OSC Panel Approves Settlement Agreement for Insider Tipping Without Profit Disgorgement or Administrative Penalty

The Ontario Securities Commission’s recent decision in Re Hutchinson confirmed the important role of cooperation with Commission Staff in reducing sanctions for breaches of Ontario’s securities law.

Background

Donna Hutchinson worked as a legal assistant at a large Toronto law firm, assisting with merger and acquisition transactions. Through the course of her work, Ms. Hutchinson routinely gained access to non-public, confidential information regarding certain transactions. Ms. Hutchinson was alleged to have knowingly provided non-public information about six transactions to Cameron Cornish, another respondent in the proceeding, in violation of section 76(2) of the Ontario Securities Act, which prohibits insider tipping.

A Panel of the Ontario Securities Commission (the Panel) accepted a settlement agreement (the Agreement) reached between Donna Hutchinson and the Commission Staff which provided for a number of sanctions but notably excluded disgorgement of profits or administrative penalties.  Neither Mr. Cornish nor any of the other respondents were party to the Agreement.

Analysis

The Panel noted that Ms. Hutchinson’s breaches of Ontario securities law were serious and could contribute to a lack of confidence in and cynicism towards the fairness of public markets. Although Ms. Hutchinson did not herself trade on the information, her tipping actions were sufficient to undermine public confidence in capital markets.

However, in accepting the Agreement, the Panel identified a number of mitigating factors:

  • Ms. Hutchinson’s acknowledgement of her involvement in the matter saved the Commission from having to expend further resources to establish her liability. The Panel also noted that there was some evidence of remorse on Ms. Hutchinson’s part;
  • Ms. Hutchinson’s employment was terminated, leaving her with extremely limited future career prospects in the legal industry and limited means to pay monetary sanctions;
  • In contrast to the larger profits made by other respondents in the proceeding, Ms. Hutchinson received relatively small profits as a result of her misconduct;
  • Ms. Hutchinson had no prior record of breaching Ontario securities law;
  • Ms. Hutchinson was not and had never been a registrant; and
  • Ms. Hutchinson had been manipulated by an experienced trader.  Based on these mitigating factors, the Panel held that the reduced sanctions proposed under the Agreement aligned with the policy objectives of the Revised Credit for Cooperation Program to promote self-policing, self-reporting, and self-correction by market participants of potential breaches or other conduct contrary to the public interest.
  • The sanctions against Ms. Hutchinson included a reprimand, mandatory resignation from any directorship or officer positions held by her, and time-limited prohibitions on trading, acquisition of securities, registration under the Act, or acting as an officer or director of any issuer, registrant, or investment fund manager.
  • In addition, the Panel emphasized Ms. Hutchinson’s cooperation with Staff, identifying it as a significant mitigating factor.  In March 2014, the Commission published Staff Notice 15-702, “Revised Credit for Cooperation Program” to encourage market participants to cooperate with Commission Staff in exchange for “Credit” in the form of narrower allegations, limited enforcement, reduced sanctions, and/or settlement. Ms. Hutchinson agreed to cooperate with Staff in its investigation of the other respondents and to testify against them in any future proceedings. Given that insider tipping cases tend to be difficult to prove and usually rely on circumstantial evidence, the Panel noted that Ms. Hutchinson’s direct evidence in the matter would be valuable in the proceedings against the other respondents.

Trends

Re Hutchinson is note-worthy because the sanctions against Ms. Hutchinson excluded disgorgement of profits and administrative penalties, which usually form part of the sanctions for insider tipping.  This decision stands in contrast to Cheng, Benedict et al, 2017 ONSEC 14, another insider tipping decision that imposed sanctions including disgorgement of profits and an administrative penalty in the amount of $5,500.  In differentiating between the conduct of Ms. Hutchinson and Mr. Rothstein, it appears the Panel placed significant weight on Ms. Hutchinson’s cooperation and her testimony against the other respondents.  While the Panel did suggest that its findings would be limited to the circumstances of this decision, it may open the door to future arguments that deterrence may be served, even with reduced sanctions.

 

The author would like to thank Kassandra Shortt, student-at-law, for her contribution to this article.

OSC Continues Mediation Program on a Permanent Basis

On April 9, 2018, the Ontario Securities Commission (OSC) announced that its Mediation Program, which began as a pilot program in May 2015, will be continuing on a permanent basis.

The Mediation Program provides respondents represented by counsel, as well as enforcement staff, with the option to seek resolution through an independent third party mediator. Mediations will only occur with the consent of Staff and participating respondents, who must be represented by counsel. The ultimate aim of the program is to resolve outstanding enforcement matters in an efficient and cost-effective way. With respect to costs, each party is to pay an equal portion of the total costs of the mediation.

Jeff Kehoe, Director of Enforcement at the OSC, delivered the following statement expressing optimism about eh continuing role of the mediation program:  “Our Mediation Program has proven to be successful in fostering fast and fair resolutions in appropriate cases. We’re pleased to permanently add this valuable resource to our growing enforcement toolkit.”

While a full discussion on the procedure under the mediation program may be accessed through the OSC’s website, some key considerations are set out below:

  • Mediators can assist with multiple action items, such as facilitating the negotiation of settlement terms, determining an agreed statement of facts, and resolving other enforcement issues.
  • Mediators are mutually selected from a list of candidates produced by the OSC. Mediators serve on the Program’s roster for a three-year term.
  • Mediation takes place according to standard terms of a mediation agreement.
  • Each party is required to provide the mediator with a briefing document.
  • Both the parties and the mediator are free to withdraw from and terminate the mediation at any time.

The OSC encourages the use of mediation in order to facilitate the expedient resolution of outstanding enforcement-related issues. However, the OSC is also clear that mediation will not be permitted to negatively impact or delay any investigation or proceeding, and should not be used to delay any parties’ disclosure or other pre-hearing obligations or the hearing of the matter.

The author would like to thank Justine Smith, articling student, for her contribution to this article.

Yahoo Settles Cyber Security Class Action Lawsuit

On March 5, 2018, Yahoo! Inc. (Yahoo) announced that it had accepted a proposed settlement in In re Yahoo! Inc. Securities Litigation – a U.S. class action lawsuit launched in the United States District Court for the Northern District of California. The settlement has yet to be approved by the court.

The Yahoo class action was filed in California in January 2017 in response to cyber security breaches experienced by Yahoo.  The first, occurring in 2013, involved the theft of names, email addresses, telephone numbers, dates of birth, hashed passwords and security questions from more than 1 billion Yahoo user accounts.  The second, occurring in late 2014, involved the theft, allegedly by state-sponsored hackers, of similar data from more than 500 million user accounts.

Yahoo disclosed both cyber security breaches in late 2016. Upon these disclosures, Yahoo’s share price dropped. Subsequently, several shareholders launched class action lawsuits, which were eventually consolidated into one proceeding.

The Plaintiffs alleged that, between 2013 and 2016, Yahoo had made materially false and/or misleading statements in its quarterly reports to the Securities and Exchange Commission (SEC). Specifically, the Plaintiffs alleged that Yahoo neglected to disclose that:

  • it had failed to encrypt its users’ personal information and/or failed to encrypt its users’ personal data with an up-to-date and secure encryption scheme;
  • sensitive personal account information from more than 1 billion users was vulnerable to theft; and
  • a data breach resulting in the theft of personal user data would foreseeably cause a significant drop in user engagement with Yahoo’s websites and services.

After extensive mediation, the parties agreed to the settlement announced on March 5, 2018.  Under the terms of the agreement, Yahoo will settle the claims for $80 million dollars paid to shareholders, but will not admit to violating securities law or misleading investors.

However, one of the named Plaintiffs did not agree to the settlement terms. Yahoo has moved to dismiss the claims being pursued by this non-settling plaintiff.

With increased inter-connectivity, political tensions, and criminal sophistication, entities that safeguard large amounts of customer data, such as financial institutions and technology companies, frequently face more attacks of an increasingly sophisticated nature.  Given this and associated risks arising from a data breach,  regular reviews of cyber security practices and the adoption of current industry best practices may help to mitigate this risk.

For more on cyber security within the securities context, please refer to our previous postings on the matter:

Only 61% of issuers address cyber security in their risk factor disclosure. Is your company one of them?

More Cyber Security Lessons from the Canadian Securities Administrators

 

The author would like to thank Samuel Keen, Student-At-Law, for his contribution to this article.

Not All’s Fair in Disgorgement and Fraud

On April 18, 2018, the Ontario Superior Court of Justice released its reasons in Ontario Securities Commission v. Bluestream Capital Corporation which is a useful illustration of the Ontario Securities Commission (OSC)’s power to garnish funds held by victims of investment fraud that are payable as debts to the perpetrator of the fraud.

The Background

Peter Balazs solicited a number of people to invest in his companies.  However, neither Mr. Balazs nor any of the companies were registered with the OSC, as required by the Ontario Securities Act, and the majority of the “invested” funds were used by Mr. Balazs for personal expenditures.  The OSC made a number of orders against Mr. Balazs and his companies, including that they jointly and severally disgorge over $1,500,000 to the OSC which was to be allocated for the benefit of third parties.

One of the victims of Mr. Balazs’s investment scheme was an electrician living in Vaughan named Fred Camerlengo.  Mr. Camerlengo and his sons invested significant sums of money in one of Mr. Balazs’s companies, Bluestream International Investments (Bluestream).  Mr. Camerlengo was required to participate in a compelled interview with OSC investigators pursuant to s. 13 of the Ontario Securities Act where the OSC learned the details of a $200,000 loan made by Bluestream to Camerlengo Holdings Inc., a company controlled by Mr. Camerlengo.  In his interview, Camerlengo said that the loan had nothing to do with his investments with Bluestream, but was a favour to him.  He had not repaid the loan because Mr. Balazs had disappeared.

Upon learning of the loan, the OSC issued a Notice of Garnishment to Camerlengo Holdings requiring it to pay its debts to Bluestream to the Sheriff.  Mr. Camerlengo argued that him and his family were owed $622,008.01 by Bluestream and that this amount ought to be set-off against the debt owed by Camerlengo Holdings.  The OSC brought a motion seeking to enforce its garnishment.

The Decision

Justice Schreck granted the OSC’s motion for a declaration that Camerlengo Holdings owed a debt of $200,000 to Bluestream and an order that Camerlengo Holdings pay that debt to the Sheriff.

The chief issue was whether Mr. Camerlengo and his company were entitled to set-off.  There was no dispute that Mr. Camerlengo was not entitled to contractual set-off, leaving only claims for legal and equitable set-off.

In order to claim legal set-off, Schreck J. held that the law is clear that “[f]or a valid claim of legal set-off there must be mutuality which requires that the debts be between the same parties and that the debts be in the same right”.  In this case, Schreck J.  found that the debts were not between the same parties.  The loan was from Bluestream to Camerlengo Holdings.  None of the investments funds came from Camerlengo Holdings.

Turning to Mr. Camerlengo’s claim for equitable set-off, Schreck J. held that it could not be said that the equitable ground goes to “the very root of the plaintiff’s claim” or that the cross-claim is “clearly connected with the demand of the plaintiff” as required for a claim of equitable set-off.  To the contrary, while he attempted to reverse this position on the motion, Mr. Camerlengo told the OSC investigators under oath that the loan to Camerlengo Holdings had “nothing to do with the investment”.  Further, the monies said to be owed by Bluestream are to Mr. Camerlengo, his sons, and two numbered companies, while the loan from Bluestream was to Camerlengo Holdings.  Justice Schreck held that the absence of mutuality was further evidence that the claims were not “clearly connected”.

Finally, Schreck J. held that permitting set-off would be unfair to other investors who suffered losses due to their investments with Mr. Balazs.  If Camerlengo Holdings was permitted to set-off its losses against the loan owed to Bluestream, this would have the practical effect of giving the Camerlengo family priority over other investors with equally valid claims for compensation.  Justice Schreck held that the Camerlengo family should not be in a better position than other investors simply because they had the benefit of a loan from Bluestream while others did not.

The Takeaway

While the decision in Bluestream is a fairly straightforward application of the principles of set-off, Justice Schreck’s holding that discretionary remedies like equitable set-off should not be exercised to protect defrauded investors in a manner that puts them in a better position than other defrauded investors – even if that means defrauded investors have to repay loans arranged with the fraudster, is of interest.  If justice is fairness, it may not always feel that way to everybody.

U.S. Securities and Exchange Commission Proposes “Best Interest” Standard for Retail Broker Dealers

On April 18, 2018, the U.S. Securities and Exchange Commission (“SEC”) announced proposed rules that would require broker-dealers to act in the best interests of their retail clients when recommending investments. The SEC opened the proposed rules to a 90 day comment period.

This announcement follows a March 15, 2018 decision by the U.S. Fifth Circuit Court of Appeals that vacated the so-called “Fiduciary Rule” promulgated by the U.S. Department of Labor (“DOL”) covering retirement fund investment advice. The Fiduciary Rule, in actuality a package of seven rules that broadly reinterpret the term “investment advice fiduciary” and related exemptions codified in the Employee Retirement Income Securities Act of 1974, 29 U.S.C. § 1001, et seq. (“ERISA”), and the Internal Revenue Code, 26 U.S.C. § 4975, would have expanded the definition of fiduciary thereunder to the extent a person is compensated in connection with a “recommendation as to the advisability of” buying, selling, or managing “investment property.”  29 C.F.R. § 2510.3-21(a)(21) (2017).  The Rule imposed on all those within the expanded definition of fiduciary an obligation to act in the best interest of their clients and avoid conflicts of interest.

Following the adoption of the Fiduciary Rule by the DOL, the SEC began its own consideration of broadening the scope of fiduciary obligations under SEC rules. While the SEC’s newly proposed rules are more lenient than the Fiduciary Rule, their advancement nevertheless will have a major impact on the investment community.

The Fifth Circuit Decision

On March 15, 2018, the Fifth Circuit Court of Appeals vacated the DOL’s Fiduciary Rule in its entirety. Chamber of Commerce of the United States of America, et al. v. United States Department of Labor, No 17–10238 (5th Cir. March 15, 2018).  That decision was grounded on two major findings.  First, the court ruled that the DOL did not have the authority to adopt a definition of “fiduciary” that is inconsistent with the statutory definition in ERISA.  Second, the court found that the DOL violated the Administrative Procedures Act by acting in an arbitrary and capricious manner in adopting an unreasonable definition.

An earlier decision by the Tenth Circuit Court of Appeals affirmed a lower court decision upholding the Fiduciary Rule as related to fixed indexed annuity sales. The DOL may pursue further appeals from the Fifth Circuit decision, either by petitioning the Fifth Circuit for rehearing en banc or by petitioning the U.S. Supreme Court for permission to appeal.

The SEC Proposed Rule

On April 18, 2018, the SEC voted in favor of proposing a package of two new rules and interpretations affecting both broker-dealers and investment advisers. The package, known as “Regulation Best Interest,” has several components.  First, broker-dealers would be required to act in the best interest of their retail customers when making recommendations of any securities transaction or investment strategy involving securities.  Second, Regulation Best Interest includes an interpretation that reaffirms and clarifies the SEC’s views of the fiduciary duty that investment advisers already owe to their clients.  Third, it would require that investment professionals provide their retail customers a short form disclosure document, known as a customer or client relationship summary, setting forth a simple and easy to understand summary of the nature of their relationship with their investment professionals.  Lastly, Regulation Best Interest would restrict certain broker-dealers and financial professionals from using the terms “advisor” or “adviser” as part of their name or title with retail investors, unless they are actually registered as one.

The proposal was adopted by a four to one vote of SEC Commissioners. One SEC Commissioner, Kara Stein, dissented saying that the proposed standards fall short of the real reform that is necessary to curtail conflicts that impact individual investors.  She additionally complained that nowhere in the proposed changes was a definition established of what constitutes an investor’s best interest.  And while Commissioner Robert Jackson voted in favor of opening the package of proposals for public comment, he said he would not ultimately vote to adopt them if they remained in their current form.

Conclusion

The SEC’s Regulation Best Interest proposal has a long way to go to get across the finish line of adoption. The 90 day comment period undoubtedly will be robust.  Uncertainty exists over whether the proposal will ever be adopted.  But if it is, it seems likely it will be in a substantially different form than that currently proposed.

 

The OSC’s Jurisdiction on an Appeal from a Decision of a Director: Re Dhillon (2018) ONSEC 14

In Re Dhillon, the Director of Compliance and Registrant Regulation (“Director”) of the Ontario Securities Commission (“OSC” or “Commission”) refused Dhillon’s application for registration under s. 27 of the Ontario Securities Act (the “Act”) on the ground that Dhillon lacked both the proficiency and integrity for registration, and that his registration would otherwise be objectionable (the “Director’s Decision”).  Thereafter, Dhillon applied to the OSC for a hearing and review of the Director’s Decision under s. 8  of the Act. Between the time of the Director’s Decision and the time of the hearing and review by the OSC, Dhillon’s sponsor withdrew its sponsorship of his registration.

The OSC’s decision to deny Dhillon’s application considers the impact of the sponsor’s withdrawal of its sponsorship, and sheds light on the test that an applicant must satisfy on an appeal and review of a decision of the Director to deny registration as well as the scope of the Commission’s jurisdiction under s. 8.

Preliminary Issue: Commission’s Jurisdiction under s. 8 of the Act Where the Applicant’s Sponsor Has Withdrawn

Section 25 of the Act requires that an individual seeking to engage in the business of trading in securities be registered as a dealing representative of a registered dealer. As the registered dealer that had originally sponsored Dhillon’s application for registration had withdrawn its sponsorship following the Director’s Decision, the OSC was required to determine, as a preliminary matter, its jurisdiction to grant the relief requested.

The OSC concluded that Dhillon remained a person “directly affected” by the Director’s Decision within the meaning of s. 8, and as such had standing to seek a hearing and review of the denial of his application for registration. Further, the Commission’s authority to make “such decision as it considers proper” under s. 8 of the Act must surely include the authority to set aside the Director’s Decision without approving the registration. Accordingly, while the Commission did not have jurisdiction to approve Dhillon’s application for registration given his unsponsored status, the Commission retained jurisdiction under s. 8(3) to set aside the Director’s Decision to refuse it.  The hearing proceeded on that basis.

Presumably the practical effect of this approach is that if Dhillon had succeeded in persuading the OSC to set aside the Director’s Decision, and had he been able to find a dealer to sponsor him, the Director would have been required to grant a further request by him for registration as a dealing representative of that registered dealer, absent additional grounds for denying him status as a registrant.

Burden of Proof on Staff Under s. 27 of the Act

The Commission confirmed that a hearing and review to the OSC of a decision of the Director is a hearing de novo, involving a fresh consideration of the issue.  No deference is owed to the Director’s Decision, and Staff bear the burden of proof or persuasion of establishing that the applicant lacks the proficiency or integrity to be registered, or that his registration would otherwise be objectionable.

Staff argued that the burden of proof on Staff was lower than the balance of probabilities standard, based upon the wording of s. 27(1) of the Act that provides that the Director may refuse registration where it appears to the Director that the applicant is not suitable or the registration would otherwise be objectionable. The OSC noted that in F.H. v. McDougall, 2008 SCC 53, the Supreme Court of Canada recognized that it is open to the legislature to change the civil standard of proof on a balance of probabilities through statutory enactment using clear and unambiguous language.  However, the language of s. 27 fell short of the type of clear and unambiguous language required to displace the conventional standard of proof. Further, given the impact of a denial or loss of registration on an individual, requiring Staff to establish the preconditions to a denial of registration on a balance of probabilities was not onerous. Ultimately, however, the OSC declined to decide the issue as it did not have a detailed analysis of the phrase, which also appears in other sections of the Act including s. 61 concerning the issuance of a receipt for a prospectus and s. 70 concerning the issuance of an order to cease trade a prospectus distribution. Further, even using the conventional standard of proof on a balance of probabilities, Dhillon was unsuitable for registration.

Decision on the Merits of the Hearing and Review

The Commission confirmed its obligation to act in the public interest when reviewing the Director’s Decision, and to bear in mind certain fundamental principles such as the requirement for the maintenance of high standards of fitness and business conduct to ensure honest and responsible conduct by market participants enshrined in s. 2.1(2)(iii) of the Act.

In determining whether Dhillon was suitable for registration, the Director and the Commission were required to consider whether he satisfied the requirements prescribed in the regulations relating to proficiency, solvency and integrity.  The solvency requirement was not an issue in this case.

In this case, the OSC was satisfied on a balance of probabilities that Dhillon was not suitable for registration, based upon a lack of proficiency and prior conduct demonstrating a lack of integrity. On that basis it confirmed the Director’s Decision.

The issue with respect to Dhillon’s proficiency was whether, notwithstanding that Dhillon’s application for registration was dated more than three years after he was last registered in 2012, he could still meet the proficiency requirements in National Instrument 31-103 – Registration Requirements. NI 31-103 requires that a mutual fund dealing representative have passed at least one of the Canadian Investment Funds Course Examination, the Canadian Securities Course Examination or the Investment Funds in Canada Course Examination. Although Dhillon had passed one of those courses in 1990, he was deemed by NI 31-103 not to have passed such an examination as he had not passed it within a three year period prior to his application for registration. Dhillon’s argument to the Director that he satisfied an exemption for individuals who had gained twelve months of relevant securities industry experience during the three year period prior to his application failed. His submission that, notwithstanding that he had not been employed in the industry during that three year period, he had taken several industry related seminars and training courses which should qualify as securities industry experience was rejected by the Director. The OSC agreed with the Director that Dhillon’s attendance at seminars did not amount to 12 months of relevant securities industry experience.

Dhillon also failed to establish that he satisfied the integrity requirements. Dhillon’s prior registration history revealed that he had been the subject of client complaints and compliance deficiencies while working at other dealers, and was found by the MFDA to have breached MFDA rules and to have deliberately misconducted himself. The Commission determined that he had  repeatedly used pre-signed forms, recommended unsuitable leverage strategies to clients and engaged in off-book trading activities. He had mistreated compliance staff at multiple firms, and his explanations for his conduct displayed a lack of integrity. The manner in which he responded to regulators when his non-compliance was raised with him also demonstrated his lack of integrity. In sum, the evidence was “truly overwhelming that Mr. Dhillon is effectively ungovernable and completely lacking in personal integrity”.

Takeaways

Whether the use of the words “appears to the Director” in sections 27, 61 and 70 of the Act should be interpreted as importing a standard of proof lower than on a balance of probabilities is unclear and remains to be definitively determined.

Civil Forfeiture in the Securities Context

Administrative fines are are regularly imposed by the Ontario Securities Commission (the OSC) in enforcement proceedings as sanctions for violations of Ontario securities law. Less well-known, but equally important, is the ability of the OSC to require wrongdoers to forfeit to the Crown the ill-gotten proceeds of unlawful activities. This post outlines the process by which proceeds derived from securities law violations may be forfeited to the Crown and ultimately returned to victims of securities law breaches.

The OSC cannot on its own compel a civil forfeiture to the Crown. That power belongs to the Attorney General of Ontario (the AG), which is statutorily authorized under the Civil Remedies Act, 2001 (the Act) to commence proceedings before the Ontario Superior Court for an order requiring a wrongdoer to forfeit property in Ontario to the Crown in right of Ontario where the court finds that the property is the “proceeds of unlawful activity”. “Unlawful activity” is broadly defined as “an act or omission that is an offence under an Act of Canada, Ontario or another province or territory of Canada” and clearly includes violations of securities law in Ontario.

The Act explicitly states that all findings of fact in proceedings under the Act are to be made on a balance of probabilities. Accordingly, the AG must only prove that it is more likely than not that certain targeted property is “proceeds of unlawful activity.” Importantly, the Act contains provisions protecting property held by “legitimate owners”.

Following a court forfeiture order, the forfeited money or property is held by the Crown in a “special purpose account”, and the Crown is required to release a notice which conforms to prescriptions found in regulations made in O. Reg. 498/06, Payments Out Of Special Purpose Account. Among other things, the notice must:

  • identify the proceeding under the Act as a result of which the money was deposited into the special purpose account;
  • state that any direct private victim who suffered pecuniary or non-pecuniary losses as a result of the unlawful activity in relation to which the proceeding was commenced is entitled to make a claim for compensation;
  • describe the steps to be taken to make a claim;
  • name the final day for filing, which shall not be earlier than three months after the first publication of the notice; and
  • state that a claim that does not comply with the Regulation will be denied.

In Ontario, claims are made to the Civil Remedies for Illicit Activities Office (CRIA), in the Ministry of the Attorney General. An example of a statutory notice can be reviewed here.

While the ability to initiate court proceedings for a forfeiture order belongs solely to the AG by statute, this does not prevent the OSC from pursuing forfeiture remedies under the Act. The OSC has entered into a Memorandum of Understanding with the AG for the exchange of information and administration of the Civil Remedies Act (the MOU). The MOU allows the OSC to pursue civil forfeiture remedies where is it advantageous to do so. Using this mechanism, the OSC can supply vital information to the AG with a view to assisting it in discharging its burden of proof under the Act. On October 26, 2015, Monica Kowal, then the Vice-Chair of the Ontario Securities Commission, described the relationship in a keynote address at an Investor Recovery Conference:

In 2011, the OSC added a fourth mechanism through an information sharing memorandum of understanding (MOU) with the Civil Remedies for Illicit Activities Office (CRIA).

Under Ontario’s civil forfeiture law, CRIA can, with a court order, take possession of property that is determined to be a proceed of unlawful activity, search for people who have suffered losses as a result of that activity and use the property to compensate them.

Our partnership with CRIA allows us to leverage their capacity to advertise for harmed investors, process and adjudicate claims for lost money, and make large scale distributions – all under the auspices of the Office of the Attorney General of Ontario. (emphasis added)

If the AG can successfully prove to the court that, on a balance of probabilities, the defendant individuals or corporations hold property derived as proceeds of securities law violations, such proceeds may become subject to a forfeiture order by the Ontario Superior Court, and recoverable by victims pursuant to the claims procedure outlined above.

The author would like to thank Fahad Diwan, articling student, for his contribution to this article.

 

Bustle without the Hustle not an “Act in Furtherance of a Trade” under the Ontario Securities Act

A recent decision by the Ontario Court of Justice provides lessons about the scope of the Ontario Securities Commission (OSC)’s powers to regulate acts “in furtherance of a trade”.  The OSC’s case was against two individuals who helped create a website for a new company.  The website included an investors relations page which stated that the company would be listing its common shares and provided an email address for all investor or shareholder correspondence.

Staff of the OSC (Staff) charged Mark Lowman and Dave Jarett with trading in securities without the required registration, issuing securities without having filed a prospectus, and representing that securities would be listed on an exchange with the intention of affecting a trade, contrary to s. 25(1), s. 53(1), s. 38(3), and s. 122(1)(c) of the Ontario Securities Act (OSA).

In his Reasons for Judgment, Justice West dismissed all charges.

Background

The story begins with Duncan Cleworth and his aspirations to expand his waste-to-energy business.  He was a part-owner of a company involved in such a project in Madagascar and was looking to expand into Asia.  Cleworth told the manager of a local restaurant, Mansoor Igbal, of his plans.  Iqbal then introduced Cleworth to the Defendant, Mark Lowman, who owned a company called Saxon Securities.

Lowman agreed to help get Cleworth with his enterprise.  The two entered into a joint venture agreement to incorporate and develop a company and to obtain a public listing of its shares.  The second Defendant, Dave Jarett, was an employee of Saxon Securities.

The four men then set out to design a website for the company and all four appeared to have contributed to its content.  The website advised the company was seeking a listing and provided an email address for all investor or shareholder correspondence.  The company was eventually incorporated in the British Virgin Islands approximately six weeks after the website first went live.

Shortly after the company was incorporated, cold-calls were made to investors in Europe and South Africa by sales representatives situated outside of Canada seeking to sell the company’s soon to be listed shares.  Five of the investors were directed to the company’s website by the sales representatives.  Five eventually purchased shares after they were listed on the GXG Exchange.  None of the sales representatives were identified at trial and there was no direct evidence establishing a connection between the Defendants and the sales representatives.

The Defendants were never registered with the OSC to trade in securities.  No prospectus was ever filed with the OSC by the company or by anyone in respect of the securities of the company during the relevant time period.

Staff’s Position

Staff of the OSC argued that:

1) The Defendants were involved in the actual trades of shares made by the sales representatives;

2) the company’s website was designed and created for the purpose of “exciting the reader” and this alone amounted to an act in furtherance of trading thereby inducing investors to purchase shares contrary to s. 25(1) and 53(1);  and

3) the website stated the company’s common shares would be listed for trading on an exchange and specified a specific time frame for the listing in a manner that indicated an intent to effect trades in the company’s common shares contrary to s. 38(3).

The decision

Justice West dismissed all of the charges against both Defendants.  He found that the evidence was simply insufficient to draw the necessary inferences to give rise to conduct contrary to the OSA.

Staff argued that the Defendants had committed an offence under s. 53(1) of the OSA, which provides that:

No person or company shall trade in a security on his, her or its own account or on behalf of any other person or company if the trade would be a distribution of the security, unless a preliminary prospectus and a prospectus have been filed and receipts have been issued for them by the Director.

The OSA, s. 1(1) defines “trade” or “trading” to include:

(a) any sale or disposition of a security for valuable consideration, whether the terms of payment be on margin, instalment or otherwise, but does not include a purchase of a security or, except as provided in clause (d), a transfer, pledge or encumbrance of securities for the purpose of giving collateral for a debt made in good faith,

. . .

(e) any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any of the foregoing;

Justice West first reviewed two prior OSC decisions where involvement in the creation of a website was found to be an act in furtherance of a trade:

  • In First Federal Capital (Canada) Corp (Re), the OSC held an act in furtherance of trading does not require an actual or completed trade, “anticipated” trades that arise where there is a direct proximate connection between the offering and any trade that was anticipated as a result of those solicitations may be caught by the OSA. However, in that case the website at issue actually offered a “trading program” and the principal of the company engaged in direct solicitation and negotiations with investors which continued over an extended period of time.
  • In Xi Biofuels Inc (Re), the OSC found a website was created to “excite the reader” and solicit potential investors by numerous misleading statements. However, the OSC in that case also pointed to multiple other acts in furtherance of trades apart from the creation of a website that were found to be created for the purpose of “exciting the reader”, including signing treasury directions, signing share certificates, picking up share certificates, opening bank accounts, and depositing investor funds into them.

Staff conceded that the company’s website did not directly offer to sell shares to the public and there was no direct evidence of any direct or indirect contact or connection between the Defendants and the foreign investors, but argued an inference could be drawn that the Defendants were aware of and involved in the ongoing marketing of the shares of the company.

Justice West disagreed.  He found that there were alternative explanations which cut against the inferences proposed by Staff.  For example, the Defendants’ testified that the purpose of creating a website was to have governments review the website as potential clients.  Of some relevance is that none of the investors ever contacted the email address listed on the website’s investors page.

There was also no evidence that any of the promotional materials sent by sales representatives to investors were found in the possession of the Defendants.  A reasonable inference could be drawn that the sales representatives “saw an opportunity and created a scenario” which allowed the sales representatives to make cold-calls and representations which were designed to induce investors to purchase the company’s shares without any knowledge or involvement of the Defendants.

Justice West’s reasons are best encapsulated at paragraph 125 of his decision, which reads:

“All that existed, on the evidence presented, was that Jarrett was developing a website for a company that ultimately it was hoped would be listed on an exchange, a website where the content was in a state of revision and where the company’s name was changed at least four (4) times in the space of two months. No shares existed at the time the purported sales representatives solicited the foreign investors. I find there was not a sufficient proximate connection to an anticipated trade to constitute an act in furtherance of a trade.”

Due to the lack of direct or compelling circumstantial evidence of involvement by the Defendants in acts of trading in securities or any other acts in furtherance of trading in securities Staff were unable to make out the charges under s. 53(1), s. 25(1), and s. 38(3).

Commentary

The definition of a “trade” under the OSA is extremely broad.  Justice West’s decision in R v Lowman is a rare example where a court has refused to recognize that conduct fell within the scope of that definition.  The critical aspects of his decision are as follows:

  • Merely “exciting the reader” with a website is not enough for an act in furtherance of a trade. The OSC must meet the standard established in cases like Xi Biofuels Inc. and First Federal Capital (Canada) Corp (Re), where websites directly solicited investors to purchase shares and provided instructions on where and how those shares could be purchased and the individuals charged were directly soliciting and pointing investors to their company’s website.
  • Justice West’s reasons also suggest that there must be a causal connection between the act supposedly in furtherance of a trade, and the trade itself. It is not enough that the Defendants created a website informing investors of a potential opportunity to purchase securities which coincided with certain investors purchasing securities.  The evidence showed that the investors decision to purchase securities was primarily or exclusively due to third party sales representatives rather than the Defendants’ website.
  • Finally, Justice West’s reasons demonstrate the importance of direct evidence in establishing the strict liability offences under the OSA. Circumstantial evidence that Saxon Securities received a wire transfer around the time that one investor provided funds to a sales representative to purchase securities was not sufficient to draw an inference of wrongdoing.  The Defendants were able to provide equally plausible alternative explanations.

Aurora/CanniMed: Canadian securities regulators provide guidance on takeover bids in Canada – Expect to see more hard lock-ups and fewer tactical poison pills

Key takeaways:

  • expect to see an increased use of hard lock-ups (that is, lock-ups in which a shareholder agrees to tender shares even if a superior bid comes along), which will provide bidders with reduced risk during the new 105-day bid period
  • well-structured hard lock-ups do not necessarily result in target shareholders being joint actors with the bidder
  • tactical shareholder rights plans or poison pills will likely have limited uses going forward
  • ultimately, regulators expect the new takeover bid regime to emphasize target shareholder choice
  • regulators will insist on strict compliance with the new takeover bid regime

Quick Background

 

  • Aurora Cannabis Inc. launches unsolicited bid for CanniMed Therapeutics Inc. and signs hard lock-up agreements with four target shareholders representing approximately 38% of CanniMed’s shares
  • three days later, CanniMed announces it has entered into a plan of arrangement with Newstrike Resources Ltd.
  • CanniMed announces that its board has adopted a tactical poison pill in response to Aurora’s bid

Key lessons

The Ontario and Saskatchewan securities regulators (the Commissions) have released their reasons in connection with the unsolicited bid of Aurora for CanniMed (the Reasons).

Lesson 1: Lock-ups are good for bidders and do not necessarily make shareholders joint actors

 

Due to the 105-day deposit period provided for in the 2016 take-over bid regime, bidders are exposed to greater risk. The response of bidders has been to attempt to secure hard lock-ups from target shareholders as early as possible. We expect this trend to continue following the Aurora/CanniMed decision. Hard, well-structured lock-up agreements will be a critical tool for bidders.

In the Reasons, the Commissions noted that while lock-up agreements or the context in which they are used can raise public interest issues, lock-ups are a “lawful and established feature” of the M&A process and are of increased importance since the adoption of the new regime. By upholding relatively restrictive lock-ups, the Reasons indicate that generally the Commissions will accept target shareholders’ ability to execute lock-ups in furtherance of their own interests.

The Reasons held that entering into hard lock-up agreements did not automatically result in Aurora and the locked-up shareholders acting jointly or in concert. The Commissions noted that Canadian securities legislation provides that an agreement or understanding to tender securities to a bid does not, in and of itself, lead to a determination of acting jointly or in concert. The legislation does not distinguish between hard and soft lock-ups.

Notably, the provision in the agreements requiring the locked-up shareholders to vote against the Newstrike transaction and for the Aurora transaction if it were reformulated into a corporate transaction (such as an arrangement) did not make Aurora and the locked-up shareholders joint actors – the Commissions found that such voting provisions were consistent with the otherwise permissible commitments to tender to a bid. In the Commissions’ view, the lock-ups were consistent with the shareholders seeking enhanced liquidity and a higher price.

Lesson 2: Despite creative defensive tactics, regulators expect shareholders to have the ultimate say

The Reasons emphasize that despite creative defensive tactics targets may employ, the uses of tactical poison pills will likely be limited under the new regime. The Reasons suggest that it will be a rare case where poison pills will be allowed to interfere with established features of the new bid regime—including by preventing creeping 5% acquisitions or hard lock-ups.

In this case, CanniMed’s pill had a number of unusual features, including changing the mandatory extension period to 10 business days rather than the 10 calendar days provided for under the bid regime, and deeming all securities subject to lock-up agreements to be beneficially owned by Aurora.

The Commissions cease traded CanniMed’s pill, as in their view, its principal function was not to give CanniMed’s board extra time for higher bids to emerge, but rather to prohibit further lock-ups being entered into and to support the Newstrike transaction in the face of Aurora’s bid, which was conditional on the Newstrike transaction being abandoned. As such, the pill interfered with legitimate and established elements of the bid regime such as lock-up agreements, which are of increased importance under the new take-over bid regime.

Lesson 3: Regulators will insist on strict compliance with the new regime

The Reasons indicate that given the “careful rebalancing” of the takeover bid regime in 2016, the Commissions will be reluctant to waive prescribed bid requirements, favouring a predictable regime instead.

Aurora argued that the policy rationale for the “alternative transaction” exception to the 105-day bid period applied in this case. As a result, the minimum deposit period for Aurora’s bid should be reduced from 105 to 35 days to coordinate the timing of the Newstrike acquisition and the Aurora bid and allow shareholders to consider both at once.

The Commissions disagreed, and stated that the Newstrike transaction was not an alternative transaction to Aurora’s bid, noting that Aurora itself had made its offer conditional on the Newstrike transaction not being completed. The Commissions noted that Aurora was free to solicit proxies against the Newstrike transaction if it so chose and could also seek to persuade shareholders to wait it out until its bid expired. The Commissions stated that abbreviating the 105-day period was not necessary in the circumstances to facilitate a choice by CanniMed shareholders between both transactions. In addition, in their view, the Newstrike acquisition did not preclude competing bids during the bid deposit period.

The Commissions also found that Aurora could avail itself of the 5% exemption to the prohibition against it purchasing target shares outside of the bid, noting that Aurora did not own any shares and that allowing a purchase of up to 5% would not put Aurora in a blocking position to preclude any superior offers.

Conclusion

 

The Aurora/CanniMed reasons provide the clearest guidance to date on the state of hard lock-ups and defensive tactics under the new regime. Overall, the message is clear: the expectation is that target shareholders should have the ultimate say. We will continue monitoring future developments.

Deferred Prosecution Agreements: Coming to Canada Shortly

The Canadian government, as part of Bill C-74-1 the Budget Implementation Act introduced on March 27, 2018, finally introduced a bill that would make deferred prosecution agreements (DPAs) part of the Criminal Code. This new prosecutorial tool would represent a significant shift in Canada’s approach towards corporate wrongdoing – one that aligns Canada more closely with global trends. The introduction swiftly follows the consultation process which wrapped up in December. DPAs will be available for certain, not-yet-disclosed, offences.

As in other jurisdictions which have recently recommended DPAs, such as in Singapore and Australia, Canada’s remediation agreement framework is expected to encourage corporations to voluntarily disclose wrongdoing, implement remediation measures, and hold corporate entities accountable. In Canada, like the UK and unlike the US, the proposed remediation agreement framework would be subject to judicial approval.

The process at a glance

  • The prosecutor must determine whether there are appropriate conditions for a remediation agreement, including whether there is a reasonable prospect of conviction, the offence did not cause death or serious bodily harm, whether the agreement is in the public interest, and that the Attorney General has consented to the negotiations;
  • The prosecutor then gives a written notice to the organization inviting it to negotiate;
  • The parties then negotiate a remediation agreement, which must include certain elements including a statement of facts that contains an admission of responsibility, disgorgement of any benefit from the wrongdoing, a penalty, and the date by which the agreement terms must be met;
  • Optional elements of the agreement include obligations to establish or enhance compliance measures, reimbursement for the costs of the prosecutor, and the imposition of an independent monitor;
  • Then the prosecutor brings an application for court approval of the remediation agreement, and the court must decide taking factors into account including reparations made, any victim impact statement, whether the agreement is in the public interest, and that the terms of the agreement are fair, reason, and proportionate;
  • The court implements a stay of proceedings shielding the company of further prosecution for the offence;
  • Once approved, the prosecutor must direct the clerk of the court to stay the proceedings with respect to the charges that have been laid against the organization, and any relevant limitation period is tolled during the course of the remediation agreement;
  • Any variation or termination of the remediation agreement is subject to court approval, and a court hearing will be set to consider various defined factors;
  • Courts are then generally expected to order the remediation agreement to be published, but if publication is not appropriate the court must publish the reasons for non-publication; and
  • The agreement can be terminated for breach, or once the agreement is successfully completed, and a court must approve such an application brought by the prosecutor.

A corporate entity entering into a remediation agreement will have to fully cooperate with the prosecution and be as transparent as possible. This means, among other things, that the organization will have to make an admission of responsibility, fully cooperate in any investigation or prosecution into the actions, forfeit any property or benefit derived from the offence, and report on the implementation of the agreement. The draft legislation also contemplates various types of financial obligations, including disgorgement of any property, benefit or advantage, penalties, reparations and restitution to victims, and a 30% victim surcharge except for some Corruption of Foreign Public Officials Act offences.

Of particular note are considerations regarding the interest of the victim(s) of the organization’s crimes. Although this will depend on the nature of the crime, reparations to victims and communities are a stated purpose of the remediation agreements. Moreover, prosecutors will have to inform victims of any negotiations, and courts must consider reparations made to victims when approving a remediation agreement.

Next Steps

The introduction of this bill is an exciting step forward in Canada’s alignment with other jurisdictions, most notably the US which has had DPAs since 1992. The bill will work its way through Parliament and may be amended along the way.

One interesting point to watch in the bill is that the Attorney General, being the Minister of Justice, must give a prosecutor approval to negotiate a remediation agreement. This introduces a political element into what would otherwise be an independent decision of the Public Prosecution Service of Canada to enter into negotiations.

More to come!

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