Regulators are “hitting on all cylinders”

So, although the latest numbers from the Canadian Securities Administrators seem to indicate that there’s been a decline in overall enforcement activity over the past year, regulators maintain that’s simply not the case.

“I’ve actually been very pleased with the output we’ve had this year,” says Tom Atkinson, director of enforcement with the Ontario Securities Commission. “Our teams are hitting on all cylinders.”

Yet, the CSA’s latest enforcement report shows that both the number of proceedings that regulators launched and the number they have concluded were down in 2011 compared with the previous year; overall totals for monetary sanctions, disgorgement and restitution have dropped as well.

The CSA reports that regulators had initiated a total of 126 proceedings in 2011, down from 178 in 2010. They also concluded a total of 124 cases last year, a similar-sized drop from the 174 cases concluded in 2010.

Moreover, the value of overall fines and administrative penalties levied in enforcement cases also fell year-over-year, to $52.1 million in 2011 from $63.8 million in 2010. And restitution, compensation and disgorgement amounts also declined, to $49.6 million in 2011 from $58.6 million in 2010. The totals for both categories also are down significantly from 2009, when fines totalled $153.7 million and restitution orders amounted to $92.2 million.

It appears that despite securities regulators’ repeated promises to stiffen enforcement, they are actually seeing diminished results. But the data can be deceiving. Although there’s no question that the headline totals are down, the efficacy of enforcement can’t be measured on sheer numbers alone. For one thing, there are anomalies in the data: the total fines levied in 2009 are inflated by the fact that more than $100 million of this is related to the asset-backed commercial paper settlements. If you exclude that large outlier, then 2009’s numbers are more or less in line with those of the subsequent two years.

More important, there are shifts in regulatory strategy taking place that aren’t captured in the numbers. Atkinson says the OSC is going after more complex cases, which absorb more time and resources. And while this strategy may reduce the overall case count, it nonetheless addresses important enforcement issues in the market.

The OSC has been focusing on illegal insider trading cases recently, which are notoriously complicated, Atkinson points out. The regulator also has been investigating some large cases involving firms that are based in emerging markets but trade in Canada. “We’re dealing with tens of thousands of documents in Mandarin,” he says, “simultaneous investigation teams in Asia and [Canada]. And that takes a lot of resources.”

Moreover, regulators are taking a different approach to penalties. In fact, Atkinson says, the OSC is increasingly seeking jail terms for offenders in court rather than monetary sanctions to increase enforcement’s deterrent effect.

And, on that count, the numbers do point to improving results, with the length of the jail terms going up dramatically over the past couple of years. In 2009, the OSC sent securities-law violators to jail for a grand total of 45 days. In 2010, the duration rose to six and half months; in 2011, the OSC won a record 14 years and seven months in total jail time. The OSC also has five quasi-criminal cases currently in litigation.

Seeking more jail time has both raised the stakes for the accused violators and increased the evidentiary challenge for the regulators’ litigators. (The latter point may be another reason for the drop in the overall volume of cases completed.) And, the number of cases under appeal is also up, to 31 in 2011 from 19 in 2010, which highlights the increasingly contentious nature of enforcement and also consumes resources that could otherwise be used on new files.

The types of cases in which the OSC is pursuing jail terms often involve repeat offenders who aren’t put off by the hefty monetary penalties that regulators have handed out in the past, Atkinson says, but are rarely collected.

Indeed, another of the illusions in the enforcement data is the notion that the size of the monetary penalties is a good proxy for enforcement efficacy. In fact, the securities commissions’ anemic collection rates render those numbers mostly meaningless.

Earlier this year, the OSC had reported that it has collected less than half of the monetary penalties it has levied since 2005 — and the vast majority of that came from cases that were settled. Less than 1% of the penalties handed out in contested hearings have been collected.

That situation doesn’t bode well for the monetary penalties that were levied in 2011, as the split between settlements and contested hearings shifted last year; with the number of settlements reached during the year dropping to 53 from 71 in 2010, and the number of contested hearings rising to 47 in 2011 from 39 in 2010.

Nevertheless, regulators had visibly ramped up their activity in other ways during the past year — notably, by increasing their use of protective orders (such as interim orders and asset freeze orders) that aim to prevent harm. In 2011, CSA members handed down 63 interim orders and asset freeze orders, up from 41 in 2010. This increase suggests regulators are trying to be more preventative by intervening early in more cases.

And there are other aspects of enforcement that aren’t reflected in the stats, Atkinson notes. For example, last year, as part of a raid on a suspected boiler-room operation, the OSC had seized a list of 400 potential victims who were in the process of being solicited by fraudsters. The OSC called everyone on the list to warn them that they were being targeted. Atkinson calls this sort of work “very important and very effective.”

In addition to doing more to prevent harm, regulators are looking for other ways to bolster enforcement. Late last year, the OSC had proposed several changes to enforcement policy, designed to boost co-operation with the commission and speed up the resolution of certain sorts of cases, including the possible use of no-contest settlements.

The comment period concerning those policy options closed earlier this year, but the OSC also is planning to hold a public hearing at some point this spring to consider the controversial question of whether to allow no-contest settlements. (That hearing has not been scheduled.)

Another innovation that was introduced by the OSC last year is its litigation assistance program, which connects people who are facing regulatory proceedings but who don’t have their own lawyers with volunteer counsel from Bay Street. The hope is that free legal advice will help speed up the hearing process in these cases. The one-year pilot program was announced in mid-October; so far, the OSC has received 20 applications from defendants seeking free counsel. Of those applicants, 10 have been connected with lawyers. The others haven’t been ruled out, the OSC says; they just haven’t received counsel because there hasn’t been anyone available.

None of the 10 cases in which defendants are being advised by volunteers has concluded, so it’s tough to tell how well the program is working at this early stage. However, the secretary’s office at the OSC, which handles these applications, reports that the involvement of these lawyers has certainly helped to expedite those cases.

“The feedback that we’re receiving from the panels,” it says, “is that they’re very pleased with pre-hearing conferences moving more smoothly, time truncated and delays being avoided.” IE