Any good that securities regulators do is often lost on retail investors because regulators don’t do the one thing that investors really want — get them their money back when they’ve been wronged. Now regulators are looking at ways to do that.

It is not surprising that investors have become frustrated with the regulatory framework. They are encouraged to contact regulators when they have a problem, and they do so by the thousands. The trouble is that the two sides have vastly different expectations: regulators are hoping for a hot tip for enforcement, while investors are looking for ways to recover their money.
Investors are invariably disappointed.

But now that investor frustration has boiled over to government hearings and regulators are talking about the need to do more of what investors assume they do. Following hearings last summer, Ontario’s standing committee on finance and economic affairs stressed that small investors “need practical remedies when they have suffered a loss as a result of a violation of Ontario’s securities laws.” It recommended that the Ontario Securities Commission work with the government to establish a mechanism to allow investors to pursue timely and affordable restitution.

In mid-June, outgoing OSC chairman David Brown appeared at the Senate Banking Committee’s hearings and reported that the OSC is looking at several ways of achieving that goal. Two possible options were highlighted at the OSC’s investor town hall,
held on May 31 — using its existing disgorgement power to return money to investors; or, altering Section 128 of the Securities Act, which gives the OSC the ability to ask a court for a variety of remedies, including a restitution order, to make it more useful.

Brown noted that the OSC has used Section 128 only once — in 1996 — and it did not end in “a very satisfactory result.” He added that the OSC is looking at ways to amend the section to make it work better. “Our theory is that we will get bogged down quite significantly in the court system if we use that section. We just don’t think that it’s designed in a way that will enable us to adequately provide that remedy,” he explained.

This echoes the findings of the OSC’s regulatory burden task force, which reported in December 2003. It cautioned against the commission seeking more restitution orders from the court,s saying, “The few previous applications under that provision have resulted in protracted, costly procedural quagmires.”

Instead, it recommended that the OSC use
its disgorgement power to ensure that violators don’t profit from their crimes — and, in certain cases, appoint an independent trustee to administer that money and compensate aggrieved investors for their losses. It also proposed that the commission consider taking the voluntary payments made under settlement agreements and returning that money to investors who lost out as a result of the misconduct being punished.

The OSC isn’t the only regulator puzzling over possible ways to provide adequate investor remedies. So is the Investment Dealers Association of Canada. At an industry conference hosted by the University of Toronto’s Capital Markets Institute in mid-June, IDA senior vice president of member regulation Paul Bourque suggested that the IDA should be thinking about it, too. “Perhaps it’s time to look at compensation as a legitimate role [for regulators],” he proposed.

Regulators have traditionally begged off the job of seeking restitution, on the basis that their role is to prevent future harm, not to punish or fix past wrongs. But that is changing. The Australian Securities and Investments Commission for example, identifies consumer redress as one of its enforcement objectives, along with traditional regulatory goals such as stopping illegal conduct, providing a deterrent and preventing future harm.

Indeed, if the rationale for handing out punishments, such as fines and trading bans, is to deter future wrongs rather than to punish, a similar argument could be made for restitution orders. In the current system, which often allows offenders to walk away from their crimes with their ill-gotten gains as long as they leave the industry,
uncollectible fines and trading bans may not be a sufficient deterrents. If regulators could also force violators to repay their victims — and pay their fines, for that matter — then surely the deterrent effect would be
enhanced.

@page_break@Bourque’s suggestion is echoed by York University professor Poonam Puri. The ostensible purpose of the CMI conference was to present her draft paper on the effectiveness of enforcement in Canada. In that paper, she suggests that it may be time to reconceptualize the role of regulators. She recommends that regulators play a greater role as catalysts to help investors receive compensation; that they apply to the courts for restitution orders more often; and, that they should be granted the power to make these orders themselves under their public interest authority.

While regulators don’t often shy away from invitations to accumulate more power, in this instance that instinct may be overwhelmed by the fear that they would be shouldering a huge new administrative chore. The OSC’s task force discouraged the idea of giving the OSC the power to order restitution, saying that to do it fairly it would have to follow hearing procedures and rules of evidence similar to those of the courts. “This would require fundamental changes in the commission’s hearing processes and commissioners sitting on restitution panels would have to be specially qualified to act as quasi-judges,” it said.

The idea of more formal tribunal procedures may have seemed over the edge in 2003, but after both the Osborne report and the SCFEA report recommended restructuring the OSC to separate out its adjudicative function, it may make more sense. Indeed, the SCFEA report recommended that any plan to improve restitution options should take into account efforts to spin off the adjudicative function.

Bourque concedes that making restitution orders part of the disciplinary process would present new challenges for regulators — for example, are investors’ losses connected with the violation that’s being punished, is there enough money available to cover the losses, can the victims be easily identified and can the losses be easily estimated — but, he suggests, these are mostly practical problems that can be solved.

“The criminal justice system has been making restitution orders and compensation orders for 30 years in the provincial courts as they sit across Canada — in strip malls and church basements and community halls — and they have far fewer resources than securities commissions to assess losses,” Bourque notes. Surely if they can do it, the regulators that claim special expertise in these matters can figure out who was hurt by wonky trading.

The issue of whether securities regulators should be doing more to help investors receive restitution is not new. Prior to this recent debate, it was contemplated by the five-year review committee headed by Purdy Crawford. In its final report, delivered in March 2003, it recommended that the OSC consider making more use of its power to seek restitution from the courts under section 128. And it proposed amending the act, so that investors could apply for restitution, too.

However, the Crawford committee didn’t recommend giving the commission the power to order restitution itself. Instead, it suggested that it study the experience of Manitoba and Britain, where regulators do have that power. The committee also recognized that taking on this power would represent a shift from the regulator’s traditional protective function toward a more remedial role. At that time, it felt that this shift wasn’t appropriate, but it recognized that this could change.

As for those regulators that do have restitution power, it has hardly been used in Manitoba. This is not surprising, given the relatively small amount of enforcement activity that takes place in the province.

In Britain, however, the Financial Services Authority appears to be making extensive use of its restitution powers. According to its annual report, a total of £1 billion has been paid back to or set aside for consumers to address improper selling of mortgage endowments. And, about £10 billion has been returned to consumers in pension mis-selling scandals. It has also obtained much smaller restitution orders from the courts in a variety of cases, including orders against fraudulent investment clubs.

One benefit of having the power to seek restitution is that the threat of its use may often be enough. For example, the FSA recently settled with Abbey National PLC over its improper handling of complaints (including rejecting 3,500 valid complaints), with the firm committing to provide redress.

And, the FSA has established a £144-million restitution fund in settlements with 20-odd brokers and fund managers concerning improperly sold and managed split-capital investment trusts.

Britain also boasts a single, robust ombudservice. The ombudsman’s decision is binding on the firm but not on the consumer. And the FSA may involve itself in its decisions when a case or issue is thought to have broad implications, such as one involving several firms, many clients or a fundamental industry issue.

Australia has a somewhat different approach. The ASIC approves industry dispute resolution services and sets minimum standards of accessibility, independence, fairness, accountability and efficiency. Then it monitors their
effectiveness. Similar to the FSA, it relies on the services to identify and report systemic issues.

The ASIC can also seek court-ordered redress under its securities legislation, as can individuals, and can accept “enforceable undertakings” from firms, which can be used to compensate investors.

Its most recent annual report notes that court orders and undertakings resulted in compensation and fines of A$101 million, and assets of A$11 million were frozen for investors and creditors. IE