There seems to be a general consensus that Canadian securities regulators, particularly in Ontario, have a shoddy record of prosecuting corporate fraud. Are lawyers to blame for this state of affairs?
Joseph Groia is a paradox.
After all, he seems to embody many of the aggravations plaguing Canada’s system of uncovering and prosecuting fraud in our capital markets. A tall, cerebral, informal 53-year-old with salt-and-pepper beard and combative personality, as he chats in his handsomely-designed boardroom of his law firm, Groia & Company, on the 10th floor of a downtown Toronto office tower, Groia evinces the contented air of a Cheshire cat who regularly makes a meal out of canaries. Which is not surprising given his victory last summer over the Ontario Securities Commission for his client, John Felderhof, the former head geologist for Bre-X Minerals Ltd. After a gruelling eight-year legal battle, Felderhof was found innocent on all charges of insider trading and fraud — a decision that triggered cries of outrage over the nation’s apparently woeful track record for punishing alleged stock swindlers.
Ironically, this win was against his former employer. Back in 1985 as a young gun not long out of law school, Groia went to work for the OSC as an associate general counsel. “My first week at the OSC, they had me negotiating a settlement with John Robinette,” chortles Groia. One reason he was hired was to put some steel into the OSC’s enforcement branch, which was considered quite pathetic at the time. “Back then the perception was the commission would have hearings once in a while to go after the boiler-room guys who were stealing from widows and orphans,” relates Groia. “But there was no enforcement presence in mainstream securities transactions.”
Within 18 months of joining the OSC, he’d risen to become director of enforcement. And soon the big Bay Street boys were in his crosshairs — companies like Torstar, Canadian Tire, Maple Leaf Gardens, Canadian Malting, Southam, and the big banks. In the process, he pissed off a lot of people. During his reign at the OSC, the enforcement branch rose from 50 to 200 staffers, and from four lawyers to 25.
Once he was approached by a senior Bay Street lawyer who asked Groia, “Don’t you know who these people are?”
“Yes, they’re people who authorized a breach of the Toronto Stock Exchange bylaws and are acting contrary to the business interests of shareholders,” Groia replied.
Not surprisingly, in 1990, when it came time for him to move on from the commission and return to private practice, no Bay Street law firm would hire him. “I was essentially blackballed by a number of firms,” he recalls. Eventually Groia landed a job with the Montreal firm Heenan Blaikie LLP, where he stayed for 10 years working out of their Toronto office, before opening his own litigation shop. And since leaving the OSC, he’s emerged as one of the most aggressive and sought-after securities litigators in the land. Now defending people accused of corporate fraud, his client roster includes the likes of Cinar, Hollinger, Philip Services, Yorkton Securities, and Thomson Kernaghan.
Moreover, Groia’s opinion of the OSC has changed: he believes its power should actually be clipped, and complains that too many people are calling for more regulation. “I see a very alarming corporate vigilantism where you have the false perception that regulators are not doing enough and there are people who are trying to fill in that gap,” he says.
Groia’s schizoid career is in keeping with Canada’s equally schizoid history of enforcing securities laws. Right now, the general consensus is the enforcement system is ailing, if not completely dysfunctional. Indeed, if Bernie Ebbers had started WorldCom in Alberta, where he grew up, instead of Mississippi, he would likely be living in quiet retirement instead of wearing an orange jumpsuit courtesy of the U.S. prison system. While the likes of Enron’s Jeffrey Skilling and Tyco’s Dennis Kozlowski are behind bars with lengthy sentences, in Canada the landscape seems strewn with cases where few have been successfully prosecuted, or are instead being pursued by American regulators and enforcers rather than their Canadian counterparts. There’s Bre-X, Livent, Nortel, YBM, and Conrad Black, Andrew Rankin, and Ian Thow, a mutual fund salesman who is alleged to have bilked investors at Berkshire Investment Group before fleeing to the U.S. one step ahead of the RCMP. In fact, the Mounties’ Integrated Market Enforcement Team (IMET), set up to give some weight in the enforcement arena, has been an unmitigated disaster, laying only five charges despite spending $100 million since opening its doors in 2003.
With one recent study saying that more than one million Canadians have lost money to some form of investment fraud, it’s no wonder federal Finance Minister Jim Flaherty calls Canada’s regulatory system an “embarrassment” and that, “For many outside of Canada, our system is seen as cumbersome, fragmented, slow, repetitive, and lacking the proper tools of enforcement.”
Some lawyers are much more blunt. “For stock market scams to get found out, investigated, charged, and convicted, the chances are pretty slim in Canada,” says Wes Voorheis, an attorney and shareholders’ advocate who was appointed CEO of Conrad Black’s old media company, Hollinger Inc., last April. “It’s just this side of pathetic. The [regulatory] system is fucking broken in Canada and needs to be fixed.”
Others concur. “As far as I am concerned, the system is broken,” says Calgary lawyer Clint Docken, who once represented Bre-X shareholders in a class action lawsuit. “All we have is civil litigation — which is not the way it’s supposed to be.”
So if Canada is proving to be such a fabulous place for fraudsters, why is this the case? And how much of the blame for this reality falls on the shoulders of the legal profession?
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How bad is Canada’s enforcement track record? Utpal Bhattacharya, an associate professor of finance at the Kelley School of Business at Indiana University, crunched some numbers for the Task Force to Modernize Securities Legislation in Canada in 2006, and came back with some startling results. Comparing the OSC and the SEC’s records between 1997 and 2005, he found that when scaled for size of the stock market, the SEC prosecutes 10 times more cases per firm for all securities laws violations and 20 times more insider trading violations than the OSC. Moreover, the SEC resolves cases faster than the OSC, levying fines that are 17 times more per insider trading case than those of the OSC.
In some instances, the statistics are staggering. From 1997 to 2000, the OSC didn’t launch one single case or lay one single charge for insider trading (and launched only two in the following two years), while the SEC launched 110 cases. In 2005, while the SEC launched 500 overall cases of securities violations among 6,404 firms that year, the OSC initiated only 24 among 3,610 firms. “The SEC enforces securities laws much more vigorously than the OSC,” sums up Bhattacharya.
Moreover, the SEC’s track record doesn’t take into consideration the efforts of former New York attorney general Eliot Spitzer against Wall Street to stop investment banks from inflating stock prices, mutual fund companies from giving preferential treatment to selected clients, insurance companies from using contingent commissions, and stock analysts from giving biased recommendations.
And in a number of instances, the SEC has stepped into the Canadian arena to pursue companies while Canadian regulators have stood on the sidelines. This was somewhat true in the case of Nortel, where the SEC has sought up to US$100 million in fines, but was only awarded $35million, against the high-tech company over accounting manipulations compared to the $1-million pittance eventually negotiated by the OSC (although the OSC is pursuing four of Nortel’s former executives for accounting and other issues). The Conrad Black case was wholly an American endeavour. “If a Canadian company, or the conduct of Canadian citizens involving a Canadian company, rises to a level where it has any profile in the U.S., then it’s certainly a case that lends itself to Canadian regulators stepping in first in front of their American counterparts,” opines Jacob Frankel, a Maryland-based lawyer and former SEC staffer. “A case like Conrad Black, a case like Nortel, a case like Livent. Those kinds of cases.”
Another example of where Canadian regulators may be slow off the draw is stock options backdating, which occurs when an executive is offered stock options at a price when the stock was once trading at a lower price — so when they cash out, they make much more money. A study conducted by Erik Lie at the University of Iowa and Randall Heron at Indiana University published in 2006 found that 29.2 per cent of American firms manipulated grants to top executives at some point between 1996 and 2005. For the past two years, the SEC has been investigating and laying charges against companies for this practice.
In Canada, it’s an altogether different story. Lawyers from two Canadian law firms, Siskinds LLP and Cavalluzzo Hayes Shilton McIntyre & Cornish LLP, are doing research that suggests there’s greater than 95 per cent probability that at least 35 TSX-listed companies have manipulated stock options granted to senior executives since 1987. Their findings were bolstered by a draft paper produced out of the University of Manitoba’s economics department that examined data from 66 of the biggest TSX-listed companies. “We believe the number of companies we found actually understates to a significant degree the level of options manipulation in Canada,” says Dimitri Lascaris, a lawyer at Siskinds who is pursuing this research.
So far, though, only Research in Motion, makers of the BlackBerry, have stepped forward to say they may have engaged in stock options backdating. The OSC claims it’s looking into the issue, but hasn’t charged anyone yet (a spokesperson from the OSC says they are examining cases other than just RIM).
So what are the reasons for this dismal track record?
One factor that can’t be overlooked is the cozy relationship between the corporate community, their law firms, and Canada’s 13 securities commissions. For starters, the commissions are run by people who either come from the business world itself, or are lawyers who once worked for law firms that primarily service corporate clients. And they often return to those law firms when their stints at the securities commissions are finished.
Moreover, the willingness of law firms to keep corporate clients happy no matter what can be seen by the fact that investors and creditors are extracting individual settlements from law firms by claiming they negligently failed to protect stakeholders who were damaged by corporate calamities. Three multimillion-dollar settlements have been paid by Torys LLP, Goodmans LLP, and Cassels Brock & Blackwell LLP for their roles respectively at Hollinger International Ltd., Dylex Ltd., and YBM Magnex International. There was no admission of wrongdoing in any of the settlements.
Meanwhile, the current chair of the OSC is David Wilson, who used to be vice chairman of the Bank of Nova Scotia and CEO of Scotia Capital. The rest of the OSC board is made up of lawyers from Bay Street law firms or senior people employed in the financial industry. Wilson replaced David Brown, who’d been a long-time corporate lawyer in mergers and acquisitions at Davies Ward & Beck LLP (now Davies Ward Phillips & Vineberg LLP) in Toronto, where he returned when he left the OSC in 2005. Other former OSC chairs include Edward J. Waitzer (Stikeman Elliott LLP), Peter Dey (Osler Hoskin & Harcourt LLP), and former Osgoode Hall Law School dean Stanley Beck, who now sits on many corporate boards, including Scotia bank’s Scotia Utility Corp. and Scotia NewGrowth Corp., Canadian Tire Bank Inc., Hollinger Inc., and First National Financial LP. Meanwhile, Bill Rice, the current chair of the Alberta Securities Commission, worked for 25 years as a securities lawyer for Bennett Jones LLP.
“I think a significant part of the problem is a lack of political will,” says one class action lawyer, speaking on the condition of anonymity. “It’s easy to go after people in the boiler room who are ripping off retirees, but they don’t have any power. But to go after any people who have any power and influence requires a very significant amount of political will. It’s unrealistic to expect that a chairman of the OSC who aggressively pursues large public corporations won’t have their prospects of earning an income after they leave from being diminished. These things are going to come back and have an impact on their professional prospects and that’s just reality. And who is not going to be influenced by that, unless you’re a saint?”
Not surprisingly, those who’ve crossed between the regulators and Bay Street law firms disagree. “I haven’t seen that [sort of bias],” insists James C. Baillie, a former OSC chairman and a senior partner at Torys LLP. “It’s a nice theory and people critical of the commission make the theory, but my experience is that people who work for regulators are professionals and they want to do a good job and want to be respected for doing a good job when they go back to private practice. . . . If you are expecting that people are reluctant to go after Northern Telecom, I will tell you the attitude of Bay Street for a bad securities situation where people think things are done wrong is, ‘Go get them!’ It affects the reputation of all of us, and they applaud when they go after people like that. . . . If people don’t trust us, we go out of business.”
Still, it’s hard to imagine any chair of any of Canada’s security commissions launching the kind of assault that Eliot Spitzer led against Wall Street between 2002 and 2006. As Eric Reguly of the Globe and Mail noted about David Brown’s tenure as OSC chairman, “[His] burden was the inevitable comparisons to Mr. Spitzer. How could the demure, soft-spoken Canadian possibly compete? There was Mr. Spitzer acting like a latter day Eliot Ness, exposing depraved behavior on Wall Street, in the insurance and mutual funds industries, wrecking careers and exacting billions of dollars in settlements. Mr. Brown couldn’t make the same claims.”
How do the commissions respond to these criticisms? Larry Ritchie, vice chairman of the OSC (and a long-time lawyer at Osler), says they’re aware of the perception that Canada and Ontario are weak on enforcement. But he dismisses comparisons between the OSC and American regulators, saying, “It is a different society and a different political environment.” Ritchie also disputes the belief that the Americans are onto cases before the OSC is, adding that, “co-operation amongst law enforcement agencies inside and outside Canada is much more effective than competition.”
What about resources? Do regulators have enough resources to pursue cases? Part of the problem in Canada is resources are fragmented and scattered among 13 regulatory commissions. In the U.S., there is one national body, the SEC, with more resources and independence and is assisted by state attorneys general. Still, over time, resources at the OSC and other commissions have improved. Moreover, the OSC is self-financing, raising money from fees and fines. If it needs more resources, it can simply levy more fees on the business community to get them.
Another issue seems to be accountability. No one seems to actually demand regulators justify their track records. “The main problem with the regulatory approach is there is very little qualitative information [about] how effectively the regulatory system is working,” says Marilyn Pilkington, a professor and former dean at Osgoode Hall Law School and co-author of a respected 2006 report on securities enforcement. “There are reports on files opened and complaints settled, but that doesn’t give you any sense how the regulatory system is working. There is no qualitative information, and we said we need more qualitative assessment.”
Former OSC chairman Ed Waitzer agrees. “When is the last time a head of OSC, any other regulators, or the RCMP and other police forces were hauled up before a legislative committee and asked, ‘Here is what you said you would do, and what have you actually done?’” he observes. “Nobody is accountable for performing. We can talk a big game but don’t have to deliver. On the other side, if you are a fraudster, after a while you don’t take the system very seriously because the execution isn’t there.”
Then there are the laws. To obtain a criminal conviction, the standard of proof is very high. But most securities fraud cases are nuanced, complicated, and rarely black and white. This was true in the Bre-X case, as the OSC discovered when it went after former head geologist John Felderhof. He was accused of profiting from the calamity by cashing in stock just before the fraud was uncovered and pocketing $84 million as well as issuing misleading press releases to the public. The OSC also said there were a series of “red flags” Felderhof should have noticed. But the case went poorly for the commission: its first prosecutor was removed, its attempt to get the judge replaced failed, and key witnesses were weak on the stand.
David Baines, a Vancouver Sun business columnist who investigates chicanery on Howe Street, says it’s almost impossible in Canada to get everyone on the same page to get a conviction. “You need to get the investigation arm, Crown, and judiciary all to agree on a case,” he remarks. “You never get those three. It breaks down at one or more stages.”
What about experience? Do the regulators have enough seasoned lawyers to wade into the fray? After all, swindlers go out and hire people like Joe Groia who not only are talented litigators but have probably forgotten more securities law than most others will ever know. The lawyers who work for the OSC or the federal Department of Justice, by comparison, are invariably not as battle-hardened. The solution most bandied about to remedy this state of affairs is creating a national securities agency, one that isn’t so incestuously tied to the business community — a Canadian SEC, if you will.
For now, this remains a pipe dream. Canada has become too decentralized in its provincial fiefdoms for this notion to be realized any time soon. Until it does, though, Canada’s regulators will continue to look like a bunch of Keystone Cops. “It’s deeply embarrassing to go to the International Organization of Securities Commissions meetings and see representatives of the regulatory commissions for France, the United Kingdom, and the U.S., and then you see one from Ontario, Québec, B.C., Alberta, and all of the other provinces,” says former OSC chairman Jim Baillie. “I find it terribly embarrassing because it suggests we can’t get it in order.”