Edited by David Di Paolo
IDA - DUTY TO COOPERATE IN AN INVESTIGATION
In a May 2007 IDA hearing, BLG represented a broker charged with failing to cooperate in an IDA investigation. The IDA Panel is expected to issue comprehensive written reasons in the next few weeks that will provide important guidelines for brokers and firms concerning the level and nature of cooperation required, and we will report on those in a future issue.
IDA Bylaw 19 requires full cooperation from brokers and their employers during investigations, and provides that the IDA, not the investigatee, is the sole authority as to what is relevant to the investigation. A difficulty for brokers and members is that should they disagree with the investigator over, for example, whether a certain requested document is privileged or protected by privacy legislation, or the extent to which they are obliged to obtain information from third parties, they risk being accused of non-cooperation and compelled to attend a Hearing on the point. Since the best outcome of a Hearing is that they will win but sustain significant angst and legal fees in doing so, and the worst outcome is a finding of non-cooperation with a likely fine of $10,000-$100,000 and a possible suspension, brokers can be caught between a rock and a hard place during investigations.
Virtually no one has ever been acquitted of a failure to cooperate charge so these are important issues. In the November 2006 IDA decision Re: Credifinance nearly all of the allegations of non-cooperation against Credifinance were thrown out by the Panel, but Credifinance was nonetheless found to have failed to cooperate in one instance by failing to fully answer an undertaking given at an interview, resulting in a $50,000 fine (that case is under appeal).
The utmost cooperation and good faith is warranted during IDA investigations. Nevertheless, brokers and members should have the right to question the scope of the investigation if it strays into privileged, unreasonable or otherwise excessive areas. The case presently under consideration is expected to provide considerable guidance to the IDA and the industry in determining the line between legitimate questioning or withholding by the member on one hand and non-cooperation on the other hand.
The Alberta Court of Queen’s Bench recently released reasons in a case that should be of some interest to brokers and, perhaps more so, their employers. Northey-Taylor v. Casey,  A.J. No. 256 (Q.B.), released March 6, 2007, explored the direct and vicarious liability of a brokerage firm that claimed its employee broker was acting outside the course of his duties and employment. The brokerage firm was, in the end, found directly and vicariously liable.
The Plaintiffs in the Casey decision, a husband-wife duo and another individual, invested approximately $200,000 through a private placement in a company known as Brier Resources Corporation in early 2000. However, Brier never delivered the shares nor did it return the money to the Plaintiffs. The Plaintiffs sued Brier’s successor, but prior to trial the successor declared it was insolvent. Accordingly, the Plaintiffs obtained a hollow default judgment.
During the course of the lawsuit against Brier, the Plaintiffs were able to obtain information about a stockbroker named Casey and his involvement in the private placement. Casey was employed by Wolverton Securities Ltd. The Plaintiffs, looking for deeper pockets, named Casey and Wolverton in a second lawsuit relating back to the private placement.
Wolverton noted that there was no formal agency relationship between it and Brier for the purposes of brokering the private placement. An agency agreement had been proposed, but never implemented or executed owing to some unexplained hesitation on the part of Brier’s principals. Despite the lack of any formal agency arrangement, Casey had attended meetings with prospective subscribers, including the Plaintiffs, wherein he allegedly touted Brier and the upcoming private placement. Not unsurprisingly, it was the Plaintiffs’ evidence that they were induced to subscribe to the private placement on the basis of Casey’s representations. Casey had also allegedly made further representations, once the investment amounts had been paid to Brier, that the shares were "on their way" to the Plaintiffs.
The evidence at trial was that Casey was not experienced with private placements and did not know the private placement was not being formally brokered by his employer Wolverton. Wolverton sought to employ these facts in its defence. Although Casey may have breached a duty to the Plaintiffs, Wolverton argued that the duty did not extend to Wolverton as it had no formal relationship with Brier to broker the private placement and was basically uninvolved with the matter. Wolverton further argued that it could not be vicariously liable for Casey’s actions, given that the steps he took to further the private placement were not taken in the course of his employment. Employers are generally liable for acts of employees conducted in the course of their job, but not for completely unrelated acts. In essence Wolverton argued that Casey was "acting in an unbrokered transaction as agent for Brier" and not for Wolverton.
The Court rejected Wolverton’s defences. It was held that, in this situation, Wolverton had a duty to inform either its brokers or the Plaintiffs that Wolverton was not officially brokering the private placement and had not done so. The Court also said Wolverton failed in its duty to properly supervise Casey.
As far as vicarious liability was concerned, the Court held that Wolverton could not rely on the fact the formal arrangement between it and Brier had fallen through. The Court ruled that Casey’s actions were either "authorized by the employer or [were] unauthorized but so connected with authorized acts that they may be regarded as modes of doing an authorized act." Consequently, in the end, Wolverton was found jointly and severally liable with Casey to make good the Plaintiffs’ respective investment losses.
If there is a proposition to be taken from this case it is that it is likely a difficult strategy for a brokerage firm to disavow the actions of their employees when it comes to transactions where a Plaintiff can point to any tangible involvement of the firm.
It is incumbent on the brokerage firm to keep its individual brokers informed. Had Casey been informed by Wolverton that Brier’s private placement was actually not being brokered through Wolverton, the outcome could have been altogether different.
DIRECTOR/OFFICER SUITABILITY CASE UPDATE
Under their bylaws, stock exchanges have the right to determine the suitability of individuals to act as directors, officers or in other capacities of listed companies. In one recent case, a seemingly routine unsuitability decision of the TSXV made its way to the Supreme Court of Canada, and the various decisions along the way set out some useful guidelines in this area of law.
In late 2004 Murdo McLeod and Sidney Miszczuk were each advised by the TSXV that they had been found unsuitable to act as directors and officers (and in McLeod’s case, an employee) of Flag Resources (1985) Limited and Golden Briar Mines Limited respectively. The TSXV process did not involve a hearing, but rather the exchange of written position letters, followed by the unsuitability decision. McLeod and Miszczuk appealed these decisions to the Alberta Securities Commission. A Panel of the ASC reviewed the materials and, as well, allowed McLeod and Miszczuk to give oral testimony, after which it dismissed the appeals and upheld the TSXV’s unsuitability decisions.
The matter was further appealed and in July 2006 the Alberta Court of Appeal dealt with various procedural considerations in terms of how exchanges and securities commissions should conduct suitability reviews and appeals. The Alberta Court of Appeal concluded that proper procedures had been followed in the case and that the TSXV and ASC had acted reasonably in declaring the two individuals unsuitable. Messrs. McLeod and Miszczuk sought leave to appeal that decision to the Supreme Court of Canada which, in March 2007, declined to entertain an appeal, bringing the matter to an end.
MARKET MANIPULATION UPDATE
Every provincial Securities Act makes it an offence for brokers or anyone else to trade securities when they know or ought to know that the trades create or might result in artificial prices for the securities (i.e., market manipulation). Such activity is not only a statutory violation, but a violation of a registrant’s code of ethics and the internal policies of every brokerage.
One of the most common forms of possible market manipulation is "high closing", where trades occur late in the day to establish a higher price. Brokers should be mindful of this, particularly when trading thinly traded stocks where very few or even a single trade can result in a noticeable price increase due to actual supply and demand. A perfectly legitimate investment decision to acquire a position in a certain stock can lead to regulatory scrutiny of the trades if they have some of the indicia of market manipulation, for example if they increase the price, occur at or near the close or are part of a pattern of trading that indicates artificiality.
In February 2007 the Alberta Securities Commission in a 2-1 decision found that a portfolio manager, James Ryan Anderson, had manipulated the market despite Mr. Anderson’s testimony that he had been employing a legitimate investment strategy. Market manipulation is an offence that requires knowledge or intent on the part of the trader and a majority of the ASC Panel imputed a wrongful motive and intent to Mr. Anderson despite his denial. This was a very rare case in which there was a dissenting judgment from one of the panel members who decided that Mr. Anderson was credible and truthful and that his trading motive reflected a genuine investment intent. The case is under appeal.
On March 7, 2007, following a contested hearing, an RS Hearing Panel found that a trader named Michael Bond had traded various securities which he knew or ought to have known would create an artificial price contrary to UMIR. Almost all of his orders were for minimum board lots, many of them were at the end of the day and they increased the subsequent bid price. The bid price, in turn, affected Mr. Bond’s compensation and the Panel concluded that this must have been his motivation for the trades. The Panel also found that Mr. Bond’s compliance supervisor was guilty of failing to properly supervise the trading.
The lesson is that brokers and their employers must be exceedingly mindful when implementing trades that could be interpreted in retrospect as creating an artificial price or high close. When taking unsolicited orders, they similarly must be aware of their role as gatekeepers and be wary if the trades could be seen as creating an artificial price.
BLG is very familiar with this area of law and has procured what is, to our knowledge, the only outright acquittal on market manipulation/high closing charges in the ASC case of Re: Roche Securities.
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.