims of the Benlolo brothers received some justice. Back in that Toronto courtroom, Madame Justice Anne Molloy was not moved by Alan and Elliot's plea agreement to pay restitution of just under $1 million to their stock-scam victims. Nor was she impressed by their efforts to organize business ethics seminars in the run-up to their sentencing. "This is more than just an ethical lapse," Molloy said. "So-called white-collar crime is still criminal conduct and should be treated as such." In the end, the Benlolo brothers were sentenced to 42 months in prison for the stock scam and 34 months for the phony telephone-invoice scheme, to be served concurrently, and a $400,000 fine each, along with $1.5 million in restitution. All in all, it was a good day for Hannaford. "These were bad guys," he says. "They hurt a lot of people, and they need to realize there are consequences for their actions."

The irony is that if IMET does its job, Canadians will never hear about some of Hannaford's greatest successes. His investigations could, for instance, prevent a company with links to organized crime from getting listed on the Toronto Stock Exchange, or a dealer with a spotty reputation from getting registered. But it's unlikely such silent victories will satisfy either RCMP brass or investors who want to see some bang for their buck. For IMET to be successful, it's going to have to haul some high-profile white-collar criminals away in handcuffs--U.S. style. So corporate criminals beware: IMET is watching you. And investors are watching them.

 


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