White-collar crackdown: 6 steps to reform Canada's securities enforcement

Six steps to help reform Canada's reputation as a haven for crooks.

After nearly a decade, the only man to face any regulatory charges in connection with the Bre-X Minerals fraud recently broke his silence. In a short press release issued weeks after an Ontario judge found the former Bre-X chief geologist and vice-chairman not guilty of insider trading and issuing false press releases, John Felderhof admitted there may have been a fraud, but reiterated he had nothing to do with it and said he was eager to volunteer his services to any company that wanted to uncover the truth: that there was, in fact, gold deep in the jungles of Indonesia. “I have always maintained, and now the court has found, that the tampering that took place at [the mine] was 'unprecedented in the history of mining,'” he said. “It is my firm belief that no amount of regulation can be put into place to prevent a sophisticated and well-planned fraud.”

That short statement gave investors a rude reminder of Canada's abysmal track record in cracking down on white-collar crime. Since the corporate scandals of Enron, WorldCom and Tyco, U.S. prosecutors have obtained more than 1,200 convictions of high-level corporate executives. In Canada, meanwhile, high-profile police investigations into companies like Nortel Networks and Royal Group Technologies have fizzled without any criminal charges. And the RCMP's much-touted Integrated Market Enforcement Teams (IMET) have secured just two convictions — both against the same man. Notwithstanding the recent fraud charges brought against the founders of Portus Alternative Asset Management — the failed Canadian hedge fund that allegedly ripped off investors for hundreds of millions of dollars — Canada has a growing reputation as a good country for crooks to do business.

Canadian authorities are starting to pay attention. Earlier this year, federal Finance Minister Jim Flaherty told attendees at a conference on securities enforcement that Canada must clean up its act. “It does concern me greatly that some Canadian investors consider it necessary to rely on the United States to hold companies to account for their actions,” he said. “We need to ensure investors are adequately protected and that consequences of wrongdoing are swift and severe.” Barbara Stymiest echoed those sentiments in a speech before federal politicians in September. The former head of the Toronto Stock Exchange, who is now a senior executive with the Royal Bank, called Canada's current securities regime “an international embarrassment.”

Flaherty's answer to those concerns is for Canada to jettison its mosaic of provincial securities regulators and adopt a single national regulator. Canada remains the only major world economy without a national securities regulator, which would allow the provinces to pool their resources to create a faster and more efficient enforcement regime and eliminate the duplication and delays inherent in the current system, argue Flaherty and other proponents.

Flaherty faces an uphill battle. Over the last 40 years, at least four different task forces have recommended Canada adopt a national securities regulator. But political opposition from provincial regulators — primarily in Quebec, British Columbia and Alberta — has always stymied the proposals. And while a national securities regulator would be a good start to addressing the lack of effective capital market enforcement in Canada, it's no panacea, says Craig Hannaford, the former head of the RCMP's IMET squad in Ontario. “A national securities regulator is not going to solve this,” he recently told Canadian Business. “We [will] have the same issues with the courts, the same issues with disclosure, the same issues with sentences and parole.”

That said, even without the formation of a new national securities regulator, cops, academics and other market players agree there are simple and tangible steps that both provincial and federal authorities can take that could help reform Canada's reputation as a haven for crooks.

1. Admit there is a problem

The first and most important step Canadians could take is to acknowledge that there is a problem and make combating white-collar crime a priority. Canada's inability to crack down on capital market fraud has already spooked many foreign investors and has lead to a “made-in-Canada” discount on Canadian stocks. The additional risk associated with investing here costs Canadian companies billions of dollars in investment as foreign investors reduce the amount they are willing to pay for Canadian stocks.

The discount was first identified by the Investment Dealers Association's Task Force to Modernize Canada's Securities Legislation. Of the 65 recommendations the task force made to improve Canada's securities regime, the most critical was improving enforcement ability to bring fraudsters to justice. “In our consultations, the most commonly cited reason for the perception of weakness in Canadian securities enforcement is the apparent inability to enforce securities laws in high profile cases that have substantial links to Canada,” reads the report.

And while discussions of those weaknesses often play out on the business pages of Canada's newspapers, it rarely makes it to the front pages. Though violent crime directly affects a relatively small number of Canadians, just about every Canadian who owns a stock, a mutual fund or is invested in a pension plan has been harmed by investment fraud. A survey released in October by the Canadian Securities Administrators estimates that as many as one in 20 Canadians has lost money in a fraud. What's more disturbing that is that around 70% of those surveyed believe that people who commit fraud in Canada are likely to get away with it.

2. Pursue cases aggressively

Authorities in the U.S. are not only more successful in getting convictions when it comes to insider trading, they pursue such crimes more aggressively. Take the case of John Fraleigh, the Canadian businessman who has been the subject of a long-running SEC investigation regarding his trading in Placer Dome shares just prior to a takeover bid by Barrick Gold. Last November, the Ontario Securities Commission issued a public statement saying it had closed the book on its investigation into Fraleigh. By comparison, as recently as September, the SEC filed new court documents in its investigation against Fraleigh, demanding to question his Canadian friends, family members and business contacts. Fraleigh has maintained his innocence and claims his timely investment in Placer Dome came as the result of his own research into the company.

If all Canada wanted to do was send a dramatic message, the federal government could simply treat white-collar crimes like insider trading as seriously as it does the threat of terrorism, provocatively states Marilyn Pilkington, a law professor at York University's Osgoode Hall Law School. (Pilkington studied Canada's seemingly inability to successfully investigate and prosecute white-collar crime as part of the Investment Dealers Association's Blue Ribbon Task Force on modernizing Canada's securities laws.) With the stroke of a pen, Canada's justice minister could rewrite insider trading laws, tilting the burden of proof from prosecutors to the accused. This “reverse onus” of guilt is contrary to the way every other crime is prosecuted — with the exception of terrorism. In essence, prosecutors would no longer have to climb the steep hurdle of proving the guilty state of mind of those accused of insider trading. Rather, the defendants would be forced to prove their innocence when confronted with suspiciously timed stock trades. “There was an angry outcry when the government adopted that for terrorists. I can guarantee there would be an even bigger backlash if we tried to use that for insider trading,” says Pilkington. “However, if the government just wanted to get convictions they could always uphold any challenge to the law by using the notwithstanding clause.”

That's a draconian proposal, she says, that goes way too far and does little to address the underlying problems Canadian authorities face in identifying, investigating and prosecuting white-collar crime.

3. Address weaknesses in investigations and prosecutions

While the formation of the RCMP's IMET squads was a good first step, it has failed to deliver the promised results. Despite more than $100 million in funding set aside for IMET, the police still face difficulties in attracting and retaining talented investigators who are familiar with Canada's capital markets and can effectively and efficiently investigate complicated frauds. The fact that Canada has let so many high-profile frauds go unchallenged in court only hurts efforts to keep police and prosecutors focused, says Pilkington. “Police and crown attorneys are just like everyone else: they want to build their career and have some success,” she says. “You will have a lot more success by going after murderers or other violent criminals than you will by pursuing white-collar criminals.”

Pilkington is hopeful some of those internal barriers will be addressed in an upcoming review of IMET being conducted by Nicholas Le Pan, former head of the Office of the Superintendent of Financial Institutions.

Canada's police also need to overhaul the way they investigate complex securities fraud. In the U.S., such investigations are often headed up by prosecutors who will ultimately take the case to court. This allows the investigators to focus on a number of key allegations that a jury may find compelling and could lead to a conviction. It also allows prosecutors to use the power of the grand jury system to compel witnesses to give evidence before charges are laid.

In Canada, by comparison, there is no grand jury system and police have limited powers to compel witnesses to come forward. There has also been a traditional divide between police and prosecutors that can sometimes result in investigations becoming bogged down in the minute details of the alleged crime, says Pilkington. “The police often want to run down every lead and try to talk to every witness,” she says. “It's easy to get lost in the details.”

4. Hold politicians accountable

While Canada's inability to crack down on white-collar crime makes big news on the business pages, those concerns rarely make it into mainstream political debate. Politicians are more eager to talk about guns, gangs and violent crime that directly affect a relatively small number of people rather than white-collar crime, which indirectly affects every Canadian who owns stocks, mutual funds or is invested in a pension plan. It's hard to muster the political will to change the situation since responsibility for securities enforcement is divided among so many different organizations, provinces and levels of government. Even a centralized federal government unit like IMET ultimately reports to four different ministries whose priorities may or may not include addressing weaknesses in securities enforcement, says Pilkington. “Even if Canadians made this a real political priority, it's hard to say who they could vote for to express their anger,” she says.

The diffuse nature of enforcement in Canada makes it easier for each group to point the finger and claim the problem lies with another government body. That's the message Doug Hyndman, chair of the B.C. Securities Commission, brought to a packed house at the Economic Club of Toronto in September. “Public criticism of [securities] enforcement has now replaced hockey as Canada's national sport,” he said. “How many times have you heard the complaint that Canadian regulators never send crooks to jail? Guess what? Regulators have neither the responsibility nor the authority to send people to jail. That's the responsibility of police, prosecutors and courts.”

Hyndman defended the BCSC's track record on enforcement, showing that over the past six months the commission had commenced 65 proceedings, issued 66 interim orders, handed down sanctions in 32 cases and concluded 37 settlement agreements. Of course, many of those decisions related to routine regulatory infractions such as late filings.

Those cold statistics don't reflect some of the more colorful — and baffling — recent decisions of the commission. They include a recent move to overturn the ban by the TSX Venture Exchange of William Nichols — a convicted cop killer, thief and extortionist — to act as a registered investor relations consultant. While Nichols did disclose that he was a convicted murderer on his TSX application, he failed to include the 19 other serious convictions he had racked up prior to going to prison. In June, the BCSC overturned the TSXV decision, saying he was a low risk to re-offend.

The case illustrates the different ways provincial securities regulators deal with problems. Just two months after the BCSC accepted Nichols's appeal, the Ontario Securities Commission rejected a similar application by Jack Wall to become a limited market dealer in Ontario. Wall has no murder convictions, but his application was rejected after he failed to disclose that he had been a defendant in two recent lawsuits alleging fraud or negligence.

That's not the only difference between the two commissions. Unlike the OSC, the BCSC has the power to penalize market players who have been found guilty of criminal conduct in court. Without a formal hearing, the BCSC can merely recognize a criminal conviction and impose its own penalties. Hyndman would not comment on whether the commission had any plans to use those powers in connection with the recent fraud convictions in Chicago of former Hollinger International executives Conrad Black and David Radler.

5. Increase penalties and ensure fines are collected

While Hyndman bragged that the penalties meted out by the BCSC show “Canada is not an enforcement-free zone of popular mythology,” he failed to mention that often those penalties go uncollected. Many market players who are caught and convicted of securities regulation offenses merely ignore their fines and penalties. According to the BCSC's most recent annual report, the commission collected only about 45% of the fines and penalties it issued. That number drops to about 38% at the Mutual Fund Dealers Association (which governs the conduct of Canada's mutual fund companies and dealers) and just 20% at the Investment Dealers Association of Canada (which oversees brokers and brokerage firms). That compares to about 83% of fines and penalties that are collected by the SEC in the United States.

It's not much better when it comes to penalties for criminal fraud. While Conrad Black could serve more than 15 years in prison for his recent fraud and obstruction of justice conviction in Chicago, white-collar criminals in Canada routinely serve only a small portion of their sentences. Take Michael Lee Mitton, the only man convicted of fraud by the RCMP's IMET squad. Mitton pleaded guilty to two counts of fraud in March and received a six-year sentence. According to Corrections Canada, he could be out as early as next year after serving just one-sixth of his sentence. The relatively light sentence was imposed despite the fact that Mitton is a serial fraudster with more than 105 criminal convictions on his rap sheet.

There has been some movement to increase the sentences for white-collar criminals. Recent changes to federal sentencing guidelines have removed such factors as employment or charitable works that could mitigate the sentences a judge could impose. Still, it is tempting for judges who don't fully understand the damaging effects of white-collar crime to treat fraudsters less harshly, says Pilkington. “A judge who doesn't deal with white-collar crime a lot can easily look at these defendants and think, 'Oh, he's not so bad compared to the violent criminals I usually see.'”

6. Increase judicial awareness of white-collar crime

Judges are generalists by nature and may not have the skills or knowledge to effectively oversee a complicated fraud case that includes dozens of witnesses and mountains of documentary evidence, says Bill Majcher, the former head of IMET's Vancouver squad and now managing director of Baron Group International, a Hong Kong-based investment bank. As a result, cases can often become bogged down in procedural wrangling that can last for months. Just look at the recent Bre-X case that began in the fall of 2000 and did not wrap up until the middle of 2006. Even after all the evidence was heard, Justice Peter Hyrn took nearly a year to deliver his acquittal verdict.

One solution to the problem would be to dedicate a special court with its own specially trained judges to hear fraud cases, says Majcher. “We have special drug courts because we recognize that drug crime has its own unique characteristics. Maybe it's time we adopted the same approach when it comes to these complicated fraud cases.”

For Canada, the need to address these issues has never been more important, says Majcher. The stakes are high. Majcher has seen foreign investors factor the “Canadian discount” into their investment decisions, or simply look elsewhere to invest. “Canadians believe this Pablum we are fed that we have a trade surplus and our economy is doing great, but it's doing well because the world wants our raw materials,” he says. “Where is the investment in research and development, biotech, manufacturing and the other things that make a diversified economy? What happens when the commodity boom starts to bust?” If Canada's federal and provincial regulators don't begin to overhaul their enforcement regimes, Canadians may find out how costly that inaction has become.