Findings of Fraud Constitute “Other Good Reason” to Order Security for Costs

Hung v Ontario Securities Commission, 2018 ONSC 6729 (Div Ct)

The Divisional Court has released yet another chapter in the saga of one of the largest frauds in Canadian history.  In 2017, after a 188-day merits hearing, the Ontario Securities Commission (the Commission) released its decision concerning allegations of fraud against Sino-Forest Corporation (Sino-Forest) and its senior officers.  In that decision, the Appellants, as senior officers of Sino-Forest, were found to have authorized, permitted, or acquiesced in the company making misleading statements in its disclosure documents and to have misled Staff of the Commission during their investigation.  The hearing panel also found that the Appellant, Mr. Chan, committed fraud in the sale of his undisclosed interest in Greenheart Resources Holdings Limited to Sino-Forest.  Almost a year later, the Commission released its sanctions and costs decision.

The Appellants, Messrs. Hung, Ip, Ho, and Chan, appealed both the decision on the merits and the decision on sanctions and costs. The Commission subsequently sought an order for security for costs.  The Divisional Court released its decision on the motion for security for costs on November 26, 2018.

The Legal Framework

Rule 61.06(1) of the Rules of Civil Procedure, RRO 1990, Reg 194, states when security for costs may be ordered.  The Commission relied on rules 61.06(1)(a), (b), and (c):

61.06(1) In an appeal where it appears that,

(a) there is good reason to believe that the appeal is frivolous and vexatious and that the appellant has insufficient assets in Ontario to pay for the costs of the appeal;

(b) an order for security for costs could be made against the appellant under rule 56.01; or

(c) for other good reason, security for costs should be ordered,

a judge of the appellate court, on motion by the respondent, may make such order for security for costs of the proceeding and of the appeal as is just.

With respect to rule 61.06(1)(b), Horkins, J. noted that the Court of Appeal has determined that a respondent on an appeal may not rely on rule 61.06(1)(b) to obtain an order for security for costs of an appeal as against an appellant. The policy rationale is not to impose security for costs upon foreign or impecunious defendants who are forced by others to defend themselves in a legal proceeding.  Because the appellants were compelled to attend the hearing before the Commission to defend themselves, the Commission was only entitled to rely on rules 61.06(a) and (c).

The appeal did not appear to be vexatious

Under rule 61.06(1)(a), the Commission must show that it “appears” there is good reason to believe that the Appellants’ appeal is frivolous and vexatious, and that they lack sufficient assets in Ontario to pay the costs of the appeal. The lack of sufficient assets was not disputed.

Horkins, J. found that there was good reason to believe that the grounds of appeal were frivolous: The hearing lasted 188 days and the panel issued detailed reasons in support of its findings of wrongdoing. However, the Commission did not show that there was good reason to believe the appeal was vexatious given that the usual indicia of vexatiousness were not present.  The Appellants had expeditiously proceeded with their appeal, and there was no history of non-compliance with court and Commission orders.

There was some other good reason to order security for costs

Horkins, J. relied on the Ontario Court of Appeal’s decision in Mechanical Services Inc. v Flesch, 2010 ONCA 633 to determine what constitutes “other good reason” under rule 61.01(1)(c):

The court does not have a closed list of cases in which security for costs has been ordered under the residual category. […] However, the “other good reason” must be related to the purpose for ordering security: that a respondent is entitled to a measure of protection for costs incurred and to be incurred in the proceeding, which is now on appeal. And, the “other good reason” should be a fairly compelling reason…

The Commission submitted that the “other good reason” to order security for costs was the fact that the merits panel made “powerful findings of fraud” against the Appellants.

Horkins, J. agreed that strong findings of fraud constitute “other good reason” to order security, particularly where an appellant has taken steps to put assets out of the reach of creditors. There was evidence that the appellants received substantial monies as a result of the breach of Ontario securities law.  These monies were obtained by the Appellants outside Ontario and were beyond the reach of the Commission.  There was also evidence that Messrs. Ho and Ip transferred real property to their respective wives after the Commission’s Statement of Allegations was filed against them.

It was just to order security for costs

Once the Commission proved that rule 61.06(1)(c) was satisfied, part two of the test triggered an inquiry into the justness of the order sought.

Horkins, J. held that it was just to order security for costs. The Commission was not using the motion for security for costs as a litigation tactic to prevent the appeal from being heard.  The parties were working together to ensure that the appeal proceeded without delay.  Further, the Commission had good reason to be concerned about the costs of the appeal and being able to collect on a costs order that may be made if the appeal was dismissed.  The Appellants had, after all, orchestrated an elaborate premeditated and coordinated fraud to overstate the assets and revenue of Sino-Forest – one of the largest frauds in Canadian history, resulting in a loss of approximately US$6 billion in market capitalization.

Accordingly, Horkins, J. ordered that the Appellants post security for the costs of the hearing before the Commission and the appeal in the amount of $100,000.00.

 

The author would like to thank Elana Friedman, articling student, for her contribution to this article.

Stop the presses! Canadian securities regulators raise concerns about press releases and other promotional activities

The Canadian Securities Administrators (CSA) have issued a notice regarding misleading promotional activities by issuers.  The notice includes examples such as press releases, presentations, social media posts and other marketing materials that provide insufficient or unbalanced information or that include unsubstantiated claims about the issuer.

Problematic Promotional Practices

Examples of potentially misleading promotional activities identified by the CSA include:

  • describing early-stage plans with “unwarranted certainty”, or making unsupported predictions about growth of the market or future product demand;
  • issuing multiple press releases that do not disclose any new material facts;
  • compensating third parties for promotion through social media and investing blogs without disclosing the relationship between the issuer and third party;
  • announcing a change of business, particularly in a trendy industry such as cannabis, cryptocurrency or blockchain, without a supporting business plan or comprehensive risk disclosure; and
  • announcing a positive event such as a large acquisition but:
    • not filing the corresponding material contracts;
    • not disclosing the material conditions necessary to complete the transaction such as financing or due diligence; and/or
    • subsequently changing or cancelling the transaction with no announcement.

The CSA also provides industry-specific examples of potentially misleading promotional activities in the notice.

Top 10 Ways to Ensure You Comply

  1. Provide sufficient and balanced information so as not to be misleading or inconsistent.
  2. Announce material changes in a factual and balanced way.
  3. Disclose unfavourable news just as promptly and completely as favourable news.
  4. Avoid exaggerated third-party reports and potentially misleading promotional commentary, do not cherry-pick analyst reports and prominently disclose when you pay for reports and articles.
  5. Ensure that any person or company you engage in investor relations activities clearly and conspicuously discloses in all publications and oral statements that such information has been issued by or on your behalf.
  6. Disclose forward-looking information only if there is a reasonable basis for such information, identify it as being forward looking, state the factors or assumptions used to develop such information and provide appropriate cautions.
  7. Update any previously disclosed forward-looking information if something happens (or doesn’t happen) that will likely cause actual results to differ materially.
  8. Ensure that material company information is not released on social media before being generally disclosed in a press release or other disclosure document, and do not (as an issuer) participate in, host or link to chat rooms or bulletin boards.
  9. Limit the number of people authorized to speak on behalf of the issuer to analysts, the media and investors.
  10. Establish written corporate disclosure and social media governance policies and establish appropriate board and/or senior management oversight of disclosures.

Additional Information

The CSA notice is available here.

Refer also to our publication from March 2017: #needsimprovement: CSA releases report on social media disclosure practices by Canadian public companies here.

Crime Doesn’t Pay: OSC Permanently Bans Convicted Fraudster

On November 26, 2018, the Ontario Securities Commission (OSC) issued an order permanently prohibiting Daniel Reeve, a financial planner based in the Kitchener, Ontario area, from participation in Ontario’s capital markets, including trading in any securities and becoming or acting as a registrant.

The permanent ban came after Reeve was convicted in the Ontario Superior Court of Justice in 2017 for having defrauded at least 41 investors of nearly $10 million (see R v Reeve, 2018 ONSC 3744). Justice Skarcica found Reeve’s conduct to have “presented virtually every aggravating circumstances recognized by the Criminal Code and the case law”. Accordingly, Reeve was sentenced to 14 years in custody—the maximum sentence under the Criminal Code—and ordered to pay $10.9 million in restitution to his victims, which included “the disabled, the elderly, …close long-time friends and loyal clients”.

Mr. Reeve’s criminal conduct involved soliciting investors to make “low-to-no risk investments”, which he promised would return between 12 to 20 percent. He was later found to have diverted those investor funds for his personal use, such as making payments for his spousal support, his failing business as well as repayments to other investors. Investors lost more than $10 million.

Subsection 127(1) and 127(10) of the Ontario Securities Act work together to allow the OSC to make an order in the public interest with respect to a person who has been convicted of an offence arising from conduct related to securities. In particular, subsection 127(10) allows the OSC to impose regulatory sanctions under subsection 127(1) in respect of a person who has been convicted in any jurisdiction of an offence under a law respecting the buying or selling of securities.

The two issues the OSC panel was called upon to consider were:

  1. Did Mr. Reeve’s conviction involve transactions relating to the purchase or sale of “securities”; and
  2. If so, what sanctions should the Commission order against Mr. Reeve?

In answering the first question, the OSC applied the three-pronged test identified by the Supreme Court of Canada in Pacific Coast Coin Exchange v Ontario (Securities Commission), 1977 CanLII 37 (SCC) at para 128, and came to the conclusion that all three prongs have been satisfied. The transactions in question were investments with a view to profit, in a common enterprise between Mr. Reeve and the investors, where the profits were to be derived solely from the efforts of others.

Having found that the test under subsection 127(10) has been met, the Commission next deliberated on what sanctions, if any, should be ordered. The panel observed that orders made under subsection 127(1) are meant to be “protective and preventative”,  not punitive. It is essential that the imposed sanction serves to protect Ontario investors both by specifically deterring Mr. Reeve, and by acting as a general deterrent to other like-minded individuals.

By imposing a permanent ban against Mr. Reeve, the OSC panel agreed with Justice Skarcica’s characterization that this matter was “an overwhelming case of fraud”. Not only did the fraud scheme involve a large number of victims and a high dollar value of financial losses, the fraudster showed no remorse for taking full advantage of the high regard he had in the investment and general community in addition to breaching the personal trust and faith the victims had in him.

The OSC’s decision is a reminder of the severity of penalties available for securities fraud and that perpetrators may find themselves prosecuted and sanctioned under both the Criminal Code and provincial securities legislation.

 

Danny would like to thank Coco Chen, articling student, for her contribution to this article.

When Will Referral Arrangements Constitute Trading under the BC Securities Act?

In a recent decision of the BC Securities Commission (BCSC), the BCSC provides helpful guidance concerning when referral arrangements cross the line and become trading for which registration is required.

Chien-Hua Liu (Liu) and two affiliated corporations referred BC and Hong Kong investors to two issuers, leading to the purchase of over $6.5 million in securities, and earning nearly $450,000 in commissions.

In Re Liu, 2018 BCSECCOM 372, the BCSC scrutinized the details of the referral arrangements and determined that Liu and the corporate respondents had contravened section 34(a) of the BC Securities Act (the Act) by acting in furtherance of trades while not registered under the Act.

Background

Liu is a registered insurance agent and former registrant under the Act for selling mutual fund securities.  This registration lapsed in March 2013.  During the material time, he was the sole shareholder and a director of NuWealth Financial Group (NuWealth), and the sole director and officer of CPFS Professional Financial Services Inc. (CPFS, together with NuWealth and Liu, the Respondents).   CPFS was an insurance company which sold segregated funds and employed approximately 20 insurance agents, including Liu.

The Respondents entered into formal referral agreements with two companies: W, a registered exempt market dealer which sold only proprietary products; and GB, an issuer whose principal business was an early stage real estate development project.

Pursuant to these referral agreements, during the period between April 2013 and January 2016, NuWealth referred investors to W and GB, resulting in 160 trades of securities totaling $4,826,504.52 and CPFS referred investors to W and GB, resulting in 54 trades of securities totalling $1,696.878. Liu was personally involved in referrals which resulted in 48 trades totaling $1,713,070.80.

In the absence of direct evidence to the contrary, the BCSC accepted Liu’s evidence about the referral arrangements:

  • he provided general promotional brochures about W and GB […] to investors, without any discussion of specific investments;
  • he referred the investors to representatives of W and GB and, on occasion, assisted in setting up those meetings;
  • he and other representatives of the corporate respondents attended seminars put on by W and GB. but none of the investors were ever at these sessions;
  • he, NuWealth and individual brokers of CPFS received commissions from W and GB, as the case may be, for these referrals; and
  • he believed that NuWealth, CPFS and their representatives also did what he testified that he had done himself.

The referral arrangements were terminated in late 2016.

Analysis

The BCSC considered whether the Respondents were in breach of section 34(1), which provides that “A person must not…trade in a security… unless the person is registered in accordance with the regulations…”.  The BCSC observed that the definitions of “trade” and “acts in furtherance” of a trade are intentionally broad in order to support the Act’s purpose of investor protection.  These broad definitions include both direct and indirect conduct.

The BCSC rejected the notion that an introduction or referral was, in and of itself, an “act in furtherance” of a trade.  Referrals occur on a spectrum and vary from uncompensated introduction to full service registrants offering a range of securities, to highly compensated introductions to issuers who offer limited securities.  The context and circumstances will determine where a referral is on this spectrum and whether it is an act in furtherance of a trade within the meaning of the Act.

The BCSC set out a non-exhaustive list of factors that are material for determining where a referral falls on the spectrum:

  • was there material (relative to the amount invested in securities) compensation paid for the referral?
  • was that compensation tied to specific trades in securities? If so, this suggests that the referrer played a material role in causing the trade.
  • what is the range of securities offered by the person to whom the investor is referred? If there is only one product, this suggests that the referrer anticipated a trade in that product as the likely outcome of the referral.
  • was the investor receiving financial services from the referrer prior to the referral? An existing financial services relationship indicates a level of trust and that a referral would be more likely to be interpreted as a recommendation.

Each of these factors in this case supported a finding that the Respondents, in making referrals to W and GB, were engaged in acts in furtherance of trades and were therefore “trading” for the purposes of s. 34(a) of the Act.

The BCSC rejected the Respondents’ submission that since there was no evidence of investor harm there was no need to consider their referral activities to be “trades”.  Investor protection concerns are raised in the circumstances regardless of whether any harm is established: the investors here could not benefit from the Respondents satisfying “know your product” and “know your client” obligations required of registrants.

The BCSC also rejected the Respondents’ reliance on the guidance set out in the Companion Policy to NI 31-103 regarding permissible referrals by registrants.  Not only is the Companion Policy not binding on the BCSC, but also on a technical basis this only applies where registrants made referrals, which the Respondents were not.

The Respondents further submitted that they were entitled to an exemption as they were “not in the business of trading”.  The BCSC disagreed, finding that by finding and soliciting a large number of investors, and connecting them with issuers over many months and in exchange for significant compensation, the Respondents were “in the business of trading”.

The Respondents made a number of submissions urging the BCSC to find that sanctions are not necessary and not in the public interest.  The BCSC distinguished this case from others where such a finding was made at an early stage, and deferred these submissions to a later sanctions hearing.  Written submissions on sanctions are scheduled for January 2019.

 

Divisional Court Upholds OSC Finding that Trading Software License Contracts are Securities Within Meaning of Securities Act

The Ontario Superior Court of Justice in Furtak v Ontario (Securities Commission), 2018 ONSC 6616, has upheld the Ontario Securities Commission’s (OSC) merits and sanctions decisions with respect to the Strictrade Offering, which we previously reported on here.

Background

In 2015, OSC Staff brought enforcement proceedings against Edward Furtak, Axton 2010 Finance Corp., (Axton), Strict Trading Limited (STL), Strictrade Marketing Inc. (SMI), Trafalgar Associates Limited (TAL), Ronald Olsthoorn, and Lorne Allen (collectively the Strictrade Parties) arising out a scheme that involved the marketing and offering of a set of computerized trading software license contracts (the Strictrade Offering).  Under the Strictrade Offering, third party participants signed a promissory note in favour of Axton, a company operated by Furtak, for the purchase of a license to use the Strictrade computerized trading software. The participants simultaneously contracted with STL, another company operated by Furtak, to host the Strictrade software and trade in financial instruments.  Participants purchased licenses in $10,000 units and were required to pay upfront annual fees and interest to Axton and STL.  In exchange, participants received annual trading report payments.  The annual fees and interest paid by purchasers exceeded the trading report payments they received.  The Strictrade Offering was marketed to investors as a tax-planning vehicle meant to provide participants with an opportunity to take advantage of business tax deductions.

In a merits decision released on November 24, 2016 (2016 ONSEC 35), the OSC found that the set of contracts being marketed in the Strictrade Offering were “investment contracts” and were therefore “securities” within the meaning of the Securities Act, RSO 1990, c S. 5 (the Act).  As a result, the OSC found that:

  • Furtak, Axton, STL, SMI, and Allen engaged in, or held themselves out as engaging in, the business of trading in securities without registration, contrary to subsection 25(1) of the Securities Act, RSO 1990, c S. 5 (the Act);
  • all of the Strictrade Parties distributed securities without filing and obtaining a receipt for a preliminary prospectus, in violation of subsection 53(1) of the Act;
  • Furtak, Olsthoorn and Allen, as officers and directors of the corporate respondents authorized, permitted or acquiesced in the corporate respondents’ non-compliance with Ontario securities law, in violation of section 129.2 of the Act; and
  • Oslthoorn failed to fulfill his Know Your Client obligations, failed to fulfill his obligations as Chief Compliance Officer and Ultimate Designated Person of TAL, and failed to take reasonable steps to determine whether the Strictrade Offering was suitable for investors, contrary to sections 3.4, 13.2 and 13.3 of National Instrument 31-103.

In a separate sanctions and costs decision released May 4, 2017 (2017 ONSEC 12), the OSC reprimanded the Strictrade Parties and imposed a number of hefty sanctions including cease trade orders, administrative monetary penalties, disgorgement of proceeds, and costs in the amount of $186,013.  In a minority opinion, Vice-Chair D. Grant Vingoe disagreed with the scope of the cease trade orders imposed by the majority, indicating that he would have allowed an exception to permit the remaining investors in the Strictrade Offering to continue their investments if they so wished.

Appeal to the Divisional Court

The Strictrade Parties appealed the OSC’s merits and sanctions decisions to the Ontario Superior Court of Justice, Divisional Court. The Strictrade Parties argued that the OSC (i) erred in finding that the set of contracts met the legal test for an “investment contract”, (ii) erred in making factual findings and drawing inferences unsupported by evidence, and (iii) imposed unreasonable sanctions.

Standard of Review

The Divisional Court determined that the reasonableness standard of review applied to all three grounds of appeal.  The Court rejected the Strictrade Parties’ argument that the presumption in favour of a reasonableness standard that applies where a tribunal is interpreting its home statute was rebutted in this instance because the issue on appeal was not related to the OSC’s threshold jurisdiction to sanction conduct and was not a matter of central importance to the legal system outside of the OSC’s specialized expertise.  The Court also rejected the Strictrade Parties’ submission that the standard of “palpable and overriding error” should apply to the Commission’s findings of fact, holding that that standard is not applicable in a judicial review of an adjudicative tribunal’s decision.  Rather, factual errors may only be a ground for overturning a tribunal’s decision if they go to a “core finding” that is fundamental to the reasonableness of the ultimate decision.

Investment Contracts

In determining that the set of contracts marketed under the Strictrade Offering were “investment contracts”, the OSC adopted the test from Pacific Coast Coin Exchange v Ontario Securities Commission, [1978] 2 SCR 112 and outlined the following four elements of an “investment contract”:

1.  an investment of money,

2.  with an intention or an expectation of profit,

3.  in a common enterprise in which the fortunes of the investor are interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties,

4.  whether the efforts made by those other than the investor are the undeniably significant ones – essential managerial efforts which affect the failure or success of the enterprise.

The Divisional Court found that, while the OSC broke down the test for an “investment contract” into four components in a manner not reflected in the Supreme Court of Canada’s decision in Pacific Coast Coin, the OSC recognized that the elements of the test are not “airtight compartments” and many of the same considerations may apply to more than one aspect of the test.  The OSC’s reformulation captured the “essence” of the test. The Divisional Court further held that the OSC’s application of the test to the Strictrade Offering and the finding that the set of contracts constituted “investment contracts” and were therefore “securities” under the Act was reasonable.

Factual Findings

The Strictrade Parties argued that the OSC made a number of factual errors and drew improper inferences not supported by the evidence.  In dismissing this ground of appeal, the Divisional Court noted that the Strictrade Parties had failed to demonstrate that any of the factual errors alleged would have impacted the OSC’s conclusion that the set of contracts were “investment contracts”.  In essence, the Strictrade Parties were asking the Divisional Court to improperly re-weigh the evidence that was before the OSC.  In any event, the Divisional Court found that the OSC referred to evidence that amply supported its conclusion and its findings were therefore reasonable.

Sanctions

The Strictrade parties argued that the sanctions imposed by the OSC were unreasonable, disproportionate to the nature of the misconduct, and failed to serve any identifiable public interest goals.  The Divisional Court disagreed, holding that the OSC properly considered all of the relevant factors, including the different circumstances, roles, and histories of the various Strictrade Parties and imposed sanctions that fell within its broad discretion.

The Divisional Court also considered Vice-Chair Vingoe’s minority opinion that would have allowed an exemption to the cease trade orders to permit the remaining participants to continue their investment in the Strictrade Offering.  The Divisional Court determined that both the majority and Vice-Chair Vingoe, in the minority, provided a reasonable basis for their respective positions on the cease trade orders and that each was defensible.  Faced with two reasonable interpretations, the Divisional Court concluded that it was obliged to defer to the findings of majority, and upheld the sanctions decision.

 

The Hard Way – SEC announces first penalties and compliance roadmap for unregistered ICOs

On November 16, 2018, the Securities and Exchange Commission (SEC) announced consent orders settling actions in respect of two unregistered initial coin offerings (ICOs), including the first fines levied against non-compliant ICO issuers made by the SEC to date.

The consent orders demonstrate the SEC’s willingness to follow through with enforcement proceedings against issuers of ICOs not in compliance with securities laws, and provide a roadmap for how existing ICOs can bring themselves into compliance going forward.

The parties – Airfox and Paragon

The issuers charged in the two SEC enforcement actions each raised substantial amounts of capital through an ICO for vastly different purposes:

  1. CarrierEQ Inc., doing business as Airfox, is a financial services company focused on emerging markets that raised $15 million in digital assets through an ICO to finance the creation of a token ecosystem by which users would earn and exchange tokens in connection with the acquisition of data and interaction with advertisements;  and
  2. Paragon is an online company that raised $12 million through an ICO with a view to implementing blockchain technology in the cannabis industry.

According to the SEC’s consent orders for Airfox and Paragon, neither company or its ICO was registered with the SEC.  In each case, the SEC charged that the company marketed its ICO on the representation that it expected its coin to appreciate in value with an opportunity for future profit.

Consent orders level heavy penalties and lay out a compliance framework

The penalties leveled against Airfox and Paragon are largely similar, and demonstrate the SEC’s intention to backstop its enforcement of regulation against ICO issuers along with its commitment to ensuring other would-be issuers understand the path to proper compliance.

Both Airfox and Paragon were ordered to pay a civil money penalty of $250,000.  While the Airfox penalty was ordered payable within 90 days, the Paragon penalty is payable in three instalments spread over 240 days.  Airfox and Paragon also undertook in their consent orders to issue press releases notifying the public of the order.

On the compliance side, among other requirements, Airfox and Paragon undertook to register their respective tokens as a class of securities, and to establish a claims process for purchasers of those tokens:  specifically, within 60 days after registering their tokens as securities, each company must notify all purchasers of their potential claims under section 12(a) of the Securities Exchange Act of 1934 including the right to sue to recover the consideration paid with interest for the security, less any income received from that purchase.  Each company is required to provide token purchasers with a claim form, and to pay the amount due pursuant to section 12(a) to each person submitting a proper claim form by the deadline specified in the order, with some opportunity for the company to seek documentation from the claimant to support their claim.  The companies will then have to report the results of this claims process to the SEC on a monthly basis.

SEC orders send clear compliance message

The Airfox and Paragon orders make clear that token issuers that fail to comply with securities laws will (a) be prohibited from profiting from their breaches, (b) face substantial penalties, and (c) end up required to comply with securities laws in any event.  The message is clear: “Comply now, or we will take action to force you to be compliant.”  Anyone considering a token offering with any doubt about the SEC’s willingness to sanction unlawful ICOs should take serious notice.

Alberta Securities Commission Introduces Whistleblower Program

On November 19, 2018, the Alberta Securities Commission (ASC) implemented its first whistleblower program (the Program) through the release of ASC Policy 15-602 Whistleblower Program (the Policy) and simultaneous amendments to the Alberta Securities Act (the Act).

The Program is effective as of November 19, 2018.  Its protections apply retroactively to securities misconduct but only in relation to tips communicated to the ASC on or after November 19, 2018.

According to the ASC, the highlights of the Program include the following:

  • the facilitation of simple reporting by providing a dedicated telephone “tip” line and access to forms for submission by email, mail or in-person
  • whistleblower access to trained, knowledgeable ASC staff
  • rigorous protection of the confidentiality of the identity of whistleblowers
  • prohibition of obstruction and reprisal
  • protection of whistleblowers from the application of contractual clauses that directly or indirectly attempt to prevent whistleblowing.

No Whistleblower Awards

Unlike certain whistleblower programs in other jurisdictions (such as Ontario), the Program does not provide for the payment of awards to whistleblowers.  It only goes so far as to provide for possible credit for cooperation in the case of whistleblowers who are themselves involved in securities misconduct.

Under the Ontario Securities Commission Whistleblower Program, for example, individuals who meet certain eligibility criteria and who voluntarily submit information regarding breaches of Ontario securities laws may be paid a whistleblower award if there is an “award eligible outcome” and the Commission, in its discretion, determines it appropriate to order an award.

Efficacy of Whistleblower Programs

It remains to be seen whether the Program will be an effective tool in connection with the ASC’s enforcement of Alberta’s securities laws, particularly in that whistleblowers will not be eligible to receive any financial awards.

According to an OSC press release issued in June 2018, the OSC Whistleblower Program has been very effective in “shining a light on information that previously would have remained in the shadows”.  To that date, the OSC Program had generated approximately 200 tips, of which 45 were under review, 19 had been referred for enforcement, and 68 were or are in the process of being shared with another OSC operating branch or another regulator for further action.

To date no awards have been announced by the OSC.

In its fiscal year ending September 30, 2018, the United States Securities and Exchange Commission (SEC) received over 5,000 tips, including over 200 FCPA-related complaints.  The tips originated from over 70 different countries, and awards of almost US $170 million were paid out to 13 individuals.

The authors would like to thank Sunny Mann, articling student, for his contribution to this article.

Re Fauth: A Primer on ss. 75(1)(a), 92(4.1) and 93(b) of Alberta’s Securities Act

The Alberta Securities Commission (ASC) recently released its decision in the matter of Re Fauth, finding the respondent, Vernon Ray Fauth (Fauth), in breach of ss. 75(1)(a), 92(4.1) and 93(b) of Alberta’s Securities Act, RSA 2000, c S-4 (the Act). The decision offers some important insight on issues regarding limitation periods, illegal dealing, misrepresentations, and fraud under the Act. The decision also discusses the use of hearsay evidence in proceedings before the Commission; specifically, the use of transcripts of witness interviews conducted by the Alberta Securities Commission Staff (Staff) in the course of their investigation.

Facts

Fauth operated a financial and estate planning business through Fauth Financial Group Ltd. (Fauth Financial), a corporation licensed to sell insurance and mutual funds. Fauth was also involved in a number of other corporations and limited partnerships:

  1. Espoir Capital Corporation (Espoir): Espoir was set up to raise funds from the public for re-investment in other opportunities. The investments would then generate the returns to be paid to Espoir investors. Fauth was the founder and sole shareholder, director, officer and signing authority of Espoir.
  2. FairWest Energy Corporation (FairWest): FairWest was a publicly-traded oil and gas company listed on the TSC Venture Exchange. Fauth and his son were two of the six FairWest directors. FairWest became insolvent and sought protection under the Companies’ Creditors Arrangement Act in December 2012.
  3. Limited Partnerships: Fauth had an interest in and control over a number of other oil and gas entities, including Royalty Investments Limited Partnership (Royalty LP). Royalty LP’s general partner was AFM Management Inc. (AFM Management), of which Fauth was president, sole director and sole voting shareholder. Royalty LP was described as a “conglomeration of one corporation [AFM Management] and six partnerships”. Fauth was involved with and had an interest in all six of these partnerships.

From November 2002 through November 2012, Espoir issued approximately $15 million in debentures (Debentures) to over 70 investors in Alberta, British Columbia, and Ontario. In soliciting investments, Espoir distributed one-page summaries to investors and potential investors, describing the kinds of investments that Espoir would make. Although there were minor variations in these summaries over the years, they all represented that Espoir was established to invest in a pool of interest paying investments such as money market, treasury bills, mortgages, GICs and term deposits.

Some of the Debentures were described as “unsecured” (Unsecured Debentures) while the others were described as “secured” (Secured Debentures). The certificate accompanying the latter stated on its face that it represented a “Secured Debenture”. The Unsecured Debentures stated in their preambles that “[t]he Debenture is an unsecured obligation of [Espoir] and is specifically subordinated to Senior Indebtedness, as defined herein”. “Senior Indebtedness” was defined to include all of Espoir’s other indebtedness, apart from the Unsecured Debenture itself and any other subordinated indebtedness. Both Debentures also contained a “No Security” clause stipulating that:

The Holder [i.e., the purchaser] acknowledges that no security interest is granted to the Holder by [Espoir] hereby and the Holder covenants that he shall not seek to cause any registration of the Debenture against [Espoir] or its assets in any jurisdiction.

According to Fauth, the only real differences between Espoir’s Unsecured Debentures and its secured Debentures were the interest rate and the date of issue. His evidence was that, despite their names, both had “the same” underlying security: “the assets that were in…Espoir…”. The Unsecured Debentures typically offered an interest rate of 10.5% while the Secured Debentures typically offered an interest rate of 8%.

In addition to the Debentures, Espoir also issued a number of promissory notes (Espoir Notes). Each had been issued in 2012, had a two-year term and paid 8% interest per annum.

Around 2010, Espoir became unable to repay the Unsecured Debentures as they matured. In response, Fauth began asking the Unsecured Debenture holders to enter into amending agreements, the majority of which reduced the interest rate on those paying 10.5% to 8%, extended the term (usually for a further three years), and changed the timing of interest payments from semi-annually to quarterly.

By mid-2013, Espoir ceased making interest payments to Debenture holders. Espoir’s financial records showed that, as of December 31, 2014, it owed its investors over $12.3 million.

A Notice of Hearing was subsequently issued on May 11, 2016 by the Staff, alleging that Fauth breached statutory prohibitions on engaging in unregistered trading contrary to s. 75(1)(a) of the Act, making a misrepresentation contrary to s. 92(4.1) of the Act and perpetrating a fraud contrary to s. 93(b) of the Act. Twelve witnesses testified at the 12 day hearing before the ASC. These included eight investors, two current members and one former member of the ASC investigative staff and one individual who used to work with Fauth. Fauth refused to testify, but instead chose to rely on the transcript of his interview conducted by the Staff during the course of their investigation.  The Commission allowed Fauth to file the transcript of his investigatory interview, but took into account that Fauth had not made himself available for cross-examination at the hearing and, thus, it could not directly assess his credibility.

A recurring theme in the evidence of all eight investor witnesses was that Fauth assured them that their transactions were “secure” and represented low risk. He variously represented to the investors that their money would be used to invest in “real estate”, in “[real estate developments] secured against land registered on title”, “in mortgages”, “in property around Alberta”, and in “shopping centres and business office buildings”. Fauth also represented to the various investors that their investment “was about as safe as anything [they] could do”, would “be first on title if something happened”, and was “a hundred percent secured…by property”. Fauth expressly represented to one investor that he would not invest his money in FairWest, the investor being aware of the financial woes of FairWest at the time.

The forensic accounting evidence indicated that between January 1, 2009, and September 30, 2014, $8,453,915.49 was deposited to Espoir’s bank account. Of this, $5,851,581.24 was paid in interest and principal to holders of Debentures and Espoir Notes and $2,585,414.87 was paid to non-arm’s length parties (including Fauth Financial and FairWest). The forensic accountant concluded that the funds received by Espoir were generally used for three things: (i) to pay interest and principal owed to Espoir investors; (ii) to benefit the Fauths through the payment of management fees and transfers to other companies; and (iii) to benefit entities related to Fauth or over which Fauth had “significant influence”. The evidence further suggested that Espoir often loaned money to non-arm’s length parties without written loan agreements or any security.

In terms of the few secured investments/loans Espoir did participate in, the security provided either far-exceeded the debtor’s financial assets or, in the case of loans to non-arm’s length parties, the mortgages were discharged without any payment from the mortgagor. Finally, as of the end of 2007, Espoir did not hold any third-party mortgages.

ASC’s Analysis

Based on the evidence before it, ASC found Fauth in breach of ss. 75(1)(a), 92(4.1) and 93(b) of the Act.

Preliminary Matters

As a preliminary matter, the ASC had to determine the use that could be made of transcript evidence of two witnesses who were unable to testify before the ASC. The two witnesses were Espoir investors who were interviewed by the Staff during their investigation. One of these witnesses had passed away, while the other was elderly and too ill at the time of the hearing to testify. Relying on: ss. 29(e) and 29(f) of the Act;[1] the relevance of their transcript evidence; the fact that the evidence was given under oath; and the availability for cross-examination of relatives of the two unavailable witnesses,[2] the ASC decided to admit the impugned transcripts. The ASC did, however, ascribe less weight to these transcripts as compared to direct evidence of available witnesses.

Limitations[3]

From 2002 through December 16, 2014, s. 201 of the Act provided that “[n]o proceedings under this Part [i.e., Part 16 of the Act, Enforcement] shall be commenced in a court or before the [ASC] more than 6 years from the day of the occurrence of the event that gave rise to the proceedings.” As of December 17, 2014, the section was modified slightly to provide that “[n]o proceedings under this Part shall be commenced in a court or before the [ASC] more than 6 years from the day of the occurrence of the last event on which the proceeding is based.”

The ASC concluded, quoting Re Dennis, 2005 BCSECCOM 65 at paragraph 37, that “[w]hen a series of events or transactions in a continuing course of conduct spans a period of time, the ‘date of the events’, in the ordinary sense of that phrase, can only mean the date of the last event in the series that allows staff to allege a breach of the legislation…”. On this basis, the ASC was satisfied that the misrepresentations and fraud alleged in Re Fauth likewise constituted an ongoing scheme and continued course of conduct.[4]

s. 75(1)(a): Fauth Engaged in the Business of Selling Securities Without Being Registered

Section 75(1)(a) of the Act prohibits anyone from acting as a “dealer” in securities “[u]nless registered in accordance with Alberta securities laws”. The ASC began its analysis by noting that in order to find Fauth in breach of s. 75(1)(a) of the Act, it must be demonstrated that: (i) there was a security as defined in the Act; (ii) there was a trade as defined in the Act in relation to that security; (iii) Fauth engaged in or held himself out as engaging in the business of trading in securities; (iv) Fauth was not registered; and (v) Fauth could not rely on an exemption from the registration requirement.

The evidence was clear in satisfying the first, the second and the fourth prong of the test. In relation to the third prong, ASC noted the non-exhaustive list of factors contained in Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) relevant to determining whether a party has engaged or held itself out as engaging “in the business” of trading in securities. These factors include:

  • engaging in activities similar to a registrant (such as “promoting securities or stating in any way that the individual or firm will buy or sell securities”);
  • intermediating trades or acting as a market maker (which “typically takes the form of the business commonly referred to as a broker” or “[m]aking a market in securities”);
  • directly or indirectly carrying on the activity with repetition, regularity or continuity;
  • being, or expecting to be, remunerated or compensated; and
  • directly or indirectly soliciting securities transactions.

Relying on these factors, the ASC was satisfied that Fauth engaged in and held himself out as engaging “in the business” of trading in securities.

Regarding the final branch of the test, the ASC rejected Fauth’s argument that the Debentures fell under a prospectus exemption and, accordingly, he was exempt from registering with the ASC.[5] The ASC was not persuaded by this reasoning, noting that Fauth had the onus to prove the availability of and compliance with all of the terms of an exemption and he had failed to do so. The ASC also was not satisfied, as Fauth had argued, that this was a mere technical breach, noting that Fauth was a past registrant with considerable experience in the capital markets and the associated regulatory environment.

s. 92(4.1): Fauth Made Misrepresentations

The ASC began its analysis by noting the test under s. 92(4.1): (i) a statement was made by a respondent; (ii) the respondent knew or reasonably ought to have known that the statement was, in a material respect, untrue or omitted a fact required to be stated or necessary to make the statement not misleading; and (iii) the respondent knew or reasonably ought to have known that the statement would reasonably be expected to have a significant effect on the market price or value of a security.

Based on the evidence before it, the ASC was satisfied that Staff had proven all parts of the test under s. 92(4.1). Fauth had ensured investors that their investments were secure, low-risk, and would be invested in a certain way. Instead, he invested their money in non-arm’s length entities with meager protection for the investments and in circumstances where the investments were far from secure. Further, the misrepresentations were material and had a significant effect on the value of the Debentures since an investor would have been more willing to invest in Espoir when assured that his/her investment was “secure”.

s. 93(b): Fauth Committed Fraud
During the relevant time, s. 93(b) of the Act prohibited anyone from “directly or indirectly, engag[ing] or participat[ing] in any act, practice or course of conduct relating to a security…that the person or company knows or reasonably ought to know will…perpetrate a fraud on any person or company”.[6]

The ASC confirmed that the test for fraud under the Act is the same as set out by the Supreme Court of Canada, albeit in a different context, in R v Théroux, [1993] 2 SCR 5, and requires the Staff to prove:

  • the actus reus, which is established by proof of:
    • a “prohibited act, be it an act of deceit, a falsehood or some other fraudulent means”; and
    • “deprivation caused by the prohibited act, which may consist in actual loss or the placing of the victim’s pecuniary interests at risk”;

and

  • the mens rea, which is established by proof of:
    • “subjective knowledge of the prohibited act”; and
    • “subjective knowledge that the prohibited act could have as a consequence the deprivation of another”.

In relation to the actus reus, the evidence was clear that the investors were misled, their funds were exposed to the risk of loss, and then, ultimately, they suffered actual loss. Further, investors were not informed that their funds were exposed to a risk of loss that they did not anticipate, and, ultimately, were lost.

Finally, in terms of mens rea, the ASC was satisfied that Fauth had subjective knowledge of his prohibited acts and the consequences and potential consequences of these acts.

 

Key Takeaways

Re Fauth provides a useful summary of the test for establishing liability under each of ss. 75(1)(a), 92(4.1) and 93(b) of the Act.

Re Fauth is also a useful reminder that the rules of procedure and evidence applicable before the ASC are more relaxed than those applicable in a criminal trial before a court. As the ASC noted, in relation to a respondent’s ability to cross-examine a witness:

[I]n a regulatory context such as this, natural justice and procedural fairness do not necessarily dictate that an opportunity to cross-examine must be provided, as long as a party is given “a reasonable opportunity to comment on and challenge such evidence” in another way (citing Re Arbour Energy Inc., 2012 ABASC 131 at paras 49 and 52).

Further, the ASC was clear in noting that a respondent seeking to rely on a registration exemption must make a reasonable, serious effort – or take whatever steps were reasonably necessary – to satisfy himself that the exemption was available at the time of the trade of the security (citing Re Cloutier, 2014 ABASC 2 at para 308). Bald assertions of the presence of an exemption, or reliance on legal advice vis-à-vis the ostensible exemption, is not sufficient. Moreover, evidence is required to prove reliance on legal advice.

In terms of misrepresentations under the Act, the panel in Re Fauth reiterated that it is not necessary to prove reliance by specific investors on any specific statements or omission alleged to constitute a misrepresentation. Accordingly, what matters is the misrepresentation, the representor’s knowledge of the misrepresentation and the effect of the misrepresentation on the market price or value of the security.

On the issue of fraud, ASC emphasized that it is unnecessary to prove that the accused knew that what he was doing was wrong or that he intended to cause someone else to incur a financial loss. All that is required is proof that the respondent intentionally committed the prohibited acts knowing that the consequence could be deprivation, including the risk of deprivation. Moreover, evidence of personal benefit is not required.

 

The authors would like to thank Sunny Mann, articling student, for his contribution to this article.


[1] Section 29(e) of the Act stipulates that an ASC hearing panel “shall receive that evidence that is relevant to the matter being heard”. Section 29(f) provides that “the laws of evidence applicable to judicial proceedings do not apply [to a hearing before the ASC]”. These sections allow the admission of all relevant evidence, including hearsay, subject to the rules of natural justice and procedural fairness and the ASC’s discretion.

[2] These relatives too had invested in Espoir. They had personal knowledge of the unavailable witnesses investments and interactions with Fauth and gave viva voce evidence before the ASC during the hearing.

[3] The ASC was not required to consider whether the alleged breaches of s. 75(1)(a) in the Notice of Hearing were limitation barred since these occurred after May 11, 2010 and were therefore within the six-year limitation period.

[4] The ASC also relied on the British Columbia Securities Commission’s decision in Re Williams, 2016 BCSECCOM 18 in concluding that the misrepresentation and fraud allegations were not statute barred. In Williams, investors loaned money on the representation that it would be “put into safe investments”. Instead, the funds were used for other purposes, including payments to earlier investors. The panel in Williams concluded that it was a Ponzi scheme involving ongoing acts of deceit which persisted until the scheme collapsed. Accordingly, it was found to constitute a continuing course of conduct, none which was held to be statute-barred.

[5] The Debentures contained language whereby the subscribers, by signing, ostensibly acknowledged that Espoir was a “private issuer” and warranted that they either were family, friends or close business associates of a “director, senior officer or control person” of Espoir (i.e., Fauth) or were accredited investors. If proven, these facts could have established that a prospectus and registration exemption was available prior to September 28, 2010. A number of the investors, however, were neither family, friends or close business associates of Fauth nor accredited investors at the time they purchased their first Unsecured Debenture in July 2006.

[6] Section 93(b) now also prohibits an “attempt to engage or participate in any act, practice or course of conduct relating to a security …that the person or company knows or reasonably ought to know will…perpetrate a fraud on any person or company”.

Time is of the Essence: Public Interest Considerations on a Motion for Standing to bring a s. 127 Proceeding Before the Ontario Securities Commission

A private party cannot commence a proceeding under s. 127 of the Ontario Securities Act (the “Act”) seeking enforcement remedies as a matter of right.  In Pearson (Re), 2018 ONSEC 53 the Ontario Securities Commission provides further guidance concerning when it will permit someone other than Enforcement Staff to commence such a proceeding before it.

The Facts

In Pearson (Re), the Commission refused a motion by a disgruntled minority shareholder of LeadFX Inc. (“LeadFX”), for standing to bring a s. 127 proceeding against that company.  Pearson was seeking orders under s. 127, including an order restraining LeadFX from completing a going private transaction without complying with the requirement in Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions (“MI 61-101”) to obtain majority of the minority shareholders’ approval.

The application related to an upcoming special meeting of shareholders of LeadFX to consider and approve a going-private transaction to be completed by means of a statutory plan of arrangement under s. 192 of the Canada Business Corporations Act.  Pearson alleged LeadFX had structured the going-private transaction to circumvent the need for approval by a majority of the minority, including by entering into a prior transaction that made it possible for LeadFX to rely upon the “90 Per Cent Exemption” from the minority approval requirement contained in s. 4.6(1)(a) of MI 61-101.

Test for Obtaining Standing Under s. 127

The Commission determined that Pearson met most of the factors for obtaining standing to bring a s. 127 proceeding set out in MI Developments (Re), (2009), 32 OSCB 126.  The application related to both past and future conduct regulated by Ontario securities law, the application was not, at its core, enforcement in nature, the relief sought was future looking, the Commission had the authority to grant an appropriate remedy, and Pearson was directly affected by the conduct.

However, Pearson failed to persuade the Commission that it was in the public interest for it to hear Pearson’s application for orders under s. 127, a key element of the test for obtaining standing.  Pearson was late in bringing the application, had failed to establish a prima facie case that LeadFX had breached MI 61-101, and the Commission was not the appropriate forum for Pearson’s resolving complaints.

Delay

The Commission determined that Pearson could, and ought to have commenced the application for relief under s. 127 in a timelier manner following the press release announcing the going private transaction on July 23, 2018.  Waiting almost two months after that date was too long, even if the Management Information Circular was not issued until August 10.

According to the Commission, it is necessary to carefully scrutinize the speed with which such applications are brought “to protect reasonable expectations for certainty in corporate transactions that could be inappropriately frustrated through such delays.  It is also necessary to avoid incentivizing tactical delays that would affect the ability of the Commission and other parties to adequately prepare during a compressed hearing schedule”.

Existence of a Prima Facie Case

The Commission concluded that Pearson also failed to make out a prima facie case that a scheme had been employed to permit LeadFX to qualify for the 90 Per Cent Exemption without proper disclosure, or “as a result of non bona-fide multipart transactions as an end-run around a requirement of minority shareholder approval”.  In particular, there was simply no evidence of a multi-stage scheme to take LeadFX private and force minority shareholders out at the lowest possible price as Pearson alleged, only speculation.

Proper Forum

Finally, the Commission was not satisfied that a s. 127 hearing before it was an appropriate forum for resolving Perarson’s complaint about the conduct of LeadFX.

Pearson’s primary complaint was about the price fixed in the Plan of Arrangement.  His focus was on recouping at least his original investment.  Pearson had other remedies for pursuing his complaints about price, either in the fairness hearing to approve the Plan of Arrangement, in an oppression action, or pursuant to an appraisal remedy under the Canada Business Corporations Act.

In the circumstances, it would be inappropriate for the Commission to exercise its s. 127 jurisdiction to protect investors or the capital markets in the absence of “substantial evidence” that the purpose underlying the 90 Per Cent Exemption had been subverted by LeadFX.

Key Public Interest Take-Aways

Pearson (Re) confirms that the onus is on a private party seeking standing to obtain remedies under s. 127 of the Act to satisfy the criteria set out in MI Developments (Re).

In order to satisfy the Commission that it is in the public interest to grant the request for standing, it will be incumbent upon the party seeking standing to act quickly in bringing the application before the Commission.  In addition, it is important that evidence be filed to demonstrate that there is a prima facie case of misconduct justifying a s. 127 remedy, either in the interests of investor protection, or of  protection of the capital markets.

Finally, If the dispute is really about money, even if the Commission has jurisdiction to grant a remedy under s. 127, the availability of an appropriate remedy before the courts may incline the Commission to refuse the request for standing.

MFDA Publishes Principles-Based Sanction Guidelines

The Mutual Fund Dealers Association of Canada (MFDA) has published new Sanction Guidelines which will take effect on November 15, 2018.  The Sanction Guidelines, which replace the MFDA’s Penalty Guidelines, in place since 2006, are intended to promote consistency, fairness and transparency while focusing on a principles-based approach to sanctioning.  While the Sanction Guidelines are not binding on MFDA Hearing Panels, they are intended to provide a summary of the key factors that Hearing Panels may refer to in exercising their discretion in imposing sanctions.

The Sanction Guidelines identify the following Key Factors to be considered in determining sanctions that promote the MFDA’s goal of protecting the investing public:

  • General and specific deterrence. A sanction should achieve both general and specific deterrence in that it should (i) discourage the Respondent from engaging in future misconduct and (ii) strike an appropriate balance between the Respondent’s misconduct and the public’s expectations as to an appropriate sanction in the circumstances.
  • Public confidence. Sanctions should be in line with what the public would reasonably expect for the misconduct in question.
  • The seriousness of the proven allegations. Distinctions should be drawn between conduct that was unintentional or negligent and conduct that was intentional, manipulative and fraudulent. Whether the misconduct was an isolated event or part of a series of violations will also be relevant.  Other factors to consider in determining the seriousness of the allegations include:
    • Attempts to conceal, mislead, deceive or intimidate will be considered an aggravating factor.
    • Vulnerability. Evidence that the Respondent’s conduct involved vulnerable investors, including those who are at risk due to age, disability, limited investment knowledge, or a high level of trust and reliance on the Respondent, will be an aggravating factor.
    • Evidence of planning and premeditation will be an aggravating factor.
    • Reasonable reliance. Reasonable reliance by the Respondent on competent supervisory, accounting or legal advice will be a mitigating factor.
    • Prior warnings. Evidence that the Respondent engaged in misconduct despite having received prior warnings will be an aggravating factor.
  • The Respondent’s recognition of the seriousness of the misconduct. The Respondent’s acceptance of responsibility prior to intervention by the MFDA and an admission of wrongdoing will be considered mitigating factors.  Attempts to frustrate, delay or undermine the MFDA investigation or hearing will be aggravating factors.
  • Benefits received by the Respondent. Where the Respondent receives a financial benefit from the misconduct, which may include the avoidance of a loss, the sanction should reflect the extent of that financial benefit.
  • Harm suffered by investors. The harm suffered by investors can be quantified in terms of the type, number and size of transactions at issue, the number of investors affected by the misconduct, the size of the loss suffered, the length of time over which the misconduct took place, the impact on the investor, the reputation of the Member, and the integrity of the mutual fund industry as a whole.
  • Past conduct. Evidence of past misconduct on the part of the Respondent, which includes disciplinary measures imposed by the MFDA and other regulators and tribunals, should be considered in determining an appropriate sanction.  Hearing Panels should impose progressive sanctions for each successive instance of misconduct.
  • Prior sanctions. Generally, where the Respondent has already received a sanction from a Member or other regulator for the same misconduct at issue before the MFDA, that will be considered a mitigating factor.
  • Previous decisions. Previous sanctions imposed in similar circumstances will be instructive, but ultimately each case should be decided on its own facts.
  • Totality of the misconduct. Where there have been multiple violations, Hearing Panels should consider the gravity of the totality of the misconduct and impose a proportionate sanction.
  • Ability to pay. Evidence of the Respondent’s bona fide inability to pay a monetary sanction may result in a reduction or waiver of a contemplated fine, or the imposition of a payment plan.  The onus is on the Respondent to establish an inability to pay.  On the flip side, where the Respondent has significant financial resources, a higher fine may be warranted in order to achieve specific deterrence.
  • Voluntary implementation of corrective measures. Evidence that the Respondent voluntarily implemented corrective measures to avoid recurrence of the misconduct should be considered.
  • Voluntary acts of restitution. Evidence that the Respondent made voluntary acts of compensation, restitution or disgorgement should be considered by a Hearing Panel.  The Panel should consider whether the voluntary action was timely and whether efforts at full compensation were made.
  • Proactive and exceptional assistance. All Respondents are expected to cooperate with an MFDA investigation. However, evidence of proactive and exceptional assistance by the Respondent will be considered a mitigating factor.

The Sanction Guidelines also identify the types of sanctions available to a Hearing Panel, which include fines; suspension, permanent prohibition, or termination of a Member’s rights and privileges of membership; reprimands; conditions on the authority of an Approved Person; terms and conditions on the membership of the Member; the appointment of an independent monitor or consultant to oversee the Member’s activities; and directions for the orderly transfer of client accounts from the Member.

LexBlog