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Octagon facing shortfall in bankruptcy of as much as $6.1-million

The CN Tower stands in the distance of a Bay Street sign displayed in Toronto, Ontario, Canada, on Tuesday, Feb. 5, 2013. Octagon Capital is facing a multimillion-dollar shortfall in bankruptcy.

Reynard Li/Bloomberg

Octagon Capital Corp. has been declared bankrupt, its chief financial officer has been fired and the brokerage is facing a shortfall of as much as $6.1-million.

The Canadian Investor Protection Fund (CIPF) paid out millions of dollars to investors after the small Toronto-based investment firm was unable to meet obligations to clients when it entered bankruptcy proceedings earlier this month. The Investment Industry Regulatory Organization of Canada (IIROC) discovered the deficiency in late November after a routine audit, according to court documents filed by Octagon's bankruptcy trustee, Ernst and Young Inc. The reason for the shortfall is unknown and an investigation continues.

"I am co-operating fully with the trustee," John Palumbo, Octagon Capital's chief executive officer, said in an e-mail. "I can say that [the $6.1-million shortfall] represents an accounting amount which is in dispute, and I believe the total is much less."

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On the same day the shortfall was revealed, Octagon notified the IIROC that its chief financial officer, Christopher Everest, "was unable to return to work and was being removed from Octagon's accounts, e-mail and payroll systems," according to court documents.

"He was terminated for cause," Mr. Palumbo said on Thursday.

Mr. Everest was not reachable for comment.

The CIPF has so far advanced $4.7-million – the initial tally of the shortfall – to former clients of Octagon. Since the latest estimate is materially higher, it may be called upon to advance more funds as proceedings continue. Specifically, the shortfall was in clients' cash balances at Octagon.

"Investment dealers are allowed to use client funds in their business just like other financial institutions do – for example, a bank when you deposit funds," CIPF CEO Rozanne Reszel said in an interview.

"Their obligation was to maintain adequate regulatory capital, which would ensure that they always had sufficient funds to return to their clients."

Octagon primarily catered to institutional investors and did not have a sizable retail business.

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Many independent brokerages have faced difficulties of late amid a rough resources market, a ragged equities environment and widespread upheaval in investment banking's business model. More than 50 Canadian investment dealers have either gone out of business, merged or been acquired in the past three and a half years.

The CIPF's chief mandate is to act as a backstop for any shortfalls in clients' accounts when brokerages are declared bankrupt. It is sponsored by IIROC dealer members.

Most brokerages are wound down in an orderly fashion without any backstopping by the CIPF being necessary. The CIPF payout in Octagon's case is one of the largest in its history. The biggest payout ever made was $15.5-million in 1987 after Osler Inc., a bond trading boutique, went bust. Since 1971, the CIPF has paid out roughly $47-million to investors.

Editor's note: An earlier version of this article said that CIPF paid $6.3-million to investors in the wake of First Leaside Inc.'s receivership. In fact, $6.3-million is an estimate of CIPF's expenses in relation to First Leaside's receivership.  

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