Advisers: Grey Matter

An investment adviser's mental illness unleashes big trouble.

Robert Frost, the American poet, once observed that the brain is a wonderful organ. “It starts working the moment you get up in the morning,” he said, “and doesn't stop until you get into the office.” That was not the case, however, for former Vancouver investment adviser John Frederick Pryde. The functioning of his mind on the job–or, rather, its malfunctioning due to mental illness–may have cost his employer more than $10 million.

Canaccord Capital Corp. is today one of Canada's largest independent investment dealers. During the 1990s, as part of an ambitious growth-by-acquisition strategy, the Vancouver-based independent investment dealer swallowed half a dozen smaller Canadian brokerages, among them Vancouver's Brink Hudson & Lefever Ltd., which it purchased in 1998. The brokerage industry relies heavily on the performance of individual advisers; what Canaccord really bought was a collection of people, each of whom had his or her own strengths and idiosyncrasies.

One of those people was Pryde, an employee who'd joined Brink three years earlier. On the surface, he seemed a fine asset. He was regarded as successful, intelligent and hard-working. He seemed to know a lot about small-cap stocks. And he appeared to perform admirably, bringing in impressive revenues for the firm while ostensibly keeping clients happy. By the time of the acquisition, however, Pryde was already off the rails. He later admitted that, by then, he'd already conducted more than 400 unauthorized discretionary trades in the accounts of 14 clients.

In other words, Pryde was executing transactions without explicit consent. Discretionary trading can mean something as simple as a broker attempting to sell a plummeting stock to avoid losses for a client who's hiking in the Peruvian Andes; alternatively, some advisers have been known to trade without permission in order to generate commissions for themselves at their clients' expense. (The latter practice is commonly known as “churning.”) Sometimes clients informally acquiesce to unauthorized trading. In any case, the practice is against industry rules, unless the broker has explicit permission to trade on behalf of a client–both from the client and from his or her brokerage.

Pryde continued behaving recklessly at his new employer. In the three years following the Brink acquisition, he executed more unauthorized discretionary trades–in several hundred client accounts. Though few details are publicly available, it seems Pryde fell in love with a small number of small-cap stocks. In early 2001, he converted five client cash accounts into margin accounts, also without notifying the clients or receiving their consent. (Cash accounts are subject to specific rules that can be circumvented, albeit improperly, by converting them into margin accounts.)

Why was Pryde doing these things? One factor may have been that he suffered from bipolar disorder, also known as manic depression. Health Canada says about 1% of the population will experience it during their lifetime. Fortunately, it's treatable. But according to the Toronto-based Centre for Addiction and Mental Health, sufferers typically experience dramatic mood swings–and, when manic, they “may take part in risky and unusual activities…or get in trouble with the law. They may also feel invincible or all-powerful.” As well, they may spend freely and acquire debt. Those are not ideal qualities in an investment adviser.

Pryde would later admit to enforcement officials at the Investment Dealers Association of Canada that through it all, he knew “due to his state of mental health…he posed a significant threat of loss to his clients.” Between 1998 and 2000, manic episodes caused him to be hospitalized twice. Even then, he continued to place trade orders.

Somehow, Pryde's infractions went undiscovered for years. For one thing, Canaccord says it received no customer complaints. Another possible reason was that following its acquisition of Brink, Canaccord failed to integrate the firm quickly; the Brink office remained in a separate building and its compliance apparatus remained in place and largely unchanged. What's more, Canaccord says that Pryde hid his malfeasance well. “From what I understand, John Pryde was a very intelligent man,” says Canaccord spokesman Anthony Ostler. “When he received client complaints, he managed to satisfy his clients' issues, and so they never came to the attention of branch management.” (An IDA hearing panel, however, stated that Pryde made no effort to conceal his activity.)

At long last, in 2001, client allegations surfaced against Pryde. Canaccord suspended him in May of that year, and commenced an investigation. Alleging discretionary trading, unsuitable investments and conduct unbecoming, it fired Pryde one month later. The IDA immediately commenced its own investigation.

Mental illness is often said to come at significant personal and financial cost. For Canaccord this proved abundantly accurate. The company voluntarily settled with a majority of Pryde's clients, reportedly at a cost of at least $9.7 million. “No hardball was played here,” says Ostler. “Canaccord was embarrassed by this. To the best of my knowledge, there have been few, if any, voluntary settlements of this magnitude in our industry.”

The brokerage firm didn't settle with everyone, however; it saw several cases as materially different from the rest. According to Canaccord, six former clients sued Canaccord and Pryde in the Supreme Court of British Columbia. Collectively, those lawsuits seek $2.2 million in damages, plus other damages “that have not been quantified,” according to Canaccord's latest annual report.

One plaintiff is Dale Johannesen. He alleges that in July 2000, and unbeknownst to him, Pryde began buying and selling shares in six small-cap companies, including Dexton Technologies Corp., Voxcom Inc., CST Coldswitch Technologies, Polymer Solutions Inc., ESI Environmental Sensors Inc., and the ironically named Illusion Systems Inc.–stocks that, Johannesen claims, Pryde personally held large positions in. The trading created misleading prices and trading volume in those securities, Johannesen further alleges. “In or about April 2001, Pryde could no longer support and continue the market manipulation,” Johannesen's statement of claim reads. “Consequently, the prices of the manipulated securities fell.” Lawsuits from other Pryde clients make similar allegations, none proven in court.

Canaccord denies the allegations and, generally, argues that the plaintiffs were sophisticated investors who knew what they were doing and were aware of all trading in their accounts. (They allegedly received trade confirmation and regular statements, for instance.) It even countersued two of the plaintiffs, including Johannesen, claiming that they had participated in Pryde's illegal activity. Canaccord alleges that Johannesen cut a deal with Pryde, wherein he would not tell the brokerage about Pryde's activities in exchange for assurances that Johannesen would receive guaranteed prices on certain investments and not be charged commissions. Johannesen, however, denies those allegations.

Pryde, for his part, denies many of the plaintiffs' allegations. And due to his illness, his statement of defence claims, he “did not understand and appreciate the duty upon him” to exercise reasonable care and diligence in serving his clients. “If he did understand and appreciate such duty he was prevented by his disability from discharging such duty,” it reads. Pryde claims the plaintiffs knew or ought to have known about his illness–which they deny.

Trial dates have been set in May 2006 for three Pryde-related actions, including Johannesen's. The IDA's investigation, meanwhile, has concluded. In interviews with enforcement staff, Pryde denied nothing. Theoretically, he could have faced fines totalling as much as $2 million. But IDA investigators faced an unenviable task: they had to separate the man from his disease.

Not everyone chalks up Pryde's actions entirely to bipolar disorder. Enforcement staff, however, received a number of expert medical opinions, and came to believe that the illness played a leading role. “For something of this nature, we would normally have asked for a fine,” says Warren Funt, the IDA's vice-president of member regulation for Western Canada. “But quite frankly, we saw very little point, because of the nature of the mental illness involved here. It seemed to justify an unusual settlement.”

Rather than plunge forward into a lengthy hearing, Pryde and the IDA struck a settlement agreement in September. At its heart lay recognition that bipolar disorder had distorted his ability to think rationally. The proposed sanctions were remarkably light. Pryde would pay $20,000 in legal costs, but no fine. He would be permanently banned from being registered as an “approved person” by the IDA, but even that was not written in stone; he could reapply if he felt he was up to it. And Pryde agreed to co-operate with any future IDA hearings.

The settlement agreement was subject to review by an IDA hearing panel. “Counsel for the Association and Mr. Pryde acknowledged that had the foregoing offences occurred under anything resembling 'normal' circumstances, very severe penalties and sanctions would be imposed,” the panel noted. “However, it was urged upon us that this case presents extremely unusual, and indeed unique circumstances, which require unique considerations and penalties.” The panel accepted the agreement. The IDA duly announced Pryde's expulsion in November.

Pryde continues to suffer from bipolar disorder, and keeps the symptoms in check through counselling and medication. He told the IDA that he has found some work as an administrative clerk and relies on his family for money.

Canaccord, meanwhile, drew important lessons from the experience. “You can't assume just because someone is bringing in big revenue and is well-regarded that everything is fine,” Ostler says. “We've learned that it's important to look at the human aspects and not just the flow-through items of trading. I'd hope that, with this heightened awareness in management to the problems that can arise in this type of situation, that we'd be better at dealing with them.” Settlements of the magnitude paid in the Pryde matter do have a way of focusing the mind.