In the wake of a Supreme Court of Canada decision that found fraudsters can evade regulatory penalties by declaring bankruptcy, the British Columbia Securities Commission (BCSC) is calling on legislators to fix the law and prevent that outcome.
On July 31, Canada’s top court handed down a ruling that overturned lower court decisions and introduced a new limitation to regulators’ enforcement powers.
In a split (5–2) decision, the court found that, while disgorgement orders imposed by regulators would still have to be paid even after the target of an order is discharged from bankruptcy, that’s not the case for penalties imposed by regulators.
A court-imposed penalty in a fraud case can’t be wiped out by declaring bankruptcy, and the Supreme Court distinguished between such a sanction and a penalty imposed by a regulator, which is subsequently entered as a court order (a mechanism to facilitate collection of sanctions).
The majority ruled that regulatory penalties, which include an element of deterrence and arise indirectly from fraudulent misconduct — unlike disgorgement orders, which are directly tied to misconduct — can be eliminated by bankruptcy proceedings.
“We are disappointed that people who cheat or swindle investors can avoid paying administrative penalties through an exit from bankruptcy,” said Brenda Leong, chairwoman and CEO of the BCSC, in a release.
According to the regulator, since 2001 “more than 40 individuals and companies, owing a total of about $80 million to the BCSC, have gone through bankruptcy, and as a result have had their BCSC debts extinguished.”
The ruling sets a limitation on regulators’ ability to collect enforcement sanctions that are imposed through their own in-house proceedings.
In its ruling, the Supreme Court majority said Parliament could have drafted the bankruptcy legislation (the Bankruptcy and Insolvency Act) to specify that financial sanctions ordered by regulators, or administrative tribunals, survive bankruptcy proceedings, but Parliament didn’t do that.
“An obvious solution is to revise the law to deal with this ‘escape hatch,’” Leong said.
“The fact that administrative penalties can be extinguished through bankruptcy seriously undermines securities regulators’ duty to protect investors, and highlights a significant flaw in federal bankruptcy law that needs to be fixed,” she said.
JP Vecsi, senior public affairs specialist with the Ontario Securities Commission (OSC), which now has an independent tribunal to preside over its enforcement proceedings, said, “We’re reviewing the decision and assessing any implications for the OSC.”
The case made its way to the Supreme Court after respondents in an enforcement proceeding challenged lower court rulings that held that their debts to the BCSC — a $13.5-million penalty and a $5.6-million disgorgement order imposed against them by the regulator — would still have to be paid after they are discharged from bankruptcy.
While the majority of the Supreme Court ruled that regulatory penalties wouldn’t survive bankruptcy, two of the justices dissented, concluding that both penalties and disgorgement orders shouldn’t be wiped out by bankruptcy.
“Parliament has determined that some bankrupts simply do not deserve to be free of particular debts, based on the nature of the conduct giving rise to those debts,” the dissenting opinion said.
“This purpose would surely extend to a decision of a securities commission, charged with enforcing securities laws in order to protect the interests of the public and promoting the integrity of the capital markets,” it said.