The pursuit of protection and deterrence: the OSC finds MFDA panel erred in failing to impose a fine

Under Table Agreement

Introduction

Last month, the Ontario Securities Commission (the OSC) ruled that a hearing panel of the Mutual Fund Dealers Association of Canada (the MFDA) erred when it failed to order financial sanctions against a mutual fund representative (the respondent) who had misappropriated client funds. What makes this appeal unique is that it was the staff of the self-regulatory organization (SRO) who appealed the decision of its own panel. The following article explores the background of this MFDA appeal, other similar cases and some potential implications on future cases involving appeals of SRO decisions.

Background

The respondent, a former mutual fund representative, admitted to misappropriating nearly $40,000 from a client’s line of credit and using the money for his own benefit. While the respondent admitted the misconduct, the parties could not agree on a penalty. The MFDA hearing panel published its decision on January 29, 2021, ruling that the respondent should be permanently banned, but did not impose a fine. In reaching this decision, the MFDA hearing panel considered a number of mitigating factors, including the following:

  • the financial loss was that of a bank as the client was compensated by the bank for the misappropriated amounts
  • the respondent was not previously the subject of MFDA disciplinary proceedings
  • the respondent was struggling financially and did not use the funds to support a lavish lifestyle but to pay his bills
  • the respondent was both remorseful and cooperative

Ultimately, the MFDA hearing panel explained that the primary purpose of securities regulation was to protect investors and prevent future harm, not to punish past conduct. For this reason, the hearing panel did not impose a fine and found a permanent ban and the payment of $2,500 (costs) to be sufficient punishment.

Interestingly, it was staff of the MFDA who appealed the hearing panel’s decision, arguing that its own panel had erred, and sought a fine of over $50,000. The OSC agreed and imposed a $52,270 financial penalty on the respondent, explaining that “the MFDA panel erred in law, proceeded on an incorrect principle, and adopted and applied a perception of the public interest that is inconsistent with that of the Commission by deciding not to order disgorgement or any financial penalty against the Respondent.” In coming to its decision, the OSC noted that disciplinary penalties are intended to be “protective and preventative” by restraining future harmful conduct. Disgorgement, in particular, is an important tool to advance these aims and ensure “specific and general deterrence of misconduct” and maintain public confidence in capital markets by making it clear that contravening securities regulations does not pay.

The OSC panel found that the MFDA panel had specifically erred in several ways:

  • by treating the bank’s reimbursement to the client and the fact that the bank, not the client, suffered the loss as mitigating factors
  • by treating the respondent’s motivation for misappropriating client funds as a mitigating factor
  • by placing too much emphasis on the respondent’s inability to pay a financial penalty and concluding that the imposition of a financial sanction would be punitive

For these reasons, the OSC ordered that the respondent disgorge his wrongfully obtained gains of $32,270 (the respondent had already repaid $7,000 to the bank) and imposed a $20,000 administrative penalty.

Unique, but not the first of its kind

While it is uncommon for regulatory staff to appeal a decision of its own SRO panel, it is not unprecedented. A similar issue arose in a 2012 case involving a different SRO, the Investment Industry Regulatory Organization of Canada (IIROC).

In Mark Allen Dennis, 2012 ONSEC 24, IIROC staff made an application to the OSC for a review of a 2011 decision in which a former broker was found guilty by IIROC’s hearing panel of misappropriating $1.4 million from a client and of failing to cooperate with IIROC’s investigation. The hearing panel imposed a permanent ban as well as financial penalties of $1 million for misappropriating client funds, $25,000 for failing to provide information to IIROC, and $7,500 in costs. These fines, however, were significantly less than those requested by IIROC’s enforcement counsel, who had requested disgorgement of the funds plus an additional fine.

On appeal, the OSC found that the IIROC hearing panel erred. As with the recent MFDA case, the OSC substituted its own decision, which included (among others) a sanctions order for full disgorgement of the misappropriated funds. As in the MFDA case, the other sanctions were left intact.

Both cases involve an instance of staff appealing a decision of its own SRO, specifically with respect to financial penalties, and, in both cases, the underlying conduct was the misappropriation of client funds. The cases demonstrate that SRO staff are prepared to exercise their powers to ensure misappropriation of client funds is deterred through substantial financial penalties.

These cases stand in contrast to the outcome in Investment Dealers Assn of Canada v. Kasman, 32 OSCB 5729. While the misconduct at issue in that case was “manipulative and/or deceptive trading,” staff of the Investment Dealers Association of Canada (the IDA, the predecessor of IIROC) challenged the IDA hearing panel’s decision on the grounds that it imposed “a less stringent sanctions and costs order than what was requested by IDA Staff.” In this earlier case, the application was dismissed by the OSC, which deferred to the discretion of the hearing panel.

Implications

Taken together, the above-noted decisions may reflect the willingness of statutory tribunals to exercise their powers, particularly when it comes to advancing the protective and preventative objectives of securities regulation. These decisions signal that the OSC is equipped and ready to intervene in an appeal where it determines that it is necessary to assert the desired level of specific and general deterrence.

They also give a shot in the arm to enforcement staff in their push for the right to appeal decisions of their own tribunal. Currently, a respondent in an enforcement proceeding can appeal a decision of the OSC to the Divisional Court of the Ontario Superior Court of Justice under section 9 of the Ontario Securities Act. However, as we have previously reported, in March 2021, the Government of Ontario announced several changes aimed at modernizing the province’s capital markets sector. These changes largely focused on the structure of the OSC and seek to advance the recommendations made by Ontario’s Capital Markets Modernization Taskforce in January 2021 (see our previous reporting on its final report and its road to implementation).

One such proposed recommendation put forward by the Taskforce relates to the separation of adjudicative functions at the OSC as well as the creation of a new Capital Markets Act (which would replace the Ontario Securities Act). We understand that the creation of this new legislation is currently being pursued, and would open the door to such an appeal right. Further, section 136 of the current consultation draft of the Capital Markets Act contemplates an appeal mechanism for the Chief Regulator of decisions of the newly constituted tribunal. In light of these proposed recommendations and forthcoming changes to Ontario’s capital markets sector (coupled with the recent SRO appeals), it remains to be seen whether the appeals process will allow OSC staff to appeal decisions of its own tribunal.