MFDA Publishes Principles-Based Sanction Guidelines

By Erika Anschuetz on November 14, 2018 Posted in Other developments

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

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

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

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

DOJ provides additional insight on compliance and investigations matters

By Kevin James Harnisch, Keith M. Rosen, Paul Sumilas, Ilana Beth Sinkin and Vijay Rao on November 13, 2018 Posted in Cross border issues, Legislation, rules and policies, Other developments, White collar crime

On October 25, 2018, John Cronan, Principal Deputy Assistant Attorney General of the Criminal Division of the US Department of Justice (DOJ), delivered an important speech that touched on several key issues for legal and compliance counsel trying to balance business realities with regulator expectations, particularly with respect to compliance with the US Foreign Corrupt Practices Act (FCPA).[1] Of particular note, Cronan discussed:

The application of the DOJ’s FCPA Corporate Enforcement Policy;
The DOJ’s expectations as to what constitutes full cooperation in the course of an investigation;
The use of coordinated resolutions; and
The recent update to the DOJ’s policy on implementing monitors as part of an enforcement resolution.

The Corporate Enforcement Policy and voluntary disclosure

As noted in our prior client alert in November 2017, the DOJ announced a significant update to its process for evaluating and rewarding corporate cooperation and self-disclosure in FCPA cases. The DOJ subsequently clarified that the policy applies in the M&A context and expanded the policy to apply in non-FCPA cases as well. An important component of that policy is whether a company voluntarily self-discloses the existence of potential misconduct to the DOJ. For a self-disclosure to be “voluntary,” it must: (1) occur before “an imminent threat of disclosure or government investigation;” (2) be made “within a reasonably prompt time after [the company] becom[es] aware of the offense;” and (3) include all relevant facts known to the company about the alleged misconduct.

In his recent speech, Cronan emphasized that companies “should make their initial disclosures sooner rather than later” and “should not wait until completing a significant internal investigation before coming forward.”

Key takeaways

Although the DOJ encourages self-disclosure and the FCPA Corporate Enforcement Policy attempts to clarify its benefits, the decision to make such a voluntary self-disclosure is complex, particularly for cross-jurisdictional matters. As noted in our prior alert comparing the US and UK regimes, self-reporting is ultimately both a legal and a business decision, with wide-reaching implications that must be evaluated at an early stage, often before all the facts are known.

For a self-disclosure to qualify as “voluntary” under the new policy, a company must go to the DOJ before there is a threat of public disclosure. As a result, a company may fail to qualify for full credit, even if the DOJ or other regulators are unaware of the conduct, if the DOJ determines that information about the misconduct was about to become public through media reporting or other means. While a company may prefer to have all the facts from a robust internal investigation first, Cronan’s speech confirmed that the DOJ will not guarantee “self-disclosure” credit under such circumstances. On this issue, the DOJ retains significant discretion to determine whether the company has been “reasonably prompt” and whether there was an “imminent threat” of disclosure. Both are obviously subjective factors.

Cooperation expectations

In his speech, Cronan provided examples of what a company should do to best position itself to obtain maximum cooperation credit. For example:

When making an initial self-disclosure, in addition to summarizing the facts and the investigative steps being taken, explain who is conducting the investigation (e.g., external counsel, internal employees, other consultants) and who is overseeing the investigation (e.g., audit committee, general counsel);
Describe the steps taken to preserve and collect relevant evidence (including from electronic devices);
Provide a list of interviewees (both completed and planned) and individuals who know about the investigation, including third parties; and
Identify any types of information that the company is unable to share with the DOJ because of privilege, data privacy, blocking statutes, or other reasons.

Cronan also reiterated that cooperation typically requires providing the DOJ with a consistent flow of information, including disclosures of significant information as it is uncovered.

Key takeaways

Once again, understanding how to manage the DOJ’s expectations (which may be different from regulators in other relevant jurisdictions) is critical. Satisfying the criteria for credit under the Corporate Enforcement Policy is not a matter of checking off a series of boxes. Striking the right balance between performing sufficient due diligence to confirm the accuracy of information and keeping the DOJ fully informed of significant information on a real-time basis is critical to ensuring maximum cooperation credit.

Coordinated resolutions

Reiterating prior DOJ policy statements about discouraging the “piling on” of duplicative penalties from multiple regulators for the same conduct, Cronan also discussed the DOJ’s goal of “[p]ursuing fair and equitable outcomes … [by] working toward a resolution that avoids punishment that exceeds what is necessary to rectify the harm and deter future violations, particularly when a company faces a combination of criminal penalties along with civil or foreign penalties.” Cronan emphasized that the DOJ is actively working with other domestic and foreign regulators to ensure that companies do not face duplicative penalties and that any monetary fine, restitution or disgorgement is commensurate with the alleged misconduct.

Key takeaways

If a company becomes the focus of a multi-jurisdictional investigation, it should utilize a global, coordinated strategy to manage the investigations across jurisdictions and require that any external counsel or consultants implement a similar strategy. By doing so, a company may be able to minimize its total liability.

Corporate monitors

Cronan’s speech also addressed the DOJ’s recent memorandum updating its considerations regarding when to seek the imposition of a corporate monitor when resolving an investigation (the “Memorandum”).

The Memorandum notes that prior DOJ statements set forth two broad considerations to guide prosecutors as to whether a monitor is appropriate: (1) the potential benefits that employing a monitor may have for the corporation and the public, and (2) the cost of a monitor and its impact on the operations of a corporation. The Memorandum elaborates on those considerations by requiring prosecutors to take into account:

Whether the underlying misconduct involved the manipulation of books and records or the exploitation of an inadequate compliance program;
Whether the misconduct was pervasive across the business or approved/facilitated by senior management;
Whether the corporation has made significant investments in, and improvements to, its compliance programs; and
Whether any remedial improvements to the corporation’s compliance program have been tested for efficacy.

As Cronan noted, the DOJ shall consider “whether the misconduct took place under different corporate leadership or in a compliance environment that no longer exists, and whether the changes in leadership and the corporate culture adequately safeguard against a recurrence of the misconduct.” Other considerations include the remedial measures put in place (e.g., the termination of certain business relationships and practices related to the misconduct) and the unique risks and compliance challenges for the particular jurisdiction(s) and industry in which the company operates. Finally, prosecutors must consider the costs associated with a corporate monitor—not only the projected monetary costs, but also whether the proposed scope of a monitorship imposes undue burdens on the corporation’s business.[2]

When a monitor is warranted, the Memorandum requires the DOJ to appropriately tailor the scope of the monitorship to address the specific issues and concerns that created the need for the monitor in the first instance.[3] Cronan specifically noted that the imposition of a monitor is not meant to be “punitive” but rather to reduce the chances of future misconduct.

Key takeaways

The DOJ’s recent pronouncements on the issue of corporate monitors reinforce the importance of having both an effective compliance program and the agility to promptly remediate if potential misconduct is uncovered – including taking any necessary personnel actions. Although a company cannot predict whether or when a government investigation may occur, conducting regular risk assessments and ensuring that the company’s compliance program is tailored to the company’s compliance risk profile are necessary first steps. The existence of a demonstrably robust program can be a critical factor in minimizing the fallout should a government investigation occur.

[1] A full copy of the speech.

[2] Id. at 2.

[3] Memorandum at 2.

What auditors need to know about blockchain

By Robert A. Schwinger on November 12, 2018 Posted in Cross border issues, Legislation, rules and policies, Other developments

The implications of blockchain and other disruptive technologies for many legal areas have been addressed by a variety of regulators. While much attention has been focused on the pronouncements by bodies such as the US Securities and Exchange Commission, other regulators have been looking at these matters as well. A recent speech by a member of the Public Company Accounting Oversight Board (PCAOB) discusses implications of such technology for auditing, accounting and investors.

As noted on the PCAOB’s website, the PCAOB is a nonprofit corporation established by Congress to oversee the audits of public companies in order to protect investors and the public interest by promoting informative, accurate and independent audit reports. The PCAOB also oversees the audits of brokers and dealers, including compliance reports filed pursuant to federal securities laws, to promote investor protection.

On November 2, 2018, PCAOB Board Member Kathleen M. Hamm gave a speech titled “Mexican Mangos, Diamonds, Cargo Shipping Containers, Oh My! What Auditors Need to Know about Blockchain and Other Emerging Technologies: A Regulator’s Perspective.” Although just a statement of Ms. Hamm’s own views and not necessarily those of other PCAOB board members or staff, her remarks provide useful insight to how the PCAOB may view how auditing procedures and financial reporting will need to address the challenges of blockchain and other disruptive technologies.

Ms. Hamm identified emerging technologies as an area that was a “strategic imperative” for the PCAOB to address. She focused primarily on blockchain technology but also noted such areas as robotic process automation, big data analytics and artificial intelligence. She cited experts as expecting worldwide spending on blockchain technology to be $1.5 billion this year, double the amount spent last year, and to reach almost $12 billion by 2022. As an illustration, she discussed how Walmart has piloted blockchain technology to track sliced Mexican mangos from farms, packing houses, brokers, import warehouses and processing facilities ultimately to Walmart stores, reducing the time it took to track a specific shipment back to the farm from almost a week to just 2.2 seconds. She noted how Maersk, the world’s largest container shipping company, is testing blockchain to track globally its cargo and related documents in near real-time, and how London-based Everledger uses blockchain to digitally track diamonds. She raised the prospect that “blockchain could be revolutionary” if companies, instead of using manual processes for account reconciliation, deployed blockchain technology “automatically, in near real-time, reconciling not only internal ledgers but also external ledgers.”

Faced with developments like these and countless new technologies that offer the promise of improving audit quality, Ms. Hamm addressed the question of “what auditors need to know.”

First, “the advent of emerging technologies does not change the fundamental financial reporting framework.” She explained:

“If an emerging technology is being used to meet financial reporting or internal control requirements established by the federal securities laws, then auditors need to understand the design and implementation of that technology. And at the risk of stating the obvious: For audits of public companies and broker-dealers, PCAOB standards still apply.

“In the case of blockchain, if an audit client uses it for business or operational activities, the auditor must understand the information systems, including the related business processes, relevant to financial reporting and how the use of blockchain affects the client’s flow of transactions.”

Second, “[b]lockchain does not magically make information contained within it inherently trustworthy.”:

“Events recorded in the chain are not necessarily accurate and complete. Recording a transaction on a blockchain does not alleviate the risk that the transaction is unauthorized, fraudulent, or illegal. Blockchain also does not address threats that parties to a transaction are related, or that side agreements exist that are not reflected in the chain. And nothing in the technology ensures proper classification of transactions in the financial statements.”

“Moving beyond blockchain to other emerging technologies,” Ms. Hamm raised some additional points:

She stressed that “auditors must be clear-eyed about the new challenges that these technologies create. For example, many of these applications require systematic access to quality data. Clients may be reluctant to provide their auditors unfettered access to such data for control and security reasons. Here is where an auditor’s strong cybersecurity posture may go a long way to lessen those concerns.”
She noted as another challenge “the risk that the technology does not operate as intended due to coding errors when developed, or intentional or unintentional changes made after the technology is deployed. Audit firms, therefore, should have robust controls in place around developing and testing tools before deployment and strong change-management processes for tools that are in use.”
Last, she noted that “in changing environments, computer code underlying complex technology can degrade over time, becoming less responsive. As a result, processes should be in place to continuously monitor and confirm that the output of an application remains consistent with expectations.”

Ms. Hamm also discussed the “five broad principles” she applies when thinking about emerging technology:

“First, when used for matters within our [pur]view, as regulators, we are not here to pick winners and losers in the race for innovation through the use of emerging technology. Let ideas compete.

“Second, as regulators, we should not inappropriately impede creativity. We should be open-minded and prepared in appropriate circumstances to use our regulatory tool kit – guidance, experimental sandboxes, and, possibly under the right circumstances, no-action relief – to remove inappropriate hurdles to new, creative uses of technology…

“[Third,] When an innovation offers the potential to reinforce or enhance a public policy object, we as regulators should be open to removing barriers as appropriate. If the proposed solution offers the potential to drive audit quality forward, you have my attention. If a proposed solution reinforces one or more of the three pillars of the federal securities laws – investor protection, market integrity, or effective capital formation – I want to know more.

“[Fourth,] I am particularly impressed by emerging technology that builds regulatory requirements and cybersecurity into solutions from the start, rather than bolting them on after the fact.

“A fifth principle: To be most effective, as technology around financial reporting and auditing continues to evolve, stakeholders – including investors, preparers, boards, audit committees, auditors, regulators, and academics – should actively participate in that development, sharing their unique perspectives.”

In sum, Ms. Hamm concluded: “Mexican mangos, diamonds, cargo shipping containers and beyond, blockchain and other emerging and disruptive technologies offer immense promise; not only to change financial reporting, but also auditing and assurance activities” — developments that portend “exciting times” ahead for auditing and financial reporting.

Ms. Hamm’s remarks offer useful guidance to how the PCAOB may be likely to view the challenges posed to auditing and financial reporting by blockchain and other disruptive technologies. Companies whose operations are being transformed by such technologies would be well advised to take note of her views in this area.

Supreme Court of Canada Rules that Proposed Canadian Cooperative Capital Markets Regulatory System is Constitutional

By Jeremy Devereux and Justine Smith on November 9, 2018 Posted in Other developments, Securities regulatory decisions

Today the Supreme Court of Canada (the Supreme Court) released its much-anticipated decision on the reference regarding the proposed Canadian Cooperative Capital Markets Regulatory System, finding that the proposed national regulatory system is constitutional.

Previous Attempts to Create National Securities Regulator

It has been suggested by the a number of governments, academic commentators and others that a national securities system in Canada would protect investors, foster fair, efficient and competitive capital markets, and contribute to the integrity and stability of Canada’s financial system. As a result, various attempts have been made to centralize the regulation of securities in Canada with limited success. While certain interprovincial initiatives aimed at coordinating regulatory functions have succeeded – such as the adoption by some provincial securities commissions of various national and multilateral instruments, and the implementation of the “passport regime” – attempts to create a national securities regulator have failed.

The last major attempt to create a national securities regulator was in 2009, when the Federal government developed the Proposed Canadian Securities Act. The system was designed to function on an opt-in basis such that each province retained its right to choose to participate or to keep its existing regulatory framework.

The constitutionality of the Proposed Canadian Securities Act was considered by the Supreme Court in 2011 in Reference re Securities Act, in which the federal government sought the Supreme Court’s opinion as to whether the proposed legislation would constitute a valid exercise of Parliament’s power over trade and commerce pursuant to s. 91(2) of the Constitution Act, 1867 (the Constitution). The Supreme Court held that the proposed legislation would not be a valid exercise of Parliament’s power as it would be outside its sphere of legislative authority. However, the Supreme Court acknowledged that certain aspects of the proposed legislation may be constitutional as falling within the federal sphere. In particular, although the Supreme Court found the Proposed Canadian Securities Act to be unconstitutional, it recognized that a scheme based on a cooperative approach to regulating securities in Canada might be constitutional, if it allowed provinces to address issues falling within their powers over property and civil rights and matters of local nature, while leaving room for Parliament to address genuinely national concerns.

Background

After the Supreme Court’s decision on the 2011 reference, the Federal government and the governments of Ontario, BC, Saskatchewan, New Brunswick, PEI and Yukon developed a proposed national cooperative system for the regulation of capital markets in Canada, the Cooperative Capital Markets Regulatory System (the Cooperative System). The Cooperative System’s framework is set out in an agreement between the federal government and participating territorial and provincial governments (the Memorandum).

Included in the Cooperative System are:

The Model Provincial Act , which deals with day-to-day aspects of securities trade. Section 5.5 of the Memorandum provides that any proposals to amend the Model Provincial Act are subject to a vote and must be approved by at least 50% of the members of the Council of Ministers (discussed below) and by the members representing the Major Capital Markets Jurisdictions (presently Ontario and BC).
The Draft Federal Act (DFA), which prevents and manages systemic risk and establishes criminal offences relating to financial markets. This would complement uniform provincial and territorial securities legislation.
A National Securities Regulator (the Authority), which would be a single operationally independent capital markets regulatory authority to which the federal government and the participating provinces would delegate certain regulatory powers. The Authority would have the power to make regulations but any regulations proposed by the Authority must be approved by the Council of Ministers before coming into force.
The Council of Ministers, which would comprise ministers responsible for capital markets regulation in each participating province and the federal Minister of Finance.

The Decision of the Quebec Court of Appeal

The Government of Quebec referred two questions pertaining to the Cooperative System to the Quebec Court of Appeal:

1. Does the Constitution of Canada authorize the implementation of pan-Canadian securities regulation under the authority of a single regulator, according to the model established by the most recent publication of the “Memorandum of Agreement regarding the Cooperative Capital Markets Regulatory System”?

The majority of the Court of Appeal answered this question in the negative and held that the Cooperative System would be unconstitutional. The Court of Appeal held that the process for amending the Model Provincial Act, and the requirement for any amendments to be approved by the Council of Ministers (Memorandum, s. 5.5) effectively fettered the sovereignty of the participating provinces’ and territories’ respective legislatures. The process for making federal regulations set out in the DFA and Memorandum was deemed inconsistent with the principle of federalism, given that it allowed certain provinces to veto the adoption of a federal regulation.

2. Does the most recent version of the draft of the federal “Capital Markets Stability Act” exceed the authority of the Parliament of Canada over the general branch of the trade and commerce power under subsection 91(2) of the Constitution Act, 1867?

The Court of Appeal answered this question in the negative. The Court of Appeal recognized that although the DFA was within Parliament’s jurisdiction under the general trade and commerce power, the provisions setting out the role of Council of Ministers in making the federal regulations (ss. 76-79) were not constitutional and, unless removed, would render the entire DFA unconstitutional.

(For more details on the decision of the Quebec Court of Appeal, please see our previous blog post here.)

The Decision of the Supreme Court of Canada

The Attorneys General of Canada, Quebec and British Columbia appealed to the Supreme Court of Canada. The Supreme Court analyzed the two questions referred to the Quebec Court of Appeal and held that that proposed national scheme was constitutional.

Question 1

A unanimous Supreme Court determined that the proposed pan-Canadian securities regulation is constitutional. In large part, this was based on the Court’s view that the Quebec Court of Appeal had misread or misunderstood the proposed scheme. The Supreme Court found that the proposed scheme would not improperly fetter the legislatures’ sovereignty nor would it entail an impermissible delegation of law-making authority.

Parliamentary sovereignty and the fettering of provincial legislative authority

The Supreme Court held that the terms of the Memorandum do not and cannot fetter the provincial legislatures’ primary law-making authority. The Council of Ministers’ role is limited to proposals for amendments to the Model Provincial Act and the Council is not contemplated to have any formal involvement in the amendment of legislation already enacted by provinces. Further, the Memorandum does not imply that the legislatures of participating provinces are required to implement the amendments to the Model Provincial Act approved by the Council, nor that they are precluded from making any other amendments to their securities laws. These legislatures are free to reject proposed statutes (as amended) if they choose. The definition of the Council cannot be understood as incorporating the voting rules of s. 5.5 into the statutory scheme. The Supreme Court rejected the proposition that the Cooperative System purports to fetter law-making powers of participating provinces’ legislatures.

More broadly, the Supreme Court recognized that the executive is incapable of interfering with the provincial legislatures’ powers to enact, amend and repeal legislation. Parliamentary sovereignty means that Parliament and the provincial legislature are supreme with respect only to matters that fall within their respective spheres of jurisdiction. While the majority of the Quebec Court of Appeal took issue with the Memorandum because it believed that the combined effect of these sections would fetter the sovereignty of the participating provinces’ legislatures, the Supreme Court found that this reflected a misunderstanding of the Memorandum and rests on a flawed premise that the executive signatories are actually capable of binding the legislatures of their respective jurisdictions to implement any amendments as dictated by the Council, and precluding those legislatures from amending their own securities law without Council approval.

The principle of parliamentary sovereignty preserves the provincial legislatures’ right to enact, amend, and repeal their securities legislation independently of the Council’s approval. The Supreme Court found that even if the Memorandum actually purports to fetter this legislative power, it would be ineffective in this regard, rather than constitutionally invalid, given that it cannot bind the legislature.

The Supreme Court did draw attention to the fact that the Memorandum will have political effects distinct from its legal effects. To achieve uniformity, the legislatures of participating provinces would need to enact a statute that mirrors the Model Provincial Act, as amended from time to time. The Council then plays an important political role in the area of securities regulation. According to the Supreme Court, the majority of the Quebec Court of Appeal went a step too far: it rejected the proposition that the Memorandum is merely a political undertaking that is not legally enforceable, instead finding it necessary to assume the Memorandum’s mechanisms will have their intended effect. The Supreme Court held that such an assumption cannot be relied upon.

Delegation of law-making powers

The Attorney General of Quebec argued that the Cooperative System is unconstitutional because of limits on the legislature’s authority to delegate law-making powers to some separate person or body. The Attorney General submitted that the Memorandum obliged the legislature of participating provinces to enact the provisions of the Model Provincial Act into law and to implement any amendments approved by the Council, and that the Memorandum otherwise prohibited participating provincial legislatures from amending that legislation.

The Supreme Court disagreed and held that, while Parliament or provincial legislatures may delegate regulatory authority to make subordinate laws in respect of matters over which it has jurisdiction to another person or body, a government is barred from transferring its primary legislative authority (to enact, amend and repeal statutes) with respect to a particular matter over which it has exclusive constitutional jurisdiction.

The Supreme Court found that the Cooperative System does not allow the Council to bypass provincial legislatures. The Memorandum does not create an unprecedented legislative body through the Council whose establishment goes against the Constitution. The Model Provincial Act will only have force of law if and when its provisions are properly enacted by legislature of a participating province. As such, the Council is and remains subordinate to the sovereign will of the legislatures.

Question 2

The unanimous Supreme Court agreed that the DFA falls within the general branch of Parliament’s trade and commerce power pursuant to s. 91(2) of the Constitution Act, 1867. The provisions setting out the role of the Council of Ministers in making the federal regulations (ss. 76-79) were not unconstitutional and thus cannot render the DFA unconstitutional.

The Classification of the Draft Federal Act

The Supreme Court found that the pith and substance of the DFA is to control systemic risks having the potential to create material adverse effects on the Canadian economy. It does not relate to the regulation of trade in securities generally. It promotes and protects the stability of Canada’s financial system and protects capital markets, investors and others from financial crimes. The DFA is less broad than the proposed legislation at issue in Reference re Securities Act, limiting the federal government’s role in regulating capital markets to detection, prevention and management of risk to the stability of the Canadian economy and the protection against financial crimes. The intention of the DFA is not to displace provincial and territorial securities legislation, but to complement these statues by addressing economic objects that are considered to be national in character.

The Supreme Court further held that some aspects of securities regulation are actually national in character. Accordingly, Parliament is competent to enact legislation that pursues genuine national goals, including the management of systemic risk. The concept of systemic risk can differentiate matters that are genuinely national in scope from those of local concern.

Using the framework from the decision General Motors of Canada Ltd. v. City National Leasing, [1989] 1 S.C.R. 641, the Supreme Court decided that the DFA addresses a matter of genuine national importance and scope that relates to trade as a whole. The federal government’s foray into securities regulation under the DFA is limited to achieving these objectives and this supports the validity of the proposed statute. The Supreme Court determined that the legislation is therefore within parliament’s power over trade and commerce pursuant to s. 91(2) of the Constitution.

Regulations under the Draft Federal Act: ss. 76-79

The Council’s role in making regulations is set out in ss. 76-79 of the DFA. Council’s approval is necessary before a regulation can be made. The mechanism applicable to the approval or rejection of regulations by Council is set out in s. 5.2 of the Memorandum. The majority of the Quebec Court of Appeal held that this, in combination with ss. 76-79, conferred a veto right over proposed federal regulations, which undermines the constitutional foundation of the DFA.

The Supreme Court found nothing problematic about the way in which the DFA delegates power to make regulations to the Authority under the supervision of the Council. The DFA sets out a broad framework for the regulation of systemic risk in capital markets, but delegates extensive administrative powers, including the power to make regulations to the Authority. This delegation is entirely consistent with parliamentary sovereignty since the delegated authority can always be revoked and its scope remains limited and subject to the terms of the governing statute.

The Supreme Court further held that the manner in which the DFA delegates regulation-making powers to the Authority under the oversight of the Council is not problematic from the perspective of federalism or the constitutional division of powers. The delegation of administrative powers in a manner which solicits provincial input is not incompatible with federalism, provided that the delegating legislature has the constitutional authority to legislate in respect of the applicable subject matter.

Finally, the Supreme Court held that the fact that some regulations might never be adopted because of provincial opposition does not change the reality that the regulations that are adopted must be respected by all the provinces if the objectives of the DFA are to be achieved. The fact that the Council is populated with minsters of provincial governments does not invalidate the delegation. Parliament can chose to structure the internal mechanics and approval process of the regulatory body in such a manner as deemed appropriate.

Final Thoughts

For nearly a century, calls for a Canadian national securities regulator have invariably been squashed by constitutional concerns. While it remains to be seen what will come of the Supreme Court’s most recent decision, this may mark a turning point for Canadian securities law. As the Supreme Court wrote in its conclusion: “It is up to the provinces to determine whether participation is in their best interests. This advisory opinion does not take into consideration many of the political and practical complexities relating to this Cooperative System.”

A tough break for third party litigation funding in Ontario? Not so fast.

By Linda Fuerst and Saam Pousht-Mashhad on November 9, 2018 Posted in Class actions, Other developments

The Ontario Superior Court (ONSC) issued two back-to-back decisions on acceptable litigation financing agreements, both involving the same third party funder. While the ONSC continues to approve classic litigation financing arrangements, uncertainty remains as to whether third party financiers may profitably fund counsel fees in the context of class actions.

Classic funding schemes continue to receive unfettered court approval

In David v. Loblaw, 2018 ONSC 6469, Morgan J. approved IMF Bentham’s funding agreement in a class action regarding the alleged price-fixing of bread without modifications, recognizing litigation financing as a potential tool for access to justice.

The litigation funding agreement was straightforward: Bentham agreed to pay adverse costs, disbursements and court-ordered security for costs. In return, it would receive 10% of the litigation proceeds net of its expenses. The 10% return was capped according to a sliding scale, increasing with the duration of the proceedings.

In reviewing the terms, Morgan J. highlighted several factors that made the funding agreement “fair and reasonable”:

Claimants had sole right to direct proceedings and instruct counsel.
Bentham could only terminate the funding agreement with the leave of the court.
Bentham would pay costs up to the termination date.
Any assignments of the funding agreement had to be done with notice to all parties and court approval.
Claimants had received independent legal advice on the terms of the funding agreement.
The Court reviewed the unredacted funding agreement and was satisfied that Bentham’s obligation to fund the litigation was sufficient to cover any adverse cost awards.

David is the most recent in a series of decisions where the ONSC accepted similar funding agreements.

Funding plaintiff counsel fees in class proceedings may attract judicial scrutiny

In Houle v. St. Jude Medical Inc., 2018 ONSC 6352, (Houle’s appeal) Myers J. dismissed an appeal from Perell J.’s decision in Houle v. St. Jude Medical Inc., 2017 ONSC 5129, (Houle) to grant a nun pro tunc order, amending Bentham’s funding agreement due to clauses that he deemed were overly broad and potentially unfair.

The funding agreement in Houle was novel in Canadian law: Bentham agreed to pay for 50% of the plaintiffs’ counsels’ fees throughout the case in addition to 100% of disbursements, adverse cost awards and security for costs. In exchange, Bentham would receive an uncapped ~20-25% of any judgment or settlement, depending on when the matter was resolved.

Myers J. affirmed Perell J.’s following concerns about the agreement:

provisions in the agreement “bel[ied] any assurances of the Houles having autonomy and having control over the action,” particularly, the provision granting Bentham the right to terminate the agreement on ten days’ notice in its sole discretion; and
risk of overcompensation given the high uncapped percentage of the proceeds.

Perell J. required changes to Bentham’s funding agreement that would make it acceptable. He also pre-approved Bentham’s recovery of up to 10% of the class recovery at outset of the case. At the end of the case, the court would determine if any further compensation would be appropriate. In doing so, Perell J. (1) pegged Bentham’s return to the 10% levy received by Ontario’s Class Proceedings Fund and (2) subjected Bentham’s return to the same procedural mechanism used to assess lawyers’ fees at the conclusion of class proceedings.

The appellants and Bentham argued that Perell J. erred because:

Ontario’s Class Proceedings Fund receives a 10% levy of any awards or settlements in exchange for costs of disbursements and adverse costs. However, Bentham undertook higher risk than the Ontario’s Class Proceedings Fund because it funded far more than adverse costs and disbursement, which justified more than a 10% return;
The assessment of the fairness of fees for a third-party funder is different than the assessment of lawyers’ fees. While the assessment of the fairness of lawyers’ fees requires consideration of the amount and quality of effort performed by the lawyers, the assessment of returns for loaned funds does not;
Insufficient weight was given to the fact that independently advised parties made a commercial decision at arm’s length, providing an objective measure of the reasonableness of the proposed loan terms;

Myers J. disagreed.

Meyer J. affirmed that Bentham’s compensation should be pre-approved at 10% with reserve. He distinguished Houle from another case where the full funding fee was approved at the outset of the case on the basis that litigation financiers have never funded plaintiff counsels’ fees in return for an uncapped percentage return to the tune of ~20-25%. Moreover, courts must await the outcome to assess the reasonableness of lawyer fees. The same rationale applies to levies for loans used to fund legal fees.

Myers J. characterized the concern regarding the terms of the agreement “not just for the immediate parties but for some 8,000 absent parties whose interest are at play.” As such, he approved Perell J.’s decision to (1) strike clauses allowing Bentham to withdraw from its funding obligation on its own assessment and (2) add court approval as a pre-condition to Bentham’s withdrawal to guard against the “champertous fear of officious intermeddling”.

Concomitantly, these additional terms increase the complexity of litigation funders’ decision to lend by compounding the uncertainty of estimating litigation funding returns when financing counsel fees.

Houle already distinguished in non-class action matters

While Houle might leave litigation financiers guessing as to what courts might decide is a reasonable return on their capital at risk, a competing line of jurisprudence regarding the funding of counsel fees began in Quebec in early 2018.

In a CCAA proceeding, the Quebec Superior Court in 9354-9186 Quebec Inc. (Bluberi Gaming Technologies Inc.) v. Ernst & Young Inc., 2018 QCCS 1040, rejected the thrust of Perell J.’s decision in Houle. Michaud J. approved a litigation financing similar to the arrangement in Houle whereby Bentham paid a portion of the plaintiff counsel’s hourly rates, in addition to disbursements and adverse costs.

The Houle and Blueberi decisions considered similar clauses in a Bentham agreement. While Perell J. found that some clauses were too broad, Michaud J. saw no issue. Michaud J. began by distinguishing Bluberi from Houle on the basis that it “was rendered in the context of a class action where the motivation and ability of the plaintiff to pursue the litigation are important.” In CCAA proceedings, Michaud J. opined that “the objectives are different.”

Michaud J. then found that Bentham’s termination clause – also at issue in Houle – was reasonable in the context of CCAA proceedings:

“Taking into consideration the amount of time and money Bentham has invested so far […], it is obvious that Bentham has no intention of terminating the LFA unless it perceives that it would not gain from it.”

In a further divergence from his ONSC colleagues[1], Michaud J. found that the decision as a “whole” did not “allow Bentham to exert undue influence in the litigation”.

Effect of Houle’s appeal may ripple across non-class action proceedings

An intervener in Houle’s appeal requested that the Court circumscribe its reasons to class proceedings. The Court refused to grant the intervener’s request. Myers J. explained that it was not for him to determine “how other courts might use this decision if it is ever argued before them by counsel.” If the funding parameters in Houle applied to the litigation of private entities in Ontario, then the complexity and cost of financing litigation agreements for non-class proceedings would likely increase commensurably.

[1] Mr. Zarnett makes the same argument in Houle’s Appeal at para 47. Myers J. expressly rejects it.

The Securities and Exchange Commission’s Long Reach

By Sophie Melchers on November 5, 2018 Posted in Cross border issues, Other developments

You are a third-party witness to a potential breach of U.S. securities laws, living in Québec, if you think that you are out of reach of the SEC, think again. In United States Securities and Exchange Commission v. Ouellet, 2018 QCCS 4239, the Québec Superior Court did just that and granted an order compelling a resident living in Québec to produce documents and produce themselves for questioning in relation to an investigation in the U.S.

Background

As discussed in our previous post, the founders of PlexCoin token issuer PlexCorps are under investigation by securities regulators on both sides of the Canada – U.S. border. In a U.S. complaint, the Securities and Exchange Commission (SEC) alleges that PlexCorps and its founders made materially false statements in connection with the Initial Coin Offering (ICO) of PlexCorps and defrauded investors.

Yan Ouellet was an employee of one of PlexCorps’ founders at the time of the ICO. Despite not being under investigation himself, the SEC took an interest in him as a third-party witness able to provide evidence (testimony and documents) relevant to the SEC complaint.

Why is the SEC interested in Ouellet?

According to the SEC, Ouellet:

assisted the PlexCorps founders with its websites
helped set up accounts with payment service providers to collect funds from investors
knew whether statements made in connection with the ICO were true or false
knew of PlexCorps’ efforts, if any, to avoid offering PlexCoins to U.S. investors.

SEC first asks U.S. Court to request international judicial assistance from Québec Court

To gain access to Ouellet, the SEC began by asking the U.S. District Court for the Eastern District of New York to issue an order and request for international judicial assistance to the Québec Superior Court, also better known as letter rogatory. The letter rogatory requested that the Québec Superior Court compel Ouellet to turn over documents relating to the PlexCorps ICO to the SEC and submit himself for questioning by counsel to the SEC and PlexCorps in Québec. Despite opposition from PlexCorps and its founders, the SEC was successful and obtained the letter rogatory from the U.S. District Court.

SEC then turns to Québec Court with U.S. Court request for judicial assistance

Armed with the letter rogatory, the SEC appeared before the Québec Superior Court and argued that Ouellet is a third-party witness with evidence that is relevant to the U.S. complaint, necessary for use at the trial in the U.S., a material witness for the U.S. court to do justice and that the evidence and oral testimony sought from Ouellet could not be obtained from any other source.

Ouellet’s unsuccessful contestation

Ouellet contested the SEC’s demands by arguing, among other things, that:

the SEC’s letter rogatory was a fishing expedition (their extremely broad list of 20 topics could cover many thousands of documents); and
he would invoke section 50 of the Canada Evidence Act and refuse to answer questions that would incriminate himself.

The Superior Court noted that out of mutual deference and respect, courts will enforce a foreign request if, among other things, the evidence sought is relevant, necessary for trial and will be used at trial, not otherwise obtainable and that the order sought is not against public policy.

The Court found that the SEC application met all of these criteria.

The Court also dismissed Ouellet’s argument that he could refuse to answer self-incriminating questions because:

Section 50 of the Canada Evidence Act does not apply because Ouellet was being compelled to testify under a letter rogatory as opposed to under Part II of the Canada Evidence Act, which contains section 50.
As was established in the Ontario Court of Appeal case of Treat America Limited v. Leonidas, 2012 ONCA 748, a person ordered to give evidence pursuant to a letter rogatory does not have the ability to refuse to answer questions neither under the Fifth Amendment of the U.S Constitution nor under Canadian law.
The only available protection to that person is that an answer given to a question objected to as potentially self-incriminating will not be used in any criminal proceeding against him, other than a prosecution for perjury.

The Québec Superior Court granted the SEC motion and ordered Ouellet to turn over the broad universe of documents covered by the letter rogatory and to submit himself to questioning by counsel to the SEC and PlexCorps’. At the end of the day, the fact that Ouellet lives in Québec did not put him out of the SEC’s reach.

Nova Scotia Bill 67 – IIROC expands its enforcement authority

By Andrew McCoomb on October 24, 2018 Posted in Legislation, rules and policies, Other developments

On October 12, 2018, Bill 67 was proclaimed into force in Nova Scotia. Bill 67 expands the enforcement powers of the Investment Industry Regulatory Organization of Canada (IIROC) in Nova Scotia in the interest of strengthening investor protection, with a focus on safeguarding the financial interests of seniors and vulnerable retail investors.

Bill 67 amends the Nova Scotia Securities Act to give IIROC broad investigatory and enforcement powers, including the ability to collect fines through the courts in Nova Scotia against wrongdoers found guilty of misconduct, the authority to collect and present evidence during investigations and at disciplinary hearings, and immunity from civil suits while it carries out its mandate in good faith. These three sets of powers are known as IIROC’s full enforcement toolkit.

With the passage of Bill 67, IIROC can now enforce fine collection in seven provinces: Nova Scotia, Prince Edward Island, Quebec, Ontario, Manitoba, Alberta and British Columbia.

Nova Scotia joins Alberta and Quebec as the only provinces that hand over the full enforcement toolkit to IIROC. In other provinces, IIROC has some but not all of these powers. For example, Ontario and British Columbia allow IIROC to collect fines through the courts, but do not provide it with the ability to collect and present evidence during investigations and at disciplinary hearings and do not provide IIROC with immunity from civil suits. Manitoba provides IIROC with collections powers, immunity from civil suits and the ability to launch appeals to the Manitoba Securities Commission. PEI allows IIROC to register disciplinary decisions with the Supreme Court of PEI and to collect evidence at the hearing.

The efficacy of these legislative amendments in other provinces is already showing: for example, in Ontario, fines collected by IIROC increased from $2.7 million to $3.4 million between 2016 and 2017 following passage of collections amendments.

IIROC’s enhanced enforcement authority has serious implications for market participants. In the past when IIROC lacked the authority to collect fines or enforce penalties, persons found guilty of serious infractions could evade disciplinary fines by ceasing practice and leaving the industry. Canada has an estimated $1.1 billion of unpaid securities fines. IIROC’s enhanced enforcement tools appear to provide a meaningful backstop to regulatory penalties, and create significant incentives for market participants to abide by IIROC rules, cooperate with investigations and negotiate settlements. Given the increased rates of collection already seen in the provinces granting IIROC enhanced powers, one may expect the remaining provinces to follow.

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

The Scope of Securities Commission’s Public Interest Jurisdiction: What Constitutes Abuse of the Capital Markets?

By Linda Fuerst on October 22, 2018 Posted in Securities regulatory decisions

In Re Hamilton, 2018 BCSEECOM 290, the British Columbia Securities Commission (BCSC) was called upon, yet again, to consider the scope of its public interest jurisdiction in an enforcement proceeding pursuant to s. 161 of the British Columbia Securities Act, RSBC 1996, c. 418 (the “Act”) in the absence of allegations of specific breaches of securities law.

The Allegations

Commission Staff alleged that John Hamilton and Braeden Lichti created a publicly traded shell company for use in a securities manipulation by deceiving foreign regulators and the public. Hamilton and Lichti allegedly controlled the company by installing and impersonating nominee directors and officers, concealed Hamilton’s control over all of the company’s shares by pretending to have independent shareholders, made false filings with US securities regulators to secure the company’s registration and public quotation of its shares on the OTC Bulletin Board (“OTCBB”), and sold secret control over all the shares in the publicly trading company.

Staff argued that the respondents’ conduct as a whole “did not squarely engage a specific provision of the Act” and was abusive, and therefore warranted the imposition of enforcement sanctions in the public interest.

Challenges to the Exercise of the Commission’s Public Interest Jurisdiction

The respondents argued, among other things, that because Staff could have alleged specific contraventions of particular sections of the Act, and that the SEC had enforcement powers to deal with the specific aspects of the alleged misconduct, it was both unnecessary and inappropriate for the BCSC to exercise its public interest jurisdiction.

The Hearing Panel disagreed. The allegations related to a pattern of deceptive conduct alleged to have brought harm to the capital markets. While certain aspects of the conduct could have resulted in allegations of breach of specific sections of the Act, there were no specific prohibitions against other aspects of the conduct. The entirety of the conduct must be assessed when considering the use of the Commission’s public interest jurisdiction.

Further, the case did not raise the potential procedural unfairness concerns that had arisen in Re Carnes, 2015 BCSECCOM 187, where the notice of hearing alleged that the respondent’s conduct contravened a specific fraud section of the Act and the basis for an order in the public interest was the same. “There is potential unfairness to a respondent in circumstances in which an allegation is made under a specific provision of the Act and, in the event that the executive director is unable to prove the requirements of the statutory provision, then the [sic] use of the same conduct as the basis for public interest orders”.

The fact that the SEC had enforcement tools and the jurisdiction to use them in a manner that overlaps with the enforcement tools and jurisdiction of the BCSC was irrelevant.

The hearing panel also rejected submissions that the adoption of BC Instrument 51-109 Issuers Quoted in the US Over-the-Counter Markets (the “OTC Rule”) and related legislative changes “covered the field” with respect to the regulation of manufacturing shell companies which are subsequently quoted for trading on the OTCBB such that compliance with those provisions could have generated a reasonable expectation that if the respondents did not breach those requirements then there would be no basis for regulatory action. The OTC Rule did not prescribe certain activity as misconduct that the Commission would be undermining by finding similar activity to be contrary to the public interest.

Threshold for the Exercise of the Public Interest Jurisdiction in Enforcement Proceedings: Abuse of the Capital Markets is Required

The Hearing Panel considered the threshold for the exercise of its public interest jurisdiction and identified the following principles that emerge from a review of the jurisprudence: (1) Panels must tie their analysis of the scope of that jurisdiction to the twin mandates of the Act: investor protection and ensuring fair and efficient capital markets; (2) any analysis should focus on the totality of a respondent’s conduct; and (3) the public interest jurisdiction must be exercised cautiously as any orders that flow from its use serve to restrain conduct that is otherwise not expressly prohibited by statute or regulation.

Observing that some decisions of Canadian securities commissions have suggested a narrow scope for the exercise of the public interest jurisdiction (requiring conduct to be clearly abusive of the capital markets) and others have adopted a broader approach (permitting it to be used where the conduct contravenes one of the “animating principles” of the applicable statute), the Hearing Panel affirmed its view expressed in the Carnes case that the abuse threshold was appropriate at least in the enforcement context.

Establishing Abuse of the Capital Markets

The Hearing Panel stated that the “abuse” threshold is high and connotes, at least “serious behaviour that is outside the ordinary course of conduct in the capital markets” and “either risk, or actual harm, to the capital markets arising from the conduct”. Further, a useful check on a conclusion that conduct is abusive of the capital markets is whether the reasonable expectations of participants in the capital markets would be met with the exercise of the Commission’s public interest jurisdiction in the circumstances.

In this case, the Commission was satisfied that it was in relation to Hamilton. “[M]aterial public interest concerns arise as a consequence of the sustained and concerted effort…to deceive foreign regulators (and the Commission by subsequent filings of the registration statement), critical gatekeepers in the capital markets and the public” about the true ownership of the company in issue.

While the allegations against Lichti were dismissed, the Panel found that Hamilton’s conduct was deceitful and abusive of the capital markets. Unlike the reasonable expectations of market participants about the conduct of the respondent in Carnes, the public would not be surprised by a finding that those who conceal their control and direction of a public company and file false disclosure statements, conceal their identity from critical gatekeepers, fabricate records and file them with securities regulators and secretly sell control of a public company risk securities regulatory sanction.

Motions for Further Disclosure in OSC Proceedings: Privilege, Relevance and Proportionality

By Linda Fuerst on October 18, 2018 Posted in Securities regulatory decisions

In a recent decision of the OSC in Re Caldwell Investment Management Ltd. (October 12, 2018), a hearing panel (the “Panel”) denied a motion by Caldwell Investment Management Inc. (“Caldwell”) for further pre-hearing disclosure from OSC Staff. The motion was made in the context of an upcoming enforcement proceeding alleging, among other things, that Caldwell had breached its best execution obligation under s. 4.2 of NI 23-101 by placing most of its trades for execution through a related dealer, without having adequate policies and procedures in place to ensure that Caldwell’s best execution obligation was being met.

Caldwell brought a motion under R. 27 of the OSC’s Rules of Procedure seeking an order requiring Staff to disclose additional documents and information in Staff’s possession alleged to be necessary to enable Caldwell to defend itself. This included materials related to Staff’s discussions with its expert, and materials related to best execution practices and procedures of other OSC registrants obtained through the Commission’s regulatory programs, including information from firms that use affiliated dealers to execute orders on behalf of clients.

The Panel denied both requests.

With respect to the request for materials related to Staff’s discussions with its expert, consistent with Moore v. Getahun 2015 ONCA 55, the Panel determined that notes reflecting an expert’s preliminary views and “partial draft expert reports” of an expert who had not yet produced a final report are protected by litigation privilege and do not have to be disclosed. Since an expert report, if delivered by Staff, would be provided to Caldwell in due course, there was “no compelling reason to subordinate the privilege to a need to disclose to allow for full answer and defence”.

The Panel also denied the request for production of information and materials in Staff’s possession related to other OSC registrants.

In its Statement of Allegations, Staff allege that Caldwell was in a conflict of interest in directing trades to its related dealer for execution, and that in many cases, the equity commission rates and bond spreads charged by the related dealer were significantly less favourable than what unaffiliated dealers were charging Caldwell. Examples of the average commission rate charged to a particular Caldwell mutual fund by the related dealer in comparison to the average rate charged to the same Caldwell fund by the unaffiliated dealers were specified in the Statement of Allegations. Staff also allege that Caldwell made misleading statements in its Annual Information Form that it paid brokerage fees “at the most favourable rates available to the Funds”.

According to the Panel, at issue was Caldwell’s best execution practices measured against the applicable regulatory standard, not against other registrants whose business models, services, markets and types of clients will all vary. Accordingly, the “raw materials” demanded by Caldwell were judged not to be helpful to its defence and accordingly not required to be produced by Staff pursuant to its obligations under the Stinchcombe standard.

The Panel also concluded that disclosure of such information obtained by Staff from other registrants, who were not party to the motion, would undermine those registrants’ expectations of confidentiality in the examination process.

Finally, the Panel noted that in addition to lack of relevance, the requested production “would be a very onerous task that would adversely affect the efficiency of a proceeding of this kind”. Unfortunately, this concept of proportionality has not been applied by OSC Staff during investigations, when vast amounts of electronic documents and data may be demanded of market participants pursuant to a summons issued under s. 13 of the Securities Act, regardless of the cost to produce.

Even “Small Frauds” May Warrant the Imposition of Significant Sanctions by Securities Regulators

By Peter Tae-Min Choi on October 16, 2018 Posted in Securities regulatory decisions, White collar crime

In Re Davis, 2018 BCSECCOM 284, the British Columbia Securities Commission upheld permanent market prohibitions against Mr. Davis who committed fraud on one investor in the aggregate amount of (only) $7,000.

Background

Mr. Davis, who was never registered under the Securities Act (B.C.), purported to sell shares that he did not own to an investor over a period of two years. Throughout that time, Davis continued to deceive the investor by providing false assurances regarding the status of the shares. Although the investor was successful in obtaining repayment of her $7,000 through court proceedings, the Commission, in its 2016 decision, imposed permanent market prohibitions and a $15,000 administrative penalty.

Appeal

Mr. Davis appealed the Commission’s imposition of the permanent market prohibitions on the basis that they were unreasonable. In particular, Mr. Davis argued that the panel had failed to consider his unblemished record in the industry and the principle of proportionality. The Court of Appeal agreed. It concluded that the Commission had failed to conduct an individualized assessment of Mr. Davis’ personal circumstances, and remitted the matter back to the Commission for reconsideration.

Analysis

As directed, the Commission considered Mr. Davis’ personal circumstances, in particular the evidence regarding his livelihood and his unblemished career in the capital markets industry. The evidence revealed, however, that since late 2011 or early 2012, he had moved on to other types of work and was no longer dependent upon his involvement in the capital markets to earn a living. Further, the fact that Mr. Davis had no prior regulatory history was inconsequential to the Commission’s decision to impose section 161 prohibition orders, which are intended to be “protective and preventative”.

While the amount of the fraud was relatively small, Mr. Davis’ misconduct involved ongoing deceitful conduct over two years, which demonstrated a significant lack of honesty and integrity. In addition, the investor was deprived of her funds for several years, suffered emotional harm and had to seek recourse to the courts for recovery. Accordingly, the Commission found that the significant risk Mr. Davis posed to the integrity of the capital markets and to investors warranted (re)ordering permanent market prohibitions.

Takeaway

This decision serves as a reminder that participants in the securities industry are held to high standards of honesty and integrity. As a result, they should expect that the securities regulators will impose significant sanctions if they commit securities fraud, even “small” ones.

The author would like to thank Maha Mansour, articling student, for her contribution to this article.