Court of Appeal for Ontario expands on auditors’ duty of care

By Fahad Siddiqui on September 14, 2018 Posted in Civil claims, Other developments

Key take-aways

On September 5 the Court of Appeal for Ontario issued its decision in Lavender v. Miller Bernstein LLP, 2018 ONCA 729.

The decision is now the leading judgment by Ontario’s highest court on the duty of care owed by auditors.
The Court of Appeal held that an auditor does not owe a duty of care to account holders with a securities dealer simply by virtue of auditing the dealer’s annual registration renewal requirements filed with a securities regulator.
The decision confirms that the legal determination of the class of persons to whom an auditor owes a duty of care at law will turn on the facts of each case, in keeping with the Supreme Court of Canada’s decision in Deloitte & Touche v. Livent Inc. (Receiver of), 2017 SCC 63.

Background

In 2001, the Ontario Securities Commission (OSC) suspended the registration of a securities dealer and placed the dealer into receivership for failing to segregate investor assets and maintain a minimum level of net free capital.^[i] Clients with investment accounts at the firm lost millions.

A class action was commenced on behalf of all clients with accounts at the securities dealer alleging that the dealer’s auditor negligently audited an annual registration renewal requirement filed with the OSC (known as Form 9 Reports). The dealer’s Form 9 Reports incorrectly stated that the dealer was in compliance with regulatory segregation and minimum capital requirements.^[ii]

A motion judge of the Superior Court of Justice granted summary judgment to the class concluding that the auditor owed class members a duty of care in conducting audits of the dealer and that the auditor fell below the required standard of care.

The auditor appealed the summary judgment decision to the Court of Appeal.

Key holdings

Historically, courts applied the two-stage analysis outlined in Anns v. Merton London Borough Council, [1978] A.C. 728 (H.L.) and Cooper v. Hobart, 2001 SCC 79, to determine the threshold question of whether a duty of care exists in negligence cases. The first stage of the test considers whether a prima facie duty of care exists based on a relationship of proximity and reasonable foreseeability of injury, while the second stage considers whether there are any residual policy reasons for denying liability notwithstanding a finding of duty in the first stage.^[iii]

The Supreme Court of Canada’s 2017 Livent decision explained how the Anns/Cooper framework applies to define the duties of care owed by auditors. In that judgment, the Supreme Court reaffirmed that the applicable analysis comprises the following steps:

The court will first determine whether a prima facie duty of care exists by:
Examining whether the relationship between the auditor and the plaintiff falls within, or is analogous to, a previously established category in which proximity has already been found to exist. If a risk of reasonably foreseeable injury can also be shown—or has already been shown through an analogous precedent—the first stage of the Anns/Cooper framework is complete and a duty of care may be identified. If no established proximate relationship can be found, the court must undertake a full proximity analysis.
To determine proximity, the court will examine the circumstances of the relationship between the auditor and the plaintiff—including expectations, representations, the interests involved, and any statutory obligations—to determine whether it is sufficiently close to impose a duty of care.
If proximity is established, the court will determine whether the plaintiff’s injury was reasonably foreseeable by looking to whether the auditor should reasonably understand that the plaintiff would rely on its representations and whether such reliance would be reasonable in the circumstances.
Where a prima facie duty of care is recognized, either through an existing category or on the basis of a full proximity and reasonable foreseeability analysis, the court must go on to ask whether there are any public policy concerns beyond the relationship of the parties, including the effects of recognizing a duty on other legal obligations, the legal system, and society more generally, that may negate imposing a duty of care.^[iv]

Applying this analysis, the Court of Appeal vacated the judgment below, granted summary judgment to the auditor, and dismissed the class’s claim for negligence.^[v]

The court held that the motion judge did not have the benefit of the Livent decision at the time the motion was considered,^[vi] and as such the motion judge conflated the questions of proximity and foreseeability and made factual findings that amounted to palpable and overriding errors.^[vii] Specifically, it found that the relationship between the auditor and the investors was too remote because it was attenuated by the intermediary relationship between the securities dealer and the OSC, and thus the motion judge’s decision stretched proximity “beyond its permissible bounds.”^[viii]

The court also noted that the auditor made no representations to the investors directly^[ix] and that there was no reliance (or even awareness of) the auditor’s functions by the investors.^[x] For these reasons, there was no proximity or reasonable foreseeability to sustain a determination that a duty of care existed, and the court declined to conduct a second-stage policy analysis.

In reaching its conclusion, the court commented that negligence claims for pure economic loss require more heightened scrutiny than other negligence claims.^[xi]

The court’s decision provides important guidance to auditors facing claims in negligence, and should be carefully considered by counsel in developing effective defence strategies. In particular, the decision appears to limit the liability of defendant auditors who make no representations to members of a putative class,^[xii] whose existence or involvement with a dealer is unknown to investors,^[xiii] or whose work product is not shared with plaintiffs or relied on by them in making investment decisions.^[xiv]

The author wishes to thank law student Maha Mansour for her help in preparing this article.

[i] 2018 ONCA 729, at para. 1.

[ii] Ibid, at para. 2.

[iii] Ibid, at para. 29.

[iv] Ibid, at paras. 30-41.

[v] Ibid, at paras. 76-77.

[vi] The motion was argued on June 27 and 29, 2017, and reasons for judgment were issued on July 12, 2017. The Supreme Court of Canada’s Livent decision was not released until December 12, 2017.

[vii] 2018 ONCA 729, at para. 68.

[viii] Ibid, at paras. 25-26.

[ix] Ibid, at para. 65.

[x] Ibid, at para. 67.

[xi] Ibid, at para. 72.

[xii] Ibid, at para. 66.

[xiii] Ibid.

[xiv] Ibid, at para. 67.

Quebec Court of Appeal clarifies the essential elements of the offences of market manipulation and complicity under the Quebec Securities Act

By Sophie Melchers on September 10, 2018 Posted in Other developments, Securities regulatory decisions

On September 5, 2018, the Quebec Court of Appeal rendered a unanimous judgment in Autorité des marchés financiers c. Forget, 2018 QCCA 1419 (Forget) clarifying the essential elements of the mens rea offence of market manipulation set out at section 195.2 of the Quebec Securities Act (QSA):

195.2. Influencing or attempting to influence the market price or the value of securities by means of unfair, improper or fraudulent practices is an offence.

and of the offence of complicity set out at section 208 QSA :

208. Every person who, by act or omission, aids a person in the commission of an offence is guilty of the offence as if he had committed it himself. He is liable to the penalties provided in section 202, 204 or 204.1 according to the nature of the offence.

The same rule applies to a person who, by incitation, counsel or order induces a person to commit an offence.

Background

The Autorité des marchés financiers (AMF) charged the founding shareholder and CEO of Les Technologies Clémex (Clémex) with the offence of market manipulation under section 195.2 QSA for :

having purchased 20,000 shares of Clémex at market price (which ended being in the range of $0.22 to $0.24 per share) on July 29, 2008, a few days before the announcement of a private placement of Clémex shares at a price of $0.20 (the July transactions); and
having purchased 15,000 shares of Clémex at market price with a cap of $0.20 per share on December 9, 2008, when the then most recent transaction was at a price of $0.04 per share (the December transactions).

His financial advisor was also charged under section 208 of the QSA, for having aided the CEO in the commission of an offence.

In respect of the July transactions, the AMF mainly argued that they had caused the Clémex share price to move up 41% to $0.24 per share, that their timing was close to the upcoming announcement of the private placement at $0.20 per share and that the CEO had an ‘indeniable interest’ in having the Clémex share price increase ahead of the private placement to ensure that it could close at the agreed-upon price of $0.20 per share. In respect of the December transactions, the AMF argued that they sought to ensure a higher closing price on December 9 than $0.04 per share.

The first instance judge acquitted the CEO and his financial advisor, finding that the AMF had failed to meet its burden of proving all elements of the offences beyond a reasonable doubt. The Superior Court dismissed the AMF’s appeal of the acquittal. The Court of Appeal confirmed the acquittal and seized the opportunity to clarify the essential elements of the offences of market manipulation and of complicity.

The Decision

The Court of Appeal begins with an important introductory comment to the effect that the importance of protecting the integrity of the financial markets in no way diminishes the prosecution’s burden of proof. In any penal proceeding, the AMF has to prove the essential elements of the offences beyond a reasonable doubt to secure a conviction.

The essential elements of the offence of market manipulation

The Court confirms at the outset that section 195.2 creates a mens rea offence, requiring proof of the accused’s intent, as opposed to a strict liability offence not requiring any proof of intent.

The actus reus of the offence of market manipulation will be established by proof, beyond a reasonable doubt, of a dishonest act, namely the use of an unfair, improper or fraudulent practice, which influenced or attempted to influence the market price or the value of a security.

The Court confirms that an “unfair, improper or fraudulent practice” must be dishonest, failing which many legitimate transactions which do influence the market price of a security could wrongly fall under section 195.2 QSA. As all courts involved in this case pointed out, “any stock market transaction is likely to influence the price of a security, particularly in the case of an illiquid, low-price security: this cannot, in itself, lead to the conclusion that this effect stems from an unfair, improper or fraudulent practice”[1].

In the words of the Court of Appeal, the common denominator to the three adjectives used in section 195.2 QSA – unfair, improper and fraudulent – is a “dishonesty attached to thwarting the mechanisms of the free market, to manipulate it (in the pejorative sense of the term): we are talking here about subterfuge, artifice, machination”[2].

Evidence of unfair, improper or fraudulent practice will be established in accordance with the objective standard of the reasonable person, without it being necessary to try to distinguish between the unfair, the abusive and the fraudulent.

The mens rea of the offence of market manipulation will be established by proof, beyond a reasonable doubt, that the accused “had the subjective knowledge that he was committing a prohibited act (the dishonest act incarnated in the unfair, improper or fraudulent practice) and the subjective knowledge that this act would influence or be likely to influence the price or the value of the security, or that he did not care about either of them”[3].

The essential elements of the offence of complicity

The Court begins its analysis of the charge against the financial advisor by recalling that section 208 QSA ‑ which provides that any person (in this instance, the financial advisor) who aids a person (in this instance, the CEO who was the ‘principal author’ of the offence) in the commission of an offence is guilty of the offence as if he had committed it himself – does not create a distinct offence but rather a mode of participation in the offence committed by the ‘principal author’.

The actus reus of the offence under section 208 QSA will be established by proof, beyond a reasonable doubt, of the commission of an offence by the ‘principal author’[4] and of aid provided by the accused to the commission of the offence by the ‘principal author’. Referring to the Court of Appeal’s decision in Desbiens c. Autorité des marchés financiers, [2017] QCCA 1690 (Desbiens), the Court reminds us that the aid referred to in section 208 QSA must “be connected, temporally and logically, with the commission of the offence; it must have had the real effect of aiding the commission of the offence by the principal author”[5].

Finally, the Court specifies that proof of the commission of an offence by the ‘principal author’ need only be made against the charged accomplice and does not require that the ‘principal author’ have been charged, nor convicted.

Takeaways

The reminder by the Court of Appeal that the mission of the AMF to protect the integrity of the financial markets does not lighten its burden of proof when it chooses to engage penal proceedings ensures that Courts will hold the AMF to the same standard of proof – beyond a reasonable doubt ‑ as all public prosecutors in order to secure a conviction.

It is now firmly established – barring a successful appeal of the AMF to the Supreme Court of Canada – that the offence of market manipulation is a mens rea offence, requiring proof of intent, and that the actus reus requires proof, beyond a reasonable doubt, of a dishonest act, namely the use of an unfair, improper or fraudulent practice.

Courts should thus no longer convict on the basis of a fluctuation in the market price of a security, without evidence, beyond a reasonable doubt, that a dishonest practice caused the fluctuation.

[1] Unofficial translation, Forget, para 51.

[2] Unofficial translation, Forget, para 35.

[3] Unofficial translation, Forget, para 37.

[4] Unofficial translation, Forget, para 84: “one cannot of course, within the meaning of this provision, be criminally responsible for having helped a person who has not committed an offense”.

[5] Unofficial translation, Desbiens, para 43.

Quebec Superior Court dismisses action for damages against Autorité des marchés financiers

By Sophie Melchers and Caroline Larouche on September 7, 2018 Posted in Civil claims, Cross border issues, Other developments

In Mallat c. Autorité des marchés financiers de France, 2018 QCCS 3867, Cohen J. granted a motion to dismiss an action brought by three Ubisoft executives (Plaintiffs) against the Autorité des marchés financiers de France (AMFF) and the Autorité des marchés financiers du Québec (AMFQ).

Among many demands[1], the Plaintiffs requested declarations that the Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information (the MMoU) ‑ to which more than one hundred securities regulators world-wide are parties ‑ was invalid, that the subpoena sent by the AMFQ compelling the testimony of the Plaintiffs was an illegal search and seizure, that the evidence gathered, namely through the compelled interviews, was illegally obtained and abusive and sought $3.2 million in damages.

Cohen J. unequivocally disagreed with all of Plaintiffs’ submissions, finding no basis for any of the conclusions sought by them.

Background

On February 21, 2014, pursuant to the terms of the MMoU, the AMFF requested the AMFQ’s assistance in connection with an investigation of Ubisoft Montreal employees. The Plaintiffs had allegedly sold Ubisoft shares before an October 2013 public announcement about delays in the delivery dates of Watch Dogs and The Crew, two much-anticipated videogames.

On March 10, 2014, further to a request of the AMFF, the AMFQ sent a subpoena to Plaintiffs requesting the disclosure of documents, including their work emails. In response thereto, to the knowledge of Plaintiffs, Ubisoft France remitted the requested documents to the AMFF directly.

Six month later, the AMFQ informed the Plaintiffs that the AMFF wanted to meet with them on a voluntary basis. The Plaintiffs refused to meet unless compelled to do so. The Plaintiffs were subsequently subpoenaed by the AMFQ. Their examinations were held in the AMFQ’s offices in the presence of AMFQ and AMFF investigators. The latter had been designated as AMFQ investigators for the sole purpose of the compelled examinations. The role of the AMFQ investigators was essentially limited to reading them their rights under the Canadian Charter[2] and the Quebec Charter while the AMFF investigators asked all the questions.[3] Following the examinations, the AMFQ closed its investigation file while the AMFF continued on with its investigation.

The AMFF prepared an investigation report which included references to the transcripts of the Plaintiffs’ examinations conducted in Quebec as well as their emails and voicemails disclosed by Ubisoft France further to the AMFQ subpoena. On the basis of this investigation report, the College of the AMFF instituted penal proceedings in France against the Plaintiffs for insider trading.

In a December 7, 2016 decision, France’s “Commission des sanctions” (Commission) decided that the transcripts of the Plaintiffs’ examinations conducted in Quebec should be struck from the record due to violation of French law, namely violation of the protection against self-incrimination[4] afforded to Plaintiffs, but nevertheless condemned the Plaintiffs to pay sums of several hundred thousand euros.

The Issues and the Decision

Cohen J. decided numerous issues, her most salient conclusions being the following:

The Quebec Superior Court does not have jurisdiction to determine the constitutionality of the MMoU

Citing art. 529 of the Code of Civil Procedure, Cohen J. determined that the Superior Court of Quebec did not have jurisdiction to declare that a private international accord, such as the MMoU, is invalid because it is neither a law, a regulation or a governmental decree.

The AMFQ’s actions did not breach any of Plaintiffs’ Charter rights

Relying on the SCC’s guidance in Branch[5], Cohen J. affirmed that the AMFQ’s power to compel testimony and production of documents in the context of securities investigation does not violate articles 7 and 8 of the Canadian Charter.[6] The Court held that the AMFQ’s conduct was within its competence as prescribed by the Securities Act[7] and the MMoU, signed and executed in accordance with article 33 of the Act respecting the Autorité des marchés financiers[8] (the LAMF).

The subpoena and seizures were not abusive

The Court declined to recognize the seizures of Plaintiffs’ documents as abusive. Indeed, the seizure was done by way of a subpoena as opposed to a search warrant and Plaintiffs had a low expectation of privacy towards their work emails. The Court questioned the Plaintiffs delay in opposing the disclosure of documents. The Court observed that the Plaintiffs only objected to the document subpoena in early 2017, three years after the voluntary delivery of documents to the AMFF.

Cohen J. further reasoned that even if there had been a violation of the Canadian Charter by the AMFQ and AMFF in issuing a subpoena and requesting disclosures, article 24 of the Canadian Charter could not provide adequate remedies as no further procedures were instituted against the Plaintiffs in Canada.

The compelled examinations did not breach Plaintiffs’ right to remain silent

Cohen J. held that Plaintiffs did not have a right to remain silent when questioned by investigators of the AMFQ as its investigation is administrative in nature, as opposed to criminal or penal. Under the Securities Act, a compelled person is obliged to answer questions put to her by AMFQ investigators, failing which the person is in contempt. In return for being so obliged, the person benefits from the protection of Canada’s Evidence Act and the person’s compelled answer shall not be used or admissible in evidence against her in any criminal trial or other criminal proceeding, other than a prosecution for perjury in the giving of that evidence or for the giving of contradictory evidence. In this instance, no criminal or penal proceedings were ever instituted against the Plaintiffs in Canada.

The AMFQ is protected from any recourse against it by its immunities

The Court recalled articles 283 of the LAMF and 32 of the Securities Act, which grant the AMFQ absolute immunity from proceedings, “no matter the nature of the recourse against it”, for official acts done in good faith in the execution of their duties.[9] Cohen J. added that articles 240 of the Securities Act and 16 of the Act respecting public inquiry commissions[10] afford additional immunity in the context of investigations. The Court found that the AMFQ had acted within its competence and the execution of its duties, and was thus protected by its immunities.

Takeaways

A foreign regulator can request and obtain the assistance of the AMFQ in the context of a foreign securities investigation under the MMoU, which can include (1) the designation of the foreign investigators as AMFQ investigators and (2) the conduct of compelled interviews of targets by these foreign investigators in Québec.

In this instance, the French regulator essentially took advantage of the legal regime in Québec – which prohibits the target of an “administrative securities investigation” to refuse answering questions – to compel the testimony of the Plaintiffs when the French legal regime would have given those targets protection against self-incrimination.

The authors would like to thank Saam Pousht-Mashhad, associate, for his contribution to this article.

[1] For a full list of conclusions sought by the Plaintiffs, see Mallart, para 48.

[2] The Constitution Act, 1982, Schedule B to the Canada Act 1982 (UK), 1982, c 11.

[3] Charte des droits et libertés de la personne, RLRQ c C-12.

[4] Mallat, para 40.

[5] British Columbia Securities Commission c. Branch, [1995] 2 R.C.S. 3.

[6] Mallat, para 108.

[7] CQLR c V-1.1.

[8] CQLR c A-33.2.

[9] Unofficial translation, Mallat, para 170.

[10] CQLR c C-37.

SEC to Resume Administrative Law Proceedings Following Supreme Court Ruling

By Robert A. Schwinger on August 31, 2018 Posted in Cross border issues, Securities regulatory decisions

In response to the U.S. Supreme Court’s June 21, 2018 decision in Lucia v. SEC, No. 17-130, holding that administrative law judges (ALJs) at the U.S. Securities and Exchange Commission (SEC) had been improperly appointed because they had been appointed by SEC staff rather than the President or the full SEC, which was discussed in our June 27, 2018 blog post, the SEC issued an August 22, 2018 order explaining how it would now proceed on pending cases affected by the Lucia ruling.

The SEC order stated that the SEC would begin to rehear some 128 cases that were pending before its ALJs, including the very case against investment adviser Raymond Lucia that had led to the Supreme Court’s Lucia ruling in June. Those cases had been stayed since the Supreme Court’s ruling. The SEC order stated that the full SEC had now reaffirmed the appointments of the same five ALJs who had been hearing cases before the Supreme Court’s ruling. The SEC’s order formally ends the stay, and provides for these pending cases to be reheard by a different ALJ, who would start each case afresh if the respondent in the case so wished. In any event, the SEC’s order provides that the assigned ALJ “shall not give weight to or otherwise presume the correctness of any prior opinions, orders, or rulings issued in the matter.” Moreover, previously-set case deadlines are to be vacated and adjusted in accordance with guidelines set down in the order.

The SEC’s order appears to respond to two key parts of the Supreme Court’s ruling in Lucia: first, that SEC ALJs must be appointed either by the President or the full SEC, and second, that cases that had been started under an improperly appointed ALJ would need to be referred to a different properly appointed ALJ who had not been involved with that case during its earlier stage. The order provides an efficient plan for resuming the pending cases consistent with the Lucia ruling. Apart from resulting in a few months’ delay from the now-terminated stay, and the need in some cases to re-do certain portions of prior proceedings in these matters, it remains to be seen if the Lucia ruling will ultimately have any practical impact on the outcome of these pending cases or if it will turn out to be little more than the tidying up of constitutional niceties that are far more significant to constitutional scholars than to investors, brokers, advisers, issuers and other participants in US securities markets.

Stay of proceedings based on AMF failings in its disclosure of evidence : Baazov v. AMF, 2018 QCCQ 4449

By Sophie Melchers and Caroline Larouche on August 15, 2018 Posted in Other developments, White collar crime

In the recent decision Baazov v. AMF, Mascia J. of the Quebec Court, Criminal and Penal Chamber granted a stay of proceedings in respect of all tipping, insider trading and market manipulation charges laid against the accused based on the repeated failings of the prosecutor, the Autorité des marchés financiers (AMF), the Quebec securities regulator, in its disclosure of evidence to the accused. The AMF has decided not to appeal the judgment, which is now final.

Background to the Decision

In March 2016, the AMF laid 23 penal charges against David Baazov, Benjamin Ahdoot, Yoel Altman and three companies, alleging breaches of the Quebec Securities Act (QSA) in connection with the acquisition by Amaya Gaming of Rational Group (PokerStars) announced on June 12, 2014. All accused pleaded not guilty to the charges.

Pursuant to R. v. Stinchcombe, [1991] 3 RCS 326 and subsequent Supreme Court of Canada judgments, the AMF had a constitutional duty to disclose to the accused all relevant evidence, which includes all evidence that can be useful to the defense.

The disclosure of evidence by the AMF to the accused was plagued with mistakes.

In November 2017, nearly two months after the AMF chose to disclose to the accused 16 million documents it had collected in a related investigation referred to as Project Bronze, the AMF asked the accused to immediately cease reviewing same since it had inadvertently disclosed 14 million documents, including documents that fell outside the period authorized by the search warrants issued by the courts.

In January 2018, the AMF asked the accused to stop reviewing disclosed evidence which the AMF had obtained directly from Amaya’s external auditors because the documents had not been reviewed for privilege by Amaya.

In February 2018, the AMF was ordered to disclose to the accused the remaining 6 million documents collected in Project Bronze as well as all of the evidence collected by the AMF in yet another related investigation referred to as Project Cordon. This evidence contained a number of documents which disclosed Mr. Ahdoot’s defense strategy and were protected by privilege.

In April 2018, Mr. Ahdoot filed a Motion for a stay of proceedings based namely on access of the AMF to his privileged documents.

Mid-May 2018, as the parties were entering week five of their trial which would require at least 12 more weeks, the AMF asked the Court to order the accused to put in place measures to quarantine more than 320,000 documents which had been disclosed over the previous eight months and which were potentially protected by privilege of third parties. All accused filed a joint Motion for a stay of proceedings in connection thereto.

In support of both Motions for a stay, the accused argued that:

the AMF had had access to privileged documents disclosing Mr. Ahdoot’s defense strategy.
the quarantine of 320,000 documents during the trial would have a clear and definite impact on all accused’s right to a fair trial as they would lose access to evidence disclosed to them due to its potential relevance to their defense.
the repeated errors committed by the AMF in matters wholly within its control, i.e. disclosure of its evidence, warranted a stay of proceedings.
allowing the trial to continue would bring the administration of justice into disrepute as the sloppy and careless manner in which the AMF dealt with the evidence showed a blatant disregard for privilege despite having a duty, as public prosecutors and officers of the Court, to protect it.

The Court’s Analysis

Legal principles

When the Crown institutes a complex prosecution, it must ensure that it is prepared to proceed within a reasonable time and that it has “a well thought-out plan” in order to bring the proceedings to completion, under acceptable conditions. No manageable trial may be held unless a number of conditions are present:

Disclosure has to be timely.
Disclosure must present the evidence in an accessible, searchable and appropriately inventoried manner.
While the duty to disclose is continuous, disclosure must have an end which should be closer to the laying of charges than to the trial.

When complying with its disclosure obligations, the prosecution is tasked with protecting privilege.

If the prosecution finds itself in possession of a document of the accused protected by professional secrecy, the prejudice to the accused is presumed. It has been held that it would be difficult, if not impossible, for the court to determine what effect the privileged document may have had on a witness’s testimony and whether the prosecutor’s strategy has been indirectly, at least, affected by its witnesses having read the privileged document.

While a stay of proceedings is the most drastic remedy a criminal court can order, there are rare occasions — the “clearest of cases” — when a stay of proceedings for an abuse of process will be warranted. According to the Supreme Court in R. v. Babos, 2014 CSC 16, these cases generally fall into two categories: (1) where state conduct compromises the fairness of an accused’s trial (the “main” category) and and (2) where state conduct creates no threat to trial fairness but risks undermining the integrity of the judicial process (the “residual” category). The test used to determine whether a stay of proceedings is warranted is the same for both categories and consists of three requirements:

(1) There must be prejudice to the accused’s right to a fair trial or the integrity of the justice system that “will be manifested, perpetuated or aggravated through the conduct of the trial, or by its outcome”;

(2) There must be no alternative remedy capable of redressing the prejudice; and

(3) Where there is still uncertainty over whether a stay is warranted after steps (1) and (2), the court is required to balance the interests in favour of granting a stay, such as denouncing misconduct and preserving the integrity of the justice system, against “the interest that society has in having a “final decision on the merits”.

Application of legal principles to the facts

Based on the evidence, including admissions made by the AMF, Justice Mascia found that the AMF had indeed had access to documents disclosing the defense strategy of Mr. Ahdoot which were protected by privilege; as per the case law, prejudice to Mr. Ahdoot was presumed. As the AMF had offered no convincing evidence that it would not be making use of the privileged information of which it gained knowledge in order to rebut the presumption, Justice Mascia concluded that the equity of the trial was compromised.

In respect of the 330,000 potentially privileged documents to be quarantined, Justice Mascia found that it would be impossible for defense counsel to “unsee” documents that they had already reviewed and integrated in their defense strategy and that defence counsel could not be asked, in the middle of a trial, to isolate the 330,000 potentially privileged documents while preparing cross-examinations of witnesses.

Justice Mascia found that the treatment of potentially privileged documents by the AMF was preoccupying, the evidence having shown not only that the protocol of the AMF to protect potentially privileged documents is inadequate but that in this instance, its implementation was deficient. The laxism and lack of rigour of the AMF in the treatment of potentially privileged documents was found to be unacceptable by the Court and that continuing the trial despite the impugned conduct would further compromise the integrity of the judicial system.

Justice Mascia held that there was no alternative remedy and ordered the stay of proceedings.

Take Aways

The volume of evidence to be managed by the Crown cannot serve as an excuse for repeated failings in respect of its disclosure to the accused. The greater the volume of evidence, the greater the need for the prosecution to organize it and make it accessible and searchable for the accused.

While society has an interest in having penal charges heard and decided on the merits, there comes a point where it is no longer acceptable to have the accused suffer the consequences of repeated errors of the prosecution.

Justice Mascia cited R. v. Keyes, 2017 ONCJ 5 (CanLII) in support of the propositions that “for the most part, … disclosure, and its timing, is a matter entirely within the Crown’s control. … It is the Crown’s job to monitor and manage the process of disclosure” and that “[i]t is not the court’s function to excuse the Crown’s miscarriage of its constitutional duties by elevating routine “mistakes” into exceptional circumstances.”

The Importance of Cooperation Among Interjurisdictional Securities Regulators: United States Securities and Exchange Commission v. Autorité des marchés financiers, 2018 QCCQ 4417

By Sophie Melchers on August 14, 2018 Posted in Cross border issues, Other developments, White collar crime

In the recent decision of United States Securities and Exchange Commission v. Autorité des marchés financiers, 2018 QCCQ 4417, the Quebec Court, Criminal and Penal Chamber held that the United States Securities and Exchange Commission (SEC) had the required interest under section 122 of the Code of penal procedure (CPP) to be allowed to examine materials seized by the Autorité des marchés financiers (AMF), the Quebec securities regulator, from persons under investigation. The CPP applies with respect to proceedings in view of imposing a penal (as opposed to criminal) sanction for an offence under any Act, except proceedings brought before a disciplinary body, including penal proceedings commenced by the AMF for breaches of the Quebec Securities Act.

Background to the Decision

The AMF executed search warrants and seized documents and hardware in the context of its ongoing securities investigation of Dominic Lacroix, Sabrina Paradis-Royer, DL Innov. Inc., and PlexCorps (PlexCoin and Sidepay.ca) (Lacroix et als). Besides being under investigation by the AMF, Lacroix et als were under investigation by the SEC and also named defendants in a lawsuit prosecuted by the SEC in New York for breaches of US securities laws.

The SEC made a request for international assistance from the AMF based on two international agreements between the securities law enforcement agencies: the Multilateral Memorandum of Understanding concerning consultation, disclosure, cooperation, and the exchange of information (MMOU) and the Memorandum of Understanding between the SEC and AMF (MOU).

In response thereto, the SEC was provided with documentation by the AMF and determined that the materials seized by the AMF were relevant to the SEC’s investigation and to its proceedings against Lacroix et als. The SEC therefore sought access to the seized materials, relying on section 122 CPP which allows every person who has an interest in a thing seized to apply for leave to examine them. As a courtesy, the SEC included Lacroix et als as mis-en-cause (impleaded parties) to its motions. The AMF was the respondent. The AMF consented to the SEC motions while Lacroix et als, the mis-en-cause, contested.

The Court’s Analysis

The only question to be adjudicated by the Court was whether or not the SEC had the required legal interest under section 122 CPP to be granted leave to examine the materials seized by the AMF.

In its motions, the SEC alleged the existence of the pending New York proceedings against Lacroix et als, the ongoing SEC investigation, the SEC request for international assistance addressed to the AMF and the relevance of the materials seized by the AMF for i) the New York proceedings, ii) the depositions of Lacroix et als and iii) the ongoing SEC investigation. Those allegations were supported by an affidavit from SEC counsel attesting that the facts alleged in the motions were true. In support of its motions, the SEC filed the AMF search warrants and supporting affidavits of AMF investigators, the minutes of execution of the search warrants, which included a description of the items seized, excerpts from the Quebec corporate registry and the pending New York proceedings.

Lacroix et als contested the SEC motions and argued that the affidavits supporting the SEC motions had no probative value. In their view, the facts alleged were insufficient without testimony regarding how the SEC became aware of them.

The Court firmly disagreed with the position of Lacroix et als, stating that the allegations in the SEC’s sworn affidavits referred to investigative documents of the AMF and those issued by the New York court. The Court emphasized that it was clear that the SEC prosecutor had personal knowledge of the contents of these documents, knowledge acquired as part of his professional duties as a lawyer for the SEC. For these reasons, the Court found that the evidence adduced in support of the SEC’s motions was sufficient to establish the legal interest of the SEC in the materials seized by the AMF and accordingly allowed the SEC to examine the materials and obtain copies of same, subject to paying any applicable fees.

The Court made reference to a decision in the Pharmaciens (Ordre des) c. Meilleur case, in which it granted a request under section 122 of the CPP giving a disciplinary council access to evidence seized pursuant to a search warrant. In addition, the Court clarified that case law does not require the entity requesting access to show that it has reasonable grounds to believe that an offense was committed in order to gain access to it.[1]

Key Take Aways

This decision clarified that the threshold to be met by a foreign regulator wishing to access materials seized by Quebec’s securities regulator is not particularly burdensome, the test being the existence of an interest in examining the seized materials as per section 122 CPP. Allegations concerning the AMF investigation and the parallel SEC investigation and proceedings, supported by a simple affidavit, proved to be sufficient.

Reference is made in this case to the international cooperation agreements, such as the ones between the AMF and the SEC. While those are held in high regard and validate the necessity for cooperation between jurisdictions to ensure that criminal or penal liability is enforced both domestically and abroad, the SEC’s request for access to the materials seized by the AMF fell outside their scope, hence the request under section 122 CPP.

The author would like to thank Daniel Lupinacci, Summer Law Student, for his assistance with this article.

[1] Nova Scotia Securities Commission v Canada (Minister of National Revenue), 2007 NSSC 51 (CanLII), at para 4.

Take Note: Class Action Defendants May be Ordered to Bear the Costs of Notice to Class Members

By Danny Urquhart on August 9, 2018 Posted in Class actions

Justice Perell’s decision in Fantl v. ivari, teaches class action defendants an important lesson in being careful what they wish for. In a rare decision, he ordered that a defendant contribute the majority of the costs of providing potential class members with notice of certification.

Background

When a class action is certified by a court, efforts must be made to notify potential class members of the decision so that they are able to exercise their right to opt-out of the class. Notice is usually provided by newspaper publication, advertisements and dedicated website, among other things.

Typically, the successful plaintiff bears the financial costs of providing notice of certification (see Quinte v. Eastwood Mall Inc., 2014 ONSC 249). However, defendants have an interest in ensuring that the form of the notice and the plan for its distribution are sufficiently robust to ensure they will constitute a binding issue estoppel—which bars future claims by class members who did not opt-out.

The Defendant in Fantl v. ivari was concerned that the plan of notice would not reach all class members and challenged the notice plan on the basis that it was not robust enough to create binding issue estoppels should the class action be resolved by settlement or judgment. ivari proposed a more expensive direct notice plan and argued that the plaintiff should be the one to pay for it. The plaintiff defended its proposed notice plan as satisfactory, but did not oppose ivari’s notice plan provided that ivari was footing the bill.

The Decision

Justice Perell’s decision took place in relatively uncommon procedural circumstances. The plaintiff’s class action had been commenced in 2003 and alleged i) that the defendant’s insurance contract investments underperformed and ii) that management fees on those investments were overcharged. The management fee allegations were settled in 2009. The remainder of the class action continued to a certification hearing and was certified by Justice Perell in 2013.

Five years after granting certification, Justice Perell was called on to resolve the parties’ dispute on the form of notice of certification. Justice Perell noted the general rule that plaintiffs should bear the cost of notice of certification but also emphasized that the costs of notice is always a matter of discretion. He quoted Justice Nordheimer’s statement from Markle v. Toronto (City), [2004] O.J. No. 3024 (S.C.):

“5. In terms of the costs of notice to the class members and recognizing that this is always a matter of discretion, the normal order is that the representative plaintiff has to bear the costs of that notice. I say that is the normal order because it is the representative plaintiff that seeks certification and one of the consequences of certification is the requirement under section 17 of the Act that notice be given to the class members. […] The burden of notice therefore clearly falls on the representative plaintiff. This general rule is not without possible exceptions. For example, if a defendant admitted liability and the class proceeding was certified just to determine the relief to which the class members were entitled, then that might be a case where the defendant would be ordered to bear the cost of the notice programme. There may be other situations which would warrant a departure from the general rule. This case is not one of those exceptions, however. I would also note that the class is estimated at approximately 600 potential members. If notice were to be given by mail to each member of the class, it would not then represent a significant expense for the representative plaintiffs.”

Justice Perell noted that the defendant’s request took place in the context where the first ‘half’ of the class action, the management overcharge claim, had been settled in 2009 and the notice of that settlement included direct mail notices to policy-holders along with newspaper publications, internet notices and emails to distributors and key advisors. About 1.5% percent of potential class members opted out of the management overcharge claim. In constructing its plan of notice of certification in respect to underperformance claim, which was now certified but not settled, the plaintiff wanted to take advantage of the earlier notice by directly mailing notice only to: those who had opted-out of the management fee settlement, the defendant’s professional advisor network, and anyone who had previously contacted class counsel about the class action.

Although the plan of notice for the underperformance claim did not follow the same plan of distribution as the settled management fee overcharge claim, Justice Perell held that there was not necessarily a good reason for these two notices to be symmetrical. In his view, generally speaking, a robust notice plan alerting potential class members of the right to opt-out following certification “is far, far less important than a robust notice plan where there is a settlement fund to be distributed”.

In conclusion, Justice Perell held that there was substance to the defendant’s position that the notice plan needed to be more robust in order to protect the defendant from future claims. However, he exercised his discretion to order that 2/3 of the costs of notice be paid by the defendant. The defendant was, after-all, the predominant beneficiary of the robust notice plan.

Justice Perell’s decision is a lesson in the discretionary powers of the court to determine who pays for notice of procedural developments in a class action. In some cases it may be in the interest of defendants to contest the notice plan. However, defendants to all types of class actions should be cautioned that in some circumstances the court may require them to write the cheque for improvements that they seek.

Ontario Securities Commission confirms test for severance

By Fahad Siddiqui on August 4, 2018 Posted in Other developments, Securities regulatory decisions, White collar crime

In a decision issued on July 24, 2018, the Ontario Securities Commission held that the test to determine whether a respondent’s case should be severed and heard separately is the same test used in criminal proceedings.

The decision, Hutchinson (Re), 2018 ONSEC 40, is available here.

Allegations of insider trading and insider tipping

The OSC commenced proceedings against four individuals alleging insider trading and insider tipping with respect to the securities of eight companies.

Commission staff alleged that Donna Hutchinson, a legal assistant at a law firm, provided material non-public information to her friend Cameron Edward Cornish regarding M&A transactions being handled by her law firm. While the information was to remain confidential, Cornish was alleged to have shared it with Patrick Jelf Caruso and David Paul George Sidders. Before the information was generally disclosed, Cornish, Caruso, and Sidders acquired positions in the companies that improved after the information became public.

Hutchinson agreed to a settlement. She acknowledged that she provided material information, not generally disclosed, to Cornish about M&A transactions being handled by the law firm where she was employed.

The motion for severance

Sidders brought a motion to the Commission for an order severing his hearing from the hearing of Cornish and Caruso on the basis that most of the allegations either did not involve him or turned on different questions of fact than those at the heart of the allegations against Cornish and Caruso. Sidders also argued that his case would be unfairly tainted by any findings made against Cornish and Caruso, and he should not be exposed to the additional expense and delay associated with a joint hearing.

The Commission applies the criminal law test for severance

The Commission adopted the test for severance articulated by the Supreme Court of Canada in R v. Last, 2009 SCC 45, for criminal proceedings.

In Last, the Supreme Court identified a non-exhaustive list factors to be weighed when considering an application under section 591(3) of Canada’s Criminal Code to sever a multi-count criminal indictment: (1) general prejudice to the accused; (2) the legal and factual nexus between the counts; (3) the complexity of the evidence; (4) whether the accused intends to testify on one count but not another; (5) the possibility of inconsistent verdicts; (6) the desire to avoid a multiplicity of proceedings; (7) the use of similar fact evidence at trial; (8) the length of the trial given the evidence; (9) the potential prejudice to the accused with respect to the right to be tried within a reasonable time; and (10) the existence of antagonistic defences as between co‑accused persons.

In adopting the Last approach in Hutchinson, the Commission rejected a more formulaic two-part test applied by the Alberta Securities Commission.

In the result, the Commission concluded that Sidders did not establish that severance would be appropriate and concluded that the R v. Last factors strongly favoured denying severance.

Implications

Hutchinson explicitly holds that the Supreme Court’s decision in Last governs motions for severance brought before the OSC. Nevertheless, it remains to be seen how many of the factors identified by the Supreme Court in Last and subsequently applied by criminal courts will be applied in the context of regulatory proceedings.

For example, the Hutchinson decision posits that there are “special reasons, unique to criminal accused, including certain constitutional protections”, that may explain or give heightened importance to the inclusion of the “whether the respondent intends to testify on one allegation but not another” factor, and leaves open the question of “whether this factor should figure prominently, or at all, in the regulatory context”.

Similarly, in relation to the “potential prejudice to the respondent with respect to the right to be tried within a reasonable time” factor, the Commission comments that “[i]n the regulatory context, there is no constitutional right to a trial within a reasonable time, as exists for criminal accused”, suggesting that there is no delay in OSC proceedings that would presumptively require severance.

Despite significant open questions, Hutchinson stands as the leading decision on severance in OSC proceedings, and counsel should carefully assess the Last factors when strategizing in matters before the Commission involving multiple respondents.

The author would like to thank Tyler Morrison for his assistance with this article.

Copy and Paste Securities Fraud? The U.S. Supreme Court to Decide

By Seth M. Kruglak and Lisa Schapira on July 17, 2018 Posted in Cross border issues, Other developments, White collar crime

Last month, the U.S. Supreme Court granted certiorari to hear a case where an investment banker copied and pasted misstatements from his boss into emails that, at his boss’s request, he sent to prospective debenture purchasers. In Lorenzo v. Securities and Exchange Commission, 872 F.3d 578 (D.C. Cir. 2017), a divided United States Court of Appeals for the District of Columbia held that the investment banker was not the “maker” of the misstatements, but nevertheless affirmed the SEC’s determination that he committed securities fraud under a fraudulent scheme theory. The Supreme Court will thus be faced with the dichotomy of whether an individual can be held liable for fraudulent scheme liability when transmitting a statement that he did not “make” (i.e., the statement was attributed to another person).

Background

In Lorenzo, Francis Lorenzo was director of investment banking at a small registered broker dealer. Although he knew that Waste2Energy Holdings, Inc. (“W2E”) had issued a Form 8-K reporting an impairment that essentially reduced the value of its intangible assets (previously valued at $10 million) to zero, he omitted the devaluation when soliciting two potential investors by email to invest in debentures for W2E. Lorenzo sent those emails at the request of his boss, stated in the emails that the messages were being sent at the request of his boss, and copied and pasted the content in the emails to the potential investors from an email that he received from his boss. However, Lorenzo signed the emails with his name and title and indicated that investors could call him with questions.

Fraudulent Statements and Fraudulent Schemes

As background, the antifraud provisions of federal securities laws prohibit two well-defined categories of misconduct in connection with the offer and sale of securities: fraudulent statements and fraudulent schemes.

Regarding fraudulent statements, Rule 10b-5(b), promulgated under Section 10(b) of the 1934 Securities Exchange Act (“Exchange Act”), prohibits making any “untrue statement of a material fact.” The SEC also can avail itself of Section 17(a)(2) of the Securities Act of 1933 (“Securities Act”), which establishes liability for untrue statements or omissions of a material fact.

In Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), the Supreme Court held that only the “maker” of a fraudulent statement may be held liable under Rule 10b-5. According to Janus,

“[f]or purposes of Rule 10b-5, the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. Without control, a person or entity can merely suggest what to say, not ‘make’ a statement in its own right. One who prepares or publishes a statement on behalf of another is not its maker.”

Janus, 564 U.S. at 142.

With respect to fraudulent schemes, Rule 10b-5(a) prohibits the employment of “any device, scheme, or artifice to defraud.” Relatedly, Rule 10b-5(c) prohibits anyone from engaging in “any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.” Claims that are brought under Rules 10b-5(a) and (c) are referred to as “scheme liability” claims. The SEC can also avail itself of this theory under Section 17(a)(1) of the Securities Act, which prohibits the employment of any “device, scheme, or artifice to defraud.”

The Lorenzo Action

In Lorenzo, the SEC initiated administrative proceedings and upheld an administrative law judge’s determination that Lorenzo was liable for making fraudulent statements under Section 10(b) and Rule 10b-5(b), as well as fraudulent scheme liability under Rules 10b-5(a) and (c) and Section 17(a)(1).

Lorenzo appealed the SEC’s decision to the United States Court of Appeals for the District of Columbia. The D.C. Circuit rejected the SEC’s finding of Rule 10b-5(b) liability on grounds that Lorenzo was not the “maker” of the false statements in the emails he sent to the potential investors. However, the D.C. Circuit—in a 2-1 decision—sustained the SEC’s finding that Lorenzo violated the fraudulent scheme provisions under Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act and Rules 10b-5(a) and (c).

Writing for the majority, Judge Srinivasan wrote that,

“[a]t least in the circumstances of this case, in which Lorenzo produced email messages containing false statements and sent them directly to potential investors expressly in his capacity as head of the Investment Banking Division—and did so with scienter—he can be found to have infringed Section 10(b), Rules 10b-5(a) and (c), and Section 17(a)(1), regardless of whether he was the ‘maker’ of the false statements for purposes of Rule 10b-5(b).”

Lorenzo, 872 F.3d at 588-589.

The majority reasoned that (1) unlike Rule 10b-5(b), Rules 10b‑5(a) and (c), along with Sections 10(b) and 17(a)(1), do not speak in terms of an individual’s “making” a false statement; (2) Lorenzo’s actions do not implicate concerns of overextending the reach of Rule 10b-5 as expressed in Janus and in other Supreme Court decisions that eliminated aiding and abetting liability in private securities fraud actions because here Lorenzo transmitted the misinformation directly to investors and Lorenzo’s involvement was transparent; and (3) Rule 10b-5(b) on the one hand, and Rules 10b-5(a) and (c) on the other, are not mutually exclusive and false statements may overlap in liability under such rules.

Judge Kavanaugh, who has been nominated by President Trump to fill the vacancy on the Supreme Court created by Justice Kennedy’s retirement, lodged a highly critical dissent. He first criticized the administrative law proceeding and the SEC’s decision to uphold its liability findings as containing irregularities violating Lorenzo’s due process rights, and he stated the majority opinion’s deference to the SEC was unwarranted in these circumstances. Judge Kavanaugh also cited several federal appellate decisions for the notion that “scheme liability must be based on conduct that goes beyond a defendant’s role in preparing mere misstatements or omissions made by others.” Id. at 600.

Judge Kavanaugh further emphasized that the SEC’s pursuit of Lorenzo was part of a long-standing effort to blur the distinction between primary and secondary liability matters (which is significant for private securities lawsuits, where aiding and abetting—i.e., secondary liability—is barred). As Judge Kavanaugh stated,

The distinction between primary and secondary liability matters, particularly for private securities lawsuits. For decades, however, the SEC has tried to erase that distinction so as to expand the scope of primary liability under the securities laws. For decades, the Supreme Court has pushed back hard against the SEC’s attempts to unilaterally rewrite the law. Still undeterred in the wake of that body of Supreme Court precedent, the SEC has continued to push the envelope and has tried to circumvent those Supreme Court decisions. This case is merely the latest example.

I agree with the other courts that have rejected the SEC’s persistent efforts to end‑run the Supreme Court. I therefore respectfully disagree with the majority opinion that Lorenzo’s role in forwarding the alleged misstatements made by Lorenzo’s boss can be the basis for scheme liability against Lorenzo.

Id. at 600-601 (internal citations omitted).

Implications

Although Lorenzo involved an SEC enforcement action and on the surface may appear to address a highly technical question, the Supreme Court’s decision may have a large impact on private securities actions. Holding an individual liable for securities fraud for transmitting a statement he did not “make” may, in some circles, be seen as merely aiding and abetting a Rule 10b-5(b) fraudulent misstatement violation, constituting secondary liability. However, if such conduct falls into “scheme” liability under Rules 10b-5(a) and (c), the individual would now be a primary actor and liability may be established in a private securities action.

The securities litigation bar will await the Supreme Court’s decision, which will be handed down in 2019. If Judge Kavanaugh is confirmed by the Senate and joins the Supreme Court, he would be expected to recuse himself when the Supreme Court hears the Lorenzo case. Accordingly, there is a possibility we could see a 4-4 split among the remaining Justices, resulting in the Supreme Court affirming the D.C. Circuit’s decision without opinion.

U.S. Supreme Court Holds SEC Administrative Law Judges Improperly Appointed

By Robert A. Schwinger on June 27, 2018 Posted in Cross border issues, Securities regulatory decisions

On June 21, 2018, the U.S. Supreme Court ruled that administrative law judges (ALJs) at the U.S. Securities and Exchange Commission (SEC) had been improperly appointed because they qualified as “Officers of the United States” under the “Appointments Clause” of the U.S. Constitution, who under the Constitution may be appointed only by the President, a court of law, or heads of departments. Lucia v. SEC, No. 17-130. Because the SEC’s ALJs had been selected merely by SEC staff, the Court held that they had not been lawfully appointed and therefore lacked constitutional authority to issue sanctions and penalties against the petitioner.

The Case

In Lucia, the SEC had commenced an administrative proceeding against the petitioner Raymond Lucia and his investment company under the Investment Advisors Act for allegedly deceiving prospective clients. In recent years, such SEC enforcement actions increasingly been brought through such administrative proceedings rather through court actions. The ALJ assigned to the case issued a decision concluding that Lucia had violated the Investment Advisors Act and imposed sanctions, including civil penalties of $300,000 and a lifetime ban from the investment industry. Lucia argued that the proceedings were invalid because the ALJ had not been properly appointed under the Appointments Clause and therefore unconstitutionally adjudicated the case. While both the SEC and the U.S. Court of Appeals in Washington, D.C. rejected Lucia’s argument, the Supreme Court agreed with Lucia and reversed in a 7-2 ruling.

The Court’s ruling viewed SEC ALJs as analogous to special trial judges (STJs) of the United States Tax Court, who in the 1991 Supreme Court case Freytag v. Commissioner were held to be “Officers” subject to the requirements of the “Appointments Clause.” The Court noted that like the Tax Court’s STJs, the SEC’s ALJs occupy a “continuing position established by law,” have “significant authority” under federal statutes and exercise the same “significant discretion” in carrying out similar “important functions.” While appointment by the full SEC would satisfy the constitutional requirement for an “Officer” to be appointed by the head of a department, the ALJ in Lucia was selected only by SEC staff members. Accordingly, his appointment was held unconstitutional. Two dissenting judges argued that the full SEC’s ability to review ALJ rulings before they became final suggested that the ALJs did not rise to the level of constitutional “Officers,” but the majority disagreed, noting that such review by the full SEC was not mandatory.

The decision against Lucia was thus reversed and remanded. Any new hearing that against Lucia will now need to be conducted before a properly appointed ALJ. While the full SEC had attempted to contain this potential problem several months ago by formally ratifying its previously-selected ALJs, the Supreme Court held that Lucia was entitled to have any new hearing conducted by a different ALJ who had not been part of the prior unconstitutional proceeding (although one dissenting judge questioned whether that was truly necessary to properly protect Lucia and satisfy constitutional requirements).

Implications

Beyond the specific case of Lucia, the practical effect of the Court’s decision on SEC administrative enforcement proceedings is likely to be limited, for several reasons:

Now that the full SEC has ratified the appointments of the SEC’s existing ALJs, and presumably will proceed similarly with all other ALJs going forward, the decision is not likely to have any effect on new cases filed in the future.
The Court specifically noted that Lucia had made a “timely” challenge to the validity of the ALJ’s appointment in his case, and that a prior Supreme Court ruling had established that the constitutional validity of the appointment of an officer who hears a case can be challenged by “one who makes a timely challenge.” Thus, even in cases which are not yet final, unless the party raised this objection in a timely manner and then properly preserved it for judicial review, the party is unlikely to be able to obtain relief from the ALJ’s ruling.
Similarly, the decision likewise is unlikely to have any impact on decisions that have become final and are no longer eligible for judicial review.
The SEC’s order ratifying the prior appointments of its ALJs also directed the ALJs, upon being formally appointed, to reconsider any open matters they had. However, given the Court’s holding that the remedy for a defective appointment should be a fresh hearing from an ALJ with no prior involvement in the case during any period when the ALJ was not properly appointed, it is unclear if SEC ALJs will now be able to ratify any decisions they made in cases prior to the ratification of their own appointments, or whether the proceedings now must go back to square one with a completely new properly appointed ALJ.