In its recent decision (AMF v. Desmarais), the Court of Appeal upheld the conviction of a Montreal lawyer who played a central role in the distribution of investment contracts without a prospectus and who acted as a dealer without being registered as such, while reducing his prison sentence and fine.
Facts of the case
Jean-Pierre Desmarais, a partner at a Montreal law firm, assisted Fondation Fer de Lance (FFDL) – a private not-for-profit foundation co-founded by Messrs. Desmarais and Gélinas – in recruiting and convincing 23 “sponsors” to sign a contract requiring them to make sums available to FFDL in the hope of future compensation.
Mr. Desmarais participated in the drafting of the contracts, met with potential investors in his law firm’s offices, received some of the investors’ funds, deposited some of these funds in his law firm’s trust account and later transferred them to FFDL’s trust account (of which he was signatory) or to Mr. Gélinas directly. In total, FFDL raised close to US$1.4M.
Over the years, FFDL experienced various financial difficulties; while some “sponsors” were able to recover their capital, none ever got a return on their investment.
Rationale for the generous and large interpretation of “investment contracts” and “distribution”
The Court of Appeal reiterates that:
- the goal of securities legislation is the protection of the investing public, and
- it would be impossible for any legislator to include the wide array of financial arrangements that various companies can conceive of under one precise definition
such that the concepts of “investment contract” and “distribution” under the Quebec Securities Act (QSA) need to be given a generous and large interpretation.
What is an “Investment Contract”?
An investment contract is defined in the QSA as a contract whereby a person, having been led to expect profits, undertakes to participate in the risk of a venture by a contribution of capital, without having the required knowledge to carry on the venture or without obtaining the right to participate directly in decisions concerning the carrying on of the venture.
Mr. Desmarais argued that the contracts at issue referred to “sponsors” as opposed to “investors”, to the availability of funds as opposed to their investment and to “ “compensation” as opposed to “return”, such that the contracts should not be found to be “investment contracts” under the QSA and that no prospectus need be prepared.
The semantic arguments raised by Mr. Desmarais were all rejected, in favour of an analysis of the essence of the contract. Simply put, it’s substance over style. The contracts between FFDL and the “sponsors” were found, in essence, to be “investments contracts” under the QSA. The Court added that in this case, the risk of the venture not only included the loss of the capital contributed but also the loss of the expected advantage or profit.
The Court also confirmed that the notion of “securities” (which appears in the definition of “distribution”) encompasses all the forms of investment to which the QSA applies, including an investment contract. As a result, a prospectus had to be prepared ahead of its distribution.
Reduction of the Penalty
In determining the penalty, section 202 of the QSA allows the Court to “take particular account of the harm done to the investors and the advantages derived from the offence”.
Despite confirming that in this case, the most aggravating element was the breach of trust through the abuse of the seriousness of his profession, the Court of Appeal reduced Mr. Desmarais’ prison sentence from 18 months to 6 months and his fine from $345,000 to $70,000 on account of two mistakes made by the trial judge.
First, the trial judge had found that in a worst-case scenario, the investors could lose $290,000 and had taken this into account when deciding the penalty to be imposed on Mr. Desmarais. The Court of Appeal found that there was no evidence beyond a reasonable doubt that there would be any loss. It was thus a mistake in law for the trial judge to have considered losses as an aggravating factor, the existence of which had not been put into evidence.
Second, the trial judge had considered the fees of $305,000 paid to Mr. Desmarais’ law firm. The Court of Appeal held that there was no evidence as to what portion of those fees, if any, had been received by Mr. Desmarais, such that they should not have been taken into account when deciding the penalty to be imposed on Mr. Desmarais.
In its discussion on sanction, the Court of Appeal confirmed that:
- lack of remorse cannot be considered as an aggravating factor, particularly when a person contests having ever committed the infraction, and
- an accused’s financial means and ability to pay the fine, together with the delay to pay, is a relevant factor.
No matter the terminology used, courts will favour substance over form when determining whether a particular contract or structure falls within the definition of “investment contract” in order to protect the investing public.
The author would like to thank Isaac Harris for his contribution to this article.