SEC to Resume Administrative Law Proceedings Following Supreme Court Ruling

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

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

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


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

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

Background to the Decision

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

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

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

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

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

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

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

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

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

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

The Court’s Analysis

            Legal principles

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

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

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

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

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

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

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

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

Application of legal principles to the facts

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

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

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

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

Take Aways

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

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

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


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

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

Background to the Decision

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

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

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

The Court’s Analysis

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

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

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

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

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

Key Take Aways

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

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

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


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

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

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


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

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

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

The Decision

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

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

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

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

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

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

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

Ontario Securities Commission confirms test for severance

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

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

Allegations of insider trading and insider tipping

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

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

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

The motion for severance

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

The Commission applies the criminal law test for severance

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

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

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

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


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

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

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

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


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


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

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


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

Fraudulent Statements and Fraudulent Schemes

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

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

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

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

Janus, 564 U.S. at 142.

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

The Lorenzo Action

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

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

Writing for the majority, Judge Srinivasan wrote that,

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

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

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

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

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

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

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

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


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

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


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

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

The Case

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

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

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


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

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




New York Highest Court Imposes Three Year Limitations on State Attorney General Securities Actions

On June 12, 2018, New York’s highest court issued a ruling that a three year statute of limitations, not the six year statute applicable to fraud claims, applies to claims brought under New York’s Martin Act.  People v. Credit Suisse Securities (USA) LLC, et al.  The Martin Act is the New York State Blue Sky law that gives the New York Attorney General broad authority to bring civil and criminal claims arising from fraudulent conduct in connection with the sale and purchase of securities.  While the claims thereunder overlap with those available under the U.S. federal securities laws, it has been used frequently, especially since the 2008 financial collapse, by aggressive New York Attorneys General where the U.S. Securities Exchange Commission does not step in, and at times even where it does.  While having no impact on the scope or substance of such claims, the narrowing of the statute of limitations will pressure state authorities to expedite their investigations of suspected securities fraud, or risk losing the claims.

The Martin Act

Enacted in 1921, the Martin Act (New York General Obligations Law, Article 23-A, §§ 352, et. seq.) has been considered the most expansive state securities law in the United States.  The Act prohibits deceitful acts including false statements in connection with the sale of securities and commodities in or from New York.  Notably, a number of claims available to the Attorney General under the Act do not require proof of scienter or reliance.  Given New York’s importance as a financial center, the Act gives the New York Attorney General  jurisdiction over the largest financial institutions in the world.

New York Attorney General Elliot Spitzer aggressively used the Martin Act during his term beginning in the early 2000s.  Its use escalated following the 2008 financial collapse, and its aggressive use continued by his successor, Attorney General Eric Schneiderman.

The Case

Following the 2008 financial collapse, the New York Attorney General’s office began investigating Credit Suisse and affiliates in connection with the sale of mortgages that it packaged into bonds and sold to investors in 2006 and 2007.  In 2012, Attorney General Schneiderman bought claims against Credit Suisse alleging that it had deceived investors as to the quality of the mortgages for which it was civilly liable under the Martin Act, among other grounds.  Credit Suisse sought dismissal on the grounds that a three year statute of limitations applicable to “[a]ctions to recover upon a liability, penalty or forfeiture created or imposed by statute” (New York Civil Practice Law and Rules § 214(2)) barred those claims.  The Attorney General’s office countered that a six year statute of limitations for fraud should apply, and thus the claims were timely.

In ruling in favor of Credit Suisse, the Court distinguished between fraud claims that existed under common law, to which a six year statute of limitations applies, and claims under the Martin Act.  While the Act does apply to fraud-related claims that existed under common law, the Martin Act imposes many obligations that did not exist at common law, justifying the imposition of a three year statute of limitations.


The sole Dissent to this decision warned:  “Make no mistake, this is a significant decision with potentially devastating consequences for the People of the State of New York, as well as markets beyond our borders, which depend on New York as a global financial center.”  The Dissent called upon the New York State Legislature to amend the Act to impose a longer statute of limitations “to correct this error before significant damage is done to the State’s securities markets.”  While the Legislature’s appetite for such statutory action is unclear, what is clear is that, at least until the Legislature acts, the New York Attorney General will be constrained by a three year statute of limitations.  It is likely, however, that the Attorney General will try to obtain some relief from that time limitation by seeking voluntary tolling agreements from those under investigation for potential Martin Act violations.

Parity in sentencing for insider trading: AMF v. Beauchamp, 2018 QCCQ 3604

In a recent decision, AMF v. Beauchamp, Délisle J. of the Quebec Court, Criminal and Penal Chamber, refused to follow the request of the Quebec securities regulator, the Autorité des marchés financiers (AMF), that a prison term be added to the sentence of an accused in an insider trading case.

Background to the Decision

Francis Beauchamp (Beauchamp) pleaded guilty to nine counts of insider trading. He had received privileged information (as defined in the Quebec Securities Act (QSA)) relating to four separate acquisitions from the spouse of the then assistant to the Chief Financial Officer of BCE Inc., Ms. Morier. Beauchamp had personally traded while in possession of said privileged information, making profits in excess of $275,000. He had shared the privileged information with his parents who had themselves also traded.

Earlier, the tipper, her spouse and her parents also pleaded guilty to related charges of insider trading and were all condemned to pay a monetary fine, without any imprisonment. While the AMF and Beauchamp agreed on the terms of the fine to be paid by Beauchamp following his guilty plea (i.e. $500,000), the AMF requested from the Court that imprisonment be added to his sentence.

The Court’s Analysis

The only question to be adjudicated by Justice Délisle was whether or not a prison sentence should be imposed on Beauchamp, in addition to the fine that he had agreed to pay, when the tipper Ms. Morier, her spouse and her parents had not been sentenced to any imprisonment. In other words, should the principle of parity in sentencing of similar offenders for similar offences committed in similar circumstances be applied or not?

In support of its request, the AMF sought to downplay both the guilty plea of Beauchamp – by arguing that it had come late in the day, 11 days before the start of the trial on the merits – and his collaboration with the AMF – by arguing that the information received from Beauchamp only confirmed or corroborated information already in the hands of the prosecutor. Moreover, the AMF argued that Justice Délisle was not privy to the plea bargains between the AMF and each of the tipper, her spouse and her parents and was thus not in a position to determine whether similar offences had been committed in similar circumstances.

Justice Délisle refused the AMF’s request and only sentenced Beauchamp to the $500,000 fine agreed upon.

Justice Délisle found that Beauchamp’s guilty plea had come sufficiently early so as to avoid any witness being called at trial, mentioning that the guilty pleas of the tipper and of her spouse only came 18 months after the notice of infraction had been served, and not at the first occasion.

Justice Délisle refused to minimize the collaboration of Beauchamp, stating that when Beauchamp accepted to answer the questions of the AMF investigator, he had no knowledge of the evidence already assembled by the AMF. The fact that his answers only confirmed or corroborated evidence already in the hands of the prosecutor could thus not be held against him.

Finally, Justice Délisle wrote that the AMF “had voluntarily held back the details of the plea bargains” of the tipper, her spouse and her parents “in the hopes of convincing him to impose a more severe sentence on” Beauchamp. While clearly not appreciative of this lack of transparency on the part of the regulator, he referred to a reported judgment involving the tipper, her spouse and her parents containing sufficient information for him to determine that the principle of parity in the sentencing had to be applied.

Take Aways

In addition to a fine, the Quebec securities regulator can request imprisonment against only one of several individuals accused of breaching the QSA and in support of such request, can attempt to downplay the importance of both a guilty plea based on its late timing and of the accused’s collaboration with the AMF’s investigation.

To defeat such a request, the terms pursuant to which a co-accused has already pleaded guilty to a breach of the QSA and the sentence imposed on him/her could prove to be very relevant, in light of the principle of parity in sentencing of similar offenders for similar offences committed in similar circumstances.

The Importance of Materiality in Secondary Market Misrepresentation Claims: Paniccia v. MDC Partners Inc. Securities Class Action

In the recent decision of Paniccia v MDC Partners Inc., Perell J. refused to grant leave to proceed with a putative secondary market securities class action under Part XXIII.1 of the Ontario Securities Act (OSA) against MDC Partners Inc and certain of its officers on the basis that the alleged misrepresentations were not material.  The decision presents valuable insight into the assessment of materiality, an issuer’s obligation to disclose a regulatory investigation, and a plaintiff’s obligation to plead a corrective disclosure under Part XXIII.1.

Background to the Decision

In August 2015 the Plaintiff brought a putative class action in Ontario for negligent misrepresentation and a statutory secondary market misrepresentation claim on behalf of shareholders of MDC. MDC’s shares traded on the TSX and NASDAQ, where 98.2% of the trading occurred.  However, only approximately 0.8% – 2.6% of MDC’s shares were held by residents of Canada.

While initially seeking to certify a global class, in response to a motion by the Defendants to limit the proposed class to purchasers on the TSX, the Plaintiff refined the class to persons or other entities in Canada who acquired shares of MDC on any domestic or foreign exchange or through an over-the-counter transaction during the class period.

The Plaintiff pleaded multiple misrepresentations between October 29, 2014 and March 2, 2015. In particular, the Plaintiff’s allegations were that a) MDC failed to disclose the issuance of a subpoena by the SEC requiring MDC to produce information about the expenses of Miles Nadal, the CEO of MDC, and its accounting practices, among other things;  b) MDC failed to disclose an internal investigation into its internal controls over accounting prompted by the subpoena;  c) MDC failed to disclose that it began reporting “adjusted” EBITDA because the SEC had required the qualification “adjusted” to be added;  d) MDC did not disclose the true amount of its CEO’s compensation;  and e) MDC misstated how it presented its business “segments”.

The Plaintiff argued that these misrepresentations were partially corrected on April 27, 2015 when MDC disclosed to the market that the SEC had served a subpoena. MDC also disclosed that it had formed a special committee of independent directors to investigate the matters raised by the SEC’s subpoena and that following the internal review, Mr. Nadal had agreed to reimburse the company in the amount of $8.6 million.  The following day, MDC’s shares dropped in value by 28% on both the TSX and NASDAQ.  On July 20, 2015, Mr. Nadal and MDC’s Chief Accounting Officer resigned and together repaid or forfeited approximately $40 million USD in severance and compensation.

In August and September 2015, the SEC raised a new matter with MDC about how MDC grouped or segmented its partner firms into reporting units. The SEC’s correspondence on this topic was publicly filed.

MDC’s auditor did not withdraw their unqualified audit opinions, require a restatement of MDC’s financial statements nor withdraw ICFR reports in connection with any of these events.

A parallel U.S. class action was commenced and dismissed before certification by the United States District Court – Southern District of New York in September 2016. However, the SEC brought an enforcement action against MDC and some of its officers resulting in “no contest” settlements with the SEC in January, May, and November 2017.

The Court’s Analysis

Justice Perell denied leave to commence a statutory claim for secondary market misrepresentation under s. 138.8(1) under the OSA, finding that all of the alleged misrepresentations shared a “fundamental flaw”: a lack of materiality.

His Honour summarized the law concerning the test for materiality under the OSA, which is determined objectively from the perspective of what a reasonable investor would consider important in deciding whether to invest and at what price. The determination of materiality involves a contextual and fact-specific inquiry.

On a motion for leave to pursue a statutory cause of action, the fact that a company restated its financial statements constitutes evidence that there was a material misrepresentation. However, the absence of a restatement does not mean that leave ought not to be granted. Without evidence of a restatement, a criminal or regulatory finding, or some other type of acknowledgement by the defendants that a misrepresentation was made, the onus will be on the Plaintiff to adduce other evidence demonstrating that there is a reasonable prospect of establishing a material misrepresentation.

Expert evidence on the issue of materiality is not determinative. While the Plaintiff’s expert, a certified public accountant, was qualified to opine on materiality from an accountant’s or auditor’s perspective, the assessment of materiality under securities law is ultimately the court’s prerogative:

“Depending on the nature of the alleged misrepresentation, a court may be assisted by understanding what is material from an auditor’s point of view and what is the appropriate accounting or auditing standard, […] ultimately, it is for the court to determine what is objectively important to a reasonable investor in making his or her investment decisions”.

Justice Perell undertook a careful examination of each of the alleged misrepresentations and determined that each failed for lack of proof of materiality. In each case, the evidence of a material misrepresentation was so weak that there was no possibility of success at trial.

Receipt of a Regulatory Subpoena is Not a Material Fact

He rejected the allegation that the receipt of the SEC subpoena was a material fact that ought to have been disclosed. In general, the mere service of a subpoena does not trigger a duty to disclose: “[a]n investigation is not a conclusion about a fact.” Further, under securities law, the existence of an investigation is confidential and ought not to be disclosed absent the consent to the regulator.  Premature disclosure of an investigation may in fact be harmful and adversely affect share values.  A reasonable investor would expect the company to respond to the subpoena, cooperate with the investigator, and conduct an internal investigation and then determine whether there was a material fact to correct or a material change to report to its investors.  This is precisely what occurred.

No Misrepresentation about Internal Controls

Justice Perell held that there was no misrepresentation about the effectiveness of MDC’s internal controls. No restatement had been required by MDC’s auditors and neither the Plaintiff nor its expert identified any specific weakness in MDC’s ICFR or a material misstatement about the ICFR.  The Plaintiff and its expert sought to infer a weakness from the fact that MDC later reported that it was taking steps to improve its ICFR.  According to Perell J., this inference was backwards and did not logically follow.

No Misrepresentation About EBITDA Reporting

The evidence established that MDC did in fact disclose its exchange of correspondence with SEC about the use of the term “adjusted EBITDA”, as it was publicly filed on EDGAR. Further, MDC’s EBITDA reporting was not false or misleading because it disclosed to investors how it calculated EBITDA.  Additionally, there was no public correction with respect to the alleged adjusted EBITDA misrepresentation in the pleaded corrective disclosures or otherwise.  This necessary element of the statutory cause of action was absent from the pleading.

No Material Misrepresentation about the CEO’s Compensation

There were no false statements about the CEO’s compensation nor any corrective disclosure of it. The reimbursement expenses were at all times reflected in MDC’s financial statements.  Furthermore, the quantity and nature of these expenses were not material.  The Company disclosed that it did not expect there would be any impact to its previously issued financial statements as a result of its conclusion that certain amounts had been inappropriately reimbursed to its CEO and no restatement of the financial statements has ever been made.  The SEC did not require a restatement as a result of its investigation.

No Segments Misrepresentation

Finally, Justice Perell also found no basis for the allegation that there was a business segments misrepresentation. The alleged segment misrepresentation issue arose after the disclosures pleaded as partially corrective, and the Plaintiff had not pleaded any specific public correction with respect to the alleged segments misrepresentation.  In any event, the alleged segments misrepresentation lacked materiality.

Justice Perell concluded with respect to each of the alleged misrepresentations that having considered all of the evidence, the plaintiff’s case was “so weak that it has no reasonable possibility of success”. On that basis leave, was denied.

Key Take Aways

The decision in Paniccia is significant for a number of reasons.

It emphasizes the importance of the materiality element of the statutory cause of action for misrepresentation and provides further clarity concerning both the test for materiality and proof of materiality.  In the absence of evidence of a material misrepresentation such as a restatement of financial statements,  a criminal or regulatory finding, or an acknowledgment of a misrepresentation by the defendants, plaintiffs must adduce other evidence to establish a material misrepresentation.  Courts will carefully scrutinize expert evidence on materiality.

The decision provides welcome clarity on the absence of an obligation to disclose the mere issuance of a subpoena, relying on U.S. case law such as the decision in In re Lions Gate Entertainment Corp., 2016 U.S. Dist. LEXIS 7721 and regulator guidance such as the Ontario Securities Commission’s Guidelines for Staff Disclosure of Investigations, set out in Staff Notice 15-703.  The “general rule” is that there will be no public disclosure of information about an on-going or closed investigation.

Finally, to our knowledge, this is the first decision where leave was expressly denied in respect of a misrepresentation allegation for failure to plead a corrective disclosure. The law in Canada has been developing on this issue, in particular with the decisions of Drywall Acoustic Lathing and Insulation Local 675 Pension Fund v. SNC-Lavalin Group Inc., 2016 ONSC 5784 and Swisscanto Fondsleitung AG v. BlackBerry Ltd., 2015 ONSC 6434 which laid the groundwork for understanding the corrective disclosure element of the statutory cause of action.  Justice Perell’s reasons demonstrate that a corrective disclosure is a core element of the statutory cause of action and a plaintiff must plead his/her case in such a manner that ties a correction to an alleged misrepresentation.