A Divergence in Securities Enforcement

It may surprise some people to learn just how closely the battle between US District Court Judge Jed S. Rakoff and the US Securities and Exchange Commission over the no-contest settlement with Citigroup Global Markets was followed by Canada’s most influential market regulator.

But when it comes to enforcement, the Ontario Securities Commission usually tries to move in lockstep with – or at least not counter to – the United States to minimize the chances of jurisdictional arbitrage.

That’s what makes its decision to introduce no-contest settlements north of the border so interesting. It puts the OSC offside the trend in the United States, says Jeffrey Leon, a litigation partner at Bennett Jones LLP in Toronto.

“Ontario is saying we should allow no-contest settlements where it makes sense to do so while I have the impression US regulators are going in a whole different direction, pulling back on when and if they’ll use them because of judicial criticism and public concern.”

In Canada, as in the US, no-contest settlements have come under fire from investors and activists who allege they help corporations escape the consequences of financial misdeeds by keeping evidence of wrongdoing out of the public record and away from shareholders’ lawyers.

The OSC introduced the new regime before an appeals court eventually reversed Judge Rakoff’s decision.

It’s not as though staff was unaware of the Citigroup controversy. The regulator acknowledged it had studied the implications for Ontario of Judge Rakoff’s decision, and it even published a paper highlighting key differences between the OSC and the SEC settlement regimes.

In it, the OSC argued that settlement regimes are very different in Ontario than in the US, and the factual basis for a settlement order is more transparent to the Ontario tribunal required to approve it than it is to a US judge.

It said the province – home jurisdiction to the Toronto Stock Exchange – needs a no-admission settlement regime to speed up staff’s heavy load of investigations and prosecutions, allowing enforcement to concentrate on the most serious cases.

While the Ontario Securities Commission is just one of 13 provincial and territorial market regulators in Canada, the decision has implications for listed companies right across the country.

“It affects any company that could fall under the OSC enforcement initiative, which is potentially any company that trades on the TSX,” says Julie-Martine Loranger, a litigation partner at McCarthy Tétrault LLP in Montréal.

Loranger points out the OSC is not throwing the door open to secretive deals. Under the new system, staff will have to explicitly agree on the facts at the settlement hearing.

And the new regime stipulates that no-admission settlements will not be available to anyone who has engaged in abusive, fraudulent or criminal conduct, to any market participant who has not satisfactorily addressed investor harm, or in cases where they have misled or obstructed staff in the investigation.

Loranger sees it as a positive development for Canada.

“I’m a strong believer. I’m always making the distinction between a breach of securities regulation and fault. Sometimes you want to settle with the regulator but you’re stopped because of pending civil litigation. So if you have a chance to get rid of one headache, and move on while continuing your battle with the civil ligation, it’s a great option.

“Civil litigation is civil litigation. That’s a whole different ball game.”

Now that the OSC has introduced no-admission settlements, she says, it’s probably just a matter of time until the other provincial securities regulators follow suit. “Ontario’s is usually quite a leader, things usually start there.”

Most securities litigators agree the emergence of no-admission settlements tops most lists of key developments in enforcement in Canada.

But one prominent lawyer who spoke on condition he not be identified says something in the US proved to be a real game changer north of the border: Bernie Madoff.

He says it punctured the SEC’s almost mythical status among Canadian market participants and helped level the playing field for the Ontario Securities Commission.

“Before the Bernie Madoff debacle, the OSC was constantly being criticized about being a patsy relative to the US regulators,” he says. “The SEC was always aggressive, they were always chasing after people – even Canadians – apparently with more alacrity and success that our own regulators, and the OSC was really under pressure. The OSC was bringing cases and losing.

“The OSC won a couple of cases including a mutual-fund case where defense counsel was running around saying the OSC was going to get killed, and they started to get greater confidence. Then the US got a big finger in its eye over Madoff, where the hell was the SEC? And suddenly the OSC was breathing a sigh of relief.”

The post-Madoff honeymoon didn’t last long, however. Just before Labor Day 2014, an OSC panel handed the staff a high-profile defeat in an enforcement action involving Baffinland Iron Mines Corp.

The decision sets out important guidance for the test for insider trading in M&A negotiations but just as importantly, according to several senior securities litigators, it appears to herald a new era of restraint by the OSC commissioners who preside over many enforcement prosecutions.

> Baffinland involved insider trading and tipping allegations against two well-connected mining executives: Jowdat Waheed, a former chief executive of Sherritt International, and Bruce Walter, a friend and veteran deal maker involved in the formation of Barrick Gold in the 1980s.

Baffinland retained Waheed as a strategic consultant in the first half of 2010 to advise the CEO and board on developing its mining property. 

During that time he learned the junior miner was negotiating a potential strategic partnership with ArcelorMittal S.A. and that the negotiations were not going well.

In July, his retainer ended, he approached Walter about making a potential acquisition involving Baffinland.

They formed Nunavut Iron Ore Acquisition, acquired a toehold position in the company and, in September that same year, launched an unsolicited take-over bid. Waheed was the acquisition company’s president and chief executive, Walter its chairman.

Baffinland was eventually acquired in a joint bid by ArcelorMittal and Nunavut, and Waheed and Walter were charged with not just insider trading and tipping but also conduct contrary to the public interest.

After 43 hearing days, they were completely cleared of any wrongdoing.

Because Waheed had acquired information about the company in early 2010, but the toehold purchase wasn’t made until September of that year, the OSC panel found the information obtained during his retainer was stale.

Larry Lowenstein, a litigation partner at Osler, Hoskin & Harcourt LLP in Toronto, says the decision underscores that insider information can lose its materiality in a matter of weeks or months in a fast-paced deal environment.

“What it shows is that where change is occurring rapidly over the course of protracted business negotiations, information can quickly become out-of-date,” says Lowenstein.

“Intervening events and the passage of time can negate or diminish the importance of confidential business information. If it’s stale, it doesn’t impact the market. You’re not carrying a secret.”

Baffinland also clarified the significance of the US probability/magnitude test, he says. In the past, the OSC has used the test to find that information about a potential, significant future event is material – even if there is a low likelihood that it will occur.

The OSC panel rejected staff’s argument that the probability/magnitude test should apply, saying the market-impact test governs the OSC’s assessment of the materiality of a contingent event. “So the real question is whether disclosure of that information could reasonably be expected to have a significant effect on the market price.”

The OSC panel’s decision to clear the two men of allegations of conduct contrary to the public interest is creating a lot of buzz.

In the past, the OSC has been accused of using the public-interest jurisdiction as a net to catch behavior that cannot be caught by the Ontario Securities Act.

In Baffinland, OSC staff asked the commission to find that Waheed and Walter engaged in conduct contrary to the public interest even if they didn’t determine an actual breach of the act, says Leon.

The panel declined to do so, “which has been interpreted by securities practitioners as a refreshing restraint.

“There has been a sense within the last several years that the commission, at the urging of staff, has been finding conduct has been contrary to the public interest too easily. And there is law that shows it should be reserved for the most serious conduct that is abusive or reaches a high level of concern.

“In this case, the commission declined to do that, I think signaling for the first time that there should be restraint in how you apply this. That’s important because there should be certainty in the capital markets.”

Michael Robb, a class-action litigator with Siskinds LLP in London, Ont., says he and his partners were “somewhat surprised there were no findings against the respondents.

“This was a massive undertaking for the OSC, they invested a lot in this,” says Robb, who is lead counsel in a class action against Baffinland. “The respondents had tremendous legal teams and threw a ton of resources at it, and the OSC of course has resources that are limited by the fact it’s a public entity.

“So it was a surprise but not a total surprise because of the way the playing field tilts a little bit.”

The senior lawyer who asked not to be identified says Baffinland has put the OSC’s next few prosecutions under an enormous pressure.

“At some point, you may find people asking whether the defense Bar overmasters the staff in these cases. If that happens, you wonder whether an argument will start to be made for contracting out, for rent-a-prosecutor, whether you’ll hire [Toronto] Bay Street lawyers to prosecute these cases.”

In fact, the OSC has lined up a senior Bay Street litigator to help with its next high-profile prosecution involving Sino-Forest Corp.

> In Alberta, home to most of Canada’s oil patch companies, the securities commission staff hasn’t been having much better luck with insider-trading prosecutions.

“They’ve had a very bad run of luck enforcing insider-trading cases,” says John Blair, national head of the commercial litigation group at Borden Ladner Gervais LLP in Calgary. “There have been outright acquittals on four insider trading cases — this is what most people in Alberta are talking about in enforcement issues these days.

“The Alberta Securities Commission just hasn’t had a lot of luck at proving the cases where they’re relying on circumstantial evidence.”

The ASC has been bringing cases where trades are conducted under questionable circumstances, he says, and the panels hearing the actions are demanding proof.

“They’re going to the panels saying: ‘This trade is simply too suspicious to be anything other than illegal. And the panels are really holding their feet to the fire in proving that there’s really no other possible explanation.”

Asked whether he believes a single national regulator might have more success in enforcement prosecutions, Blair says no.

The idea of a national regulator has been kept alive even though Ottawa’s attempt to legislate one was dealt a death blow by the Supreme Court of Canada.

Four provinces are pushing ahead with a plan to voluntarily adopt a uniform securities Act.

Ontario, British Columbia, Saskatchewan and New Brunswick have committed to joining Ottawa’s Co-operative Capital Markets Regulatory System, which will be opening an office in late 2015, and they are working on other provinces to come in as well.

Those four provinces alone represent about three quarters of Canadian listed companies and about 53 per cent of total market capitalization.

Alberta and Québec are two notable holdouts.

> Blair, who’s based in Calgary, says while some people may view Canada’s system of 13 separate provincial and territorial regulators as quaint in a globalizing world, it works well.

“Provincial regulators, if anything, are actually very motivated to keep an eye on enforcement because, if they don’t, they lend credence to the movement that there should be a single national regulator,” he says.

“Alberta regulators are very conscious there are issues unique to Alberta and that they need to be very vigilant or risk adding fuel to the argument there should be a single regulator looking at everything.”

In Montréal, Julie-Martine Loranger holds much the same view.

“I think it’s more efficient like this, especially in Québec where AMF [Autorité des marchés financiers] is really on top of its game. They are sophisticated, they’re good. I don’t see how it could be better done. And I’m afraid if they’re not right here, they wouldn’t be as effective.”


Sandra Rubin is a Toronto-based legal-affairs writer.