David Baines of the Vancouver Sun has published another article detailing an abusive leverage strategy. Enzo DuVuono recommended and sold $750,000 worth of mutual funds, using their $500,000 home as collateral, to an older couple who were “experiencing difficulty paying their monthly expenses”. The MFDA has alleged that DuVuono did so without ensuring that the investments and leveraged investment strategy were suitable and appropriate for the clients, who were 77 years old and retired and 56 years old and unemployed. The initial loan of $300,000, secured by their home, was made by TD Canada trust, $250,000 of which was invested in mutual funds. Two further loans by B2B Trust and AGF Trust, each of $250,000, were secured by the mutual funds and were invested into more mutual funds. In total, the couple paid at least $37,500 in sales commission, nearly all of which went to DeVuono.

The so-called investment strategy hinged on the fact that the investment returns had to provide enough income to cover the monthly interest-only payments. When the monthly investment returns were suspended due to poor performance, the couple faced a margin call that they could not meet, their loans were called, and their investments were liquidated at a time that they were significantly down.

FAIR Canada views leverage strategies to be too risky for most retail investors. Leverage purchases of mutual funds also appear to be poor investment strategies in a zero interest rate environment: 10-year Government of Canada bonds yield approximately 2%, while the typical investor in a Canadian fixed income mutual fund pays between 1.25% and 1.49%, without taking into account the interest on the loan (commonly between 3.75% and 5.0%), taxes and inflation. FAIR Canada calls on regulators to address what appears to be a growing systemic problem before even more consumers are victimized. Loan agreements between mutual fund dealers and lending institutions like AGF Trust and B2B Trust appear to exacerbate the problem, given the ease and speed with which registrants can have their clients obtain loans. We have written to the Canadian Securities Administrators, asking them to enhance investor protection from advisors who push inappropriate leveraging strategies. Given the risk that leverage adds to a portfolio, there should be a presumption that leverage is unsuitable for the average investor and the onus must rest on the registrant to prove such a strategy is suitable, and more supervision and oversight is needed in order to protect investors. The leverage strategy is almost always profitable for the “financial advisor”, mutual fund companies, and the financial institutions who provide the loans but not for the investor who may suffer catastrophic financial consequences.