Regulator at a crossroads

Regulator at a crossroads
Illustration: Marco Cibola
The Ontario Securities Commission is looking far beyond the province’s borders as it formulates a plan for its future approach to regulation.
High-profile proceedings against Chinese companies have forced the commission to confront the challenges of pursuing foreign-based companies, while enforcement initiatives unveiled late last year borrow heavily from measures already in place at regulators internationally.

The OSC is still drafting its strategic plan, but hinted at its future approach in October 2011 with a staff notice that controversially mooted no-contest settlements and whistleblower bounties, among others, as new weapons in its enforcement armoury. Both ideas have a history south of the border at the U.S. Securities and Exchange Commission, where companies have for decades been able to settle without admitting to a breach of securities law, and recent legislation allowed whistleblowers to share in the monetary sanctions it imposes.
While some say the proposals could prove a springboard to strengthened enforcement and increased investor protection in Ontario, others are warning the commission is in danger of overreaching.
Anita Anand, chair of the OSC’s Investor Advisory Panel, says the regulator can learn a lot from its foreign counterparts. “This type of initiative and focus on making enforcement more effective is extremely important. Studying other jurisdictions enhances the quality of the proposal. The investor advisory panel believes that investors in Ontario should be as well protected as they are in other jurisdictions,” she says. “Thus, learning what other jurisdictions are doing is extremely important.”

Susan Hackett, the former general counsel of the Association of Corporate Counsel, says the increasingly global nature of business forces all securities regulators to consider the approach of their foreign counterparts.“You’re going to see an awful lot more handholding on enforcement, because companies are multinational. To regulate them one way in one jurisdiction and another way in every other
jurisdiction doesn’t really make sense,” she says. “And if regulators deem one jurisdiction to have created a best practice, they’re certainly going to examine it and potentially implement it.”

According to Anand, that task may be made more difficult for the OSC by the Supreme Court of Canada’s nixing of the federal government’s attempt to create a national regulator. “Lack of national co-ordination on enforcement is a major drawback of the current system. While the [Canadian Securities Administrators] has been able to ensure co-ordination on prospectus approvals, enforcement is a different story,” she says.

Ed Waitzer, the director of the Hennick Centre for Business and Law at York University and a former chairman of the OSC, says the commission needs to make sure it won’t be spread too thin as a result of any changes it makes. “We have this habit of piling on more and more regulation as opposed to thinking about how they all interact and thinking about what the unintended consequences might be,” he says. “You’ve got to worry about the commission trying to be all things to all people. Let’s not jump on something just because it’s the idea du jour.”

Waitzer has particular concerns over the OSC’s proposed whistleblowing program, which would be a first for Canadian securities regulators. In the October release, the OSC invited comments on a system that would give employees who suspect misconduct in the marketplace a direct line to the regulator, rather than having to go through any internal systems that exist at their companies. The suggested program could include incentives, such as protection from retaliation or financial compensation.

“We’ve spent a lot of time over the last 20 years trying to encourage better corporate governance, and, in effect, self-regulation, by building up compliance cultures. If people are going to end-run the internal culture, where do we end up? It’s going to undermine all that,” Waitzer says. “A bounty encourages all kinds of people to come forward, and I wonder if the commission has the resources to deal with that. They’re going to have a hard enough time doing what they’re supposed to be doing now.”

In May 2011, the SEC created its own Office of the Whistleblower, fulfilling a demand in the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed the previous year by the U.S. Congress. The office takes tips from employees and allows them to claim between 10 and 30 per cent of sanctions imposed by the SEC as a result of the information provided, as long as the penalties are worth at least $1 million in total.
The program has been popular. An SEC report indicates the office received more than 300 whistleblower tips in its first seven weeks of operation. No money has been paid out yet, and it could take a while for tips to translate into payouts.
Hackett, now a law firm consultant at Legal Executive Leadership, spearheaded the fight against the whistleblower provisions of Dodd-Frank during her tenure at the ACC. She says regulators risk becoming buried under an avalanche of speculative tips from employees hoping to hit the jackpot. “Government agencies are going to be investigating thousands and thousands of violations, most of which won’t bear the kind of fruit that most of these laws I think are intended to address,” Hackett says.

In addition, she suggests bounties provide potential whistleblowers with perverse incentives to let wrongdoing develop beyond its early stages in order to maximize their personal payout. In practice, Hackett says the SEC has simply added an unneeded extra layer of bureaucracy, because, after receiving the tip, the regulator processes it and sends it back to the company for investigation. “Now if there actually is a failure, we’ve got potentially months between when that failure was uncovered and the time that the company can begin to address it, and that doesn’t really help anybody.”
Canadian companies such as BMO Financial Group, Royal Bank of Canada, Bell Canada Enterprises, and TD Bank Financial Group signed on to Hackett’s ACC campaign in the U.S., and more Canadian companies have since added their voices to the whistleblower dissent, including George Weston Ltd., the parent company of Loblaw Companies Ltd. and President’s Choice Financial. Robert Balcom, its senior vice president and general counsel, wrote to the OSC to voice his objections to its latest proposals. “Any proposed rules must not allow potential whistleblowers to circumvent an issuer’s internal compliance processes and procedures,” he said, adding that the commission should steer clear of financial rewards and focus on protecting whistleblowers from retribution.
But Dimitri Lascaris, a partner at Siskinds LLP in London, Ont., who has acted for plaintiffs in numerous securities class actions, says corporations are deliberately exaggerating the effect of bounties on compliance structures for their “own self-interest.”

“Bay Street is all up in arms at the idea of compensating whistleblowers because Bay Street understands perfectly well that if you compensate whistleblowers, more people are going to co-operate than would otherwise be the case, and a lot more wrongdoing is going to be exposed,” he says. “A corporation is a very hierarchical entity and to force people who have become aware of senior wrongdoing by management to press the issue only through interaction with senior management or with the board just ignores the reality of how a corporation operates. The first place they should go is to the authorities, rather than be funneled into some internal corporate process which ultimately is going to result in a whitewash.”

According to Lascaris, he’s dealt with dozens of potential whistleblowers who were reluctant to co-operate for fear of retribution. In the event they did co-operate, the beneficiaries were the victims of any fraud, not the whistleblower. “These people are taking risks for no benefit, and they should be rewarded,” he says.
Marian Passmore, the associate director of the Canadian Foundation for Advancement of Investor Rights, sees no reason why an OSC whistleblower program shouldn’t exist in tandem with corporate ones. “Perhaps there’s a benefit to allowing the whistleblower to report where they’re most comfortable doing so,” she says. “If there’s a culture of compliance and ethical behaviour internally, that would encourage more people to report internally.”
Donald DeGrandis is the vice president and corporate secretary at Calgary-based TransCanada Corp. Since the company is listed on the New York Stock Exchange, it’s already subject to the SEC whistleblower rules, and DeGrandis says it has complicated its internal compliance procedure. TransCanada has put a lot of emphasis on its whistleblower system over the last decade, with an internal anonymous hotline, and training for employees around corrupt practices and securities regulation. “To me, it’s a fact of life and just another regulatory oversight we have to live with from now on,” DeGrandis says.
He sees the Dodd-Frank Act as a reaction to corporate scandals in the U.S. and says cases here such as Nortel and Sino-Forest Corp. have helped cultivate the view that securities regulators in Canada need an enforcement boost. “I think the vast majority of companies meet their obligations. It’s the ones that don’t that these rules generally get written for, and knee-jerk reactions always require the good guys who actually follow the rules to do the same as the bad guys who don’t,” DeGrandis says. “I’ve said to our governance committee, that once a whistleblowing regime is up and running in the United States, give it two years and it will be here. I just think it’s an inevitability.”

But Lascaris isn’t so certain the OSC will jump on the whistleblower bandwagon. “To the extent they’re actually looking at it, that’s progress. But I’m skeptical that anything will actually come of it,” he says. “I had hoped that the events of 2008 and 2009 would cause a sea change in attitudes towards enforcement, but I think the OSC and Canadian securities regulators generally have not been sufficiently aggressive over the years, and I don’t sense a dramatic change in the levels or quality of enforcement here.”

Lascaris sees the other major proposal in the October staff notice, the no-contest settlement program, as evidence that the OSC may actually be moving backwards on enforcement. The program would allow protective orders to be made by the OSC without the need for a specific admission of a breach of the Securities Act. The OSC says the program, launched alongside new guidelines for self-reporting and credit for co-operation, is “aimed at resolving enforcement matters more quickly and effectively.” The proposals were prompted in part by settlement negotiations getting bogged down in disputes over admissions, with companies often fearing they will be used against them in concurrent or subsequent civil litigation.
“If you’re willing to settle for less, you can always settle faster, but what’s the benefit if it doesn’t achieve anything meaningful? You’re far better off having more protracted proceedings if it achieves something meaningful,” Lascaris says. “This policy is really one that serves the interests of a small group of well-heeled defendants who actually have the resources to pay compensation to investors.”
The idea drew sharp criticism in a submission to the OSC from Michael Watson, who spent 10 years as its enforcement director. He called no-contest settlements “wrong in principle” and cast doubt on the time and money savings, arguing the majority of settlement efforts go into the wording and that respondents will be just as keen to get that right whether or not they admit to wrongdoing.
In the U.S., where the practice is long-standing, authorities are taking a second look after U.S. federal Judge Jed Rakoff rejected a proposed $285-million settlement between the SEC and Citigroup Global Markets Inc., citing fears over its fairness.

“If the allegations of the complaint are true, this is a very good deal for Citigroup,” he wrote. “Even if they are untrue, it is a mild and modest cost of doing business.”
Lascaris says there’s no evidence no-contest settlements in the U.S. have enhanced deterrence and suggests they may actually weaken it. “The obligation to make admissions is itself a powerful deterrent. It really imposes costs on the person who’s making it, not just for private litigation, but also in reputational terms.”
By handicapping class actions, Anand says no-contest settlements could cut off an avenue that is often the only realistic prospect of restitution for investors. If that is to happen, she’d like to see the OSC opening up new routes for investors. “Alternatives for investor compensation must be considered. Perhaps settlement agreements should require the payment of compensation to investors harmed by the respondent’s misconduct,” she says.
But Waitzer argues it makes sense for the OSC to limit its focus on restitution, especially with the development of a robust securities class action market. “A no-contest settlement doesn’t preclude private enforcement, it just doesn’t hand it to the plaintiffs’ bar on a platter,” he says, adding that the OSC needs to be careful with its limited resources. “There’s certain things that the commission does well and there’s certain things that the courts do well.”
According to Waitzer, the OSC has already been burned by overreach with the explosion of issuers from emerging markets. Suspected fraud at Sino-Forest Corp. and alleged capital market abuse by sportswear company Zungui Xaixi Corp. have left the OSC with an enforcement headache in China. “It’s not just the OSC. The TSX too has been out running up listings, and the OSC is clearing prospectuses,” Waitzer says. “So something goes wrong, and we don’t have in place the necessary co-operation agreements with Chinese regulators, and nobody really understands how you go about getting information from Chinese banks or what the legal regime is to enforce claims there.”

At an event last November, OSC chair Howard Wetston told an audience that an ongoing emerging market issuers review had highlighted a number of challenges for his team. At the same event, he wondered out loud whether the OSC can “effectively enforce the Ontario Securities Act internationally,” reassuring the audience it would “do whatever is reasonable and practical to investigate and take appropriate enforcement action.”

Waitzer would like to see more energy devoted to preventative measures upfront. “We need to think more carefully about what could go wrong ahead of time, and try to address those concerns. I’m not just pointing the finger here at the OSC. It’s the stock exchange, the lawyers, the accountants, all the gatekeepers in the process,” he says.

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