The issue about 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 against BMO Nesbitt Burns, BMO Trust Company and the BMO Bank of Montreal. 

The lawsuit was brought forward by James MacDonald of Stouffville Ontario, 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, based upon revisions to the Income Tax Act which 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 14th, 2001 change to the Income Tax Act which allows RRSPs, RRIFs and RESPs to hold foreign currency as an investment, and 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. RRSP’s 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 US equity (Citigroup) for my SDRSP portfolio. I am now reconsidering holding any US securities in my SDRSP at all, in light of the information you presented [see Portfolio Matters July 24th]. 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 brokers explanation is not correct. 
According to taxtips.ca withholding tax is not withheld on US securities if they are held in RRSP accounts. (see http://www.taxtips.ca/RRSPs.htm#investmentsInsideRRSP). 

Mr. S. writes that while it is legal [from the tax department] to hold foreign currency in RRSPs, for some reason brokers do [not] want to set up the [RRSP] accounts this way. I cannot help wonder if it is because they are making a profit on the conversions back and forth. 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 will provide a feature to hold foreign currency inside RRSP accounts. Even though it is allowed by CCRA and recent Investment Dealer Association (IDA) bulletins. According to Ms. O, the IDA issued a bulletin (#3522) on March 31st, 2006, 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 Corporation (CDIC) or the Quebec Deposit Insurance Corporation (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 to FORM 1 will correct these issues by permitting the classification of foreign currency cash balances in RRSP accounts, held at an acceptable institution that is a participating organization in either CDIC or QDIC (now Autorité des marchés financiers (AMF) with respect to deposit insurance), as allowable assets.”

Ms. O’s 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 is 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 law suit will bring that to the forefront.