Canadian securities regulators are beginning to deal with an ages-old complaint of small investors: that regulators fail to lift a finger to get money back when a client has been wronged by someone in the industry.

The theme was raised repeatedly when investors trooped before Ontario’s standing committee on finance and economic affairs last summer. Many were outspoken about the regulators’ inability, or unwillingness, to help investors get restitution when they lost money because of dodgy dealings by industry players. Much the same story was told at the Ontario Securities Commission’s recent investor town hall.

Regulators’ response has always been that they don’t have the power or the mandate to seek consumer redress. Yet they now appear to be more willing to extract restitution payments from firms facing enforcement hearings.

The change follows the mutual fund market-timing case. Last December, the OSC and a group of fund companies agreed to $205 million in restitution to investors affected by improper market timing in the companies’ funds.

The case was unusual for a number of reasons. It involved large, well-resourced
companies, a few of them public issuers that could afford restitution but couldn’t stomach too much adverse publicity. As well, the harm to investors was widespread and relatively easy to attribute, and the case occurred in the shadow of New York State Attorney General Eliot Spitzer’s well-publicized words and deeds about seeking justice for small investors.

Given all the unusual circumstances, the case could hardly be considered a trend. Yet, in a much quieter case that came before it in late September, the OSC signalled a greater interest in seeking investor restitution.

In a settlement agreement with the OSC, TD Waterhouse Canada Inc. agreed to return $1.5 million to investors caught up in an RRSP loan scheme. The firm also agreed to a reprimand, a voluntary payment of $250,000 (a little more than double the $105,000 in commissions it earned from the scheme), as well as costs of $125,000.

In a closed-door session to consider the settlement agreement, OSC senior litigation counsel Matthew Britton highlighted the importance of the restitution component, noting it was considered “particularly important” to OSC staff. “It reflects staff’s commitment to obtain compensation for investors — particularly small investors, as is the case here — who have been harmed financially,” he said.

The stance marks something of a departure for securities regulators who typically characterize their role as one of preventing future harm, rather than righting past wrongs and getting people their money back. While it is hardly on the same scale as the market-timing scandal, the case is just as important for what it says about the evolving role of regulators.

“It’s always been something that we’ve looked to do,” says Eric Pelletier, the OSC’s manager of media relations. “Whenever there’s a case that presents itself, such as this one, if it’s something that can be done, we will certainly try to get restitution for investors.”

So far, regulators’ efforts to secure restitution have been limited to cases that are resolved by a settlement agreement, whereby the accused has to agree to make restitution. It remains to be seen whether regulators will seek restitution in a contested hearing. But if the OSC staff is truly committed to obtaining compensation for small investors who have been harmed financially, it’s not clear why they shouldn’t pursue such a remedy in a contested hearing, as well.

One pitfall is that the OSC’s power to require restitution is not clear. It can apply to the court for an order that could include restitution, but it has rarely done so. It can also order disgorgement and administrative penalties, which could theoretically be administered for the benefit of wronged investors. It hasn’t done this, either, and it could be inviting a massive headache if it did.

Investor reimbursement is also a problem in the U.S. A recent report by the Government Accountability Office says U.S. securities regulators haven’t done a great job of ensuring that the financial penalties they levy on behalf of investors are actually paid out. Between 2002 and April 2005, the Securities and Exchange Commission handled 75 cases, ordering more than $4.8 billion in disgorgement and civil monetary penalties that were meant to be returned to harmed investors. Yet the GAO found that, while the SEC has collected money for 73 of the 75 cases, “approximately $60 million from only three cases has been distributed to harmed investors, and funds totaling about $25 million from only one other case were being readied for distribution.”

@page_break@The SEC counters, the report notes, that distribution is often a lengthy process that can be further complicated by external factors such as a pending criminal indictment. The GAO also found, however, that the SEC lacked a reliable method by which to identify and collect data on cases involving restitution.

An easier route to restitution may yet emerge. OSC staff aren’t the only ones who have heard investors’ complaints. The SCFEA’s final report recommended that the government do something about the lack of effective redress. Specifically, it called for the government and the OSC to come up with a more timely and affordable system of investor restitution.

The Ontario government has pledged to act on all the report’s recommendations, including redress. The OSC also echoed that pledge in its town hall report and in its latest statement of priorities. Fulfilling the promise is particularly important, as the government has recently adopted legislation that limits investors’ opportunity to use the courts for redress by dropping the time limits for a civil action to two years from six years from the time the loss is suffered.

Until the government and the OSC come up with a new mechanism, it looks as though the enforcement process may come to represent a more common path to restitution.

In this respect, the TD Waterhouse case is particularly unusual because the restitution it has pledged to pay covers losses resulting from a scheme carried out by a third party.
In short, an individual is alleged to have induced financially strapped investors to collapse their RRSPs or pensions to invest in his numbered company in exchange for a “non-repayable” loan worth 40%-60% of their locked-in funds. A registered rep at TD agreed to open accounts for the investors in which they would hold the shares in the company. In total, they deposited $1.5 million into the accounts, which was then exchanged for shares in the company.

The OSC alleged that in facilitating the transactions, TD didn’t comply with its suitability obligation. The commission also alleged that TD charged an undisclosed 7% commission on the deals. “This is not the case of a rogue broker. TD Waterhouse was aware of the unsuitable nature of the clients’ investments,” the OSC’s Britton noted in his submission to the enforcement hearing panel.

TD agreed that it didn’t live up to its suitability obligation and it also agreed to various sanctions, including the restitution. However, it has pledged to repay investors the full $1.5 million they deposited as part of the scheme, even though the money was apparently obtained from the investors by the person who set up the scheme.

The OSC has also initiated enforcement proceedings against Richard Ochnik and his company, the person it accuses of running the RRSP loan scheme. It alleges Ochnik sold shares without being registered and distributed securities without filing a prospectus. The allegations have not been proven.

In its notice of hearing against Ochnik, the OSC indicates that, along with the other sanctions it is seeking, it could ask the courts for a restitution order. It refuses to clarify what it may seek in restitution from Ochnik. IE