Despite being shot down in court, Rob Kyle, a derivatives trader who is now also an investors’ advocate, pledges to carry on his fight to show that Canada’s system for regulating the securities industry is fundamentally flawed.

The latest setback in a long-running battle with regulators came May 26, when the Ontario Superior Court of Justice handed down a decision rejecting Kyle’s effort to challenge the jurisdiction of the Investment Dealers Association of Canada over its members. Kyle had sought to have the court rule that the IDA should be considered an agent of the government, and that Charter of Rights and Freedoms’ protections and other statutory limits to its investigative powers should apply. The court rejected his case in all aspects in a unanimous opinion.

Disappointed but undaunted, Kyle vows to march on. He has filed a motion seeking leave to appeal the verdict, and expects a decision by mid-August. He pledges to go all the way to the Supreme Court of Canada, if necessary.

First, the case will have to get to the Appeals Court in Ontario. If it refuses to hear the case, the fight will be over. Kyle insists there are important public policy issues at stake, and that is why he hopes the higher court will agree to give him a further hearing. “Did the government anticipate, when it created the [Securities] Act, a parallel system of regulation?” he asks. “I can’t believe that. I can’t believe they’d allow a contract to exist, to which neither the public nor the government is a party, [that purports to defend the public interest].”

Essentially, Kyle argues that the regulatory system is improperly constructed, and hence operates as an agent of the government without statutory authority. It is missing some powers, yet lacks limits to its existing powers. He says the imbalance stems from the Ontario Securities Commission’s decision to grant the IDA regulatory authority by way of a recognition order rather than a statute like that which backs up other self-regulatory bodies.

The problem, Kyle argues, is that the IDA is in the position of regulating in the “public interest” when its only authority comes from the contract it has with its members. While the IDA is subject to OSC oversight, it is not administering a public law and is not answerable to the public via the government in the same way that the OSC is or self-regulators are in the U.S. This is doubly complicated by the fact that the IDA also serves as an industry lobbyist.

The IDA also gives the OSC a route to effect rule changes without ministerial approval — by implementing them through the SROs, Kyle argues. He points to the proposed fair-dealing model as an example in which securities commissions are contemplating imposing fundamental changes to the dealer/ client relationship through SRO rule changes.

In Kyle’s view, the betwixt-and-between status of the IDA and its dual regulatory/lobbying function is at the root of investor dissatisfaction with the regulatory system. Such wariness, heard most recently at the OSC’s investor town hall on May 31, was also clearly aired in legislative hearings held in Ontario last summer.

The legislative committee that conducted the hearings concluded the testimony it heard “revealed a deep-seated skepticism on the part of the investing public. They simply are not confident complaints will always be handled in an objective manner under a system of self-regulation.” It recommended the government strike a task force to consider the role of self-regulation.

The government endorsed the committee’s report and pledged to act upon it. While it has acted on several of the recommendations, it has not yet acted on the one to review the status of self-regulation.

It remains to be seen whether the government will take up the challenge, but apparently the court was not willing to burn down the current system just yet. It found the decisions of the IDA and OSC were reasonable throughout the disciplinary process, and that the penalties levied against Kyle and his firm, Derivative Services Inc., were “eminently reasonable and responsive to the offence.”

The court noted in its decision that there is no requirement for consistency in the regulatory scheme. It wholeheartedly rejected the claim that firms are compelled to join the IDA by “economic necessity,” saying “any other conclusion would undermine the self-regulatory scheme.” The court also reiterated the Supreme Court of Canada’s position that securities commissions are owed substantial deference.

@page_break@Alex Popovic, IDA vice president of enforcement, says the decision against Kyle is a good one because it confirms what the IDA has said all along: “That the IDA process is fair; that members who have contracted to become members have to respect that contract; that we are not subject to the Charter; and that we are not an arm of government. And, notwithstanding that, we are subject to the same principles of fairness and natural justice you would expect with any tribunal.”

The decision validates the fact that the IDA hearing panel properly applied the principles in the assorted Kyle hearings, Popovic says, as did the OSC in hearing his appeals. He says Kyle has “no issue” with the panel. More generally, the decision validates the IDA process as being fair, he adds.

Since the start of this long and winding journey through the legal system with Kyle, the IDA has made some substantial changes to its investigation and enforcement practices. It is compiling a formal investigation manual, publishing penalty guidelines, adopting its ComSet complaint/incident tracking system and making changes to some of the key bylaws that deal with investigations. The IDA has also posted a guide for subjects of investigations and its policy for making disclosure to those facing disciplinary action on its Web site, www.ida.ca.

The Kyle case wasn’t necessarily the impetus for the changes, says Popovic.
Indeed, he says, the IDA hasn’t made any specific reforms in response to issues raised by the case. Rather, the changes have come about, in part, because of the oversight of the various securities commissions, but mainly because the IDA’s board wanted to “do the right thing” and ensure that the enforcement department had the tools it needs to do its job properly.

Notwithstanding that the decision went wholeheartedly against Kyle, the judgment nevertheless weaves a somewhat sympathetic tale about the events that led up to the protracted legal fight. First, the investigation itself was something of a rarity — originating with an internal complaint and looking into whether Kyle and his firm, DSI, had complied with an earlier IDA order.
According to the decision’s account of the testimony, less than 10% of the IDA’s investigations originate with an internal complaint and few, if any, examine whether an IDA order has been complied with.

Additionally, the investigator initially assigned to the case had only been on the job for two months and had only looked at one other file. At the time, the IDA didn’t have a training manual or a written policy on conducting investigations. The regulator’s unwritten policy was to pair a new investigator with a senior investigator so the junior could learn on the job. But even this unwritten policy wasn’t followed in Kyle’s case.

In mid-April 1998, Kyle and DSI were told that an investigation into whether the firm had complied with an earlier order was underway. Kyle phoned the IDA and asked for a copy of the complaint against him, and promised to hand over any books and records it needed for its investigation. The IDA refused. One of its unwritten policies was not to provide those under investigation with a copy of the complaint against them until allegations are formally brought. That way, the scope of the investigation is not limited.

In early May 1998, the IDA sent a letter requesting a long list of documents from DSI. Kyle complained about the volume of the material it was requesting, then he lawyered up. His lawyer sought more information about the complaint but, again, the request was denied. The IDA reiterated its request for documents, and again DSI refused. Then disciplinary proceedings began.

DSI was charged with failing to provide documents. It brought motions at the preliminary IDA hearing and lost. It sought to appeal that decision to the OSC, and was told that it was premature. The IDA hearing eventually went ahead, and DSI and Kyle lost. They were hit with fines of $35,000 and $45,000, respectively.

That decision was appealed to the OSC, which said the request was too late. DSI appealed that decision in court and won.
The OSC was instructed to give the company an appeal hearing. It did and, again, it upheld the IDA’s ruling. The latest appeal aimed to challenge these rulings — but the court found them all to be reasonable.

At its heart, the case is about whether the targets of a regulator’s investigation should be informed of the specific matter that is being investigated. Popovic says the issue of notifying the subject of an investigation is a balance between informing them and not wanting to provide the opportunity to thwart an investigation by alerting them to evidence they could destroy.

Popovic says that the IDA’s notice requirement is a minimal one, and it has been upheld in subsequent hearings. Most recently, the IDA published its reasons for a decision in a case against Union Securities Ltd., which deals with the issue of notice. It cites the Kyle case, and the facts are much the same.

According to the panel’s reasons, after Union Securities found out the IDA was investigating, it sought more detail from the regulator. It argued the information was necessary to help it determine what it had that could be relevant to the investigation. It also cited a precedent involving optometrists in Saskatchewan to support its point.

The hearing panel allowed that, while the cases are similar, the key difference is the investigator in the Saskatchewan case was required to decide whether an offence had occurred. By contrast, IDA investigators just investigate and report their findings; they don’t make decisions about whether an offence has been committed.

The purpose of informing the subject of an investigation, the panel says in this latest case, is to trigger the individual’s obligation to co-operate. “In our view, the purpose of advising a member of an investigation is to engage the member’s obligation to co-operate. It cannot be for the purpose of enabling an unscrupulous member to prejudice the investigation,” it says. “The narrow purpose for which notice is required to be given implies that the information conveyed by it need not be broad. It must be sufficient to alert the member to its obligation to co-operate. But it should be as narrow as possible so it does not give to an unscrupulous member information that could help it defeat or hinder the investigation.”

Although it is hard to fault the IDA for wanting to ensure that its investigations are thorough, there have to be limits to its inquiries. Early on, Kyle pledged to turn over whatever was necessary. The public was not at risk, as his firm did not deal with the public. The issue under investigation was somewhat technical. It is hard to imagine that it needed to drag on this long. And it may go on even longer. IE