1. Summary. 2. Methodology

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1 THE REALITY OF SETTLEMENT IN REGULATORY ENFORCEMENT CASES Joel Wiesenfeld and Celesse Dove * 1. Summary The vast majority of concluded regulatory enforcement cases at the Ontario Securities Commission (OSC) and the Investment Industry Regulatory Organization of Canada (IIROC) in the ten years from 2000 to 2009 inclusive resulted in a settlement, as opposed to an adjudication following a contested hearing. Notwithstanding this largely unrecognized fact, regulatory enforcement proceedings are conducted without having in place any formal process or designated personnel to facilitate settlement agreements between regulatory enforcement staff ( Staff ) and respondents. Our conclusion is that this is a gap in the regulatory enforcement framework that needs to be filled. 2. Methodology We analyzed administrative enforcement proceedings brought by Staff of the OSC and IIROC in the ten-year period 2000 to 2009 inclusive against individuals and entities (corporations, partnerships, etc.) that concluded by way of an approved settlement agreement or adjudication (whether contested or uncontested) before a hearing panel (including, in the case of the OSC, Executive Director Settlements). In addition to these 977 concluded proceedings, there are also proceedings commenced by these regulators that were simply dropped or discontinued but the public record in respect of those proceedings is incomplete. Our study was of enforcement proceedings and, therefore, the data excluded securities litigation proceedings before administrative tribunals dealing with issues arising from transactions such as * Joel Wiesenfeld is a partner at Torys LLP. The views expressed in this article are strictly personal. Celesse Dove (Law Clerk, Broker Dealer and Securities Litigation at Torys LLP) compiled the data, a not insignificant undertaking. We would like to thank a number of people who greatly contributed to this article including Andrew Gray, Mary Laszlo, Dina Buonincontro, the Honourable Justice Colin Campbell and The Honourable Patrick J. LeSage. 1. Of the 977 number, 399 were OSC proceedings and 578 were IIROC proceedings. 68

2 2011] Settlement in Regulatory Enforcement Cases 69 contested take-over bids and poison pill proceedings and excluded other matters that arose from other areas of securities regulation such as registration. Only administrative enforcement proceedings were analyzed, as opposed to enforcement charges brought by OSC staff pursuant to s. 122 of the Ontario Securities Act 2 before the Ontario Court of Justice. A number of regulatory enforcement proceedings conclude following uncontested hearings that result in sanctions including cease trade orders, the loss of trading exemptions, and/or loss of registration as a dealer, advisor or licensed registered representative. At the IIROC level, a number of enforcement cases against registrants who have a regulatory duty to cooperate in enforcement investigations conclude by way of an uncontested hearing based on the charge of failing to cooperate, resulting in the individual being barred from further participation as a registrant in the industry and a monetary fine that is otherwise uncollectible. Regarding IIROC, the study included proceedings concluded during the relevant period by IIROC and its predecessors, the Investment Dealers Association of Canada, Market Regulation Services Inc. and the Toronto Stock Exchange (Enforcement Division), but not the Vancouver Stock Exchange, the Alberta Stock Exchange, or the Canadian Venture Exchange. Finally, while our initial intention was to review each proceeding as a single unit, regardless of the number of individuals and entities named as respondents, this methodology proved to be overly simplistic. In numerous matters, while some or most of the respondents entered into settlement agreements, one or more of the respondents contested the charges through to an adjudicated hearing. Therefore, rather than reviewing each matter as comprising one unit in the statistics, we compiled the data by respondent which, of course, vastly increased the number of cases subject to analysis. In comparison with IIROC, OSC matters tended to have a larger number of respondents in each matter. For IIROC, we reviewed concluded cases by respondent categorized as either (1) contested adjudications, (2) settlements, or (3) uncontested adjudications (whether resulting from a failure to cooperate, a failure to attend the hearing, a failure to respond to the allegations and deliver a reply, not contesting the proceedings, or an ex parte application by regulatory Staff). 2. R.S.O. 1990, c. S.5.

3 70 The Advocates Quarterly [Vol. 38 Over the 10-year period 2000 to 2009 inclusive, there were 139 contested IIROC adjudications (that is, 139 respondents whose cases were concluded by a contested adjudication), 374 settlements, and 65 cases in the uncontested category, in all totalling 578 concluded cases. Thus, of the 578 cases, 24% were contested adjudications, 65% were settlements, and 11% were uncontested cases. Comparing the number of contested adjudications only to settlements (i.e., eliminating the third category), the percentages are 27% contested adjudications (139 of the reduced total of 513) to 73% settlements (374 of 513). For the OSC, we reviewed concluded cases by respondent over the 10-year period as catalogued on the OSC website under OSC proceedings. This database contains a record of all proceedings before the OSC from which was winnowed settlements and adjudications (both contested and uncontested) of enforcement matters. As such, there is not included in the statistics the following: (1) matters concluded outside of the date range 2000 to 2009 inclusive; (2) opportunity to be heard cases, principally under s. 26 of the Act; (3) cease trade orders where the matter did not proceed to a final order, whether on a contested or uncontested basis (in this regard there were many cases where a temporary cease trade order was issued and there did not appear to be any conclusion to the matter); (4) matters where Staff discontinued the case or withdrew the allegations against a particular respondent, or obtained an order removing that individual or entity as a respondent; (5) reciprocal orders; (6) matters that came to the OSC by way of appeal or review of an SRO decision; (7) non-enforcement matters; (8) matters that dealt with the failure to file financial statements, and (9) matters where concurrent administrative proceedings before the OSC and criminal or quasicriminal proceedings before the courts were commenced, and the administrative proceedings were held in abeyance or stayed pending the conclusion of the criminal or quasi-criminal proceedings. Over the 10-year period 2000 to 2009 inclusive, there were 100 contested adjudications (that is, 100 respondents whose cases were concluded by a contested adjudication), 265 settlements, and 34 cases in the uncontested category, in all totalling 399 concluded cases. Thus, of the 399 cases, 25% were contested adjudications, 66% were settlements, and 9% were uncontested cases. Comparing the number of contested adjudications only to settlements (i.e., eliminating the third category), the percentages are 27% contested adjudications (100 of the reduced total of 365) to 73% settlements (265 of 365).

4 2011] Settlement in Regulatory Enforcement Cases Analysis The fact that settlements heavily outnumbered (by a ratio of approximately 3 to 1) contested hearings leading to a decision is not startling to any regulatory or defence counsel practicing in this area. Nevertheless, the formal process of investigation leading to enforcement notice, then to notice of hearing, disclosure and the hearing itself, is geared towards an adjudicated hearing, with little or no process dedicated to facilitating settlement. Unlike the civil litigation context, there is no requirement or even process equivalent to either rules-required mediation or courtscheduled settlement conferences. Settlements in regulatory enforcement matters occur by means of ad hoc communications, rarely including the input of or facilitation by OSC commissioners or other non-party persons. Are the parties disadvantaged by this lack of process, structure and staffing? Is the fact that so many enforcement settlements occur indicative of the efficiency and effectiveness of the status quo? One cannot obtain statistics or anything other than anecdotal evidence regarding lost or delayed opportunities to settle regulatory enforcement cases. In other judicial adversarial contexts, such as civil actions and criminal proceedings, administrators have seen fit to build into these proceedings settlement processes. Regulatory enforcement settlements frequently occur late in the game, just prior to or during hearings, meaning enforcement Staff and respondents overspend resources of time and money in preparing for a hearing that does not commence or conclude by adjudication. Why has this occurred in regulatory enforcement matters and yet not in the civil litigation or criminal contexts? Is it an historical anomaly from the period when the adjudicative function of securities regulatory enforcement matters was less independent of regulatory staff? Are securities regulators concerned about being secondguessed by authority figures at mediations or settlement conferences, even if they are not compelled by the process to accept a contrary opinion regarding their position? Are securities regulators afraid of a diminution of their settlement leverage over respondents, which consists of the risk of reputational damage caused by the issuing of a notice of hearing and the hearing itself, and the risk of a respondent (but not the regulator) being exposed to an adverse costs award if that party loses at the hearing? Are securities regulators wary of their frequently unreasonable settlement positions being exposed to the light and scrutiny of an independent third party?

5 72 The Advocates Quarterly [Vol. 38 On the other side of the fence, most respondents are not frequent repeat parties to enforcement proceedings and therefore lack the experience with and knowledge of the existing process so as to assess the risks inherent in the present process and determine whether change is required. Defence counsel in a particular case may or may not be sufficiently settlement oriented, depending on their view of the risks arising from a contested hearing and the cost and other benefits of settlement, whether at any particular point in the process, or at all. When the value of a file for defence counsel is calculated on billable hours rather than the interests of their clients in the result, the monetary incentive lies in proceeding to a contested hearing and not settling at the earliest possible opportunity. Whatever the reason, or even if there is no reason, the lack of a settlement process and of designated persons to fulfil the facilitation of the settlement function is a gap in the regulatory enforcement framework. Hearing panels in settlement approval hearings regularly reiterate the benefits of settlements in enforcement cases, citing several important considerations. Settlements create certainty of result while litigating a matter through a contested hearing carries with the process considerable risk of result. Even cases that appear to a party as clear and obvious all too frequently break down as new documents appear, witnesses are discredited, or the hearing panel just does not accept the validity of a party s position or their credibility. Settlements allow for a balancing of factors and interests as set out in a negotiated agreement between regulatory enforcement Staff and the respondents (as set out in the reasons of the hearing panel in Melnyk (Re)datedJune6, ). Fromtheregulators standpoint,a settlement allows for the regulatory policy perspective (that was, or should have been, the driver of the prosecution) to predominate over what in a decision and reasons resulting from a contested hearing might be a conclusion based on unique findings of fact and therefore of narrow future precedent or message to the securities industry. Most importantly, a settlement, with its carefully negotiated language in the settlement agreement, allows the parties complete creative control to achieve a balance of the various objectives of the parties in dealing with the regulatory liability, potential civil liability (predominantly in class actions) and reputational damage to the respondents, and sometimes the industry of which the respondents are a part. A clear recent example of regulatory enforcement settlements in Canada where such a balance was achieved through negotiation was in the OSC market timing proceedings against, and 3. Melnyk (Re) (2007), 30 OSCB 5216.

6 2011] Settlement in Regulatory Enforcement Cases 73 settlements with, fund companies. OSC Staff were able to obtain substantial compensation to unitholders of the various mutual funds at issue through settlements with the fund companies while the fund companies were able to negotiate language in the agreements setting out the admitted facts and regulatory liability that minimized exposure to civil liability and reputational fallout from the regulatory proceedings. Regulatory enforcement proceedings engage the interests not only of regulators and responding parties but frequently also, whether directly or indirectly, those of investors in the shares of issuer respondents, clients of dealer respondents and other respondents engaged in the distribution of securities, unitholders of mutual fund company respondents and others. These persons or entities, who are not respondents in the regulatory proceedings, may be involved either as plaintiffs in civil actions or as class members in class proceedings against the same responding parties as in the regulatory proceedings. The timing and fact of settlement of the regulatory proceedings may have a material effect on the conduct and outcome of such related civil litigation. Regardless of whether there is such civil litigation, a respondent s dealings with investors and other nonparties, by way of compensation or otherwise, may be delayed pending resolution of regulatory enforcement proceedings. It is in the public interest that these interests of such affected persons be dealt with in a timely way. This is particularly true in the case of a respondent in a regulatory proceeding who or which is in financial or operational difficulty and whose remaining assets, which might otherwise go to injured third parties or its own shareholders, are depleted to pay lawyers, consultants and experts in the contested regulatory proceedings. In July 2010, the OSC approved the adoption of a new rule in its Rules of Procedure 4 changing its settlement agreement approval process to ensure the fair and efficient resolution of proceedings before the Commission. 5 This development applies only to the settlement approval process subsequent to the parties having entered into a settlement agreement. In so doing, the OSC focused on the goal of encouraging settlements, with a view to providing flexibility to avoid high costs and time delays, and with a view to decreasing the number of lengthy hearings. Settlements reduce the costs and expense involved in the litigation process, particularly the hearing process, and remove the uncertainty as to the outcome to the benefit of all 4. Made under the Statutory Powers Procedure Act, R.S.O. 1990, c. S Notice of Amendments to Rule 12 of the Rules of Procedure of the Ontario Securities Commission released July 20, 2010.

7 74 The Advocates Quarterly [Vol. 38 parties. Settlements allow for creative solutions, whether in an order that contains terms that would not have been within the jurisdiction of the hearing panel following a contested hearing, or for a resolution completely outside of the enforcement and hearing framework (such as in the OSC case where a large number of mutual fund dealers accepted conditions on their registration as part of a nonenforcement resolution of the issues arising from their having referred retail investment clients to Portus Alternative Asset Management). For the many enforcement cases that involve otherwise compliant registrants and market participants, settlement agreements contain an admission and self-recognition by the respondent (whether explicit as now required by Canadian securities regulators, or implicit as in no contest settlements which are the U.S. norm) of conduct contrary to the public interest and/or contrary to securities laws. For any respondent with a reputation to protect, the process of being charged and going through a public hearing is itself penal regardless of outcome. Settlements lessen the negative reputational impact arising from a notice of hearing and the hearing process. Settlements, as opposed to adjudicated orders, do not carry with them a punitive association. The lack of any process to facilitate settlement may also account for the relatively low percentage of matters concluding by way of settlement as compared to commercial civil litigation cases where well in excess of 90% of such cases are resolved by way of settlements. 4. Suggested Process We therefore recommend that securities regulators and, in particular the OSC and IIROC, adopt a new rule to establish a protocol for settlement conferences designed to ensure the fair and efficient resolution of securities regulatory administrative enforcement proceedings, as follows: 1. A settlement conference may be initiated by any party to the proceeding subsequent to the delivery of an enforcement notice and prior to a hearing panel or tribunal rendering its decision on the matter. 2. The content of a settlement conference shall be privileged and confidential. 3. All parties to a settlement conference shall act in good faith. 4. If a matter involves more than one respondent or potential respondent, one respondent cannot compel any of the other

8 2011] Settlement in Regulatory Enforcement Cases 75 respondents to participate in a settlement conference. 5. The settlement conference shall be presided over by a settlement commissioner/ tribunal or panel member (the settlement commissioner ). 6. With the consent of the parties, the settlement commissioner may participate at a pre-hearing conference or a settlement approval hearing. The settlement commissioner may not participate at a contested hearing of the same matter. 7. The scheduling of a settlement conference shall not delay any parties disclosure or other pre-hearing obligations or the hearing of the matter. 8. The purpose of a settlement conference is to allow the parties the opportunity, in a structured setting and with the protections of privileged and confidential communications, to explore settlement of the substantive, but not the procedural, issues arising from the enforcement notice and/ or the notice of hearing in the matter. 5. Conclusion The reality of settlements should be recognized by securities regulators, and the benefits of settlements enhanced by putting in place a process to facilitate settlement parallel to the investigation, enforcement notice, notice of hearing and hearing process currently in place, and by appointing the appropriate personnel to staff the process.