Raising the red flag on leveraged investment loans

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Osgoode IPC is speaking out about the need for new practices and legal reform

An uptick in the number of leveraged investment cases at the Investor Protection Clinic has prompted calls for more stringent evaluation of investment loans and obligations for the advisers recommending them. The IPC is raising a red flag on the issue after the market uncertainty of the last year revealed an increasing number of potentially fraudulent cases.

“Mismanaged accounts can sometimes go unnoticed when the market is up. When market returns decline, however, there can sometimes be a big gap between the investment returns and the leveraged loan payment obligations,” explains Cameron Teschuk, a third year Osgoode student working in the Investor Protection Clinic this year and slated to join Sullivan & Cromwell LLP in New York City in 2021 as an associate.

Luigi Rulli, JD/MBA’20, agrees. Now an articling student at Davies, Ward, Phillips & Vineberg LLP, he worked on a leveraged investment file during his year at the Investor Protection Clinic in 2019-20. A young couple lost the better part of their savings and were at risk of defaulting on their loan after their financial adviser recommended they borrow to invest and then falsified their loan application to ensure that they were approved for a substantial investment loan.

“When their investments plummeted, the adviser began taking disbursements out of their principal in order to pay the lender,” remembers Rulli. “When the lender inquired about the declining principal, the adviser disappeared, leaving his clients to pay the outstanding balance on the loan.”

Fortunately, the couple found their way to IPC. Guided by a supervising lawyers Michael Nowina and Glenn Gibson of Baker & McKenzie LLP, Rulli and his student colleagues helped the clients secure partial compensation after a recommendation from Canada’s Ombudsman for Banking Services and Investments (OBSI).

This is just one example among many. Between May and August of this year, the number of active leveraged investment files at IPC has increased significantly.

“We’re committed to raising awareness among investors so that when their adviser comes to them with the idea, they can ask the right questions,” explains IPC student Byungjin Lee. The clinic is also looking at possible regulatory responses to both prevent these situations and increase options for clients to recover their losses (read about IPC’s submission to the Capital Markets Modernization Taskforce).

Adds Rulli: “The Investor Protection Clinic isn’t just a source of legal advice for those who have suffered an investment loss; it also has a role to play in preventing this type of activity from happening again.”

Testimonial:

“Know that this is not just another case you solved. Also remember the impact you made and the many lives you potentially changed. I thank you from the bottom of my heart.” — from an email from an IPC leveraged investment client

IPC’s leveraged loan recommendations

  • Advisers should have full and frank conversations with clients about leveraged investment strategies, highlighting the risks and costs of borrowing.
  • Advisers should implement a rigorous suitability assessment. Leveraged investment strategies are not for everyone.
  • Regulators should evaluate investment loans and consider imposing specific obligations on advisers when recommending them.
Luigi Rulli
Cameron Teschuk Byungjin Lee Luigi Rulli