You’re a broker and you receive a letter from a U.S. lawyer saying your client may be in danger of breaching U.S. securities law.
How do you respond? What are your regulatory responsibilities? And how do you manage your client’s reaction?
A broker’s duty to a foreign regulator and a
domestic client has garnered attention recently, thanks to an unusual case — Hamouth v. Edwards & Angell — which has made its way through the British Columbia court system.

Legal experts tell us the first step is to consult your compliance department and in-house counsel about your regulatory responsibilities. Canadian dealers are expected to co-operate with foreign securities regulators in their efforts to govern their markets, says Neil Gross, partner at Toronto law firm Carson Gross Christie Knudsen.

Then you must deal with your client.
Considering the context — a potential regulatory breach — this may be one of those moments when you have to get tough.
You may have to refuse the client’s request to do another trade. If the client is a hothead, you may have to bite the bullet and ask the client to take his business elsewhere.

“The worst thing you can do is just follow your client’s instructions or ignore the letter,” says Steven Sofer, a partner with Gowling Lafleur Henderson LLP in Toronto.

In Hamouth v. Edwards & Angell, B.C. resident Rene Hamouth brought a defamation lawsuit against the lawyers representing Florida-based Smart Video Technologies Inc.

Hamouth owned more than 10% of the company’s stock. In March 2004, the company’s lawyers, Edwards & Angell, sent two letters to Hamouth’s stockbrokers in Vancouver alerting them to the fact that his level of trading activity in the stock appeared to have placed him in violation of U.S.
Securities and Exchange Commission rules against “short-swing trading.”

Sec. 16 (b) of the SEC Act authorizes an issuer, or owner of securities of the issuer, to sue for recovery of any profit realized from the sale of a stock by the beneficial owner of more than 10% of the shares within a six-month period.

A letter from Edwards & Angell to Hamouth’s stockbroker dated March 17, 2004, stated that Hamouth owned more than 10% of Smart Video Technologies, and it appeared that Hamouth had violated the SEC Act. The letter also stated that the SEC had initiated an inquiry into trading activity of the company’s common stock, “which the company believes is directly the result of Mr. Hamouth’s trading activity.”

A second letter from the Florida law firm, dated March 29, 2004, arrived at Hamouth’s stockbrokers saying that Hamouth appeared to be violating the SEC’s rules regarding the total amount of shares he may sell in any given three-month period. It stated that Hamouth was limited to selling in that period no more than 1% of the outstanding shares of the company’s common stock.

The defamation case was based solely on the second letter, which does not refer to the SEC inquiry. This was a crucial point in the Appeal Court’s decision to dismiss the defamation lawsuit.

Lawyers cannot be sued for acting on behalf of their clients in preparation for court proceedings. They are covered by “absolute privilege.” That privilege also extends to “quasi-judicial” proceedings, such as administrative tribunals and securities hearings.

The law firm brought an application in B.C. to have Hamouth’s claim struck down, but the motions court master who heard the case made an odd decision. He said a trial court should hear whether the first letter — attached by the law firm to its application documents — should be viewed as evidence that there was a pending tribunal proceeding.

The B.C. Supreme Court affirmed his decision, but the B.C. Court of Appeal disagreed, and upheld the law firm’s appeal. The Appeal Court called the SEC inquiry “the missing fact” in Hamouth’s claim against the law firm.

The fact that this case went as far as it did in the court system is surprising. From the get-go, the case looked like what is known as a “frivolous” lawsuit. It’s also a pretty safe to say that a person who is this litigious is probably a difficult client. So how should a broker handle this type of client?

You have to contact the client and tell him or her that you have a legitimate concern. “You can never use the excuse that you don’t want to deal with a client just because you don’t want to,” says Ed Waitzer, securities lawyer and chairman of Toronto-based Stikeman Elliott LLP.