The Alberta Securities Commission (ASC) recently released its decision in the matter of Re Fauth, finding the respondent, Vernon Ray Fauth (Fauth), in breach of ss. 75(1)(a), 92(4.1) and 93(b) of Alberta's Securities Act, RSA 2000, c S-4 (the Act). The decision offers some important insight on issues regarding limitation periods, illegal dealing, misrepresentations, and fraud under the Act. The decision also discusses the use of hearsay evidence in proceedings before the Commission; specifically, the use of transcripts of witness interviews conducted by the Alberta Securities Commission Staff (Staff) in the course of their investigation.
Fauth operated a financial and estate planning business through Fauth Financial Group Ltd. (Fauth Financial), a corporation licensed to sell insurance and mutual funds. Fauth was also involved in a number of other corporations and limited partnerships:
- Espoir Capital Corporation (Espoir): Espoir was set up to raise funds from the public for re-investment in other opportunities. The investments would then generate the returns to be paid to Espoir investors. Fauth was the founder and sole shareholder, director, officer and signing authority of Espoir.
- FairWest Energy Corporation (FairWest): FairWest was a publicly-traded oil and gas company listed on the TSC Venture Exchange. Fauth and his son were two of the six FairWest directors. FairWest became insolvent and sought protection under the Companies' Creditors Arrangement Act in December 2012.
- Limited Partnerships: Fauth had an interest in and control over a number of other oil and gas entities, including Royalty Investments Limited Partnership (Royalty LP). Royalty LP's general partner was AFM Management Inc. (AFM Management), of which Fauth was president, sole director and sole voting shareholder. Royalty LP was described as a "conglomeration of one corporation [AFM Management] and six partnerships". Fauth was involved with and had an interest in all six of these partnerships.
From November 2002 through November 2012, Espoir issued approximately $15 million in debentures (Debentures) to over 70 investors in Alberta, British Columbia, and Ontario. In soliciting investments, Espoir distributed one-page summaries to investors and potential investors, describing the kinds of investments that Espoir would make. Although there were minor variations in these summaries over the years, they all represented that Espoir was established to invest in a pool of interest paying investments such as money market, treasury bills, mortgages, GICs and term deposits.
Some of the Debentures were described as "unsecured" (Unsecured Debentures) while the others were described as "secured" (Secured Debentures). The certificate accompanying the latter stated on its face that it represented a "Secured Debenture". The Unsecured Debentures stated in their preambles that "[t]he Debenture is an unsecured obligation of [Espoir] and is specifically subordinated to Senior Indebtedness, as defined herein". "Senior Indebtedness" was defined to include all of Espoir's other indebtedness, apart from the Unsecured Debenture itself and any other subordinated indebtedness. Both Debentures also contained a "No Security" clause stipulating that:
The Holder [i.e., the purchaser] acknowledges that no security interest is granted to the Holder by [Espoir] hereby and the Holder covenants that he shall not seek to cause any registration of the Debenture against [Espoir] or its assets in any jurisdiction.
According to Fauth, the only real differences between Espoir's Unsecured Debentures and its secured Debentures were the interest rate and the date of issue. His evidence was that, despite their names, both had "the same" underlying security: "the assets that were in...Espoir...". The Unsecured Debentures typically offered an interest rate of 10.5% while the Secured Debentures typically offered an interest rate of 8%.
In addition to the Debentures, Espoir also issued a number of promissory notes (Espoir Notes). Each had been issued in 2012, had a two-year term and paid 8% interest per annum.
Around 2010, Espoir became unable to repay the Unsecured Debentures as they matured. In response, Fauth began asking the Unsecured Debenture holders to enter into amending agreements, the majority of which reduced the interest rate on those paying 10.5% to 8%, extended the term (usually for a further three years), and changed the timing of interest payments from semi-annually to quarterly.
By mid-2013, Espoir ceased making interest payments to Debenture holders. Espoir's financial records showed that, as of December 31, 2014, it owed its investors over $12.3 million.
A Notice of Hearing was subsequently issued on May 11, 2016 by the Staff, alleging that Fauth breached statutory prohibitions on engaging in unregistered trading contrary to s. 75(1)(a) of the Act, making a misrepresentation contrary to s. 92(4.1) of the Act and perpetrating a fraud contrary to s. 93(b) of the Act. Twelve witnesses testified at the 12 day hearing before the ASC. These included eight investors, two current members and one former member of the ASC investigative staff and one individual who used to work with Fauth. Fauth refused to testify, but instead chose to rely on the transcript of his interview conducted by the Staff during the course of their investigation. The Commission allowed Fauth to file the transcript of his investigatory interview, but took into account that Fauth had not made himself available for cross-examination at the hearing and, thus, it could not directly assess his credibility.
A recurring theme in the evidence of all eight investor witnesses was that Fauth assured them that their transactions were "secure" and represented low risk. He variously represented to the investors that their money would be used to invest in "real estate", in "[real estate developments] secured against land registered on title", "in mortgages", "in property around Alberta", and in "shopping centres and business office buildings". Fauth also represented to the various investors that their investment "was about as safe as anything [they] could do", would "be first on title if something happened", and was "a hundred percent secured...by property". Fauth expressly represented to one investor that he would not invest his money in FairWest, the investor being aware of the financial woes of FairWest at the time.
The forensic accounting evidence indicated that between January 1, 2009, and September 30, 2014, $8,453,915.49 was deposited to Espoir's bank account. Of this, $5,851,581.24 was paid in interest and principal to holders of Debentures and Espoir Notes and $2,585,414.87 was paid to non-arm's length parties (including Fauth Financial and FairWest). The forensic accountant concluded that the funds received by Espoir were generally used for three things: (i) to pay interest and principal owed to Espoir investors; (ii) to benefit the Fauths through the payment of management fees and transfers to other companies; and (iii) to benefit entities related to Fauth or over which Fauth had "significant influence". The evidence further suggested that Espoir often loaned money to non-arm's length parties without written loan agreements or any security.
In terms of the few secured investments/loans Espoir did participate in, the security provided either far-exceeded the debtor's financial assets or, in the case of loans to non-arm's length parties, the mortgages were discharged without any payment from the mortgagor. Finally, as of the end of 2007, Espoir did not hold any third-party mortgages.
Based on the evidence before it, ASC found Fauth in breach of ss. 75(1)(a), 92(4.1) and 93(b) of the Act.
As a preliminary matter, the ASC had to determine the use that could be made of transcript evidence of two witnesses who were unable to testify before the ASC. The two witnesses were Espoir investors who were interviewed by the Staff during their investigation. One of these witnesses had passed away, while the other was elderly and too ill at the time of the hearing to testify. Relying on: ss. 29(e) and 29(f) of the Act;1 the relevance of their transcript evidence; the fact that the evidence was given under oath; and the availability for cross-examination of relatives of the two unavailable witnesses,2 the ASC decided to admit the impugned transcripts. The ASC did, however, ascribe less weight to these transcripts as compared to direct evidence of available witnesses.
From 2002 through December 16, 2014, s. 201 of the Act provided that "[n]o proceedings under this Part [i.e., Part 16 of the Act, Enforcement] shall be commenced in a court or before the [ASC] more than 6 years from the day of the occurrence of the event that gave rise to the proceedings." As of December 17, 2014, the section was modified slightly to provide that "[n]o proceedings under this Part shall be commenced in a court or before the [ASC] more than 6 years from the day of the occurrence of the last event on which the proceeding is based."
The ASC concluded, quoting Re Dennis, 2005 BCSECCOM 65 at paragraph 37, that "[w]hen a series of events or transactions in a continuing course of conduct spans a period of time, the 'date of the events', in the ordinary sense of that phrase, can only mean the date of the last event in the series that allows staff to allege a breach of the legislation...". On this basis, the ASC was satisfied that the misrepresentations and fraud alleged in Re Fauth likewise constituted an ongoing scheme and continued course of conduct.4
s. 75(1)(a): Fauth Engaged in the Business of Selling Securities Without Being Registered
Section 75(1)(a) of the Act prohibits anyone from acting as a "dealer" in securities "[u]nless registered in accordance with Alberta securities laws". The ASC began its analysis by noting that in order to find Fauth in breach of s. 75(1)(a) of the Act, it must be demonstrated that: (i) there was a security as defined in the Act; (ii) there was a trade as defined in the Act in relation to that security; (iii) Fauth engaged in or held himself out as engaging in the business of trading in securities; (iv) Fauth was not registered; and (v) Fauth could not rely on an exemption from the registration requirement.
The evidence was clear in satisfying the first, the second and the fourth prong of the test. In relation to the third prong, ASC noted the non-exhaustive list of factors contained in Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) relevant to determining whether a party has engaged or held itself out as engaging "in the business" of trading in securities. These factors include:
- engaging in activities similar to a registrant (such as "promoting securities or stating in any way that the individual or firm will buy or sell securities");
- intermediating trades or acting as a market maker (which "typically takes the form of the business commonly referred to as a broker" or "[m]aking a market in securities");
- directly or indirectly carrying on the activity with repetition, regularity or continuity;
- being, or expecting to be, remunerated or compensated; and
- directly or indirectly soliciting securities transactions.
Relying on these factors, the ASC was satisfied that Fauth engaged in and held himself out as engaging "in the business" of trading in securities.
Regarding the final branch of the test, the ASC rejected Fauth's argument that the Debentures fell under a prospectus exemption and, accordingly, he was exempt from registering with the ASC.5 The ASC was not persuaded by this reasoning, noting that Fauth had the onus to prove the availability of and compliance with all of the terms of an exemption and he had failed to do so. The ASC also was not satisfied, as Fauth had argued, that this was a mere technical breach, noting that Fauth was a past registrant with considerable experience in the capital markets and the associated regulatory environment.
s. 92(4.1): Fauth Made Misrepresentations
The ASC began its analysis by noting the test under s. 92(4.1): (i) a statement was made by a respondent; (ii) the respondent knew or reasonably ought to have known that the statement was, in a material respect, untrue or omitted a fact required to be stated or necessary to make the statement not misleading; and (iii) the respondent knew or reasonably ought to have known that the statement would reasonably be expected to have a significant effect on the market price or value of a security.
Based on the evidence before it, the ASC was satisfied that Staff had proven all parts of the test under s. 92(4.1). Fauth had ensured investors that their investments were secure, low-risk, and would be invested in a certain way. Instead, he invested their money in non-arm's length entities with meager protection for the investments and in circumstances where the investments were far from secure. Further, the misrepresentations were material and had a significant effect on the value of the Debentures since an investor would have been more willing to invest in Espoir when assured that his/her investment was "secure".
s. 93(b): Fauth Committed Fraud
During the relevant time, s. 93(b) of the Act prohibited anyone from "directly or indirectly, engag[ing] or participat[ing] in any act, practice or course of conduct relating to a security...that the person or company knows or reasonably ought to know will...perpetrate a fraud on any person or company".6
The ASC confirmed that the test for fraud under the Act is the same as set out by the Supreme Court of Canada, albeit in a different context, in R v Théroux,  2 SCR 5, and requires the Staff to prove:
- the actus reus, which is
established by proof of:
- a "prohibited act, be it an act of deceit, a falsehood or some other fraudulent means"; and
- "deprivation caused by the prohibited act, which may consist in actual loss or the placing of the victim's pecuniary interests at risk";
- the mens rea, which is
established by proof of:
- "subjective knowledge of the prohibited act"; and
- "subjective knowledge that the prohibited act could have as a consequence the deprivation of another".
In relation to the actus reus, the evidence was clear that the investors were misled, their funds were exposed to the risk of loss, and then, ultimately, they suffered actual loss. Further, investors were not informed that their funds were exposed to a risk of loss that they did not anticipate, and, ultimately, were lost.
Finally, in terms of mens rea, the ASC was satisfied that Fauth had subjective knowledge of his prohibited acts and the consequences and potential consequences of these acts.
Re Fauth provides a useful summary of the test for establishing liability under each of ss. 75(1)(a), 92(4.1) and 93(b) of the Act.
Re Fauth is also a useful reminder that the rules of procedure and evidence applicable before the ASC are more relaxed than those applicable in a criminal trial before a court. As the ASC noted, in relation to a respondent's ability to cross-examine a witness:
[I]n a regulatory context such as this, natural justice and procedural fairness do not necessarily dictate that an opportunity to cross-examine must be provided, as long as a party is given "a reasonable opportunity to comment on and challenge such evidence" in another way (citing Re Arbour Energy Inc., 2012 ABASC 131 at paras 49 and 52).
Further, the ASC was clear in noting that a respondent seeking to rely on a registration exemption must make a reasonable, serious effort – or take whatever steps were reasonably necessary – to satisfy himself that the exemption was available at the time of the trade of the security (citing Re Cloutier, 2014 ABASC 2 at para 308). Bald assertions of the presence of an exemption, or reliance on legal advice vis-à-vis the ostensible exemption, is not sufficient. Moreover, evidence is required to prove reliance on legal advice.
In terms of misrepresentations under the Act, the panel in Re Fauth reiterated that it is not necessary to prove reliance by specific investors on any specific statements or omission alleged to constitute a misrepresentation. Accordingly, what matters is the misrepresentation, the representor's knowledge of the misrepresentation and the effect of the misrepresentation on the market price or value of the security.
On the issue of fraud, ASC emphasized that it is unnecessary to prove that the accused knew that what he was doing was wrong or that he intended to cause someone else to incur a financial loss. All that is required is proof that the respondent intentionally committed the prohibited acts knowing that the consequence could be deprivation, including the risk of deprivation. Moreover, evidence of personal benefit is not required.
1 Section 29(e) of the Act stipulates that an ASC hearing panel "shall receive that evidence that is relevant to the matter being heard". Section 29(f) provides that "the laws of evidence applicable to judicial proceedings do not apply to a hearing before the ASC". These sections allow the admission of all relevant evidence, including hearsay, subject to the rules of natural justice and procedural fairness and the ASC's discretion.
2 These relatives too had invested in Espoir. They had personal knowledge of the unavailable witnesses investments and interactions with Fauth and gave viva voce evidence before the ASC during the hearing.
3 The ASC was not required to consider whether the alleged breaches of s. 75(1)(a) in the Notice of Hearing were limitation barred since these occurred after May 11, 2010 and were therefore within the six-year limitation period.
4 The ASC also relied on the British Columbia Securities Commission's decision in Re Williams, 2016 BCSECCOM 18 in concluding that the misrepresentation and fraud allegations were not statute barred. In Williams, investors loaned money on the representation that it would be "put into safe investments". Instead, the funds were used for other purposes, including payments to earlier investors. The panel in Williams concluded that it was a Ponzi scheme involving ongoing acts of deceit which persisted until the scheme collapsed. Accordingly, it was found to constitute a continuing course of conduct, none which was held to be statute-barred.
5 The Debentures contained language whereby the subscribers, by signing, ostensibly acknowledged that Espoir was a "private issuer" and warranted that they either were family, friends or close business associates of a "director, senior officer or control person" of Espoir (i.e., Fauth) or were accredited investors. If proven, these facts could have established that a prospectus and registration exemption was available prior to September 28, 2010. A number of the investors, however, were neither family, friends or close business associates of Fauth nor accredited investors at the time they purchased their first Unsecured Debenture in July 2006.
6 Section 93(b) now also prohibits an "attempt to engage or participate in any act, practice or course of conduct relating to a security ...that the person or company knows or reasonably ought to know will...perpetrate a fraud on any person or company".
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