Public vs Private Securities Enforcement: Is Canadian Regulation Softer than the US?
Most countries enforce securities law through both public and private enforcement. Public enforcement is manly conducted through securities regulators. Private enforcement is conducted through shareholder lawsuits also known as securities class actions. Securities class actions are a mechanism relatively new to Canada. Many say that Canada has a more relaxed securities enforcement regime, but is this really the case? This post will compare Canadian and US securities enforcement, via both public and private mechanisms. Next, I will discuss how securities class actions add value to securities enforcement and propose modifications that will enhance securities enforcement.
Private enforcement in the US is primarily conducted through shareholder lawsuits for monetary damages. They can be brought against, manages, issuers, auditors, financial analysts and employees or any party whose credibility can influence the stock price. US lawsuits require “knowing misconduct” of the party when making a material misrepresentation under SEC Rule 10b-5.
The principles and policies underlying private enforcement are generally the same in Canada and the US. Private enforcement in Canada is relatively new and still developing. Class action legislation was announced in 1993 under the Class Proceedings Act 1992, with secondary market liability not coming into force until 2005. Canadian law differs from US on misrepresentations because there is a statutory “deemed reliance” on the issuer’s representation by the investor. Canada has significantly fewer securities class actions than the US, even relative to size of the markets. However, this could be due to the immature Canadian private action market. Two procedural restraints block private enforcement in Canada, being limits on statutory liability (In Ontario the greater of $1 Million of 5% of market share).
Under US law, extraterritorial enforcement was barred in Morrison v. National Australia Bank Ltd. for securities private action suits against issuers on foreign stock exchanges. However in Canada, companies listed on foreign stock exchanges may face private actions if they have a “real and substantial” connection to Ontario, as recently held in Abdula v. Canadian Solar Inc. Canadian Solar may bring many more global class actions to Canada.
Public enforcement is conducted by state organs tasked with enforcement or by institutions with quasi-governmental powers. Canada’s security regulators have a significantly smaller budget than the SEC and in fact smaller than many that they regulate. Canadian securities regulators rely on a more proactive approach at the detriment to public enforcement compared to the SEC.
Quasi-criminal insider trading rules exist in most provincial securities statutes. Canada’s securities laws are at a disadvantage over the US because each province has its own Securities Act. While each province’s legislation is generally the same, there is a significant regulatory burden keeping the laws up to date and there is the potential for regulatory arbitrage between provinces. In some provinces, the Securities Act provides securities commission staff to directly prosecute offences, while other provinces require staff to refer prosecution to Crown counsel. The Criminal Code was amended in 2004 to include the specific offence of insider trading. This was as a result of media attention indicating high rates of insider trading in Canada.
Enforcement actions between Canada and the US “align substantially although inexactly,” with different terms for certain offences and sources of law (case versus legislation), but the substantive offence remains generally the same. For instance, the offence of insider trading in the US was primarily developed in case law, whereas Canada’s is defined explicitly in provincial statute.
Canadian securities regulators, unlike the US, do not allow for no-contest settlements, where a wrongdoer can pay a penalty without an admission of guilt. This increases the amount of resources needed to a particular file. Therefore, Canadian regulators use a risk-based approach to enforcement, weighing the degree of harm to the capital markets by the cost to pursue the case.
Securities Class Actions Add Value
The 1994 Allen Committee report recommended secondary market misrepresentation because it would serve as a deterrent as well as a method to compensate the injured party. While Kraakman puts class action law firms akin to “Old West” bounty hunters, earning a reward on successful prosecutions, I do not believe this should be the case. Securities class action’s primary purpose should be to compensate the aggrieved party, and as a secondary consideration, to punish the wrongdoer.
Securities class action litigation has the capacity to alert public enforcement. If a private litigator finds an issuer potentially committed a breach, but deems it is not worthwhile to bring a private action; they can alert the public enforcement instead.
Canada’s private and public actors are known to work together. For instance, the 2007 ABCP crisis was resolved through a multilateral court sanctioned restructuring, with aggrieved investors benefiting from compensation, private parties benefiting from a release of liability, and public enforcement benefited from an efficient and equitable remedy.
Recommended Changes to Canadian Securities Law
To make securities class actions more appealing, provincial legislatures should consider increasing the limits to statutory liability, perhaps remove the maximum amount altogether and increase the percentage of market cap. An increase in the securities class action bar is necessary to develop private enforcement capabilities.
In terms of public enforcement, the SEC is required by the Government Performance and Results Act of 1993 to make annual reports on performance measures. This is not the case for provincial securities regulators in Canada and it has been suggested that enforcement would benefit from defining enforcement goals and publicizing the results. Further, no contest settlements should be allowed for certain offences. No contest settlements are aligned with provincial regulators commitment to operate on small budgets.
Overall, more time is needed to develop private enforcement in Canada. However, public enforcement cannot lag either. Both public and private enforcement had different roles to serve and both should grow and develop together.
This post was submitted in a revised form as part of an examination in the Corporate Governance class of Osgoode Hall Law School’s Business Law LL.M.
2012 ONCA 211. SCC appeal refused.