Canada: SROs To Receive More Power At The Expense Of Procedural Fairness

The Ontario Government is proposing to allow self-regulatory organizations (SROs) to use the civil court system to collect fines from their current and former members. The Budget for 2017, released earlier this year, calls for more effective enforcement measures in the investment regulatory regime by permitting SROs such as the Mutual Fund Dealers Association ( MFDA) and the Investment Industry Regulatory Organization of Canada ( IIROC) to register disciplinary decisions and penalty orders with the courts. In the event that a member (or more likely former member) fails to pay the fine following a disciplinary hearing, the SRO will be able to attempt to collect the amount owing as if such was a judgment obtained a civil action. No details have been disclosed as to the exact legislative changes and when these changes will take effect, although similar legislation already exists in Alberta, Quebec and Prince Edward Island. While this new enforcement power purports to promote better protection of investors, in our view it does not. The infringement on the rights of the individuals who are subjects of SRO investigations is concerning, particularly given the fact that due process rights are extremely limited in the context of an existing SRO disciplinary proceeding.

SRO and the OSC

IIROC and the MFDA are the primary SROs in the investment industry. Under subsection 21.1(1) of the Ontario Securities Act, an SRO can apply to be recognized by the OSC. Once a recognition is granted, the SRO has the power to "regulate the operations and standards of practice and business conduct of its members and their representatives in accordance with its by-laws, rules, regulations, policies, procedures, interpretations and practices".

IIROC and the MFDA have both obtained written recognition from the Ontario Securities Commission (OSC), who has the power to make decisions with respect to the SRO's rules and practices. IIROC oversees the conduct and activities of investment dealers, while the MFDA regulates mutual fund dealers. Each organization has its own rules, by-laws and policies, and each conducts its own investigations and enforcement hearings when a member is alleged to have engaged in misconducts contrary to the organization's regulations. The amalgamation of IIROC and MFDA has been talked about for years and frankly, is long overdue. Having both IIROC and the MFDA is confusing and is an added expense which is ultimately born by the investing public.

SROs' Investigative Powers

Both the MFDA and IIROC have broad investigative powers that allow them to obtain unprotected documentary and oral evidence. Individual investment advisers and their dealers may be asked to submit all transaction records or communications related to the matter under investigation. Individuals may be called to attend interviews where they must answer questions that relate to a wide range of issues, particularly any potential misconduct. They are compelled to answer all questions, even if it's against their own interests. The statements and documents provided by the member are then used to determine whether there is sufficient ground to initiate and pursue an enforcement proceeding and what penalties should be imposed on the member. Responding to these enforcement investigations is expensive and in most instances, the investigations are misdirected fishing expeditions.

(Non-Existent) Procedural Rights in SRO Proceedings

The courts have made it clear that SROs are essentially private clubs that have the power to establish their own rules, and ordinary procedural rights need not apply. In Ontario, the Divisional Court in Derivative Services Inc. v Investment Dealers Association held that an SRO's disciplinary proceeding and by-laws were neither subject to procedural and evidentiary rules nor the Charter of Rights and Freedoms ( the "Charter"). The Divisional Court followed the Court of Appeal's decision in Morgis v Thomson Kernaghan & Co., and noted that membership in the Investment Dealers Association ("IDA", now IIROC) is voluntary and contractual in nature. The IDA operates under its own constitution. It does not derive its powers and authorities from any statute. It is simply recognized under the securities legislation.

The applicant, DSI, challenged the IDA's decision to impose penalty on several grounds, two of which relate to procedural protections in an SRO-initiated investigation and disciplinary proceeding. First, whether the IDA's disciplinary decisions were governed by the Statutory Powers Procedure Act ("SPPA") and the Evidence Act; second, whether the IDA's By-law 19.5 violated DSI's rights against unreasonable search and seizure under s.8 of the Charter. The Divisional Court rejected DSI's arguments on both issues.

On the first issue, the Divisional Court held that the IDA's authority to investigate came from its own by-laws rather than a specific statute, and since the SPPA only applies to proceedings by a tribunal in the exercise of a statutory power of decision conferred by or under an Act by the Legislature, the IDA is not a "tribunal" within the meaning of the SPPA. Similarly, the Evidence Act only applies to a prosecution for an offence against a by-law made under a statute, which the IDA's bylaws were not. The Divisional Court also found that the IDA's by-laws already contained provisions that were intended to ensure a fair hearing to all respondents (which in reality, is not the case).

The Court further rejected DSI's position that the IDA was a "government" within the meaning of s. 32 of the Charter. Although a private entity may still be subject to the Charter if it engages in activities that are inherently governmental or derives its authority from the government or a legislation, the IDA's regulatory functions could not be characterized as "governmental" in nature. Rather, its investigative and disciplinary powers were part of the ordinary self-regulatory process with respect to the members. Even if the Charter were to apply, the Court held that the IDA's investigative powers under its by-law was not unreasonable in a "highly regulated industry" such as the securities market. The private club rules prevailed.

Should SROs be permitted to enforce decisions through the courts?

Currently, when a member is found to have breached the by-laws, the MFDA or IIROC may impose penalties in the form of a fine and/or a suspension following an enforcement hearing. Those who wish to continue their practice must pay the fine in order to avoid suspension or denial of membership status. However, neither the MFDA nor IIROC has the ability to enforce the penalty through other means in Ontario, against individuals who are no longer members (i.e. if they leave the industry). The proposed legislative change will provide SROs with the power to collect outstanding fines from both current and former members.

It is a mystery as to why the Ontario government believes that the proposed legislative changes will afford better protection for the investing public. From our experience of being involved in many disciplinary hearings, most go unopposed (i.e. the individuals are no longer members or licensed to practice in the industry) or are determined on consent. In light of the autonomous nature of IIROC and the MFDA and the broad regulatory authorities they already possess, allowing automatic enforcement of disciplinary decisions through the courts may do more harm than good. The only achievement will be to increase the financing of SRO's operations which are presently provided by its members, including investment houses.

Statutes such as the SPPA, Evidence Act and the Charter ensure that the individuals affected by a regulatory decision have been given adequate opportunities to respond, and that their ability to deliver a defense has not been compromised by a hearing or an investigation that was conducted in an unfair manner. When the court is being asked to enforce a decision made by an administrative tribunal governed under statutes, there is at least some level of  procedural fairness guarantee. On the contrary, SROs such as the MFDA and IIROC are private clubs that, as noted above,  are not subject to regular procedural standards.

During an investigation or a contested hearing before the MFDA or IIROC, there are really no procedural rules of substance engaged. The respondent is often placed at a significant disadvantage. Members who are being investigated are not protected from self-incrimination during the investigation process. Compulsory interviews are usually conducted without any documentary production having been made by the SRO. Trial by ambush during this forced interview is the standard practice. The SRO then selects the panel members to conduct the hearing with little if any input from the member's counsel. Further, the SRO can compel any member to attend as witness at the hearing, while the respondent has no similar powers to issue summons to witnesses. The well-established rules respecting the tendering of hearsay evidence in an MFDA or IIROC hearing are non-existent. There is no ability to award legal costs against the SRO for an unsuccessful prosecution, whereas costs are routinely awarded to the SRO even if the enforcement proceeding is resolved through a settlement agreement. Finally, the penalty amount that the MFDA and IIROC seek  are often significant, reaching up to the greater of five million dollars or three times the amount of the profit made or loss avoided due to the misconduct.

To be quite blunt, the fines sought and levied at uncontested hearings (i.e. the individual has left the industry or a "settlement" has been reached) are ridiculous. It is easy to put the puck in the net when the other team has no one on the ice. Such orders or judgments that are issued on an unfair and in certain instances, uncontested basis would not be recognised by our courts if they were issued by courts from a foreign jurisdiction, so why is it that Ontario and other provinces still insist the courts must make an exception to the SROs in the investment industry?

In our view, the proposed legislative change that provides SROs the power to enforce their orders through the courts has nothing to do with investor protection but everything to do with politics, and is very misleading to the investing public. How the new legislation will achieve the laudable goal of investor protection is mystical to be polite. The proposed legislation will be misleading to the public and will not enhance investor protection at all. Amounts collected under such judgment would not be paid to the individual in the investing public who lost money through the wrongful conduct of the disciplined investment advisor, but are simply given to the SRO. Even if there is a concern that a member can leave the industry to avoid paying fines, arguably the disciplinary process would have already achieved the goal of investor protection, since the advisor is essentially banned permanently from practicing in the industry until the fine or penalty is paid. In comparison, the SROs have little, if any difficulty in collecting fines levied against advisors who wish to continue working in the industry. Further, the advisor who engaged in the misconduct may also be sued in a civil action commenced by a wronged customer. Allowing the SRO to enforce their disciplinary orders through the courts may affect the advisor's ability to compensate the customer first.

Enforcing SRO penalties against individuals who have left the industry will detrimentally affect that individual's livelihood, professional reputation and economic well-being. It will merely force individuals to seek protection under the provisions of the Bankruptcy Act.  Investor protection (which the proposed legislation does not offer) should not be achieved at the expense of procedural fairness that have been so deeply entrenched in our legal system.  These concerns must be addressed to ensure that a better balance can be achieved between effective enforcement and fair adjudication.  Alternatively, it may be worthwhile to consider whether it is time to amend the current regulatory regime so that SROs in the investment industry are subject to the same procedural rules as other organizations in a regular judicial or quasi-judicial proceeding, as there is currently little procedural fairness in the existing practices of SRO investigations and hearings.

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.

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Wendy Sun
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