Investors Scrutinizing the Regulators

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Fox Guarding the Hen House



March 2001

Settling scores behind closed doors

Most industry players settle their grievances with regulators in private, according to Investment Executive research


By James Langton

Cutting a deal with the prosecutors in exchange for a lighter sentence isn’t just a hoary Hollywood cliché. Most securities industry players that run afoul of the rules end up settling their debts in behind-the-scenes negotiations with regulators, avoiding a full public airing of their dirty laundry.

Research by Investment Executive shows industry transgressors have a better-than-even chance of settling disciplinary actions once they reach the enforcement stage. And they are much more likely to reach a settlement with a self-regulatory organization than they would be if they were accused of crossing the line with one of the provincial securities regulators.

Between August 1999 and December 2000, IE found that a little more than 50% of disciplinary actions initiated by provincial regulators ended in settlements. However, more than 80% of cases brought by the SROs were settled.

The exchanges were the most willing to conclude cases, with the Toronto Stock Exchange settling all 20 of the cases during the period. The Canadian Venture Exchange settled eight of nine cases. The Investment Dealers Association of Canada was a tougher sell, with 52 of 70 disciplinary actions settled without going to a hearing.

Among the three provincial regulators that we studied — British Columbia, Manitoba and Ontario — B.C. was the most active. It brought the most disciplinary actions, 62, and was most likely to proceed to a hearing, as it did in 25 cases.

Ontario initiated 46 disciplinary actions, settled 20, brought six to hearings and cited simple disclosure infractions for the remaining 20.

In Manitoba, 12 of 18 cases ended in settlement, with six proceeding to hearings.

Looking at B.C., the province with the most data, it appears settlements led to smaller penalties on average. For example, the average monetary penalty for a case settled in B.C. is about $42,230, including enforcement penalties and investigation costs. By contrast, cases that went to hearings averaged total penalties of $159,520. The 37 cases that were settled brought total fines of about $1.1 million, compared with more than $1.7 million for the 25 cases that went to hearings.

While it seems that rogues get an easier ride if they play ball with regulators rather than going to hearings, it’s not that cut and dry. Settlements simply save regulators time and money — a principle common in the legal world in both criminal and civil cases.

Another likely conclusion is that there is little hope for a company if its case goes to a full hearing. Looking at the B.C. hearings, it appears that the more egregious cases go all the way to hearings, such as the action against Jean-Claude Hauchecorne, the broker who was found to have handled accounts on behalf of clients with mob connections. There may be little incentive to settle in such serious cases because the defendant has little hope of salvaging a career in the industry, and the regulators are sure to gain some public relations value from coming down hard on notorious offenders.

Of course, the bigger penalties that are levied in disciplinary hearings may also have less chance of actually being paid than those that come out of settlements. In November, according to Canada Stockwatch, the CDNX filed suit in the Supreme Court of B.C. claiming that Hauchecorne hadn’t paid the $432,000 in penalties that were ordered in a hearing at its predecessor, the Vancouver Stock Exchange. Hauchecorne sought a stay of the penalties by appealing to the B.C. Securities Commission but was denied.

At the BCSC, money from enforcement cost recoveries, administrative penalties and settlement agreements are recognized as revenue when they are actually received, "due to the uncertainty of collection of these types of assessments." In its most recent fiscal year, ended March 31, 2000, the BCSC collected about $1.23 million in enforcement costs and another $268,960 in penalties and settlements; but $2.5 million in costs and penalties remained outstanding. It does not break down the revenue from settlements as compared with assessed penalties but, given the type of case that is likely to go to hearings, it would not be surprising if settlements produced higher rates of compliance.

By contrast, the Ontario Securities Commission reports enforcement cost recoveries when they are assessed "unless management determines there is no reasonable assurance as to ultimate collection," in which case revenue is recognized if received. The OSC’s settlement revenue is often designated as a collection for payment to a third party. For example, when it settled the RT Capital Management Inc. case last summer, the deal included a payment of $3 million to be allocated to third parties, "as the commission may determine for purposes that will benefit investors in Ontario." The OSC maintains an account for this purpose, but does not specifically report its collection rate. In its latest fiscal year, ended March 31, 2000, it had $895,652 of cash in this account, with another $550,000 designated as receivable.

The SROs — CDNX, TSE, and the IDA — do not provide any meaningful public disclosure about their collection performance.

While there appears to be a slight preference toward settlement among the SROs, it is difficult to conclude any definitive preference for settlement from just over a year’s data. Nevertheless, as with any self-regulatory process, there’s a question of whether the result is fair, both for the defendants and the regulators on behalf of the public.

Larry Waite, chief operating officer of the Mutual Fund Dealers Association and former director of enforcement at the OSC, insists settlements are a "valuable part of the enforcement process, but only if the process is transparent and there are settlement guidelines to help ensure consistent treatment."

The MFDA will inaugurate an enforcement process that will likely be similar to those of established regulators. "Our policy with respect to hearings will be transparent," says Waite. The MFDA will issue notices of hearing with a statement of allegations, and cases will either proceed to hearing or possible settlement. Waite says the MFDA’s enforcement function will aim to "provide firm, fair, consistent and transparent enforcement."

The problem for the entire industry enforcement process, not just with respect to settlements, is that the injured parties — clients — are often left in the cold.

Consider the settlements that shut down three boiler rooms in Ontario last summer. In the case of Gordon Daly Grenadier Securities, for example, the OSC secured long-term bans against the principals involved, but recovered just $25,000, and that was to go to the commission’s investigative costs.

Meanwhile, the agreed statement of facts revealed that Gordon Daly earned $31 million in revenue from the trading in 13 issuers in which it controlled trading.

The other big prize for the commission in this case was that the brokerage also agreed to wind up its businesses and voluntarily transfer its clients to IDA firms, but recovery for investors was left to the court, at the investors’ expense.

In the case of settlement, investors also do not get a full airing of the facts in the case. Former OSC commissioner Glorianne Stromberg says transparency is key, and sorely lacking in the current Canadian system.

"I find this whole issue of secrecy troublesome," she says. "We really do need a national/international databank of complaints, resolutions and settlements, that is accessible to all. It seems to me that part of the price you pay to be licensed to do business with the public is to agree that if you rip off the public, your name will be posted for the world to see.

"That might go a long way to keeping people on the right side of the line." IE