Regulators ramp up enforcement activity

In fact, the total for 2011 was more than the three previous years combined. For 2010, the SRO handed out $3.2 million in penalties; in 2009, the total was less than $2 million; and, in 2008, it was slightly more than $900,000.

While it appears as though IIROC has dramatically boosted the size of the penalties it’s handing down, one or two large outliers can skew the totals.

That outlier in Q1 this year involves the case of Henry Cole, a former advisor with RBC Dominion Securities Inc., who agreed, as part of a settlement, to pay a fine of $5 million and costs of $10,000, along with accepting a permanent ban from the financial services industry. Cole had admitted that he misappropriated about $5 million from clients, created false documents and misrepresented payments out of a pool of investor funds as being returns on their investments.

The results of that case has inflated the overall penalty totals that IIROC recorded in Q1 of 2012. However, even if you drop the Cole case, IIROC still has meted out more than $2 million in financial sanctions so far this year – which, extrapolated over the full year, would still put the regulator on pace to outdo last year’s total. In addition, the total for Q1 (excluding the Cole settlement) still exceeds the total sanctions for all of 2008 and 2009.

Of course, the magnitude of financial sanctions that are handed down depend on the facts of the individual cases involved; that’s not necessarily a good proxy for enforcement activity. Another metric to consider is the overall number of decisions. And, on that count, 2012 still appears to have been a busy year for IIROC so far.

There were 23 decisions rendered in enforcement cases against individuals in Q1. This is more than all of 2008 and almost as many as in 2009. And, it’s up from the same period in 2011, when IIROC reports that there were 16 decisions against individuals.

“Generally, we are pleased by the volume of cases IIROC hearing panels have been able to complete,” says Paul Riccardi, senior vice president of enforcement, member policy and registration, at IIROC. “While it is difficult to predict future pace, we are seeing the positive impact of operational improvements we have implemented. These include the adoption of an integrated team model through which investigators and counsel work together more closely.”

Indeed, the overall volume of IIROC’s enforcement decisions has been increasing over the past few years, up to 58 in 2011 from 45 in 2010 and 28 in 2009. Currently, IIROC is on pace to deliver more than 90 disciplinary decisions this year.

Looking at the numbers in terms of IIROC’s fiscal year, which ended March 31, the preliminary figures show IIROC completed 73 prosecutions against both individuals and firms in its recently completed fiscal year. This represents a 22% increase from the previous fiscal year, when it delivered decisions in 60 cases. The majority of the year-over-year increase in the number of decisions is due to a rise in cases against individuals.

That trend also is evident in the most recent quarter, during which the number of decisions – and the size of the sanctions being levied – were on the upswing for hearings involving individuals.

However, regarding enforcement actions against firms, the case load has been much lighter so far this year. There were only three disciplinary decisions against firms in Q1, and a mere $160,000 in financial sanctions handed out. Of that total, fines against firms only amount to $30,000; the balance represents costs awards.

By comparison, about two-thirds of the individuals who were sanctioned in Q1 have been hit with fines of $30,000 or more.

Excluding the Cole case, the average monetary sanction levied so far this year against individual respondents is about $100,000. So, individuals definitely have felt the sting of IIROC enforcement activity much more acutely than firms have.

Individuals also have felt it beyond the wallet. In addition to financial sanctions, IIROC has given out 14 suspensions (including a couple of 20-year penalties) and four permanent bans.

Of course, history has shown that securities regulators are much more likely to collect the fines handed down against firms vs those levied against individuals. In IIROC’s previous fiscal year, it collected 98.8% of fines assessed against firms but just 14.6% of fines assessed against individuals.

That’s because individuals can avoid paying their fines by leaving the industry; if they do that, the SRO’s power to collect are limited. Moreover, individuals often don’t have the resources to pay their penalties. For example, according to the settlement agreement in the Cole case, he was declared bankrupt in February 2011. So, even though the regulator may be racking up big penalty numbers, the reality is the vast majority of these penalties will probably never be paid.

On the upside, the fact that firms typically will pay their fines in order to stay in business is enabling regulators to facilitate a rare victory for wronged investors this year. Both IIROC and the Ontario Securities Commission have begun the process of returning almost $60 million to investors harmed by the collapse of the non-bank asset-backed commercial paper market in 2007.

In mid-March, the regulators won court approval for their proposed plan to distribute funds to investors who had purchased third-party ABCP before the market failed. And in mid-April, the regulators announced that they have appointed Ernst & Young LLP to administer the distribution of approximately $60 million directly to investors who had purchased ABCP from the five investment dealers that settled enforcement cases in the wake of the market’s failure.

Under those settlements, Canadian Imperial Bank of Commerce (and its CIBC World Markets Inc. subsidiary) and HSBC Bank of Canada had agreed to pay $21.7 million and $5.9 million, respectively, to the OSC. Scotia Capital Inc., Canaccord Financial Ltd. and Credential Securities Inc. had agreed to pay $29 million, $3.1 million and $200,000, respectively, to IIROC.

The regulators have been holding that money in segregated accounts since the sanctions were paid, and now aim to return those funds to eligible investors by September.

The OSC and IIROC have agreed upon eligibility criteria for the distribution, based largely on the facts set out in the settlement agreements with the dealers. Ernst & Young will begin contacting potentially eligible investors, and those who are hoping to participate in the distribution will have until the end of June to apply.

Wronged investors – or, at least, their lawyers – also may be cheered up by the fact that the OSC’s bid to ramp up its enforcement productivity by introducing so-called “no contest” settlements appears to be in limbo.

In October 2011, the OSC had proposed a handful of new measures intended to improve co-operation with the regulator – including the use of no-contest settlements, which would allow those facing regulatory allegations to settle their cases with the OSC without admitting or denying any wrongful conduct – thereby speeding up the enforcement process and increasing the volume of cases the OSC can handle.

Late last year, the OSC had promised it would hold a policy hearing early in 2012 before deciding whether to introduce these deals, which have proved to be very controversial. At this point, however, the OSC still hasn’t scheduled that policy hearing, which suggests that a decision on whether to adopt these proposed enforcement tools isn’t imminent.

The proposed introduction of these settlements is opposed by lawyers who regularly represent aggrieved investors, who worry that allowing regulatory settlements without admissions of wrongdoing will make it much harder to hold securities-law violators accountable in civil court.

Conversely, defence lawyers in such cases have been lobbying in favour of these deals, as they believe it will enable them to resolve enforcement cases more quickly.

But since the OSC first proposed the idea, the U.S. Securities and Exchange Commission, which has long used no-contest settlements, has become embroiled in a legal fight over these sorts of deals.

So, for now, it appears that the introduction of no-contest settlements is up in the air. IE

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