Large and generous interpretation of “investment contract” and “distribution” under the Quebec Securities Act: AMF v. Desmarais, 2019 QCCA 898

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.

Imposition of OSC Sanctions Following a Conviction for an Offence Relating to Securities: The Availability of Carve-Outs in the Public Interest

In Theroux (Re), 2019 ONSEC 20 a hearing panel of the Ontario Securities Commission (OSC) was called upon to decide whether an individual convicted of five counts of fraud over $5,000 contrary to section 380(1)(a) of the Criminal Code should have the benefit of carve-outs from an order under section 127(10) of the Ontario Securities Act (Act) which would otherwise prohibit him from trading in securities and from being an officer or director of any company permanently.


Alain Theroux had pleaded guilty in the Ontario Court of Justice to five counts of fraud over $5,000. Theroux admitted that he had solicited and accepted funds from investors in excess of $1 million reflecting their investments in bonds, promissory notes and bridge financing marketed in respect of a biofuel venture with a company with which Theroux was associated.  Substantial portions of the funds raised were diverted to Theroux’s personal use or to pay other investors and were not invested in the biofuel market.

At a subsequent hearing before the hearing panel of the OSC under section 127(10) of the Act, the fraudulent investments were found to constitute securities under the Act, thereby giving the hearing panel jurisdiction to impose sanctions upon Theroux in addition to the sentence imposed under the Criminal Code of 12 months’ incarceration, two years’ probation, restitution in the amount of $170,800 and a fine in lieu of forfeiture in the amount of $75,000 to be paid within 15 years of his release from prison.

Sanction Carve-Outs

Theroux requested two carve-outs from the sanctions requested by OSC Staff, which included a permanent prohibition on his ability to trade securities and on his ability to act as an officer or director of any company.

He sought to retain the ability to trade securities in certain types of accounts to provide him with the ability to accumulate investment savings and increase the likelihood that he would satisfy the restitution order made under the Criminal Code. The hearing panel agreed that it was in the public interest to permit him to trade in securities or derivatives in a registered retirement savings plan, registered education savings plan, in any registered retirement income fund, and/or a tax-free savings account in which he has a beneficial interest, provided that any trades are carried out through a registered dealer.

However, his request that he be permitted to return to his role as a director of his private company at the end of his term of parole was denied, notwithstanding Theroux’s submission that the company was not involved in the public markets.  The concern was that the company could still be used to raise capital or market investment contracts through the exempt market, like the enterprise involved in the fraud that he had committed.  On that basis, it was not in the public interest to make that carve-out from the permanent prohibition on him acting as an officer or director of any company.

This decision is consistent with prior decisions of the OSC relating to requests for carve-outs from sanctions.  The granting of such carve-outs is not automatic, and must be justified on the basis that they are in the public interest.

Harrington v IIROC: No Equitable Duty Owed by Public Sector Regulators to Disclose Information to Victims of Wrongdoing

On December 31, 2018, the Ontario Superior Court of Justice dismissed an application by Harrington Global Opportunities Fund (Harrington) for a Norwich order against the Investment Industry Regulatory Organization of Canada (IIROC). Harrington sought the order to compel IIROC to provide information that would identify parties which had allegedly been involved in manipulating the market price of shares of a reporting issuer, to permit it to determine the viability of a civil action against them.

Justice Perell’s decision highlights the fact that the issuance of a Norwich order is “a rarely exercised extraordinary discretion”.  “[T]he protection of privileges and confidences and the interests of the innocent target of the order”, in this case a securities regulator operating under the public law regime, are “powerful forces” against the issuance of such an order.

This decision sends a clear message that applications for a Norwich order against other regulatory bodies operating in the public law sector will likely be an uphill battle.


Between 2016 and 2018, Concordia International Corp. (Concordia) experienced a significant drop in share price, resulting in a loss of approximately $3.9 billion dollars of its market capitalization. Harrington, a sophisticated investor, believed that Concordia was a victim of a short-selling conspiracy involving a group of traders using social and mainstream media to disseminate misleading information designed to manipulate the market. In order to pursue a conspiracy claim against the alleged conspirators, Harrington applied for a Norwich order to compel IIROC to disclose certain identifying information about the suspected conspirators and certain trade reports generated by IIROC from data provided by investment dealers and trading venues. Investigations by IIROC into the alleged wrongdoing had led it to conclude that no manipulation had occurred.

The Decision

The court dismissed Harrington’s application.  While Justice Perell agreed that Harrington appeared to have a valid cause of action for unlawful means conspiracy, it did not satisfy any of the remaining criteria for a Norwich order.  In particular:

  1. Harrington failed to satisfy “perhaps the most important criterion for a Norwich order”, the existence of a connection or relationship between the target of the order (IIROC) and the wrongdoer or the wrongdoing. The issue was whether or not IIROC, operating in the public law sector, ought to have a duty to disclose trading information to an investor thinking of bringing a private law tort claim.

Justice Perell determined that it did not.  IIROC did not have a relationship with wrongdoing or wrongdoers in the industry that it regulates that would impose a duty upon it in equity to disclose information to victims of the alleged wrongdoing. Further, how IIROC carried out its obligation to investigate potential misconduct, and what information to disclose before, during or after its investigation was for IIROC to decide.

  1. The necessity requirement was not satisfied. Harrington already had a prospective action for civil conspiracy against a particular short seller and others that it believed may have conspired to short and distort the sale of Concordia shares.
  2. Balancing the interests of IIROC against the interests of Harrington tipped the balance against granting the order. IIROC’s duties of keeping confidences and protecting privacy interests, and its interest in maintaining its relationship with other regulators such as FINRA, stood against making the order. FINRA would be less likely to share client and broker data with IIROC in the future if IIROC could be required to disclose such data.
  3. The interests of justice did not favour the granting of the Norwich


  • Norwich orders are intrusive and should only be granted in extraordinary situations. It is not a means to search out and investigate speculative actions; and
  • In general, regulators like IIROC are under no equitable duty to disclose information to parties interested in pursuing a private law remedy against suspected wrongdoers under its jurisdiction.

The authors would like to thank Travis Bertrand, Articling Student, for his contribution to this article.

MFDA Annual Enforcement Report: Trends in Mutual Fund Dealer Regulation

The Mutual Fund Dealers Association of Canada (MFDA) recently published its 2018 Annual Enforcement Report (the Report), highlighting key enforcement activities and developments over the past year.

The MFDA commenced 136 enforcement proceedings in 2018 by Notice of Hearing or Notice of Settlement Hearing, a record number for the self-regulatory organization (SRO). The SRO attributes the record number, in part, to enhanced detection and reporting by its mutual fund dealer members (the Members). The Report highlighted the following trends:

Primary sources of cases to be assessed. Roughly 65% of the cases opened in 2018 stemmed from the MFDA’s Member Event Tracking System, through which Members can file event reports. The only other significant source of complaints (28%) was the general public. There were 50% less case openings prompted by event reports from the MFDA Compliance Department between 2017 and 2018 (from 16 to 8). Conversely, there was a marked uptick in complaints brought by the Canadian Securities Administrators and other regulators compared to last year (from 1 to 11).

Primary allegations. The top five alleged violations of MFDA Rules, By-Laws, or Policies in 2018 were the following: (1) pre-signed forms; (2) unauthorized commissions and fees; (3) unsuitable investments; (4) breaches of the MFDA Rule 2.1.1(b) business standards; and (5) unauthorized or discretionary trading without client approval. Compared to last year’s figures, allegations related to unauthorized commissions and fees more than doubled.  Allegations tied to the falsification of documents/misrepresentations and outside activities decreased by more than 50%.

Hearing types and penalties. Of the 132 hearings concluded by the Enforcement Department in 2018, almost 75% were settlement hearings (as opposed to contested or uncontested hearings).  41 hearings resulted in suspensions, 19 in permanent prohibitions, and 5 in educational course requirements. Further, the MFDA Hearing Panels imposed over $6M in fines, down from $8.5M in 2017 and $21.1M in 2016.

Expanded evidentiary powers.  In 2018, the MFDA was granted enhanced evidence gathering powers in three unidentified provinces which provide the SRO with the ability to compel evidence and cooperation from non-registrants.

New sanction guidelines. November 2018 also saw the introduction of the new MFDA Sanction Guidelines, which replaced the MFDA Penalty Guidelines that had been in place for over a decade. The Sanction Guidelines, in part, provide a framework for disciplinary actions, settlement negotiations, and determining appropriate sanctions.

Supervisory obligations. In 2018, 11 proceedings were concluded against Members and supervisors for failing to properly carry out a reasonable supervisory investigation. Members must track and monitor information that they receive, both internally and externally, pertaining to potential breaches of Member requirements and to take reasonable supervisory action in response to such reports.

Looking forward, the MFDA has explicitly cited sales incentive practices as a key enforcement area that it will continue to investigate in 2019. The MFDA is targeting any sales incentive practices that: (i) may impact product sales to clients; (ii) could engender conflicts of interest; and (iii) do not comply with National Instrument 81-105, Mutual Funds Sales Practices.

The author would like to thank Sarah Pennington, Articling Student, for her contribution to this article.

US Second Circuit rules Issuer’s statements concerning regulatory compliance too generic to constitute material misstatements

On March 5, 2019, the United States Court of Appeal for the Second Circuit affirmed the dismissal of a class action claim alleging securities fraud based on purportedly misleading statements made by an Issuer regarding its regulatory compliance efforts. The Second Circuit concluded that the Issuer’s statements were too generic to cause a reasonable investor to rely on them, and rejected the claim as a “creative attempt to recast corporate mismanagement as securities fraud.” Singh v. Cigna Corp., No. 17-3484-cv, 2019 U.S. App. LEXIS 6637 (2d Cir. Mar. 5, 2019).


In early 2012, Cigna Corporation (Cigna or the Company), a health services organization, acquired a regional Medicare insurer, which subjected the Company to strict Medicare regulatory responsibilities. Between 2014 and 2015, Cigna issued several public statements addressing the regulations, including disclosure that it had “established policies and procedures to comply with applicable requirements” and that the Company “expect[ed] to continue to allocate significant resources” towards compliance. Cigna also published a ‘Code of Ethics and Principles of Conduct’ pamphlet (Code of Ethics) affirming the importance of compliance and integrity to the Company. During this same period, however, Cigna received multiple notices from the Centers for Medicare and Medicaid Services (CMS) for a variety of compliance infractions. On January 21, 2016, CMS informed Cigna it would face sanctions for failing to comply with CMS requirements, causing the Company’s stock to fall substantially. Following this drop, a Cigna investor brought a putative class action suit against the Company, claiming that Cigna’s statements regarding its Medicare compliance were materially misleading, constituting fraud under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities and Exchange Commission (SEC) Rule 10b-5.

The Ruling:

The Second Circuit held that the District Court properly dismissed the claim on the basis that the plaintiffs failed to plausibly allege that there was a material misrepresentation (or omission) under Section 10(b) and Rule 10b-5. An alleged misrepresentation is material only if “there is substantial likelihood that a reasonable person would consider it important in deciding whether to buy or sell shares of stock.” According to the Court, neither Cigna’s Code of Ethics nor its public statements created such reliance.

The Court stated that Cigna’s Code of Ethics was a “textbook example of ‘puffery’,” rendering the statements inactionable. Similarly, Cigna’s generic assertions about its policies and procedures and intention to allocate resources towards compliance would not cause a reasonable investor to view the statements as “alter[ing] the total mix of information made available.” All of the Company’s public statements were also followed by acknowledgments of the complex and evolving nature of the regulatory environment. This lead the Court to conclude that the disclosure actually expressed Cigna’s uncertainty as to its ability to adequately comply with Medicare’s regulatory requirements, rather than suggesting accurate compliance. The Company’s statements, therefore, could not be considered materially misleading.


There has been  an uptick in recent years of securities class actions based on corporations’ more general public statements regarding regulatory compliance, as compared to traditional actions which were solely focussed on allegedly misleading financial and accounting disclosure. However, as Singh demonstrates, at least some courts appear to be discouraging this trend. The decision in Singh should offer comfort that corporations’ generic statements about compliance policies and procedures cannot necessarily be recast as specific misrepresentations. Furthermore, the decision supports the notion that corporate mismanagement should not, by itself, give rise to a securities misrepresentation claim.


The author would like to thank Abigail Court, Student-At-Law, for her contribution to this article. 

Not ready yet: OSC rejects bitcoin fund prospectus

On February 15, 2019, the Ontario Securities Commission issued a decision in which it refused to issue a receipt for a prospectus filing made by 3iQ Corp. (3iQ) in respect of The Bitcoin Fund (the Fund).  The decision highlights the challenges faced by issuers seeking to do business in cryptocurrency markets, which regulators continue to view as highly problematic.


3iQ designed the Fund as a non-redeemable investment fund (NRIF) that would expose investors to bitcoin and daily price movements of bitcoin relative to the US dollar.  3iQ filed a non-offering prospectus on behalf of the Fund in order to resolve the concerns of the OSC in advance of issuing units in the Fund.  It intended to convert and refile its prospectus as an offering prospectus to raise proceeds if and when those issues were resolved.

The prospectus indicated that the Fund would appoint Cidel Trust Company to act as custodian of the assets of the fund. However, as Cidel did not have the capacity to hold bitcoin on behalf of the Fund, it would appoint a sub-custodian.

Position of OSC staff

OSC staff submitted that it was simply too early for bitcoin to be considered an appropriate asset for an investment fund available to the public. Staff expressed concern about the gaps between regulatory regimes in other jurisdictions and the high potential for abuse in a cryptocurrency market that is still very difficult to monitor.  Staff also expressed concern about the fact the Fund had not yet received from any sub-custodian a copy of a customary Service Organizational Control (SOC) audit report and submitted that it would be very unusual to rely on a custodian that could not provide such a report on request.

Notably, staff argued that the Fund had not taken sufficient steps to protect investors against the risk of loss of bitcoin, such as by obtaining insurance. Staff also took the position that the prospectus was not compliant with NI 81-102, which limits a NRIF to investing no more than 20% of its net asset value in illiquid assets.  Staff took the position that bitcoin is an illiquid asset, because it is not traded on market facilities on which public quotations in common use are widely available.

Fund manager responses

Among other things, 3iQ argued that Canadian investors are already able to gain exposure to bitcoin through: (i) the securities of issuers holding cryptoassets that went public via reverse takeovers (ii) unregulated exchanges; and (iii) ATMs. Compared to those alternatives, the Fund would be a safer way to invest in cryptoassets with the benefit of the expertise of a professional portfolio manager.  It also argued that it would be able to perform diligence to establish the source of the bitcoin acquired by the Fund to minimize exposure to fraud or other illicit activities.  3iQ also disputed that bitcoin is illiquid with trading volume evidence.

OSC refuses receipt in the public interest

The OSC founded its decision on a concern about the lack of established regulation for the bitcoin market, which raises investor protection issues. In deciding whether it is contrary to the public interest to issue a receipt for the Fund’s prospectus, the OSC is required to consider whether fund operational risks are adequately managed by measures other than providing disclosure of such risks to investors.  It therefore focused its review on operational concerns.

The OSC expressed concern about accurate valuation due to the fragmented and unregulated bitcoin market. Despite the fact that 3iQ had taken steps to ensure reliable, reputable sources of valuation information, the OSC accepted staff’s submission that trading on less reputable platforms can impact pricing on more reputable platforms.  This exposure differentiates bitcoin assets from conventional investments assets.

While the OSC acknowledged that SOC reports are not normally required by staff for publicly-offered investment funds, it stated that “bitcoin is a novel digital asset that requires novel custodial arrangements”. It found that, without customary SOC reports or insurance to protect against the risk of loss of bitcoin held in cold storage, an investment in the Fund presents a novel risk that is unacceptable for a prospectus qualified fund offering.

The OSC also found that bitcoin is an illiquid asset, and as a result, 3iQ’s prospectus was not compliant with NI 81-102.

Decision expresses regulatory unease about cryptoassets

The OSC’s decision makes clear that cryptoassets are still a long way from being considered trustworthy asset classes.

It also emphasizes the unease created by the recent death of Quadriga’s founder Gerald Cotton and related inaccessibility of nearly USD $150 million in cryptoassets. The OSC’s concerns regarding financial reporting and insurance for coins in cold storage appear to be focused at least in part on making sure that the peculiar circumstances that led to the Quadriga situation are not repeated.


The author would like to thank William Chalmers, Articling Student, for his contribution to this article.

Alberta Securities Commission Declines to Stay Enforcement Proceedings In Face of Parallel Class Actions

In February 2019, the Alberta Securities Commission (ASC) declined to stay the hearing of pending ASC enforcement proceedings on the basis of the existence of parallel, pending class action proceedings.


In June 2018, Staff of the ASC issued a notice of hearing against Alberta divisions of the Lutheran Church-Canada and several of their former officers and directors (the Respondents), alleging that the Respondents had made misrepresentations contrary to s. 92(4.1) of the Alberta Securities Act (material misleading statements) in connection with securities offered to members of the Lutheran Church.

The allegations followed the financial collapse of Church divisions in 2015 and ensuing proceedings filed under the Companies’ Creditors Arrangement Act.  The Respondents and other parties had also been sued in four class action proceedings commenced in British Columbia and Alberta.  The factual allegations supporting the class actions were similar but not identical to those supporting the ASC proceeding.  The causes of action asserted in the class actions (including breach of trust, breach of fiduciary duty, negligence, breach of contract and oppression) were different than the allegation of contravention of s. 92(4.1).

Applications for a Stay

The allegations of ASC staff were scheduled to be heard on their merits in May 2019.  In October 2018, the Respondents and some of the other defendants in the class actions filed a motion to stay the ASC proceedings pending final resolution of the Alberta class actions.  Subsequently, an additional group of defendants filed an application seeking a stay pending final resolution of all of the class actions.


The first issue to be determined was the standing of the various parties who were not named in the ASC proceeding.

As a matter of procedure, the panel determined it appropriate to hear submissions regarding standing and the merits of the stay application at the same time because no particular efficiencies would have been gained through bifurcation.  This is a matter of discretion.

Regarding standing, the panel considered the factors enumerated under ASC Rule 15-501, s. 6.1[1], which the panel saw as a codification of common law principles applicable to questions of standing.  The panel was also mindful of “flood gates” concerns raised by Staff regarding strangers to a proceeding being permitted to participate.  Ultimately, the panel concluded that certain applicants were not seeking to tender evidence or make submissions that was substantially different than that of the Respondents.[2]  They were denied standing.  On the other hand, standing was granted to one group of applicants who “presented a different perspective and made different submissions”.

Stay Denied

The panel noted that given its public interest mandate, for the panel to exercise its discretion to grant a stay there must be exceptional and extraordinary circumstances involving irreparable harm that outweighs the public interest in seeing the ASC proceeding concluded.  The evidence of irreparable harm must be clear and not speculative, and the harm must be to the applicant.

The panel emphasized that the fact of parallel legal proceedings is not sufficient to establish irreparable harm.  “ASC proceedings are often preceded or followed by criminal prosecutions, civil suits – including class actions – or both.”  Fears of making inconsistent statements, of having one’s statements in one proceeding used in another, or of inconsistent rulings, are speculative and insufficient.  The panel emphasised that “no matter how broadly a notice of hearing is framed, the ASC can only make findings against those who are named respondents, and only for the contraventions specifically alleged and proved by evidence on a balance of probabilities.”  Further, the trial judges in the class actions were capable of addressing evidentiary issues and ensuring fairness in those proceedings.

The panel also rejected the argument that a stay was warranted because the Respondents could only obtain the evidence necessary to defend the allegations made by ASC staff through the discovery process in the class actions.  The argument was speculative and begged the question as to what the Respondents would do if the ASC proceeding was the only outstanding proceeding.

The panel further concluded that the balance of convenience weighed in favour of the public interest in having the ASC proceeding be determined without delay.  The ASC’s public interest mandate to protect investors and foster a fair and efficient capital market “involves the entire market, and extends beyond the interest of a single group  or even several groups – of specific investors”.  Effective enforcement requires timeliness, efficiency and finality.

While not a surprise, this result highlights the challenges facing companies, directors and officers facing concurrent regulatory and class action proceedings arising out of the same matter.  Formerly, the ASC did not permit no-contest settlements of enforcement actions.  Effective May 4, 2018, the ASC decided that it would entertain no-contest settlement agreements in appropriate circumstances.   For more information on this, please go to:


[1] Non-Parties Seeking to Appear before a Panel.

[2] Citing Re Certain Directors, Officers & Insiders of Hollinger Inc., 2005 LNONOSC 858 at para. 48.


Ontario Securities Commission awards whistleblowers $7.5 million in first ever payout

On July 14, 2016, the Ontario Securities Commission (OSC) launched the Whistleblower Program (the Program). Under the Program, individuals that provide information on violations of Ontario’s securities law to the OSC are eligible for awards of between 5% and 15% of total monetary sanctions or voluntary payments. The maximum amount a whistleblower can collect is $1.5 million when sanctions and/or payments are not collected and $5 million when sanctions and/or payments are collected. By June 2018, the Program had generated 200 tips. Tips may be submitted anonymously through counsel and the OSC makes all reasonable efforts to protect the identity of the whistleblowers.

On February 27, 2019, the OSC announced the first payout under the Program, making it the first ever award by a Canadian securities regulator. A total of $7.5 million was paid out to three whistleblowers in separate matters for voluntarily providing high-quality, timely, specific and credible information that resulted in monetary payments to the OSC. In order to protect the whistleblowers’ identities and preserve confidentiality, further information regarding the whistleblowers was not released.

The Program initially drew some criticism because of the cap on potential payouts and its impact on the quality of tips that would be received. By comparison, the U.S. Securities and Exchange Commission’s (SEC) Whistleblower Program, which launched in 2011, has no cap on payouts, and awards range between 10% and 30% of the money collected as a result of the information. In 2018, the SEC awarded more than $168 million in awards to 13 whistleblowers. In addition, the SEC made two of its largest whistleblower awards totalling $83 million shared by three whistleblowers and $54 million shared by two whistleblowers.

Nonetheless, the Program is a step in the right direction for the OSC to attract credible tips. The size of the OSC’s first ever payout under the Program not only indicates the significance of the information provided by the whistleblowers, but also emphasizes the crucial role that whistleblowers play in protecting investors from improper and fraudulent practices.

The author would like to thank Sadaf Samim, Articling Student, for her contribution to this article.

Re Meharchand: An affirmation of fundamental securities law principles

On October 19, 2018, the Ontario Securities Commission (OSC) issued reasons for Re Meharchand, a case confirming core concepts in securities law including the definition of an “investment contract”, registration when in the business of selling securities, and the test for fraud.


The respondents, Mr. Meharchand and his company, Valt.X were in the business of cybersecurity. Valt.X purportedly developed, produced and sold cybersecurity hardware and software products. However, over the relevant time, Valt.X had very little sales ($15,000 relative to 1,600,000 contributed by investors). OSC Staff (Staff) brought an enforcement action alleging that Valt.X and Mr. Meharchand had distributed securities without a prospectus, engaged in the business of trading in securities without registering and committed fraud.

The Decision

The hearing panel determined that the respondents breached the Securities Act (Act) in all three respects as alleged by the Staff.

Distribution without Prospectus

The hearing panel found that the respondents raised funds through a program called “CrowdBuy”. Under the CrowdBuy program, the respondents represented that participants could purchase Valt.X software licences at a discount and, through the resale of those licenses, earn lucrative “guaranteed results”. Participants were also offered an option to convert their CrowdBuy subscriptions into Valt.X common shares.

In determining whether the CrowdBuy program was a security by virtue of being an “investment contract”, the panel applied the test as set out in Pacific Coast. In that case, the Supreme Court of Canada held that an investment contract involves an investment of funds with a view to profit, in a common enterprise, where the profit is largely derived from the efforts of the person who controls the enterprise. The panel found that the CrowdBuy program met all the necessary criteria of an investment contract thereby making it a security.

As a result, the hearing panel found that the distribution of these investment contracts without a prospectus or an available exemption was a contravention of the Act.

No Registration

Section 25 of the Act prohibits engaging in the business of trading in securities unless the person is registered under Ontario securities law. The OSC hearing panel found that the respondents maintained a website in which investors could pay for their Valt.X shares, actively encouraged existing investors to refer new investors, and distributed materials promoting exaggerated potential earnings. During the material time virtually all of Valt.X’s business was to trade in securities. Since the respondents were not registered, this amounted to a contravention of the Act.


The hearing panel noted that Mr. Meharchand informed his investors that he would use the funds that he raised for patents, research and development, product manufacturing, and additional staff. However, the panel found these statements misleading as the bank accounts provided little evidence that the funds were being put to any real commercial activity. The panel found Mr. Meharchand had defrauded investors and characterized Mr. Meharchand’s use of the funds as follows: “withdrawals of money for betting on horses, cash transactions for which no record was kept, the satisfaction of alleged debts to Mr. Meharchand, and other payments to him in priority to other Valt.X debt or expenses.”


At the sanctions hearing, the OSC ordered Mr. Meharchand and Valt.X to disgorge approximately $1.6 million to the Commission. In addition, Mr. Meharchand was permanently banned from serving as an officer or director for any issuer or registrant and was required to pay an administrative penalty of $550,000.

This proceeding serves as a reminder that substance prevails over form. Regulators will sniff out investments contracts in disguise and impose significant penalties for market participants trading in securities contrary to securities law.

The author would like to thank William Chalmers, Articling Student, for his contribution to this article.

US Tenth Circuit holds SEC can apply antifraud provisions extraterritorially in certain situations

One trend running through recent U.S. Supreme Court decisions is a sense of caution in expanding the scope of U.S. law to extraterritorial activities.  To that end, the Court has instructed that a statute does not apply extraterritorially unless the text clearly shows the U.S. Congress intended such a result.  Notably, the Tenth Circuit recently held that Congress has authorized the SEC to enforce the securities fraud laws extraterritorially in certain circumstances.  Foreign actors should take note of this potential expansion of the SEC’s enforcement powers.

One of the cornerstones — if not the cornerstone — in the Supreme Court’s modern extraterritorial jurisprudence is the 2010 decision in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), where it held that Section 10(b) of the Securities Exchange Act (and Rule 10b-5 promulgated thereunder) did not apply extraterritorially.  See 561 U.S. 247 (2010).  However, in SEC v. Scoville, No. 17-4059 (10th Cir. Jan. 24, 2019), the Tenth Circuit held that with respect to SEC enforcement actions, the antifraud provisions of the securities laws apply extraterritorially “when either significant steps are taken in the United States to further a violation of those anti-fraud provisions or conduct outside the United States has a foreseeable substantial effect within the United Sates.”  Here we harmonize these two significant decisions.

The U.S. Supreme Court’s Morrison Decision

Section 10(b) is used to challenge material misstatements and omissions made in connection with the purchase or sale of securities.  In Morrison — a private securities fraud action — the Court first held that the statutory text of these antifraud provisions do not apply extraterritorially.  The Court next examined whether the activity at issue — the purchase of securities of a foreign issuer by foreign persons on a foreign exchange—fell within the “focus” of Section 10(b).  Plaintiffs argued that because the misstatements at issue arose from the activities of the defendant issuer’s Florida subsidiary and public statements made in Florida, they were seeking a domestic application of the statute that fell within the statute’s focus.  The Court disagreed and held that “the focus of the Exchange Act is not upon the place where the deception originated, but upon purchases and sales of securities in the United States.”  Accordingly, Section 10(b) would only apply to “transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which § 10(b) applies.”  As the late Justice Scalia stated for the Court: “For it is a rare case of prohibited extraterritorial application that lacks all contact with the territory of the United States.  But the presumption against extraterritorial application would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case.”

The Tenth Circuit’s Decision in Scoville

In Scoville, the United States Court of Appeals for the Tenth Circuit had the opportunity to examine the extraterritorial application of Section 10(b) (and Sections 17(a)(1) and (a)(3) of the Securities Act of 1933) in a SEC enforcement action.  The Tenth Circuit held that the 2010 Dodd-Frank Act Amendments to the jurisdictional sections of the antifraud provisions makes clear in that context “that the antifraud provisions apply when either significant steps are taken in the United States to further a violation of those antifraud provisions or conduct outside the United States has a foreseeable substantial effect within the United States.”  The court based its conclusion on the text of the 2010 Dodd-Frank Act, where Congress amended the 1933 and 1934 securities acts to state the following:

The district courts of the United States and the United States courts of any Territory shall have jurisdiction of an action or proceeding brought or instituted by the Commission or the United States alleging a violation of section 77q(a) of this title [Section 17(a) of the 1933 Securities Act] involving—

(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or

(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.

15 U.S.C. § 77v(c) (bracketed material added); see also id. § 78aa(b) (amended 1934 Securities Exchange Act providing federal district courts with “jurisdiction of an action or proceeding brought or instituted by the [SEC] or the United States alleging a violation of the antifraud provisions of this chapter involving–(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States”).

In so deciding, the Tenth Circuit addressed why the Dodd-Frank Amendments addressed extraterritoriality in the jurisdictional provision of the securities fraud statutes, and not in the substantive/merits section.  It first noted that “Morrison . . . , contrary to forty years of circuit-level law, held that the question of the extraterritorial reach of § 10(b) did not implicate a court’s subject-matter jurisdiction; instead, other provisions of the securities acts gave district courts subject-matter jurisdiction to hear SEC enforcement actions generally.”  Nevertheless, the Tenth Circuit held that “it is clear to us that Congress undoubtedly intended that the substantive anti-fraud provisions should apply extraterritorially when the statutory conduct-and-effects test is satisfied” because, among other items, the Supreme Court issued the Morrison opinion on the final day that a joint congressional committee considered the proposed Dodd-Frank Act, that committee published the final version of the bill several days later, it was enacted into law less than a month after Morrison, and Congress titled this section of the Dodd-Frank Act “STRENGTHENING ENFORCEMENT BY THE COMMISSION.”

After adopting the conduct-and-effects test, the Court had no qualms affirming the district court’s decision that the SEC could enforce the anti-fraud provisions in this instance.  Scoville involved sales of revenue interests called AdPacks in a business called Traffic Monsoon that would ostensibly boost web traffic in order to rank websites higher on search engine results, but which allegedly operated as a Ponzi scheme.  Even though some sales of, and offers to sell, the AdPacks were made to persons outside the United States, the defendant conceived and created Traffic Monsoon in the United States, he created and promoted the Adpack instruments over the internet while residing in Utah, and the servers housing the Traffic Monsoon website were physically located in the United States.


As Judge Briscoe noted in her concurring opinion, the court could just as easily have decided that this case involved the offer and sale of securities in the United States without addressing extraterritoriality issues.  Traffic Monsoon was based in the United States, operated in the United States, and sold the AdPacks through computer servers based solely in the United States.  However, in cases where foreign/domestic issues are a closer call, the SEC can be expected to rely heavily on the statutory conduct-and-effects test to flex its enforcement power.  In the meantime, Morrison will continue to apply to private securities fraud actions.