BCSC

Decisions

BRUCE RUSSELL FOERSTER [Decision]

BCSECCOM #: BCSECCOM	Document Type: Decision
Published Date: 1997-05-02	Effective Date: 1997-05-09
Details:

IN THE MATTER OF THE SECURITIES ACT
R.S.B.C. 1996, c. 418

AND

IN THE MATTER OF BRUCE RUSSELL FOERSTER

HEARING

PANEL:   ADRIENNE R. WANSTALL   MEMBER
BRENT W. AITKEN   MEMBER
DIANE K. WOLCH   MEMBER

DATES:   DECEMBER 2, 3, 4, 5 and 6, 1996

APPEARING:   TODD FOLLETT   FOR COMMISSION STAFF

DECISION OF THE COMMISSION

1. INTRODUCTION

This was a hearing under sections 144(1) and 144.1 of the Securities Act, S.B.C. 1985, c. 83 (the “prior Act”), now sections 161(1) and 162 of the Securities Act, R.S.B.C. 1996, c. 418 (the “Act”), in which staff of the British Columbia Securities Commission seek orders denying Bruce Russell Foerster the benefit of exemptions under the Act, prohibiting Foerster from acting as a director or officer of any issuer and requiring Foerster to pay an administrative penalty and the costs of the hearing, as well as any other order as may be appropriate.

A notice of hearing was issued on March 4, 1996. Foerster received the notice of the hearing, but notified the Commission by fax of his intention not to appear.

It was alleged in the notice of hearing that Foerster, a registrant:

1.   recommended the purchase of certain securities to his clients that were unsuitable for them, considering their investment needs and objectives;

2.   failed to advise his clients of significant material facts concerning investment in certain of the recommended securities, including the risk, the illiquidity of the securities, and the possibility of future cash calls;

3.   with respect to certain of the recommended securities, failed to distribute copies of an offering memorandum to his clients;

4.   with the intention of effecting certain trades, represented that securities would be listed and posted for trading on The Toronto Stock Exchange and gave an undertaking as to the future value or price of securities; and

5.   distributed securities without filing a prospectus.

2. THE INVESTMENTS

2.1 Foerster's Business

Foerster was first registered under the Act as a mutual fund salesperson in October 1982. In September 1988 he obtained registration as a securities salesperson. From April 1992 to May 1995 (which includes the time frame relevant to the allegations) Foerster was employed by Vantage Securities Inc., a securities dealer under the Act. Foerster managed Vantage's White Rock office, where he was the only registrant. Foerster also maintained an office in Ganges on Saltspring Island. In addition to his clients on Saltspring and the lower mainland, he had clients on Vancouver Island.

Foerster held himself out to be a senior financial adviser and had 250 clients with a total of $30 million in assets. Foerster actively promoted his business. He produced an audio tape entitled "Commitment to Excellence - Bruce Foerster, Senior Financial Adviser". The tape jacket includes general promotional language, including the following:
Integrity and genuine concern ensure Bruce's clients of superior and ethical consultation designed to fulfill their objectives and obligations through long term relationships.

The tape goes on to promote natural gas related securities sponsored by Maxwell Resources Inc. and its affiliated companies.

In 1995 Foerster sold a portion of his business to another salesperson at Vantage, Richard Williams. A month later Foerster left Vantage and surrendered his registration in order to pursue his eco-tourism business in Belize, Jungle Sea Ventures Ltd.

2.2 Maxwell

In mid-1992 Foerster, on the recommendation of a business colleague, met with an officer of Maxwell Resources. At the meeting Foerster was presented with an overview of Maxwell Resources’ business and its associated investment vehicles. Maxwell Resources at that time was in the business of acquiring producing natural gas properties, with a combination of bank debt and equity from private investors. In consideration for its efforts in locating and evaluating the properties and managing them after acquisition, Maxwell Resources took a percentage of net production revenues.

The Maxwell group included a number of corporations. Maxwell Resources was a private corporation controlled by a Mr. Ted Konyi. Affiliated with Maxwell Resources was Maxwell Energy Corp., a public company listed on the Vancouver Stock Exchange. These corporations, directly and through subsidiaries and affiliated corporations, sponsored and acted as general partners of various limited partnerships and direct participation ventures.

Following the meeting in mid-1992, Foerster, who in his own words knew "precious little" about the natural gas market, attended several seminars on the subject sponsored by Maxwell and spoke to others he believed to have expertise on the subject.

Foerster concluded that an investment in natural gas properties, as marketed by Maxwell, was suitable for everyone. In an interview with Commission staff in June 1995 he said:
So it was appropriate for any investor, retired people in particular as a portion of their portfolio, because of the, if nothing else, the income generation, the seemingly consistent stream of income. Together with the tax advantages, you know, it made it kind of an ideal investment for somebody that was retired.
And for someone who was not necessarily retired and was looking for more from a capital-gain perspective, they were buying an asset that was seemingly at the bottom of its price cycle and seemed to have nowhere to go but up, and they could not only receive income but generate a potential capital gain on buying something low and selling it high.

In his mind, there was no better time to invest heavily in producing natural gas properties. By August 1992 he apparently felt sufficiently confident in his grasp of the natural gas business to recommend Maxwell investments to his clients. His enthusiasm is demonstrated on the audio tape referred to above. On the tape, he is heard to point out all the advantages described in the quote above. He also refers to Maxwell having done eight previous deals all then yielding over 20 percent per year. At no time on the tape does he refer to any potential risks or other negative factors to the investment. To the contrary, he states that all the investor need do is "sit back and collect the income stream".

During a period beginning in August 1992 and continuing into the first half of 1993, Foerster recommended and sold Maxwell investments to his clients. These included limited partnership units, direct participation units and common shares of Maxwell Energy. Each of these is described in more detail in the following paragraphs.

Investment in each of the two limited partnerships, Maxwell Energy 1 Limited Partnership and Crossfield 1 Energy Limited Partnership, required a minimum investment of $25,000 payable by $15,000 in cash and $10,000 by an interest-bearing promissory note due five years following the date of investment.

These securities were purportedly sold under the prospectus exemption contained in section 117(b) of the Securities Regulation, B.C. Reg. 270/86 (now section 128(b) of the Securities Rules, B.C. Reg. 479/95). Under the exemption, an offering memorandum is required to be delivered to the purchaser before an agreement of purchase and sale is entered into. In addition, section 128 of the Regulation (now section 135 of the Rules) requires each purchaser to sign an acknowledgment and undertaking as set out in Form 20A. Form 20A includes an acknowledgment that the purchaser, by virtue of his net worth and investment experience or advice from a registrant, is able to evaluate the prospective investment on the basis of information provided by the issuer.

Each purchaser of the Maxwell limited partnership also signed a subscription agreement which includes representations that the purchaser:
G   has received, reviewed and fully understands the Offering Memorandum...

I   has sufficient knowledge and experience of financial and investment matters and, by virtue of his net worth and investment experience or by virtue of consultation with or advice from a person or corporation who is... a registered adviser or registered dealer, is able to evaluate the prospective investment in the Units, and fully understands the risks in purchasing the Units;

The offering memorandum for the Maxwell limited partnership states, under risk factors: “An investment in the Units should be considered highly speculative due to the nature of the Limited Partnership’s involvement in the natural gas and oil industry. A potential investor should consider carefully the factors set forth below in deciding whether to invest in Units.” The risk factors set out cover more than two pages and refer to the illiquidity of the securities. The offering memorandum also states that: “Limited Partners will be entitled to receive distributions of Net Cash Flow. The General Partner will first withhold from any cash distributions the amount of unpaid principal plus interest due and owing under the Limited Partner’s promissory note.” However, the offering memorandum is clear that the promissory note would have to be paid in five years even if the cash distributions had been inadequate for this purpose. The offering memorandum does not describe the risk that future cash calls could be made by the limited partnership. This is, however, noted in the limited partnership agreement.

Each purchaser of the Crossfield limited partnership also signed a subscription agreement acknowledging receipt of the offering memorandum. The offering memorandum for the Crossfield limited partnership describes the speculative nature of the investment, the risks and the illiquidity of the investment using language similar to that found in the offering memorandum for the Maxwell limited partnership. The offering memorandum also contains language regarding payment of the promissory note similar to that found in the offering memorandum for the Maxwell limited partnership. However, the Crossfield offering memorandum contains a provision that the limited partnership will not make future cash calls.

Foerster also recommended and sold to several clients direct participation units in Crossfield Turner Valley Unit. Its business was the same as that carried on by the limited partnerships and therefore had substantially the same business risks. However, unlike the limited partnership units which represented an ownership interest in a separate legal entity which in turn owned the interest in the oil and gas properties, the direct participation units represented direct ownership in the oil and gas properties themselves. These investments were sold under the prospectus exemption contained in section 55(2)(4) of the prior Act (now section 74(2)(4) of the Act) and required a minimum investment of $100,000 payable in cash. Apart from a document that appears to have been prepared by Vantage and which refers to receipt of an offering memorandum for the direct participation units, there is no documentary evidence that an offering memorandum was prepared; the documents prepared by Maxwell make no reference to an offering memorandum and none was put into evidence. One of the witnesses testified that he had been given a copy of an offering memorandum before investing in the direct participation units. However, he identified the offering memorandum for the Maxwell limited partnership, with a different coloured cover, as being the offering memorandum that he received. Finally, in the participation agreement respecting the securities, the investor acknowledges that he or she has received no advertisement; where an issuer distributes securities under section 55(2)(4) of the prior Act (or section 74(2)(4) of the Act) without advertisement, the issuer is not required to provide an offering memorandum.

The total capitalization of the limited partnerships was about half equity and half debt. In the direct participation venture, the ratio was about 60 percent equity and 40 percent debt. In each case, the debt was secured by a pledge of the oil and gas properties and, in the case of the limited partnerships, also by the assignment of the investors’ promissory notes.

The net revenue from oil and gas sales was distributed after deduction of extraction and processing and other operating costs and debt service. Debt service included principal and interest on the debt secured by the pledged oil and gas properties.

Foerster's commission on the sale of the limited partnerships was 10 percent and an additional ongoing 6 percent share of total net limited partnership revenue. His commission on the sale of the direct participation units was 2 percent with an ongoing commission of 6 percent to 9 percent of total net revenue.

Foerster also recommended to his clients the purchase of common shares of Maxwell Energy, and all of the clients who testified acted upon his recommendation. Maxwell Energy was active in the acquisition, syndication and management of natural gas and oil properties. The upside in Maxwell Energy was seen to be its potential to raise ever-increasing sums of money to purchase additional production and thereby steadily increase its net production revenue. As Foerster put it,
...they had raised this, I believe, $30 million with about 15 representatives like myself during a four-month -- three-month period, really. It was really October, November, December that 90 per cent of the funds came in. And by the time the Crossfield project closed, they had attracted the attention of many other financial advisors. And by the time January rolled around, they had, I believe, about 200 financial advisors who were now ready, willing and able to march forth and raise funds for Maxwell.
So what the market said was if this little company can raise $50 [sic] million in three months with 15 representatives, what can they raise in 12 months with 200 representatives?...

So this is why the market was willing to pay $5 a share to [the] company, albeit they didn't own anything or their interests were very minimal.

Foerster acknowledged the speculative nature of the Maxwell Energy shares in an undated letter to Maxwell investors that appears to have been sent in 1993 or 1994, which states:
Remember however, that this is a small, highly volatile company, dealing in a highly volatile commodity, and regardless of how promising the Company’s outlook is this type of security should never comprise more than 10% of and individuals [sic] portfolio.
As Vantage was registered as a securities dealer and was not a member of the Exchange, Foerster had to trade Maxwell Energy shares through a dealer who was a member of the Exchange. The evidence shows that Foerster’s clients purchased Maxwell shares either through Foerster or through Bob Shepherd, a salesperson employed by Haywood Securities Ltd. According to Foerster, it was the responsibility of the salesperson executing the trade to ensure suitability of the investment for the client. This process included, in his words,

...making sure [the client] realized that it was a VSE company, that it was in the natural gas area, that it carried with it various risks and so on and they had a clear understanding of the risks. And then, of course, determine what their net worths and investment experience and such and so forth are. And from that determine whether the amount they wanted to invest was appropriate.
Subsequent to his clients’ purchases of the various Maxwell investments, the roof fell in. As Foerster hoped, gas prices shot up. Unfortunately, prices for producing properties rose proportionately. As a result, Maxwell Energy was no longer able to structure financings with a competitive return. The price of Maxwell Energy shares began a long downward slide from the $4.50 to $5.00 range to pennies. As the price fell, Foerster urged his clients to average down by buying more shares. Many did, to their subsequent regret: the stock continued to fall. It has never recovered. All of Foerster's clients lost virtually their entire investment in Maxwell Energy shares.

If this were not bad enough, gas prices then fell dramatically. The limited partnerships and direct participation venture had problems servicing their bank debt. As a consequence, investors saw their cash flow slow to a trickle, and then stop. In the end, the only way for the investors in the Maxwell limited partnership to preserve their equity was to contribute more cash. Many were unable or unwilling to do so. Worse yet, the promissory notes the investors had issued to the limited partnerships had been assigned to the bank as collateral security for the partnerships' bank debt, and the investors were required by the bank to pay the interest on their promissory notes. Several investors testified that this was news to them. Their expectation was that cash flow from production would repay the notes. The investors testified that they had no idea that they could possibly be required to come up with additional cash to cover the notes.

2.3 Columbia Fishing Resort Group

Columbia Fishing Resort Group was a venture capital corporation registered under the Small Business Venture Capital Act (British Columbia). It was established to invest in Hakai Beach Resort Ltd., a company formed to develop and operate a destination fishing resort on Calvert Island in Hakai Passage on British Columbia’s north coast. The shares of Columbia were distributed under two exemptions from the prospectus requirements of the Act. The prospectus exemption contained in section 117(a) of the Regulation (now section 128(a) of the Rules) requires no minimum subscription, while the prospectus exemption in section 117(b) of the Regulation (now section 128(b) of the Rules) requires a minimum subscription of $25,000. Foerster's commission on the shares he sold to his clients was 10 percent.

As with the Maxwell and Crossfield limited partnerships, an offering memorandum was required to be delivered to each purchaser before an agreement of purchase and sale was entered into, and each purchaser was required to sign an acknowledgment and undertaking as set out in Form 20A. Form 20A includes an acknowledgment that the purchaser, by virtue of his net worth and investment experience or advice from a registrant, is able to evaluate the prospective investment on the basis of information provided by the issuer. Each purchaser of the Columbia shares also signed a subscription agreement which was delivered to Columbia.

The offering memorandum for the Columbia shares contains a section entitled “Risk Factors”, which begins with this statement:
This is a speculative offering. The purchase of Shares involves a number of significant risk factors and is suitable only for investors who are aware of the risks and who have the ability and willingness to accept the risk of total loss of their invested capital and who have no immediate need for liquidity.
In 1995 Hakai Beach filed for bankruptcy.

2.4 Jungle Sea Ventures Ltd.

Jungle Sea Ventures Ltd. is a company formed to develop and operate eco-tourism resorts in Belize. Jungle Sea was Foerster's own business venture.

The evidence suggests quite clearly that Foerster was the directing mind and will of Jungle Sea, its promoter and, initially, its sole shareholder. In a document headed "Jungle Sea Ventures Ltd. - Business Plan", Jungle Sea is identified as a "newly formed private company" incorporated in Belize. Project financing of $800,000 is shown as coming from only two sources: $400,000 from Foerster and $400,000 from the sale of shares in the company.

Foerster is identified consistently in all of the Jungle Sea documentation as the President and no other senior management is identified, with the exception of an "Advisory Board" whose members are not identified as directors and who appear to have been chosen for their expertise in various facets of the construction industry. In a letter to investors dated April 19, 1994, Foerster said:
The only significant event that could derail this project and compromise your investment is if something tragic happened to me, as no one else involved with the project has the control or capital to make it a success. I have therefore decided to take a Life Insurance policy out on my life and named each investor as a beneficiary, to insure that should I die before the projects [sic] completion you will receive back, without delay, your original capital.

Furthermore, Jungle Sea was described by Foerster to the investors we heard as "his own venture” and "his own business"; no other individuals were identified as having any significant management involvement.

Foerster solicited a number of his clients to purchase Jungle Sea shares in early 1995 just before selling his business to Williams and leaving Vantage. The shares of Jungle Sea purchased by Foerster's clients were offered at Cdn $1.00 per share with a minimum subscription of Cdn $25,000. No preliminary prospectus or prospectus was filed under the Act and no prospectus exemption was available. No offering memorandum was delivered to Foerster’s clients. The "share purchase application" signed by investors provided, among other things, that:
3.) [The shareholder is] entitled to redeem these shares twelve (12) months after issue in U.S. dollars on the basis of 1 dollar per 1 share.

4.) Dividends will be paid annually on a pro-rata basis, the first dividend scheduled will be at the companies [sic] fiscal year end which is Oct. 31/1995.

The three Jungle Sea investors who testified were also investors in Maxwell and Columbia. Although one of the investors in Jungle Sea understood clearly that Foerster's role had changed with respect to this investment from independent advisor to promoter, the other investors did not understand this distinction and Foerster did not draw it to their attention.

All three investors have attempted, without success, to redeem their shares. No dividends have been paid.

3. THE CLIENTS

The Commission heard 14 witnesses: the Commission staff investigator, Williams and 12 former clients of Foerster. As noted previously, Foerster himself chose not to appear, but a transcript of the June 1995 interview of Foerster by Commission staff formed part of the evidence.

Foerster's Maxwell investors included the 12 former clients who testified at the hearing. Their stories vary in the details, but are completely consistent in several material respects. The following is a synopsis of their testimony.

1.   All were conservative, risk-averse investors and had a strong desire to protect the safety of their capital.

2.   The information Foerster recorded about many of them on their New Client Application forms tended to overstate their net worth and the level of their investment knowledge. Their total net worth appeared to be approximately $5.5 million, slightly over 50 percent of which represented the equity in their homes.

3.   All regarded their investment knowledge as inferior to that possessed by Foerster and relied on him for his expertise. Even those whose investment knowledge Foerster characterized as "good" had little experience outside CDIC-insured fixed income securities and conservative mutual funds.

4.   All were relying on Foerster to act in their best interests and, in particular, to protect them from risk beyond the level with which they were comfortable.

5.   Foerster represented to all of them that the Maxwell investments were without risk. There was in fact little, if any, discussion of risk. The investments were described by such phrases as "all upside", "couldn't go wrong", and "a sure thing".

6.   Though an offering memorandum was required to be given to investors in the limited partnerships, none of these investors received the offering memorandum prior to purchasing the securities. Only one recalled receiving an offering memorandum at all.

7.   The paperwork required for the investments, such as the Form 20A, the subscription form and the promissory note for the limited partnerships, was not explained to the investors. Instead, they were just asked to sign the forms and hand over their cheques. Any questions about the forms were met with a response such as "That's just the way these things are done". Consequently, although some forms included an acknowledgment that the investor had received an offering memorandum, the clients did not realize that they had made such an acknowledgment.

8.   Foerster represented to several investors before they purchased Maxwell Energy shares that the shares would soon be listed on The Toronto Stock Exchange. This was a material consideration for some investors.

9.   Foerster represented to several investors before they purchased Maxwell Energy shares that the shares would increase dramatically in price or value over the short term. Once again, this was a material consideration for some investors.

10.   Foerster's marketing style was aggressive. No alternatives were offered to his recommendations. Some clients felt intimidated by Foerster; they felt that he was ridiculing them if they were reluctant to follow his recommendations. If clients did not have sufficient funds to invest in his recommendations, he suggested that the clients sell their holdings of more conservative investments and/or borrow against the equity in their home. Regrettably, several clients went along with this advice.

All of the Columbia and Jungle Sea investors who testified were also investors in Maxwell, and their collective testimony follows a similar pattern to that described above with respect to Maxwell (except with respect to the representations in paragraphs 8 and 9). The total amount invested by the 12 former clients in securities of Maxwell, Columbia and Jungle Sea was approximately $1,170,000; of this, $90,000 was invested in Jungle Sea. Foerster would have received approximately $415,000 in commissions from the sales of the Maxwell limited partnerships and direct participation units, and the Columbia shares. In addition, Foerster would have received a minimum 6 percent share of total net revenue from the limited partnerships and the direct participation venture.

In order to more fully understand the nature of Foerster’s dealings with his former clients, it is helpful to review in more detail the evidence given by one of those former clients, Irene Orr. Mr. and Mrs. Orr were both in their late forties when they met Foerster at an investment seminar he was conducting in White Rock. At that time, Mr. Orr was running his own business, earning about $30,000 per year, and Mrs. Orr did not work. They had no prior investment experience and their only assets were their house, worth about $450,000 free and clear, some vehicles, and Mr. Orr’s business, worth about $50,000. They had no savings, no RRSPs and no investments. Their goal was to save enough money to allow them to retire in 12 to 17 years.

After meeting with the Orrs in June 1993, Foerster filled out a New Client Application form, noting their investment objectives as 50 percent “Income” and 50 percent “Long Term Growth”; the form allocates zero percent to “Venture Situations”. Mrs. Orr confirmed in her testimony that she was definitely a conservative investor.

During 1993 and 1994 the Orrs purchased, on Foerster’s recommendation, $100,000 of the Maxwell limited partnership, $11,700 of the Maxwell Energy shares, $50,000 of the Columbia shares and $25,000 of the Jungle Sea shares, at a total cost of $186,700. $40,000 of this was paid by issuance of a promissory note to the Maxwell limited partnership. The remaining $146,700 was paid in cash, all of which was borrowed in order to make these investments. Some of these borrowings were secured by a mortgage on their house. Mrs. Orr testified that, at the time he recommended that the Orrs make these investments, Foerster knew that they were borrowing the money to do so.

Foerster did not discuss with the Orrs the risks relating to any of these investments. Nor did he provide them with the offering memoranda respecting the Maxwell limited partnership and the Columbia shares. At the time the Orrs accepted Foerster’s recommendations and made these investments they believed that he was acting in their best interests. As well, when they purchased the Jungle Sea shares, they did not understand that Foerster was acting both as financial adviser to them and as promoter of Jungle Sea, and Foerster did not raise this issue with them.

Finally, in April 1995, Foerster asked the Orrs to loan him $10,000, which they agreed to do. The loan was paid back, with interest, within 90 days. However, the Orrs were not as fortunate with respect to the investments they had made on Foerster’s recommendation. In 1995, they were required to make a cash contribution of $1,600 to the Maxwell limited partnership; it is unclear whether they made this payment and whether the investment has any value today. They sold their Maxwell Energy shares for $600 in 1996. Their Columbia shares are worthless and they have been unable to redeem their Jungle Sea shares.

4. FINDINGS

4.1 Failure to Comply with the Know Your Client Rule

It is alleged in the notice of hearing that the Maxwell limited partnerships and direct participation units, the Maxwell Energy shares and the Columbia shares that Foerster recommended and sold to his clients were not suitable for them, having regard to their investment needs and objectives.

The obligation of registrants commonly known as the "know your client" rule is contained in section 43 of the Regulation (now section 48 of the Rules). Sections 40 and 43 of the Regulation then read:
40. Every dealer or adviser shall establish prudent business procedures for dealing with clients and shall ensure that those procedures are adequately supervised.

43. (1) For the purpose of section 40... every dealer... shall make enquiries concerning each client
...
(b) to determine the general investment needs and objectives of the client and the suitability of a proposed purchase or sale for that client.

The know your client rule, quoted above, clearly obliges a dealer to take into account the client's investment needs and objectives when effecting a trade. The Regulation states that the dealer must "determine the general investment needs and objectives of the client and the suitability of a proposed purchase or sale for that client." As a registered salesperson of a registered dealer, Foerster had an obligation to comply with the know your client rule in his dealings with clients. See: In the Matter of Michael Shane Ivancoe [1995] 30 BCSC Weekly Summary 13 and In the Matter of John Philip MacKenzie Williams and Aristedes Mellios [1996] 12 BCSC Weekly Summary 9.

The fact that Foerster was selling securities pursuant to exemptions under the Act did not relieve him of his responsibility to determine the suitability of those investments for his clients. A registrant must meet his or her know your client obligations regardless of the specific type of security being sold or recommended.

The first step in complying with the know your client rule is to ensure that the client's investment needs and objectives are understood. In order to facilitate this, registrants use forms designed to uncover all the circumstances of the client that are material to his or her investment decisions.

Many of the New Client Application forms that Foerster completed with respect to his clients were not accurate. Although they did generally reflect his clients' conservative investment objectives, many were not entirely accurate in that respect, tending to overstate the portion of the portfolio that the investor wished to invest in "Venture Situations". However, Foerster apparently placed little importance on that information; all of his clients who invested in Columbia had zero percent entered in the "Venture Situations" category.

Foerster himself offered at least a partial explanation of these deficiencies in his interview with Commission staff:
[INVESTIGATOR]: Just to back up a point, these new client application forms, when they're filled out, does the client fill these out, or do you fill them out?

FOERSTER: No, I fill them out.

[INVESTIGATOR]: Because I notice there was nowhere on the form where the client initials it or indicates in any way that they were involved in filling it out.

FOERSTER: That's correct.

[INVESTIGATOR]: Do you fill it out with them sort of in front of you as we are now?

FOERSTER: No. No, I fill it out after they leave.
...
[INVESTIGATOR]: I don't know Eleanor Deacon and I notice that you've got here a flag, investment knowledge of "good".

FOERSTER: Yeah.

[INVESTIGATOR]: When you are listening to a person or talking to a person, obviously for probably only the first or second time before you fill this out.

FOERSTER: Yeah.

[INVESTIGATOR]: What knowledge did they have to display to get them to --

FOERSTER: Just in conversation. Just by, you know, I spend about 20 minutes or half an hour just chatting with someone and just trying to determine what investment knowledge they have, what investments have they made in the past, what has worked out for them, what hasn't.
...
FOERSTER: [In response to a question about an apparent discrepancy between a client's actual net worth and that shown on the form] Well, again, when they -- you see, it's a matter of does he include his wife's net worth in there as well, or does he take the house and just take 50 per cent of that? It's a function of what you base the calculations upon.

Essentially, what I have tried to do is take -- if it's a married couple, I take the -- no, it's different. Because if the man is working and the wife is not, then if you ask me what his net worth is, then I will often say, it's a combination of all their assets. If, in fact, they are both working, and both have their own assets, then I will take their total net worths and divide it in two.

So it's just a matter of which numbers you apply to that to determine what the individual net worths are going to be. And in some cases I may have got, you know, specified their individual net worths and in some situations their family net worth, depending on their individual situation.

[INVESTIGATOR]: Would you have noted that on the form?

FOERSTER: No, I don't think so. It's something I just do almost subconsciously.

When it came to discovering his clients' net worths and investment knowledge, it appears that Foerster had an aversion to simply asking them. It is reasonable to assume that had he done so, more accurate information would have appeared on the file. Completing the forms with the client in front of him, and taking more care with the net worth sections would also have improved accuracy. Unfortunately, a copy of the form was apparently not sent to the client, even though the form itself indicates that one copy of the form is for the client. Had this been done, some clients might have taken the trouble to correct the inaccuracies on the form.

According to Williams, who purchased Foerster's business, Foerster's file keeping practices were poor. Upon reviewing Foerster's files of his clients, Williams found that they appeared to be in reasonable order with respect to the clients' mutual fund positions. However, Williams noted that the information in the files deteriorated from 1993 forward. There was virtually no information respecting the clients' investments in the Maxwell limited partnerships and the Columbia shares.

Perhaps more seriously, Foerster overvalued his clients' net worth by recording inaccurate figures and by including in every case the value of the client's personal residence:
[INVESTIGATOR]: So what these figures indicate then is when you are estimating someone's net worth, you include the roof over their head?

FOERSTER: Absolutely.

[INVESTIGATOR]: And when you're considering suitability of an investment, you also factor in their home as well?

FOERSTER: Sure, I do. Yeah...

It is acceptable to consider the equity in the client's home when establishing his or her net worth. However, in the case of many of those who testified, the equity in their homes represented most of their total net worth, and it appears to us that Foerster overemphasized this factor in evaluating the net worth of his clients for investment purposes.

The second step in complying with the know your client rule is determining that the proposed investment is suitable for the client, that is, that it will achieve the investment objectives of the client while keeping within the level of risk dictated by the client's comfort level and overall circumstances. The accuracy of the information in his clients' files may be largely moot, since it appears that once Foerster discovered Maxwell, he abandoned any sort of portfolio approach to his clients' accounts. Williams testified that the files revealed no sound portfolio structure and instead appeared "product driven". He said there was "no balance" to any of the portfolios.

Each of the Maxwell investments was highly speculative and involved significant risks. Each was dependent on the price of natural gas, which Foerster characterized as a “highly volatile commodity”. The limited partnerships and direct participation units were illiquid and subject to resale restrictions. Investors in the Maxwell limited partnership were subject to future cash calls.

An investment in Columbia shares also involved significant risks. Columbia was a start-up operation with no operational or earnings history. Its success was dependent on luring sufficient tourists to its remote location to cover its costs and deliver a return. It was dependent on all the risks inherent in the tourist industry, as well as the condition of the salmon fishery. Already illiquid by nature, the shares were also subject to resale restrictions.

We are of the view that the Maxwell and Columbia investments were not suitable at all for most of the investors who testified. Even the few investors who had indicated that they wanted a small percentage of their investments in “Venture Situations” ended up with Maxwell and Columbia investments greatly in excess of their desired percentage. Foerster’s clients had conservative investment objectives for a good reason: very few of them were in a position to put their principal at risk. Several were retired; many others were within a few years of retirement. Still others were younger, but had modest incomes and limited ability to rebuild their capital were it to be lost.

Investing new funds in the ventures that he did would have been bad enough but, in many cases, Foerster recommended his clients sell other more conservative investments to buy them. In some cases, on Foerster's advice, clients borrowed against the equity in their homes to invest.

We find that Foerster failed to determine the general investment needs and objectives of his clients and that the Maxwell limited partnerships and direct participation units, the Maxwell Energy shares and the Columbia shares Foerster recommended and sold to his clients were not suitable for them, having regard to their investment needs and objectives. Indeed, there is no other reasonable conclusion to be drawn from the evidence. Consequently, we find that Foerster failed to comply with the know your client rule in his dealings with his clients.

4.2   Failure to Inform Clients of Significant Material Facts

It is alleged in the notice of hearing that Foerster failed to advise his clients of significant material facts concerning investment in the Maxwell limited partnerships and direct participation units, including the risk, the illiquidity of the securities, and the possibility of future cash calls.

The nature of the fiduciary duty owed by a registrant under the Act to his or her client was recently canvassed by the Supreme Court of Canada in Hodgkinson v. Simms (1994), 97 B.C.L.R. (2d) 1. La Forest J. notes at page 28 of that decision that “courts have consistently shown a willingness to enforce a fiduciary duty in the investment advice aspect of many kinds of financial service relationships” and expands upon the reasons for this at page 30:
Apart from the idea that a person has breached a trust, there is a wider reason to support fiduciary relationships in the case of financial advisors. These are occupations where advisors to whom a person gives trust has power over a vast sum of money, yet the nature of their position is such that specific regulation might frustrate the very function they have to perform. By enforcing a duty of honesty and good faith, the courts are able to regulate an activity that is of great value to commerce and society generally.
At page 29, La Forest J. quotes with approval from Varcoe v. Sterling (1992), 7 O.R. (3d) 204 (Gen.Div), where Keenan J. states:
The relationship of the broker and client is elevated to a fiduciary level when the client reposes trust and confidence in the broker and relies on the broker’s advice in making business decisions. When the broker seeks or accepts the client’s trust and confidence and undertakes to advise, the broker must do so fully, honestly and in good faith...
It is clear from the testimony of Foerster’s former clients that each of them reposed a considerable degree of trust and confidence in Foerster and relied heavily on his advice in making investment decisions. The clients who purchased the Maxwell limited partnerships and direct participation units all did so on Foerster’s recommendation. Therefore, we find that Foerster owed a fiduciary duty to each of these clients when he advised them to purchase these investments. In order to fulfill this duty, Foerster was required to advise them fully, honestly and in good faith with respect to the investments.

To advise a client “fully” about an investment, the registrant must inform the client of all the material factors relating to the investment, both positive and negative. This obligation is well recognized in the securities industry and has been set out in the manual followed by members of the securities self regulatory organizations since before Foerster was registered in 1982. At the time of his registration as a securities salesperson in 1988, Foerster would have been required to pass an examination based on that manual even though he was not a member of one of the self regulatory organizations.

The current version of the manual, the Conduct and Practices Handbook for Securities Industry Professionals, provides that a registrant has a responsibility to ensure that “the client is made aware of all salient material, such as positive and negative factors involved in a transaction, prior to executing a trade on the client’s behalf. A balanced presentation must be offered to the client in the interest of complete disclosure and relative objectivity.”

There were several material negative factors associated with the Maxwell limited partnerships and direct participation units, including the following:

1.   The value of the units as well as the security and quantum of the cash flow to investors depended primarily on the price of natural gas which, like the price of any commodity, fluctuates, sometimes with great volatility.

2.   The investment entities had significant debt. The ability to service that debt depended not only on gas prices, but interest rates as well.

3.   In the case of both limited partnerships, a reduction of cash flow also meant that the investor's debt, represented by the promissory note issued for his or her investment, could not be serviced, and the investor had to come up with additional funds to pay it. In the case of the Maxwell limited partnership, the limited partnership could also make cash calls.

4.   The investments were illiquid.

All of these material negative factors, except those described in paragraph 3 above, and others are described in the offering memoranda for the limited partnerships. In fact, the offering memorandum for the Maxwell limited partnership describes the investment as "highly speculative", while the offering memorandum for the Crossfield limited partnership contains similar language. Unfortunately, none of Foerster's clients who testified at the hearing received an offering memorandum prior to investing in the limited partnerships; only one recalled receiving an offering memorandum at all.

None of the clients recalled any meaningful discussion of risk respecting their purchases of the Maxwell limited partnerships or direct participation units. In fact, Foerster was not honest about the material negative factors associated with these investments and actually mislead his clients about the risks involved in purchasing these securities. Foerster described them in terms such as "all upside", "couldn't go wrong" and "a sure thing". He also misled at least one investor about the liquidity of her investment, suggesting that he would be able to arrange a sale if she wanted to sell. However, when she attempted to sell, he told her he could not do so. None of the investors had any awareness that debt was a factor in the investments. In his audio tape, Foerster states that the minimum investment in the Crossfield limited partnership is $15,000; this refers only to the cash component and completely ignores the $10,000 promissory note that is also required. In his interview with Commission staff, Foerster admitted that he did not discuss with his clients the possibility of future cash calls. Finally, in the case of the investors that Foerster encouraged to borrow against the equity in their homes in order to invest, there was no discussion about the risks of leveraged investing.

We find that Foerster failed to advise his clients of material negative factors associated with the Maxwell limited partnerships and direct participation units. Further, we find that Foerster failed to advise his clients fully, honestly and in good faith respecting these investments, and therefore breached his fiduciary duty to them.

Though we have made these findings, we note that several of the investors who testified signed subscription forms stating that they had received an offering memorandum. It is the responsibility of any potential investor to read and understand anything that he or she is asked to sign in connection with the purchase of securities. If the investor lacks confidence in his or her ability to interpret such documents, he or she should seek independent advice. When a document contains an untrue statement, such as a declaration that the investor has received an offering memorandum when in fact he or she has not, the investor should not sign the form until matters are rectified. Obviously, the investors we heard did not follow this procedure. We cannot help but observe that had the investors read more carefully what they were asked to sign, much of their grief might have been avoided.

4.3 Failure to Deliver an Offering Memorandum

It is alleged that Foerster failed to distribute to his clients copies of the offering memoranda respecting the Maxwell limited partnerships and direct participation units.

The evidence produced at the hearing establishes that none of the investors in the Maxwell limited partnerships received an offering memorandum before an agreement of purchase and sale for the securities was entered into. However, it appears that an offering memorandum was neither required nor provided with respect to the direct participation units.

Foerster was acting as agent for the issuers in connection with the distribution of the limited partnerships. He arranged for each of his clients to sign the subscription agreements and Forms 20A and the purchase price was delivered to him. As agent for the issuers, Foerster should have delivered copies of the offering memoranda to his clients prior to his clients signing the subscription agreements. He also had a duty to his clients to ensure that they had received the offering memoranda prior to the time he arranged for them to sign the subscription agreements.

We find that Foerster failed to distribute to his clients copies of the offering memoranda respecting the Maxwell limited partnerships.

4.4 Prohibited Representations

It is alleged in the notice of hearing that Foerster:

1.   with the intention of effecting a trade in Maxwell Energy shares, represented that the shares would be listed and posted for trading on The Toronto Stock Exchange, contrary to section 35(1)(c) of the prior Act (now section 50(1)(c) of the Act); and

2.   with the intention of effecting a trade in Maxwell Energy shares, gave an undertaking relating to the future value or price of the shares, contrary to section 35(1)(b) of the prior Act (now section 50(1)(b) of the Act).

Representation as to Stock Exchange Listing

Section 35(1)(c) of the prior Act then read:

35.(1)   No person, with the intention of effecting a trade in a security,
...
(c) shall, except with the written permission of the superintendent, make any representation, written or oral, that
(i) the security will be listed and posted for trading on a stock exchange
Several witnesses testified that Foerster represented to them that the shares of Maxwell Energy were to be listed on The Toronto Stock Exchange. The Commission staff investigator testified that the written permission of the Superintendent to make such a representation had not been obtained. However, to be found to have contravened the section, Foerster must also have had an intention to effect a trade in the shares.

The prior Act then defined "trade" as follows:
"trade" includes
...
(c) the receipt by a registrant of an order to buy or sell a security
..., and

(e) any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any of the activities specified in paragraphs (a) to (d)

It is clear from the testimony of the investors and Foerster's interview with Commission staff that he so believed in the Maxwell story that he wanted his clients to invest in Maxwell Energy shares, even if they purchased the shares through Shepherd and Foerster received no commission. His reward, he told Commission staff, was to "have happy clients". The "trade" that Foerster intended to effect, therefore, was the placing of an order by his clients to buy Maxwell Energy shares, whether that order was placed with himself or with Shepherd, and his acts were in furtherance of those trades.

We therefore find that Foerster contravened section 35(1)(c) of the prior Act.

Undertaking as to Future Price or Value

Section 35(1)(b) of the prior Act then read:

35.(1)   No person, with the intention of effecting a trade in a security,
...
(b) shall give an undertaking, written or oral, relating to the future value or price of that security

The evidence establishes an intention to effect a trade in the shares on the same basis that it did for section 35(1)(c) of the prior Act.

Every witness who invested in Maxwell Energy shares testified that Foerster told them the stock was going to increase in value significantly. Does that constitute an "undertaking" within the meaning of section 35(1)(b)?

"Undertaking" is defined in the Oxford English Dictionary as a "pledge or promise" and in Black's Law Dictionary as a "promise, engagement or stipulation". Foerster did not merely state that the shares had excellent potential, or even just that they would increase in price. In several instances, he cited specific values for the shares, accompanied by a time frame within which the price would be met. One investor was told the shares would increase in value by "20% to 30% in four to six months". Another was told it would go to $10 in "a month or so". Yet another was told that "in two years, the stock would be worth $24".

The specific nature of Foerster's predictions amounts in our view to undertakings within the meaning of section 35(1)(b) of the prior Act, and we therefore find that Foerster contravened section 35(1)(b) of the prior Act.

4.5 Distribution without Filing a Prospectus

It is alleged in the notice of hearing that Foerster distributed shares of Jungle Sea without filing a prospectus, contrary to section 42 of the prior Act (now section 61 of the Act).

Section 42 of the prior Act then read:

42. (1) Unless exempted under this Act or the regulations, a person shall not distribute a security unless a preliminary prospectus and a prospectus respecting that security

(a) have been filed with, and

(b) receipts obtained for them from,

the superintendent.

The relevant definitions from section 1(1) of the prior Act then read:

"distribution" means, where used in relation to trading in securities,

(a) a trade in a security of an issuer that has not been previously issued;

"trade" includes

(a) a disposition of a security for valuable consideration
...
(e) any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any of the activities specified in paragraphs (a) to (d).

In addition to their testimony, the investors in Jungle Sea produced subscription forms, share certificates and other relevant documentation showing their purchase of Jungle Sea shares from Jungle Sea as a result of Foerster's solicitations. There is ample evidence that Foerster solicited clients to purchase shares of Jungle Sea that had not been previously issued.

We therefore find that Foerster traded shares of Jungle Sea to residents of British Columbia and that such sales constituted a distribution. No preliminary prospectus or prospectus had been filed with respect to the Jungle Sea shares; nor did the distribution fall into any of the prospectus exemptions contained in the prior Act or the Regulation. We therefore find that Foerster contravened section 42 of the prior Act.

5. DECISION

Foerster's breaches of his duty to his clients were egregious and damaging. He has left a trail of hardship and broken dreams. Clients who relied on him for objective advice tailored to their investment needs and objectives instead received the opposite. Put at its best, Foerster's enthusiasm for the Maxwell projects blinded him to their potential risks. At worst, he put his commissions and other self-interests ahead of his clients' needs. Either way, Foerster failed absolutely to meet the know your client rule, the cardinal rule for every salesperson registered under the Act, and breached his fiduciary duty to them by failing to advise them fully, honestly and in good faith with respect to their investments. In the process, he received commissions in excess of $415,000, plus a participation in net revenues from the Maxwell limited partnerships and direct participation venture.

Several of Foerster's retired clients now find themselves in hardship, much of their savings having been lost through investing according to Foerster's recommendations. Others have had their retirement plans significantly delayed. All of the clients that testified have suffered a material degradation of net worth (which, prior to these investments, totalled approximately $5.5 million), having lost a substantial portion of their total investment of $1,170,000.

Foerster failed to distribute copies of offering memoranda to his clients. Also, in his aggressive promotion of Maxwell Energy shares, Foerster made representations that contravened provisions of the Act designed to prevent exactly the sort of mischief in which Foerster was engaged.

Finally, Foerster showed his complete contempt for the legislation by effecting an offering of shares in his own company to his soon-to-be-former clients in flagrant contravention of the most fundamental requirement of the Act respecting offerings of securities: the obligation to file a prospectus or to structure the offering under one of the exemptions.

The Commission considers it to be in the public interest to make orders that reflect the seriousness of Foerster's misconduct. We therefore order:

1.   under section 161(1)(c) of the Act that the exemptions described in sections 44 to 47, 74, 75, 98 and 99 do not apply to Foerster for a period of 15 years from the date of this decision;

2.   under section 161(1)(d) of the Act that Foerster resign any position he holds as a director or officer of any issuer and is prohibited from becoming or acting as a director of officer of any issuer until
(a) he has successfully completed a course of study satisfactory to the Executive   Director concerning the duties and responsibilities of directors and officers, and
(b) a period of 15 years has elapsed from the date of this decision;

3.   under section 161(1)(d) of the Act that Foerster is prohibited from engaging in investor relations activities for a period of 15 years from the date of this decision;

4.   under section 162 of the Act that Foerster pay the Commission an administrative penalty of $ 50,000; and

5.   under section 174 of the Act that Foerster pay the costs of or related to the hearing in an amount to be determined following submissions from the parties.

The conduct displayed by Foerster is completely inconsistent with that expected of registrants in British Columbia. On that basis we would be very concerned should Foerster ever be granted registration again in this jurisdiction. We would expect the Executive Director of the Commission to take these concerns into account when assessing any future application for registration from Foerster.

DATED at Vancouver, British Columbia on May 2, 1997.

Adrienne R. Wanstall   Brent W. Aitken
Member   Member

Diane K. Wolch
Member