Dealing With The Securities Regulator

This article was originally published in Blakes Bulletin on Litigation - May 2005

A person who faces allegations of breach of a regulatory framework, such as securities regulation, may be confronted with the possibility of attack on several fronts. He may face litigation jeopardy in the form of a criminal prosecution, a quasi-criminal prosecution, an administrative hearing and, very often, a civil proceeding.

Obviously, in the context of the regulation of the capital markets, it is not simply the issuer company that is at jeopardy. Regulators are increasingly focusing on officers and directors in their investigations and enforcement proceedings. For instance, Tom Atkinson, President and CEO of Market Regulations Services Inc., recently stated that "[w]e are going after senior officers at firms that have had plenty of notice they were committing violations …" and that "[w]e’ll look at the management of the firm, at the directors of the firm. We’ll try to figure out where the cultural problem is stemming from." It is particularly this multi-party type of investigation which can create deep complexities for counsel – inside and outside – charged with managing an investigation. The divide – imagined or real – between corporate interests and individual interests can present the potential for explosively divisive problems which can and must be kept in check, wherever possible.

Leaving aside a criminal prosecution (which is an entire subject in itself), the focus of this article is confined to a more likely context. Specifically, let’s take as an example an alleged violation of Ontario securities laws. We will assume that a client has called for assistance immediately following the receipt of either an "informal" request or a "formal" summons pursuant to Section 11 of the Securities Act (Act) from the Ontario Securities Commission Investigation Staff (Staff) to appear to answer questions under oath or otherwise, and to produce documents.

We will then assume that the investigation leads toward a proceeding. In other words, our focus will be upon the investigation stage.

The following remarks, with some minor differences, apply equally to investigations initiated by other securities self-regulatory organizations (SROs), such as Regulation Services or the Investment Dealers Association.

As noted, the investigation of your client by the OSC may begin with either a formal summons or an informal request for answers and information. Staff have recently shown a continuing preference for proceeding informally by consent rather than formally by summons pursuant to Section 11 in the hope that by doing so they may avoid impediments in their investigation. In particular, Staff will resort to the informal practice in order to avoid the implications to Staff stemming from Sections 16 and 17 of the Act, or to facilitate the use of the evidence obtained during the investigation in later proceedings by Staff or other authorities. Accordingly, subject to comments made hereafter concerning the value of "measured co-operation", there may be reasons for having your client respond only to a formal summons. The fact that the testimony is "compelled" will then provide some legal limits on the subsequent use of the information provided by the client.

Naturally, upon receiving the client’s distress call, the most important first consideration will be to accurately evaluate the seriousness of the subject matter and the implications to your client. Unfortunately, at the earliest stages, this is often easier said than done.

As suggested above, the threshold questions have increasingly become "who is your client, have you more than one and is it possible or prudent to act for more than one?" As regulators increasingly pursue officers and directors as individuals, there is similarly an increasing need to evaluate whether there are or will likely be multiple interests at stake. There may be cases where the need for independent advice is evident at the outset but this is not always the case. Obviously, there is often a desire to minimize the need for multiple counsel, for many good reasons. The more counsel there are, the greater the likelihood of confusion and tactical disagreement (in "joint defence" contexts). Also, the costs escalate. So the need to resort to multiple counsel will be an early and difficult judgment call. Where the need is not obvious, "cautions" should be given and the future possibility for conflict clearly identified.

A further important threshold consideration for a corporate client may be whether the regulatory investigation should be supervised by a "special committee" of the Board. In the case of material investigations, particularly those implicating senior management, it may be vital to have committee oversight, with counsel reporting to that committee exclusively. The structure and utility of such special committees is also a topic unto itself.

Finally, at the threshold stages of an investigation is the need to quickly develop a public relations strategy. This may entail media relations expertise and press, "standby" statements and the like.

Whatever the decision on representation, detailed early work will certainly be necessary where there is a clear sense that the matter is serious. In such cases, it is crucial to take as much time as possible, before responding to the OSC in any detail, to thoroughly interview the client, review available documents, interview "witnesses" (subject to "gag" or "confidentiality" limitations), obtain technical securities law advice, retain "experts", and otherwise take steps to obtain a full under-standing of the circumstances leading to the OSC inquiry.

In some instances, much of the detailed early work may already have been done because it could be that the client is already facing a complaint made to his or her SRO or is joined in prior civil proceedings.

In other instances, however, the OSC investigation and request for information is the first event and, particularly where the investigation is advancing rapidly, the client may know very little or will have heard only rumours and will be uncertain as to the exact nature of his predicament. In such circumstances, it is particularly important for experienced counsel to immediately make contact with the Staff involved and obtain as much early disclosure as possible of the underpinnings of the investigation.

In my experience, particularly where Staff has confidence in the caller, Staff is often reasonably co-operative and will elaborate somewhat helpfully on what the investigation entails – subject matter and time frame – and, possibly, any preliminary conclusions and theories that Staff may have in mind.

After this early and exploratory contact, you will then be better able to gauge whether the client is a peripheral fact witness, a potential target or a definite target with all the attendant jeopardy. This, in turn, will provide the first opportunity to evaluate the subject matter and implications and, where the risks are there, carry out appropriate further inquiries, preparation and then make hard tactical decisions. This contact will help you assess whether the client may also anticipate criminal and/or civil consequences. Where either of these latter possibilities exist, you will need to be extra vigilant about what you voluntarily provide to Staff and on what basis.

Generally speaking, where the circumstances of the client are serious, the main tactical decision early in the investigation stage will be whether your client will adopt, at the outset, a measured yet co-operative relationship with Staff or a more clearly confrontational stance.

In most situations, a measured co-operation is sensible and recommended. This is the case for several good reasons. Firstly, SROs place importance on appearances and often take greater "negative" interest in an apparent confrontation. Secondly, the regulator may have a reliable co-operation "rewards" policy. Thirdly, it is a broadly held view, concerning OSC administrative proceedings at least, that the chances of winning in a battle are slim, so you do not want to "ask for" trouble. Fourthly, it is frequently said, with good reason, that the client’s best interests lie in confidential "damage control" rather than in public litigation. Fifthly, the costs associated with what are often very technical and protracted proceedings can be very high. On the other hand, and this risk has been increasing with the current exponential growth in penalties and enforcement Staff investigative activity, when the OSC shows early signs of extreme hostility and the ramifications of Staff’s suspicions upon the client are too great, confrontation or full scale litigation may be the only sensible alternative.

Assuming for our purposes that the response is to be what I have termed "measured co-operation", it is important to understand that this does not equate with "giving up" nor with being submissive to Staff authority. Rather, it means turning to more subtle steps which are productive, which avoid the public glare and which serve to reduce any advantage which Staff may have gained through surprise and their early investigative efforts.

We now come to the matter of providing a statement or providing answers to questions in the context of a transcribed examination. In our example, I am assuming that the client is appearing either voluntarily or pursuant to summons and that counsel and the client are fully prepared for what amounts to a discovery process.

Before attending, and again before answering any questions on the record, it will be important to have Staff state what use, if any, they intend to make of the record. If the examination is being conducted formally pursuant to Section 11, then the Act mandates that the answers given are not disclosed to any other persons or parties and are used strictly for the purposes of Staff’s investigation. However, it is very important to bear in mind that the OSC’s approach to not disclosing this information is currently in a state of flux and, in my opinion, it is increasingly likely that the answers your client may give will be provided to other parties in any OSC proceedings, to other enforcement authorities (including those in other countries) and, in the case of a professional client, will be sought after by the professional society during its investigation. Similarly, the issue of whether that transcript, which is provided by the OSC to the client as a matter of course, is producible in civil litigation is an open question. Whatever the case, as an application under Section 17 is increasingly a risk, I recommend that the ‘record’ disclose that your client is giving evidence with every expectation of confidentiality.

As a further preliminary, and where the client has attended with documents, it is important to ensure that Staff is made aware of any documents which may contain sensitive or private information which ought to be deleted. This may be the last opportunity to expurgate private information before losing control of who sees that information. Again, it is very important to remember that the documentary material provided may one day form part of an exhibit book and thus become public or may land in the hands of adversaries.

Thereafter, during the course of the examination, it will be necessary to remain sensitive to matters of privilege or matters requiring clarification. Counsel will want to participate in the examination of the client a little more actively than he or she might during the discovery of a client in a civil proceeding. While counsel will want to avoid unnecessary interruptions, it is entirely appropriate in my view, to participate more than is usually the case in an examination for discovery. For example, rather than wait until the end of the examination to ask the witness to clarify any points, it is my suggestion that, where appropriate, counsel also question the client on the record during the course of the examination. Similarly, if the Staff examiner skirts a favourable issue or misses a significant area of evidence, I would recommend that counsel immediately elicit that evidence from the client for the purposes of the record. In short, counsel will want to be alert to do whatever may be done to improve the likelihood that the transcript is not simply reflective of Staff’s case.

This more active role is necessary because of the process. The transcript often will be reviewed by other – perhaps more senior – Staff who were not involved at the actual examination and its contents become vitally important in the decision to proceed or not against the client and others. Consequently, the transcript must work as much as possible for the interviewee and not simply against him. This need arises from the fact that Staff will approach the investigation with a theory of guilt rather than innocence in mind. Due to this guilt-confirming tendency of investigators, the questioning which forms the framework for the interview and transcript tends to be one-sided. The unprotected interviewee often tends to conform to the interview structure and does not expand upon other helpful matters which the examiner may omit. Accordingly, the whole story must make it into the transcript and this is easiest to accomplish while the examination is occurring.

Additionally – but do not consider this as an alternative – it is possible to ask Staff to allow the opportunity to review the transcript so that the client and counsel have adequate time to ensure its accuracy or clarity and to expand or supplement its scope to balance, as much as possible, any inappropriate negative tone it may have acquired at the hand of the examiner. Even a seemingly innocent remark during the course of an examination can take on a wholly unintended connotation on a written page.

The client who faces allegations of breaches of securities law is in an extremely precarious position. Experienced counsel for such a client can best serve the client by carefully controlling the investigation process and, if possible, avoiding any OSC proceeding. A hearing ought to be taken only where the OSC allegations and demands are entirely wide of the mark and unacceptable. At all times through the investigation and pre-hearing stages, a consensual resolution should be pursued and this will be most easily achieved on the best possible terms with careful and active participation in the process.

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.