By Anita Anand
Originally published in The Globe and Mail.
Arguably the most important function of a securities regulator is to enforce the law. In the Ontario Securities Commission’s (OSC) recently released annual statement of priorities, the regulator pledges to deliver effective compliance, supervision and enforcement.
One of the key weapons in the OSC’s enforcement arsenal is the no-contest settlement. The OSC states that it “is confident that enforcement tools such as no-contest settlements … will produce effective and meaningful enforcement outcomes.” But we must question both the deterrence value and the efficiency of no-contest settlements.
Some background information is in order. The OSC introduced no-contest settlements in 2014, around the same time the U.S. Securities and Exchange Commission reduced its use of them. Respondents are not required to admit that they contravened Ontario securities law or acted contrary to the public interest. In May, the Alberta Securities Commission followed Ontario’s lead, modelling its program on the OSC’s initiative.
According to OSC Staff Notice 15-706, no-contest settlements will be used in limited circumstances and will be unavailable if the respondent has engaged in egregious, fraudulent or criminal conduct, or where the misconduct has resulted in investor harm which remains unaddressed. One of the underlying rationales of no-contest settlements is that they are efficient, allowing the OSC to enforce a violation of securities law expeditiously.
Since 2014, the OSC has reached 11 no-contest settlements, 10 of which were settled with financial institutions. As a result of these 10 settlements, the OSC has collected an aggregate of $17.2-million in settlement payouts for costs and investor-education initiatives. The compensation ordered to investors under these settlements has totalled approximately $369-million.
Nine of these 10 no-contest settlements followed allegations that the financial institutions had failed to advise clients that they qualified for a lower-cost mutual fund, allowing the institutions to collect excess fees. Other wrongs alleged include overcharging investors through embedded fees on investment accounts and failing to record interest earned on fund assets, causing investors to buy and sell units of the fund at an understated value.
The reliance on self-reporting in no-contest settlements is problematic. The OSC appears to leave it to the financial institutions themselves to report the number of affected investors, which, among other factors, raises questions as to whether self-reporting ensures that respondents disclose the full story. It also raises concerns over timeliness of reporting, one of the factors the OSC claims to consider before it decides if a no-contest settlement is appropriate.
In cases that led to a no-contest settlement, the financial institutions’ misconduct occurred over multiyear periods ranging from four to 14 years, with the wrongdoing coming to light only after the OSC implemented its policy on no-contest settlements.
All of the no-contest settlements follow a similar pattern: the OSC alleges the institution has inadequate internal controls and supervision, leading to undetected excess charges. The financial institution then engages independent experts to verify and calculate the number of clients and the appropriate compensation methodology. Given the lack of transparency in this process of calculating compensation, how can regulators be satisfied that the numbers offered by self-reporting are accurate? It is at least possible that the hired third parties used conservative assumptions, leading them to understate the amount of compensation owed.
The first five no-contest settlements reached with financial institutions occurred quickly, with an average of 11.8 months between the stated date of self-reporting and completion of the settlement. However, this period of time has steadily increased. Of the past five no-contest settlements, only one was reached in fewer than two years after the institution first came forward; the average settlement time for the five most recent no-contest settlements has increased to 29.4 months, with the most recent taking more than three years to conclude. This increase in length of time is worrying because it calls into question the efficiency of no-contest settlements as an enforcement mechanism – one of the main reasons they were instituted.
Another way of thinking about no-contest settlements is that they allow the respondent to avoid the reputational harm that can arise through a full-blown trial that lasts for days and is reported in the news. No doubt, credit for co-operation makes sense to a limited degree. But between the reputational protection, the possible biases in self-reporting and the fact that respondents are not required to admit guilt, no-contest settlements are light on deterrence, favouring respondents considerably.
In both practise and principle, no-contest settlements fall below the standards to which we should hold securities regulators in their role as guardians of the public interest. The weak deterrence power of these settlements runs contrary to the Supreme Court of Canada case law, which holds that the purpose of the public interest power (i.e. the power under which no-contest settlements are reached) is prospective and preventative. In other words, the Court has held that deterrence is a key principle that should underpin enforcement in order to ensure egregious conduct does not occur again.
At a time when securities regulators across the country have explicitly refused to endorse a statutory best interest duty for financial advisers, the possibility of Canada’s financial institutions’ charging excess fees demands our attention. We should question whether the alleged benefits of no-contest settlements, including efficiency and deterrence, outweigh the weaknesses of this enforcement program. In short, these crucial issues suggest it is well past the time to revisit the regulatory policy on no-contest settlements.