Brave New World: Recent Trends in Enforcement at the OSC

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1 TAB 9 SECURITIES LAW UPDATE 2014 Brave New World: Recent Trends in Enforcement at the OSC Linda Fuerst Lenczner Slaght Royce Smith Griffin LLP November 6, 2014

2 BRAVE NEW WORLD: RECENT TRENDS IN ENFORCEMENT AT THE OSC Linda L. Fuerst A number of recent decisions of the Ontario Securities Commission do not bode well for respondents. The power to compel testimony pursuant to a s. 11 order is now permitted before, during and after s. 127 proceedings. The privilege against self-incrimination does not preclude Staff from reading in a respondent's compelled testimony for the purpose of proving Staffs case against that individual. Finally, the utility of reliance upon legal advice as a defence or mitigating factor appears to have been significantly circumscribed. Use of Section 11 Staff of the Ontario Securities Commission ("OSC") have typically obtained s. 11 orders and issued Summonses to compel documents and evidence for the purpose of determining whether proceedings against a person or company for breach of securities law should be initiated. Recent developments suggest that that may be changing. In Re Boock (2010), 33 OSCB 1589 the OSC decided inter alia, that Staff may compel evidence from a respondent even after the issuance of a notice of hearing or statement of allegations provided the testimony and evidence is compelled "bona fide for the purpose of further investigation and not for an improper purpose". 1 According to the Commission:... the authority of Staff to investigate under a section 11 order does not end when an adjudicative proceeding is commenced. There are many legitimate reasons why an active investigation may continue after the issue of a notice of hearing or a statement of allegations. The Commission stated in Re X and A Co. that "there is no indication in the Act that a notice of hearing in any way changes Staff's ability to exercise its power under an order made pursuant to section 11 of the Act". Similarly, the Court stated in Johnson v. British Columbia (Securities Commission), [1999] B.C.J. No. 552 ("Johnson S.C.") that "the probable purpose of the further interviews is to obtain further information which may be used against Johnson at the Hearing itself. However, this would appear to be a permissible purpose under the reasoning in Branch" (Johnson S.C., supra, at para. 122). The Court in Alberta (Executive Director of Securities Commission) v. Brost, [2008} A.J. No. 250 ("Brost Q.B. ")made a similar point: I am not persuaded that Brost should not attend the interview because a hearing has been scheduled. Branch demonstrates that securities regulators are subject to much less stringent procedural safeguards than criminal laws and that compelling personal attendance for investigation purposes is not constitutionally objectionable. (Brost Q.B. at para. 30) 2 In that case, the collection of evidence from a respondent pursuant to section 11 for use at a hearing against him that had already been commenced was not considered to be for an improper purpose, as "a principal purpose of compelled testimony is to permit Staff to obtain 9-1

3 - 2 - relevant documents and evidence for use at a hearing". 3 Continuing to compel testimony and evidence from a respondent for the bona fide purpose of further investigation was permitted. The Commission suggested that the only instance in which resort to powers of compulsion under section 11 would be considered improper is where the powers are used to compel testimony and evidence for the predominant purpose of incriminating the witness, meaning to implicate him in a crime or a quasi-criminal offence with penal consequences, consistent with the decisions of the Supreme Court of Canada in British Columbia Securities Commission v. Branch, [1995] 2 S.C.R. 3 ("Branch") and R. v. Jarvis, [2002] 3 S.C.R. 757 ("Jarvis"). 4 The Commission's subsequent decision in Re Waheed (2013), 36 OSCB 1071 only muddies the waters. In that case, after the issuance of a notice of hearing, the respondents, who were alleged to have engaged in insider trading, notified Staff that they were relying upon a defence of legal advice and intended to call two lawyers as witnesses at the hearing. Shortly before the commencement of the hearing under s. 127, Staff served section 13 summonses upon the lawyers. Notwithstanding the Commission's findings in Re Boock that a principal purpose of compelled testimony is to obtain evidence for use at a hearing, the Commission quashed the summonses on the basis that their purpose was not truly "investigatory" in nature but rather intended to aid Staff in their preparation for the upcoming merits hearing: I accept that Staff's investigation in this matter may be ongoing and that there is no legal barrier to the investigation continuing. However, for Staff to be permitted to proceed with a compelled examination at this later stage in the processing, it is not sufficient for Staff to merely assert that the examinations are for the purpose of an ongoing investigation. In my view, Staff is attempting to exercise its investigative authority on the eve of the Merits Hearing in order to examine witnesses who will be testifying on behalf of the Respondents and I find that such an exercise of its investigative authority is inappropriate. 5 *** As noted above, the procedure in investigations by Staff is separate from the procedure to be followed by parties to an adjudicative proceeding before the Commission. Rule 4.5 of the Rules requires that witness lists and summaries of the evidence witnesses are expected to give at the hearing be disclosed at least 10 days before the commencement of the hearing. If, as the Respondents have indicated, they intend to call [lawyers] Gula and Harris as witnesses at the Merits Hearing, they will be required to comply with Rule 4.5 of the Rules. Staff's opportunity to test the nature, extent and strength of any evidence Gula and Harris provide will be through cross-examination at the Merits Hearing. 6 Although not clearly articulated, this case suggests that resort to s. 11 powers of compulsion on the eve of a hearing to assist Staff in preparing for cross-examination of a respondent's witness at the hearing may constitute an "improper purpose", notwithstanding that 9-2

4 - 3 - compelling the respondent to provide evidence to be used against him by Staff at a pending hearing was considered permissible in Boock. Staffs ability to resort to section 11 was considered again in the recent decision in Re Crown Hill Corporation (20 14 ), 3 7 OSCB In that case Staff sought and obtained a section 11 order after the Commission had rendered a decision in the merits following a hearing against the respondent in which it was determined that he had breached the Act and acted contrary to the public interest, but prior to a decision concerning sanctions and costs. The section 11 order was issued on the basis that there was evidence that the Respondent had transferred asserts out of his name and out of Canada. Presumably Staffs concern was that the Respondent was attempting to ''judgment proof' himself from having to pay costs of the proceeding or an administrative penalty. The Commission rejected the respondent's arguments that there was no jurisdiction to make the s. 11 order and that the Commission was functus, and approved Staffs use of the power to compel evidence for the purpose of "gathering of information for use, perhaps, in another forum", presumably the Superior Court in proceedings to enforce an order to pay costs or an administrative fine: Taking into consideration the language of section 11, the object of the Act, the scheme of the Act, and other provisions in the Act, it is my view that the investigative order made in this case was proper, and appropriate. Staff of the Commission has an obligation to enforce any sanctions order that has been made. While it is true that Staff has to seek that remedy in the Superior Court of Justice, in my view, Staff can nevertheless use the tools of an investigative order where it believes that there may be a transfer of assets so as to negate any sanctions order that is to be made, or has been made. Enforcement is an essential and fundamental object of the Act, and Staff is the appropriate party to seek timely enforcement of any order that the Commission may make. Staff does not have to wait until the assets have been transferred but may move to gather information. In essence, what is being sought here is the gathering of information for use, perhaps, in another forum. 7 This raises questions about the limits of the Commission's ability to resort to section 11. Contrary to the Commission's recognition in Re Boock that section 11 is "an extraordinary power and one that should be exercised by Staff with some restraint", this decision appears to significantly expand the circumstances in which Staff can compel evidence from a respondent. Privilege against Self-Incrimination ins. 127 Proceedings At the same time that the Commission has signalled a willingness to permit Staff to resort to section 11 in circumstances beyond an investigation leading to a notice of hearing under s. 127, it has also determined that the protections against self-incrimination available to respondents under s. 9 of the Ontario Evidence Act and s. 13 of the Canadian Charter of Rights and Freedoms do not preclude Staff from filing or reading in evidence obtained from a 9-3

5 - 4- respondent during a s. 11 investigation an administrative proceeding ansmg from that investigation. Section 13 of the Charter affords "use" immunity for compelled testimony. It expressly provides that "a witness who testifies in any proceeding has the right not to have any incriminating evidence so given used to incriminate that witness in any other proceedings, except in a prosecution for perjury or for the giving of contradictory evidence." Section 13 has been interpreted by the Supreme Court of Canada as also providing immunity from the use of evidence derived from compelled testimony, or "derivative use" immunitl. In addition to section 13 of the Charter, section 9 of the Ontario Evidence Act, R.S.O. 1990, c. E.23 (the "Ontario Evidence Act") and similar provisions in other provincial evidence statutes, and section 5 of the Canada Evidence Act, R.S.C. 1985, c. 5 (the "Canada Evidence Act") (collectively, the "Evidence Acts") also provide use immunity for compelled testimony in proceedings governed by provincial and federal legislation, respectively. Section 9 of the Ontario Evidence Act contains an important but often overlooked addition to the arsenal of protections against self-incrimination. Unlike section 13 of the Charter and section 5 of the Canada Evidence Act, which provide for protection against subsequent use for incriminating purposes (meaning to implicate the witness in a crime), section 9 also prevents compelled testimony from being used to establish the witness' liability in subsequent civil or regulatory proceedings, which are the types of proceedings typically brought by securities regulators both in Canada and in the United States: Witness not excused from answering questions tending to criminate 9.( 1) A witness shall not be excused from answering any question upon the ground that the answer may tend to criminate the witness or may tend to establish his or her liability to a civil proceeding at the instance of the Crown or of any person or to a prosecution under any Act of the Legislature. Answer not to be used in evidence against witness (2) If, with respect to a question, a witness objects to answer upon any of the grounds mentioned in subsection (1) and if, but for this section or any Act of the Parliament of Canada, he or she would therefore be excused from answering such question, then, although the witness is by reason of this section or by reason of any Act of the Parliament of Canada compelled to answer, the answer so given shall not be used or receivable in evidence against him or her in any civil proceeding or in any proceeding under any Act of the Legislature. In Re Sextant (2011), 34 OSCB 5829 the Commission adopted the reasoning of the Alberta Court of Appeal in Alberta (Securities Commission) v. Brost [2008] A.W.L.D which permitted Staff of the Alberta Commission to tender into evidence and rely upon admissions made by a respondent during a compelled examination at a Commission hearing against that individual, notwithstanding that he had claimed the protections against selfincrimination at his examination. In Sextant, the Commission determined that for purposes of the provincial Evidence Act and Charter s. 13 protections against self-incrimination, the investigative stage and adjudicative stage "are not separate proceedings but rather stages in one 9-4

6 - 5- proceeding" 9. On that basis, neither the Evidence Act, nor section 13 of the Charter, prohibit Staff from filing or reading in some or all of a respondent's compelled testimony at a s. 127 hearing to prove the matters alleged in the Statement of Allegations, even if the witness claimed the protection against self-incrimination at the time ofhis examination pursuant to Section 11. The Commission reached a similar conclusion in Re Agueci (2013), 36 OSCB 2133: The Commission's mandate, as articulated under section 1.1 of the Act, is to provide protection to investors from unfair, improper or fraudulent practices and to foster fair and efficient capital markets and confidence in capital markets. As noted above, the statutory scheme under which the Commission operates grants an investigator power to summon any person and to compel him or her to testify under oath and to produce documents pursuant to subsection 13(1) of the Act. We agree that to accept the submissions of the Respondents that the compelled testimony cannot be admitted into evidence would hamper effective enforcement of the Act by the Commission, which has the legislative power to compel testimony and use it in accordance with the Act (Sextant, supra at para. 14). One of the purposes of compelled testimony is to obtain relevant documents and evidence for use in an administrative hearing (Boock, supra at para. 1 09) In determining the scope of section 9 of the Evidence Act, the Panel has considered the apparent purpose of the legislation and the ordinary meaning of its language. In order to give subsection 9(2) of the Evidence Act a liberal and purposive interpretation in the context of this administrative hearing, the word "other" should be read into the provision, such that it would read "the answer so given shall not be used or receivable in evidence against him or her in any other civil proceeding or in any other proceeding under any Act of the Legislature" (Rizzo, supra at paras ). We would not read in the word "subsequent" as the Sextant panel did because it is possible that another proceeding could proceed concurrently with an administrative hearing. It is our view that use of compelled testimony in this administrative hearing would prevent concurrent as well as subsequent use of the compelled testimony of the witness who asserts the protection under section 9 of the Evidence Act. 10 The Commission set out the preferred procedure to be followed by Staff in making use of the transcripts of compelled testimony provided by a respondent at a hearing: Compelled testimony is admissible at an administrative proceeding commenced under the Act. Nevertheless, it remains at the discretion of the panel hearing the matter to determine whether to admit such evidence in accordance with section 15 of the SPPA and such considerations the Panel deems appropriate for a fair and efficient hearing (Boock, supra at para. 115). The Panel's discretion to control the process of the hearing includes the ability to determine the process by which evidence should be tendered. We acknowledge Staffs submission that in the past, panels of the Commission have, on occasion, allowed Staff to tender a respondent's transcript evidence, even where the respondent also later testified as part 9-5

7 - 6- of his or her defense (York Rio, MP Global, McErlean, New Found Freedom and Goldbridge). In this case, however, the Panel is of the view that it is more appropriate to follow the process in Donald since the oral evidence of the Respondents who testify would provide us with the best evidence because it would afford the Panel an opportunity to observe the witness during examination-in-chief and cross-examination, including with respect to prior admissions and prior inconsistent statements, if any (Donald, supra at para. 34). We agree with submissions of the Respondents that Staff should not propose to tender excerpts of the Respondents' compelled testimony into evidence until the conclusion of its case. At that time, Staff may seek to tender into evidence selected excerpts from transcripts of compelled testimony of those respondents who have not undertaken and do no undertake to testify. This provides the Respondents with an opportunity to consider the evidence tendered by Staff before determining whether they will undertake to testify at the merits hearing while also attempting to avoid any unfairness that could result from Staff splitting its case. In addition, we agree with the submissions of Gomitzki and Telfer that where a respondent chooses to give oral testimony, Staff may use the compelled testimony for the purpose of cross-examination of the Respondents in relation to statements made during their compelled examinations. However, we also acknowledge that the onus is on Staff to prove the allegations against the Respondents and that, out of necessity, there may be limited circumstances which require the panel to be seized of the contents of a compelled examination to have an opportunity to fully and fairly assess the allegations against the Respondents. In this case, by virtue of the allegations of misleading statements made by certain of the Respondents in the course oftheir compelled examinations, we find that the misleading statements are by necessity required to be put before the Panel. As with Goldbridge, in which the panel heard the compelled evidence of a respondent to prove that he misled the Commission, we shall also permit the use of the compelled testimony for that purpose. 11 Where does this leave a witness served with as. 13 summons who is already a respondent in an OSC enforcement proceeding or at risk of becoming one? When advising individuals in these circumstances, it will be important to consider the nature of the conduct in issue, and the likelihood that it could form the basis for a civil proceeding in the courts, a proceeding by another regulator, or lead to criminal or quasi-criminal prosecution. While the protection of s. 9 of the Ontario Evidence Act and s. 13 of the Charter will not foreclose Staff from relying upon admissions made by the client during his compelled examination to prove Staffs case against him in as. 127 proceeding, they will prevent his testimony from being used to establish his guilt in a prosecution by the Crown or liability in a proceeding by another regulator. Unfortunately, if charges carrying penal consequences are later laid, whether the information provided to the Commission under the compulsion of section 11 is "incriminating" and therefore off limits to the Crown in attempting to prove its case against the witness at trial can only be determined when a prosecutor seeks to use the evidence during the prosecution. 12 Similarly, whether evidence compelled from the witness should be excluded as part of the 9-6

8 - 7- Crown's case against him at a subsequent criminal trial on the basis that civil or regulatory powers of compulsion were exercised for the predominant purpose of establishing that individual's penal liability typically will only be determined at trial. 13 This provides cold comfort to a witness and his lawyer hearing into a compelled examination by Commission Staff in relation to conduct that could result in the laying of charges in court. Given the potential for use of any admissions made by the witness during his s. 11 examination at a subsequent Commission enforcement proceeding hearing, thorough preparation of the witness at the investigation stage is now more important than ever. Defence of Reliance Upon Legal Advice In recent decisions, the Commission appears to have significantly constrained the circumstances in which reliance upon legal advice is available as a possible defence, and set a high bar even for when it may be relied upon as a mitigating factor in relation to sanction. In Re Duic (2008), 31 OSCB 9531 in reliance upon legal advice, the respondent inadvertently breached the terms of a settlement order prohibiting him from trading securities in Canada: The Agreed Statement of Facts states that Duic was advised by his legal counsel that the 2004 Order did not prevent Duic from trading securities listed on a U.S. exchange. Because Duic's counsel anticipated that Duic would be residing in California permanently, there was no discussion as to whether or not Duic was permitted to trade securities listed on a U.S. exchange from a brokerage account in Ontario. At the hearing, Duic's counsel submitted that Duic erroneously believed that he was permitted to trade on U.S. exchanges regardless of the location of the brokerage account through which the trades were made, largely because of the legal advice provided to him by his counsel. Staff agreed that if Duic had traded securities listed on a U.S. stock exchange through a brokerage account in California while Duic was residing there, that trading would not have breached the 2004 Order. However, because Duic traded through two brokerage accounts located in Toronto, Duic did breach the 2004 Order. 14 Notwithstanding that Duic had obtained and relied upon legal advice and believed in good faith that his trading was in compliance with the settlement order, he was ordered to divest any profits derived from the trades in issue, and to pay an administrative penalty of $25,000 and costs of$15,000 as a result of his inadvertent breach of the order. In Re Crown Hill Capital (2013), 36 OSCB 8721, reliance upon legal advice as a mitigating factor was given even shorter shrift by the Commission. While the Hearing Panel concluded that it was reasonable for the respondent investment fund manager to have relied upon legal advice provided by a reputable law firm that certain transactions complied with Ontario securities law, as the legal advice did not expressly address whether the manager would be in breach of its fiduciary duty under s. 116 of the Act, it was not treated as providing a defence nor as a significant mitigating factor with respect to sanction. 9-7

9 - 8- In Re Energy Syndications Inc. (2013), 36 OSCB 6500, the Commission considered the availability of a defence of reliance upon legal advice. The respondents were alleged to have contravened sections 25 and 53 of the Act, and to have made prohibited representations contrary to s. 44(2) in relation to the sale of Land Agreements and Solar Panel Agreements. The respondents' defence was that they were selling solar panels in compliance with Ontario consumer protection law, and land in compliance with Ontario real estate law. Although they argued that their conduct should be excused because they relied upon legal advice, the advice that they sought and obtained did not emanate from a lawyer practising securities law and did not address compliance with Ontario securities law. On that basis alone, it was open to the Commission to find that the legal advice in issue had little or no probative value as the advice did not satisfy the stringent preconditions identified by the Hearing Panel: In any event, for legal advice to be of probative value, high standards have to be met. The requirements include: (a) (b) (c) (d) (e) what is being sought is an opinion that the detailed facts to be provided do not result in a contravention of the Act; the opinion of a lawyer practising securities law; a detailed disclosure to the lawyer of all the facts and circumstances giving rise to the transaction; the notes and records of the lawyer indicating the facts and circumstances he took into account and the legal research he did in coming to his conclusion; a written opinion. Absent these criteria, the legal advice has no or little probative value. 15 However, the Commission went even further, ruling that reliance upon legal advice is not a defence to breaches of sections 25 and 53 of the Act, and that "good faith reliance on well established, well formulated legal advice" may only assist a respondent at a sanctions hearing: As a matter of law, reliance on legal advice does not constitute a defence to allegations of non-compliance with sections 25 and 53 of the Act. With regard to those sections, liability is absolute and ifthe Commission determines that there has been a contravention then the principal bears responsibility regardless of the advice given to the principal by his agent (Re Sabourin (2009), 32 OSCB 2707; Re Gordon Capital Corporation (1991), 14 OSCB 2713 (Ont. Div. Ct.), Re Simply Wealth Financial Group Inc. (2012), 35 OSCB 6007). Where the legislature wishes to provide a due diligence defence, it specifically provides for such a defence and examples are found in the Act under sections 130(c) and (d) and 138(6). 16 The conclusion of the Hearing Panel in Re Energy Syndication ignores the reality of the current regulatory regime, which is highly complex and ever evolving. Responsible market participants necessarily rely upon legal advice to guide their activities in the capital markets, including when exemptions from the registration and prospectus requirements are available. The 9-8

10 - 9- effect of the decision may be to discourage market participants from going to the expense of getting legal advice given its apparently circumscribed utility in an enforcement proceeding. It may also result in the imposition of sanctions on persons who are morally blameworthy. Arguably, neither is in the public interest. The message communicated by the Commission in Re Coventree Inc. (2011), 34 OSCB about the desirability of obtaining and relying upon sound advice about the application of securities law appears to be inconsistent with Re Energy Syndication. In that case, Coventree Inc., a reporting issuer, was found to have breached the continuous disclosure provisions of the Act in relation to disclosure of events leading to the disruption in the asset-backed commercial paper market in August The Commission found that the individual respondents, who were officers and directors of Coventree, authorized, permitted or acquiesced in Coven tree's breaches, although there was no evidence that either of them intentionally breached the Act or attempted to intentionally mislead shareholders. Notwithstanding these findings, the Commission appears to have recognized the importance of encouraging market participants to seek competent and objective legal advice to guide their conduct in relation to issues such as disclosure: Cornish testified that, in his view, Coventree did not require outside legal advice as to whether a material change had occurred by early August 2007 (see, for instance, paragraph 699 of these reasons). Those reasons included (i) that the senior officers of Coventree knew Coventree's business better than any outside lawyer, (ii) Cornish's and Allan's background as former securities lawyers, and (iii) the expertise of Board members. We note in this respect that Child did speak to outside legal counsel by telephone on August 6, 2007 to obtain disclosure advice (see paragraph 698 of these reasons). As the controlling shareholders of Coventree, Cornish and Tai had a potential conflict of interest in deciding whether to disclose information that could have a material adverse effect on the market price of Coventree shares. Obtaining objective outside legal advice would have assisted in addressing that conflict. 17 Surely it is in the public interest to encourage rather than punish market participants for acting responsibly in obtaining appropriate legal advice to guide their behaviour. 1 Re Boock (2010), 33 OSCB 1589 at para Supra, at para Supra, at para In Branch, the Supreme Court determined that although a witness compelled to testify during an investigation under the Securities Act may be able to object to the use of his testimony to incriminate him in a subsequent prosecution, (the right to life, liberty and security of the person enshrined in section 7 of the Canadian Charter of Rights and Freedoms did not preclude a securities regulatory authority from compelling him to testify during an investigation, as such investigations typically result in regulatory proceedings essentially of a civil nature rather than the laying of charges with penal consequences: 9-9

11 - 10- An inquiry of this kind legitimately compels testimony as the Act is concerned with the furtherance of a goal which is of substantial public importance, namely, obtaining evidence to regulate the securities industry. Often such inquiries result in proceedings which are essentially of a civil nature. The inquiry is of the type permitted by our law as it serves an obvious social utility. Hence, the predominant purpose of the inquiry is to obtain the relevant evidence for the purpose of the instant proceedings, and not to incriminate Branch and Levitt. More specifically, there is nothing in the record at this stage to suggest that the purpose of the summonses in this case is to obtain incriminating evidence against Branch and Levitt. Both orders of the Commission and the summonses are in furtherance of the predominant purpose of the inquiry to which we refer above. The proposed testimony thus falls to be governed by the general rule applicable under the Charter, pursuant to which a witness is compelled to testify, yet receives evidentiary immunity in return: S. (R.J.) supra. 4 [para. 35] Similarly, in Jarvis, the Supreme Court concluded that section 7 of the Charter did not preclude the Canada Customs and Revenue Agency ("CCRA") from exercising its "civil" evidence gathering powers in circumstances where the predominant purpose of the investigation is not to determine penal liability. 5 Re Waheed (2013), 36 OSCB 1071 at para Supra, at para Re Crown Hill Corporation (2014), 37 OSCB 8294 at paras R. v. R.J.S., [1995] 1 S.C.R Re Sextant (2011), 34 OSCB 5829 at para Re Agueci (2013), 36 OSCB 2133 at paras Re Agueci, supra, at paras R v. Nedelcu, [2012] S.C.J. No. 59 at para R T v. Jarv1s, supra 14 Re Duic, (2008), 31 OSCB 9531 at para Re Energy Syndications Inc. (2013), 36 OSCB 6500 at para Supra, at paras Re Coventree Inc. (20 11), 34 OSCB at para