Brokers’ Report

THE COURTS

The Supreme Court of Canada recently denied Venture Capital USA Inc. ("Venture") leave to appeal from the decision of the Ontario Court of Appeal in Venture Capital USA Inc. v. Yorkton Securities Inc.

Yorkton became concerned that the principal of Venture had a serious criminal record and that some of its transactions might attract regulatory disapproval. The account agreements between Yorkton and Venture contained a "refusal clause" which gave Yorkton the right to refuse to accept purchase or sale instructions from Venture whenever Yorkton deemed it necessary for its protection or otherwise. The refusal clause also provided that Venture waived any and all claims against Yorkton for any loss or damage arising from or relating to any such refusal. Acting under this refusal clause, and without giving notice, Yorkton suspended all activity in Venture’s accounts.

In reversing the trial judge’s decision, the Court of Appeal considered the broker’s common law duties. First, at common law, a broker’s primary duty is to follow and carry out the client’s instructions. If a broker intends not to carry out the client’s instructions, then it might be under an obligation to inform them so that they can make alternate arrangements. Second, at a common law, a broker can terminate its relationship with a client with notice, however, if it fails to do so, the broker will be liable for any loss the client may sustain as a result. Justice Sharpe noted, however, that these common law duties could be modified by contract.

In considering the refusal clause, Sharpe J. held that the language of the account agreements was not ambiguous and that the trial judge erred by implying a notice requirement. Sharpe J. noted that the common law allows a broker to refuse to accept instructions to carry out an illegal transaction and held that the refusal clause in this case must have been intended to give Yorkton rights beyond those provided by the common law; otherwise, it would be redundant. In particular, the word "whenever" contained in the refusal clause did away with any common law notice requirement where Yorkton decided for its own protection that it had to refuse purchase or sale instructions. The only constraint under the refusal clause is that Yorkton must be satisfied on a good faith basis that the refusal to accept Venture’s purchase or sale instructions is necessary for its own protection or otherwise.

Sharpe J. went on to comment that the notice requirement implied by the trial judge would unduly constrain the broker's .gatekeeper. function in the securities industry, and that it failed to accord with modern commercial reality. According to Justice Sharpe, the refusal clause was to be interpreted in the context of the complex world of securities regulation where large volume transactions involving large sums of money proceed at a rapid pace and the risks are high. Moreover, the agreement between the broker and the client was to be interpreted in a manner that afforded the broker burdened with the gatekeeper function latitude to refuse suspect transactions despite a lack of clear proof of illegality. In this case, Yorkton.s concerns regarding the past conduct of Venture.s principal and the nature of the transactions he was engaged in were found to be sufficient to support a good faith conclusion by Yorkton that refusal to accept Venture’s sale instructions was necessary for its own protection.

Finally, Sharpe J. commented that related to the notice issue was the question of the broker’s obligations to its client during this notice period. While in theory the client would be seeking to transfer its accounts to another brokerage house, it was held that the broker had a duty to act reasonably in relation to the termination of its relationship with the client and to take reasonable steps to facilitate the transfer of its accounts. However, Justice Sharpe added that such steps should not be overly onerous.

On April 18, 2006 a Hearing Panel of the Investment Dealers Association of Canada (the "IDA") imposed disciplinary penalties on Union Securities Ltd. ("Union") and its Chief Compliance Officer and Ultimate Designated Person (the "UDP"). The penalties imposed were part of a settlement agreement entered into between Union, the UDP and the IDA resolving all enforcement matters from February 1997 (when Union became an IDA member) to the date of the settlement. At issue were repeat deficiencies in Union’s compliance system, the failure to adhere to Member Regulation Notices, failure to cooperate in respect of an IDA investigation, and supervision failures.

In the settlement agreement, Union acknowledged that it had failed to comply with two Member Regulation Notices. The first, Member Regulation Notice 114, warned Member firms that they must close all client accounts where the client resided in the United States if they were not registered or eligible for an exemption in the U.S. On the advice of U.S. counsel, Union advised their U.S. resident client that if they established holding companies in the Yukon, Union could open accounts in the name of the holding company (the Yukon is the only Canadian jurisdiction which permits non-resident directors to incorporate a company). By informing and permitting U.S. residents to open these accounts, Union acted contrary to by-law 29.1. Union acknowledged that it further contravened of by-law 29.1 when it failed to implement proper controls and procedures with respect to short selling U.S. stocks in accordance with Regulation SHO (the "SHO"), a newly adopted regulation under the U.S. Securities and Exchange Act of 1934 and the corresponding Member Regulation Notice MR 0320. Again on the advice of U.S. counsel, Union relied on market makers to perform this function.

As part of the settlement agreement, Union withdrew its request for a hearing and review of an IDA Hearing Panel decision which found that it had failed to cooperate with an IDA investigation into the conduct of one of its registered representatives ("RR") and Union’s supervision of the RR. While Union had provided much relevant information to the IDA, it refused to provide access to the RR’s computer, stating that some of the information contained therein was personal and irrelevant, or protected by solicitor-client privilege. An IDA Hearing Panel determined that Union had failed to comply with by-law 19.6 after IDA staff argued that the subject of an investigation did not have the right to participate in the determination of what was relevant to the investigation.

In respect of the above conduct, Union agreed to pay a fine of $1,000,000. It further agreed to retain the services of an external compliance consultant acceptable to the IDA for three years, add at least one external independent director to its Board, refrain from operating any accounts for corporations where the purpose of incorporation is to circumvent registration requirements, and correct deficiencies related to U.S. short sales as required by the SHO and MR 0320. The UDP was permanently prohibited from acting as UDP for Union or any other IDA Member firm.

The Investment Dealers Association of Canada ("IDA") and Market Regulation Services ("RS") have reached an agreement to merge their operations. The merger is intended to simplify the regulatory environment for both those in the industry and the investing public, and prevent any enforcement gaps resulting from enforcement jurisdiction being split between two bodies. The merged organization will require approval and recognition by provincial securities commissions before becoming effective.

James D.G. Douglas, - National Group Leader, Toronto
John D. Blair, Calgary
Georges R. Thibaudeau, Montréal
Carole J. Brown, Ottawa
David Di Paolo, Toronto
Gordon R. Johnson, Vancouver

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