Money-laundering threat rises on Bay Street

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Experts are raising red flags about Canada’s securities industry, saying it is increasingly susceptible to money laundering. Yet despite numerous warnings from regulatory agencies, data obtained by The Globe and Mail show that many of the country’s securities dealers are not meeting federal rules aimed at rooting out financial crime – leaving them vulnerable to exploitation by criminals looking to hide dirty money.

Statistics tell an alarming tale. Canada’s anti-money-laundering agency, Fintrac, examined more than 250 of the country’s 3,000 or so securities dealers over the past five years and found what it calls “significant” shortcomings in the firms’ controls nearly half the time, the data revealed.

“There are a lot of loopholes in our securities industry,” says Garry Clement, a compliance consultant who spent 34 years with the RCMP and specialized in financial crimes.

Christine Duhaime, a Vancouver lawyer who specializes in anti-money laundering and counterterrorist financing, calls the sector – which includes investment dealers, portfolio managers, brokerage firms and exempt market dealers – an area of concern.

“It’s like real estate a couple of years ago where, because it’s unlooked at, the practices are somewhat sloppy and oversight is really not there like it is in a lot of other sectors,” Ms. Duhaime says.

Regulators here and abroad have long warned that the Canadian securities industry was attractive to criminals. The Paris-based Financial Action Task Force, an international body aimed at tackling financial crime, warned of “weak internal controls” in the securities sector in a 2016 evaluation of Canada’s anti-money-laundering regime. In its examination, FATF found a host of shortcomings at firms, including incomplete and outdated anti-money-laundering policies and poor communication with senior management.

The report cited a “very low” level of reporting within the sector. Securities dealers reported just 1,825 suspicious transactions to Fintrac during the regulator’s 2014-15 fiscal year – compared with the 21,325 reports filed by banks, 16,576 by credit unions and nearly 4,000 by casinos.

Matthew McGuire, an anti-money-laundering expert and adviser with the Toronto-based consultancy firm The AML Shop, says many securities dealers don’t report suspicious transactions simply because they don’t know the red flags. “I think if you surveyed 10 securities dealers today, all 10 would say: ‘There’s no money laundering here,’” Mr. McGuire says. “It’s not possible. That’s a really naïve view.”

Canadian anti-money laundering rules require securities dealers to establish a compliance regime, keep records of all their clients and flag suspicious transactions to Fintrac. But data obtained by the Globe and Mail under the Access to Information Act show that many of them are failing to fulfill their obligations.

Fintrac investigated securities dealers 253 times between April, 2012, and September, 2017. The watchdog found either “significant” or “very significant” deficiencies in the companies’ anti-money-laundering and terrorist-financing controls 117 times – a worrying rate of about 45 per cent. As well, the remaining 136 investigations turned up what the regulator calls “limited” deficiencies.

Fintrac did not provide a clear definition of limited or significant deficiencies. Instead, the agency said it considers the type, severity and number of shortcomings observed during the examination when determining the level of non-compliance.

Only three penalties were issued by the regulator as a result of those exams. And in total, Fintrac has handed out eight monetary penalties, totaling $643,660, to securities dealers since Dec. 30, 2008. The violations range from failing to report a suspicious transaction to improper record keeping.

Critics say Canadian regulators have been lax on the securities sector. But Fintrac counters that its enforcement regime is not meant to be punitive, and that monetary penalties are only one of several tools for fighting financial crime. “An administrative monetary penalty is not an automatic response to non-compliant activities,” Fintrac spokeswoman Erica Constant said in an e-mail.

In general the agency strives for a more collaborative approach, working with companies to help them comply with the rules, the agency said.

Michelle Alexander, vice-president of the Investment Industry Association of Canada, says the organization’s members have “extensive” policies and procedures in place to prevent and detect money laundering.

IIAC’s members – which range from small regional securities dealers to large national firms – have to meet federal rules as well as those laid out by the Investment Industry Regulatory Organization of Canada.

The e-mails exchanged between investment adviser Sandy Bortolin and Toronto lawyer Stan Grmovsek bore innocent subject lines such as “shoes” or “ties.”

But the real reason for the pair’s frequent correspondence and meetings at the BMO Nesbitt Burns office where Mr. Bortolin worked had nothing to do with business attire, according to documents from a regulatory hearing.

Instead, the innocuously titled e-mails were used to arrange cash drops as part of a complex money-laundering scheme.

Documents from a 2012 ruling by the Investment Industry Regulatory Organization of Canada show that Mr. Bortolin helped Mr. Grmovsek open a trading account at a securities dealer in the Bahamas and launder the proceeds of an insider trading scheme through a series of complex overseas transactions.

Mr. Bortolin received a lifetime ban from the securities industry from IIROC in 2012 and was ordered to pay a $500,000 fine and $100,000 in costs. Mr. Grmovsek pled guilty in 2010 to criminal charges of fraud, insider trading and money laundering and received a 39-month jail sentence.

BMO Nesbitt Burns said in a statement it has made continuous improvements in its ability to protect clients and has “robust systems, tools and processes to monitor and respond to risks.”

Because securities dealers don’t typically accept cash, they are rarely the targets during the placement stage, when dirty money is deposited into the financial system. But they can fall prey during the second stage, where ill-gotten gains already in the system are transferred in and out of various accounts and institutions, and in some cases are used to buy stocks, mutual funds and other investment products. The process, known as layering, makes the original source of the funds more difficult to trace.

“You’re not talking about a duffel bag full of cash, so it’s hard to tell a good dollar from a bad dollar once it’s in the system,” Mr. McGuire says.

Amber Scott, an anti-money-laundering specialist at Toronto-based Securefact, says there is often a misconception that securities are “less sexy” to money launderers because they can’t be bought with cash. But the “legitimacy” they provide actually makes them the “gold standard” for laundering money, Ms. Scott says.

“I want something that looks legitimate if I’m laundering money,” Ms. Scott says. “I want something that’s not going to raise eyebrows. I want that money that’s flowing to another financial institution to come from a Fidelity or a CI Investments or a Manulife, where there’s really not going to be a lot of questions about the pedigree of those funds.”

There are a number of vulnerabilities in the securities industry, including the fact that dealers are typically paid on commission.

“Admittedly there will be a tension between getting the business, because it’s very lucrative in terms of fees, and compliance,” says Peter Aziz, a lawyer at Torys LLP who specializes in anti money laundering.

Experts say that securities dealers may be hesitant to ask tough questions, particularly of high-net-worth clients who demand privacy around their finances.

“They don’t want to offend the client,” Ms. Duhaime says. “They’re afraid they’ll lose the client, that the client will go somewhere else, where they won’t be asked those questions.”

Small dealers may be more exposed to financial crime than larger ones because it’s tougher for them to absorb the costs of implementing a compliance system. “It’s a huge burden on smaller securities dealers,” says Ms. Duhaime, who estimates it costs about $1-million to set up and implement a compliance program.

“It never seems to be enough of a fine to actually hurt their bottom line,” Ms. Duhaime adds. “In Canada, I think some dealers are making strategic decisions that they’re better off to pay the fine because that’s going to cost them less than becoming fully compliant with AML and terrorist financing.”

IIAC’s Ms. Alexander disagrees that dealers permit a higher degree of secrecy for high-net-worth clients. “When a client opens an account, there are specific questions that must be asked to satisfy the AML requirements,” she says. “Those questions have to be answered regardless of who the client is or what their net worth is.”

The fight against money laundering is waged on an ever-shifting landscape. As regulators and financial institutions beef up efforts to identify and deter crime, criminal organizations seem to be one step ahead, seeking new loopholes to exploit. Technological advancements have changed how consumers access financial services, adding another layer of complexity.

“It’s constantly changing,” says Ms. Alexander, noting that firms are increasingly adding new clients online.

“In the old days you had only the face-to-face method, where somebody would come in and have to bring a driver’s license or passport, but obviously we’ve moved beyond that in terms of the technological capabilities,” she said.

The federal Department of Finance is currently reviewing Canada’s anti-money-laundering regime, as it’s required to do every five years.

“The money-laundering and terrorist-financing environment has evolved since the last review was completed in 2013,” the department says in a consultation paper published earlier this year, “and these crimes continue to pose a threat to national security.”