Brokers' exchange practices under fire

Brokers' exchange practices under fire

Investors sue BMO for insisting on converting foreign funds in RRSPs

Richard Croft, Portfolio Matters
Monday, August 14, 2006

The issue of foreign-exchange conversion inside RRSPs, a subject we have talked about recently in this column, is heading to the courts.

Investors have launched a $110-million class-action lawsuit over the issue against BMO Nesbitt Burns, BMO Trust Co. and the Bank of Montreal.

The lawsuit was brought forward by James MacDonald of Stouffville, Ont., and the claim alleges that the defendants have systematically converted foreign currency in these (i.e. RRSP, RRIF and RESP) accounts to Canadian currency without instructions from the customers, and without there being any need to do so, despite revisions to the Income Tax Act that came into effect on June 14, 2001.

Also, in effecting all currency conversions, the defendants levy an undisclosed conversion fee, in addition to the amount that they actually pay to buy or sell currency. The claim alleges that the defendants failed to change their operational practices after the June 14, 2001, change to the Income Tax Act, which allows RRSPs, RRIFs and RESPs to hold foreign currency as an investment. The suit further alleges that the reason for the defendants' failure to effect a change was so that they could continue to earn profits from the foreign-exchange fees, at the expense of the class members.

This will be an interesting test case because it has implications for the entire brokerage industry. Conversions are not unique to BMO, as all brokers do the same thing. RRSPs and other registered accounts have always been Canadian-dollar denominated accounts and every time you implement a transaction in a foreign security, you are subjected to conversion into and out of the foreign currency. At the end of a transaction, cash in the RRSP is held as Canadian dollars.

Based on e-mails I have received on the subject, it is a hot button among investors. By way of example, Mr. V. from Calgary writes, "As an investor, I am just getting started in the markets outside of mutual funds, and was considering my first purchase of a U.S. equity (Citigroup) for my SDRSP portfolio.

"I am now reconsidering holding any U.S. securities in my SDRSP at all, in light of the information you presented [see Portfolio Matters, July 24]. I called my broker, and was informed that in addition to the currency spread, any dividends paid out by the security would also be subject to a 15% withholding tax."

Withholding taxes is an entirely different issue, and the broker's explanation is not correct.

According to taxtips.ca, withholding tax is not withheld on US dividends from shares held in RRSP accounts. (see www.taxtips.ca/RRSPs.htm# investmentsInsideRRSP).

Mr. S. writes that while it is legal to hold foreign currency in RRSPs, for some reason brokers do not want to set up RRSP accounts this way. "I cannot help wondering if it is because they are making a profit on the conversions back and forth," he says. "If so, and the banks are making millions of dollars, in my view [they are] cheating investors."

Ms. O took issue with my comments that "any cash held in that [RRSP] account must be in Canadian dollars ... " as not being completely accurate. As she contends, it is not that cash must be held as Canadian dollars, it is that she, and the others who have written, have been unable to find a financial institution in Canada that hold foreign currency inside RRSP accounts. This even though it is allowed by the Canada Revenue Agency and recent Investment Dealer Association (IDA) bulletins.

As she points out, the IDA issued a bulletin (No. 3522) on March 13 that dealt with this issue. According to the bulletin:

"Under the previous requirements, the foreign-currency cash balances held in RRSP accounts kept by a trustee that qualifies as an acceptable institution were treated as non-allowable assets. These balances in general were not insured by either the Canadian Deposit Insurance Corp. (CDIC) or the Quebec Deposit Insurance Corp. (QDIC) and thus were not eligible for the allowable-asset classification. This treatment was inconsistent compared with that of assets held in the other types of accounts for the dealers by acceptable institutions where no such insurance coverage was required.

"With the elimination of the RRSP foreign-content limit and expected increase in the flow of foreign-currency funds into RRSP accounts, it was necessary to make the amendments to correct the inconsistent and inappropriate treatment of these funds.

"The amendments will correct these issues by permitting the classification of foreign-currency cash balances in RRSP accounts, held at [insured institutions], as allowable assets."

Ms. O went on to explain that her company has a group RRSP with another broker (i.e., not BMO) and she "had it out with them last year and basically was told that they had no intention of adding this feature to their offering."

So at this stage, we know that this issue is significant enough to have caused litigation. We know that the federal government has no problem with investors holding foreign currency inside a registered account. We know that the IDA has opened the door for brokers to hold foreign currency as an asset class inside RRSP accounts. We know that Mr. MacDonald asserts that the reason brokers have failed to walk through the IDA door is that forced conversions are a profitable business for banks and brokerage companies.

The case will have to stand on its own merits and it is not my place to comment. But what is clear is that the brokerage industry has a lot of work to do in trying to explain why this problem exists. If nothing else, the lawsuit will bring that to the forefront.

Richard Croft is president of Croft Financial and is co-author of Protect your Nest Egg: Canadian Guide to Wealth Protection. Address portfolio questions to croftfin@aol.com.