Directors who rely in good faith on advice from professional advisors, such as accountants and lawyers, may have a due diligence defence to certain legal claims in some situations. However, a recent decision of the British Columbia Securities Commission (the Commission) in Photo Violation Technologies Corp. (2013 BCSECCOM 276 and 2012 BCSECCOM 284) makes it clear that reliance on legal counsel doesn't allow directors to avoid liability under securities laws when a company issues shares without appropriate exemptions from the registration and prospectus requirements.
Photo Violation Technologies Corp. (PVT) raised approximately $5.2 million from 322 investors between 2005 and 2008. In respect of 272 investors, who invested approximately $3.6 million during the relevant period, PVT purported to rely on the friends, family and business associates and accredited investor exemptions from the prospectus and registration requirements of the BC Securities Act, none of which applied in the circumstances. PVT retained legal counsel, with expertise in financing, who advised them in connection with the private placements.
Mitschele, one of the principals of PVT, took a course at Simon Fraser University for directors and officers of public companies. At that time, he realized that there may have been problems with PVT's earlier fundraising (i.e. the purchasers may not have qualified for the exemptions relied on).
PVT retained new legal counsel to contact the Commission on its behalf to see what could be done to address the issue. The new lawyer re-filed documents with the Commission and met with Commission staff. They expected that Commission staff would advise them if there were any issues with PVT's previous filings. According to the decisions, however, "[t]his did not happen. Commission staff's next step, from PVT's point of view, was the issuance of the notice of hearing for this proceeding."
At a 2012 liability hearing, Mitschele applied to enter evidence about PVT's legal advice in connection with its distributions and PVT's dealings with Commission compliance staff before the notice of hearing was issued. However, the Commission did not allow the evidence at that point because it stated that those issues were not relevant to liability (although they were relevant to sanctions).
In its 2012 liability decision, the Commission noted that, as PVT's president and chief executive officer as well as a director, Mitschele was involved in PVT's capital raising activities. Among other things, he signed subscription agreements and authorized (with the other directors) the issuance of PVT shares to investors. Because of that, the Commission found that he authorized, permitted and acquiesced in PVT's contraventions of the Securities Act and also contravened the Securities Act himself.
In its 2013 sanction decision, the Commission stated that "[e]ngaging a law firm or advisor to assist in compliance with regulatory compliance does not relieve a respondent from liability for non-compliance. It may be, however, a mitigating factor in determining the appropriate sanction for non-compliance, depending on the circumstances of each case."
Neither Mitschele nor the other insider of PVT involved in this hearing had any prior disciplinary history or profited from their involvement with PVT. In fact, both had incurred significant losses.
Ultimately, the Commission banned both Mitschele and the other insider of PVT from trading in securities for five years or holding a position as a director or officer of any issuer. However, the Commission allowed both to continue acting as director and officer of specific companies with which they were already involved. It also allowed Mitschele to engage in conduct, including advertisement, solicitation, and negotiation, for the purpose of obtaining financing for a specific company's business, provided that he seeks an appropriate variation order before that company actually sells the securities.
PVT itself wasn't subject to any orders as it is bankrupt.
Although both individuals were disciplined, it appears that the sanctions did take into account their reliance on counsel and other steps taken to address the deficiencies. The sanctions imposed by the Commission were significantly less than what the executive director was seeking, which included:
- 20 to 25 years prohibition from acting as director or officer of any issuer, acting in a management or consultative activity in connection with activities in the securities market and from engaging in investor relations activities;
- administrative penalties of $200,000 to $250,000 against the individuals; and
- disgorgement orders of over $3.5 million against PVT and Mitschele.
This case underlines that relying on advice from legal counsel will not excuse you from liability for non-compliance with securities legislation. Ultimately, in connection with a private placement, the company and its directors are responsible for making sure that purchasers of securities can rely on the prospectus exemptions that they say they are relying on.
In the 2012 liability decision, the Commission set out the following points (from Solara) of which issuers and their directors should be aware when relying on an exemption from securities legislation:
- the person relying on an exemption has the onus of proving that the exemption is available;
lack of documentation will make it difficult for the person to
meet that onus;
- mere assertions or ticked boxes on subscription forms from investors that they meet the criteria for an exemption is not adequate; the issuer must establish and document the facts that demonstrate that the investor is...an accredited investor, or a family member, close personal friend, or close business associate of a director, officer or founder; and
- after making the appropriate inquiries, the issuer must have a reasonable belief that the facts are true and that the legal requirements for use of the exemption have been met.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.