Thursday, 31 January 2013

Securities Regulatory Enforcement: U.S.-Canadian Comparative Analysis"

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July 25, 2012

Radio Shalom, Money and Business – Jack Bensimon, Co-Host
July 25, 2012 -- Show 19 – Banking and Securities Regulatory Compliance
"Securities Regulatory Enforcement: U.S.-Canadian Comparative Analysis"
with Jack J. Bensimon, Managing Director, Risk Diagnostics


Robert S. Khuzami, center, with members of his team, from left, Kenneth Lench, Daniel M. Hawke, Cheryl Scarboro, Thomas A. Sporkin, Robert B. Kaplan and Lorin L. Reisner.



Securities regulatory enforcement has become a pressing issue of concern among issuers and investors. Enforcement of securities laws is critical in promoting investor confidence and maintaining market integrity. The objectives of the securities regulators is to give Canadians and Americans a national securities regulatory system that provides protection to investors from unfair, improper or fraudulent practices while at the same time fostering fair and efficient capital markets and confidence in them.

A careful balance needs to be struck between laws that have teeth on the one hand and on the other hand the enforcement of regulations so as to not compromise investor confidence. There are significant differences in the philosophical and practical approaches to securities regulatory enforcement between Canada and U.S. securities regulators. Recent enforcement actions by the SEC and the OSC showcase the different approaches by the two leading statutory regulators. This show will highlight such differences and demonstrate their impact on investors on both sides of the border.

 - Howard Wetston, chairman of the Ontario Securities Commission.
Today on the money is our co-host and commentator Mr. jack bensimon from risk diagnostic, live from Toronto to discuss recent enforcement actions by the SEC and the OSC , showcasing the different approaches by the two leading statutory regulators; and are the new rules too tough for the banking sector? is it hindering or is it compromising investment confidence in the market place and are we seeing significantly higher levels of fraud in the securities industry, especially now that banks control the largest 5 investment dealers?
My name is Samuel Ezerzer, your host to the Money & Business show on Radio Shalom, CJRS 1650 AM. Thank you for tuning in live on the Money & Business show, with our studio and headquarters in Montreal, the financial capital and the home to the greatest hockey team, the Montreal Canadians. We have another great show for you today and as always, you can call if you have any questions, comments, or criticisms on today's topic. Please call us direct at 514 738 4100 ext 200 or email me at if you have any inquiries. You can also visit our website at – all our shows are archived there. 

Today’s topic of discussion: "Securities Regulatory Enforcement: U.S.-Canadian Comparative Analysis"

Jack Bensimon
Our guest today is Jack Bensimon, Managing Director of Risk Diagnostics Inc., an independent securities regulatory compliance consulting firm located in Toronto’s Bay St. core. He has worked in the securities industry for over 18 years, mainly acting as Chief Compliance Officer (CCO) for banks, investment banking and counselling firms, trust companies, and broker-dealers. He has testified as an expert anti-money laundering witness in federal court for a major banking litigation case.
He is a graduate of the University of Toronto, The Wharton School, University of Pennsylvania (Investment Management). Jack has a Master of Laws (LL.M.) in Securities Law and a Master of Laws in the General stream from Osgoode Hall Law School (York University). He is completing another Master of Laws (LL.M.) in Business Law at the University of Toronto, Faculty of Law, on a part-time basis. He was recently re-elected chair of the subcommittee and board member of the Canadian Technion Society for the 2012-13 year. The Technion-Israel Institute of Technology is based in Haifa, Israel. He can be reached at
Segment I: Introduction – The Basics of a Securities Regulatory Enforcement System

[sam to jack] Q1. why is securities regulatory enforcement important in our capital markets?

Enforcement allows the rules in a given capital market to be applied under its laws – to show that it has some teeth to its statute, to demonstrate to the markets and to investors that there is strength behind the rulemaking process – in effect, to show that it means business when laws or rules are breached.
Without enforcement, you have a credibility issue in markets. It’s similar to professional sports – in boxing, there are rigid rules around when you can continue to strike your opponent in the stomach – then there is a rule that says beyond a certain point of physical pain and damage, it’s a breach of the rules and the referee will stop the punching in the stomach. These rules are always enforced and impose order and integrity to the sport.
It’s not much different in the capital markets – the rigid rules and laws impose order and integrity to a system that is vulnerable to corruption and rule-breaking. The idea is not to establish stringent rules just to have the appearance of rules, but instead to show the rules will be strictly enforced when there is credible evidence to show they are breached.

Sanjay Wadhwa at the SEC's offices in Manhattan
[sam to jack] Q2. what are the leading factors contributing to an effective enforcement system?
Like any other enforcement system, there are a few leading factors. The first factor is a credible securities regulator that has the resources to go after perpetrators in the system. This includes the regulator having the financial and human resource capacity to properly investigate all allegations that come before them. Without sufficient resources, the public perception of enforcement is undermined.
Second, there must be a perception among the investing public that laws are enforced along with appropriate penalties. In other words, it’s the old axiom under the rule of law, "justice must be seen to be served". Perception is often reality in the markets. This perception is formed through extensive case law in the courts and regulatory proceedings that show regulators are taking perpetrators to task on securities breaches.
Finally, the remedy must fit the breach – that is, the punishment must fit the severity of the breach. For example, if Madoff was tried in Canada in light of a reputed $60B fraud and was sentenced to 3 years in prison despite confiscating all assets, from a public policy perspective, this would be seen as far too lax. It would be seen as not fitting the punishment for hurting thousands of investors. It doesn’t mean it’s a one-for-one system, but the punishment should fit the crime, so to speak.

[sam to jack] Q3. how is our securities enforcement perceived by foreign investors and why?

This is concern to regulators and policy makers in our legislature. Canadian securities regulatory enforcement, on balance, is seen as relatively lax when compared to our U.S. neighbor. This stems from a number of massive frauds, including Bre-X Minerals (1998) that went 10 years in the courts with not a single conviction, costing taxpayers $10-15M in court and administrative costs; Portus hedge fund scandal which saw the exodus of $2B (which was repatriated by KPMG) by the four principals; and the recent Sino-Forest scandal which has been criticized for taking too slow, of which the U.S. SEC may have wrapped-up in 1-2 years.
This has caused foreign investors to question the strength and credibility of the Canadian securities enforcement regime. It also doesn’t foreign investor perception when Canada and Bosnia are the only two countries in the world without a federal securities regulator. When you’re lumped in with Bosnia, that can’t bode well for capital market integrity.
As a result of this weak foreign perception of our enforcement regime, foreigners often attach a trading discount to shares of Canadian-listed securities – which means that Canadian public companies trade at a 10-15% discount to their peers in the U.S. and elsewhere just as a result of this foreign investor perception. This is a result of the higher perceived risk among foreign investors in investing in a less-enforced securities regime, such as Canada.

[sam to jack] Q4. why is foreign perception of our enforcement system important?

Foreign perception of our capital is very important – mainly because capital markets have become interdependent, and investing is now global. It matters what foreign investors think of our markets since Canada is a relatively small player in the global capital markets – we represent a paltry 2.5% of global capital markets, compared to the U.S. of 35-40% of the global share. This means that we have to rely on foreign investors to invest in Canada, instead of relying on our home market bias – it is simply too small. In effect, Canadian markets are too small to have any type of global impact on capital markets (outside of our mining sector base).
If you have a negative foreign perception, you typically get a discount on Canadian stocks--which means investors are not realizing full value on their shares. A strong regulatory enforcement regime, on the other hand, results in a share premium – which means you’re getting more than full value since the perception is that the market is rewarding investors for the lower perceived risk of investing in that market. In the U.S. there is evidence of an enforcement premium since U.S. enforcement is seen to be the strongest among all markets in the world. Hence, you end up paying more for U.S. companies in return for the lower perceived risk of investing.
Therefore, we should always be concerned what foreign investor sentiment is around the world – anything to compromise that, will compromise the value of your investments in Canada.

Segment II: The Strength of an Enforcement Regime: Fact or Fiction?

[sam to jack] Q1: how does a regulator strike a balance between investor protection while promoting low barriers to entry for investment?

This has been a perennial challenge for securities regulators around the world – it’s no easy task – like any statute, you have to balance a number of competing interests and give them due consideration before enacting the rules of the game.
The balance that needs to be truck is simply this – design a system that protects the players (investors and companies) while at the same time allows players to easily play the game without convoluting. Regulators attempt to balance a principles-based vs. a rules-based system. In Canada, we mainly have a principles-based system, the U.S. a rules-based regime, and the U.K. would have a hybrid of both. Enforcement around investor protection is critical for giving the marketplace , while at the same time making sure that the rules are not so cumbersome to prevent investors and issuers from operating – from parking their capital, and from raising capital for issuers.

[sam to jack] Q2. what is the major fallout when you have a weak regulatory enforcement regime?
In addition, no-contest settlements undermine the enforcement capability and credibility of securities regulators across provincial commissions. Canada’s record on its ability and willingness to pursue egregious cases of securities breaches has been dismal.
A weak regulatory enforcement system has a few fallouts. One is that it reduces investor confidence among domestic and foreign investors. This raises the cost of capital for issuers, and can dampen economic growth. Second, weak enforcement may reduce liquidity in stocks that are in sectors that are seen to be high-risk by nature – for example, mining companies that have operations in Nigeria, Congo, Zambia, or other high-risk business risk countries. Reduced liquidity in shares translates into higher transaction costs for investors. Third, weak enforcement can also cause flight of capital into other stock exchanges where the perceived risk of investing is lower. This leads to a higher cost of capital in Canada, further constraining economic growth. So, we can see that a weak securities regulatory enforcement system can have serious economy-wide implications.
[sam to jack] Q3. how does a strong enforcement regime contribute to enhancing market integrity?

A strong regulatory enforcement system does a number of things to enhance market integrity. Enforcement ensures regulators are willing to commit resources to allegations of breaches of the rules, and that a proper and due process investigation would be pursued. This increases confidence among investors. Also, a system that is perceived to have strength and teeth acts as a deterrent to breaching the rules once the penalties are known and are seen to be enforced. A system with penalties in theory, but not in practice sis of little – justice must be seen to be served, rather than just an existing theoretical concept.

In addition, a strong enforcement system attracts greater numbers of institutional investors around the world that have massive cash positions to park their capital in public equities in respected stock markets. Institutional investors account for more than half of all stock market investing in Canada – hence they have played a potent force, and attracting them to our marketplace is critical to the growth of our capital markets.
sam to jack] Q4: what is the role of iosco in global capital market enforcement?

IOSCO – the International Organization of Securities Commission – is the only credible international securities body. Canada is a member, among many other G-20 countries. We have an Ontario and Quebec rep on the IOSCO committee, and Canada has played an active role with IOSCO. The mandate of IOSCO is to provide some level of regulatory harmony among major securities commissions – spanning trading, disclosure, enforcement, and other best practices.
However, the problem is that IOSCO has no enforcement power at all. Cross-border breaches of securities rules are not within the mandate or scope of IOSCO – that is left to the whims of the securities regulators in their respective jurisdictions to coordinate enforcement efforts. Should IOSCO have an enforcement mandate? I’m not sure if that would be appropriate since they are a policy-making body, and not a global stock cop. Developing a global body of international securities enforcement capability is an extraordinary task of which I don’t think would be workable.

Segment III: No-Contest Settlements – Are they a Curse or Benefit?
[sam to jack] Q1. what is meant by a "No-Contest" settlement in enforcement practice?

Securities regulators have a public policy objective to protect investors and promote market efficiency through enforcement actions. The use of no-contest settlements by regulators includes reaching financial settlement terms with alleged perpetrators without agreeing to facts and conducting a full investigation. No-contest settlements are cost efficient for both the regulator and defendant in resolving enforcement actions. However, in a regulatory environment centred on transparency and accountability, such settlements short-circuit and undermine the securities enforcement regime.
No-contest settlements encourage case resolution through negotiated settlement and promoting expediency in enforcement outcomes. Cost efficiency arguments that support low cost alternatives in resolving securities enforcement actions conflict with the fundamental aims of the spirit and intent of s. 1(1) of the Act—that of promoting investor protection and market efficiency. No-contest settlements prohibit the OSC from aggressively enforcing cases of egregious misconduct, thereby weakening regulatory enforcement capabilities.
Section 127 of the Act strikes a tension between the public interest mandate and fairness, making the policing process challenging. Enforcement could be strengthened by the OSC more vigorously pursuing cases of egregious misconduct (e.g., quasi-criminal prosecutions, such as securities fraud).
 No-contest settlements undermine the role of SRO’s and exchanges in effectively performing their enforcement functions.
For example, the recent SEC insider trading investigation of the Galleon Group before Judge Jed Rakoff has led to 49 hedge fund managers being charged, of which 43 have been either convicted or plead guilty. This was achieved without no-contest settlements but instead through vigorous SEC investigative efforts.
 The insider trading conviction of the Galleon Group in the U.S. demonstrates the SEC and Department of Justice (DOJ) escalating its enforcement efforts in aggressively pursuing illegal insider trading violations. The SEC is significantly more successful than the OSC in securing insider trading convictions and pursuing such cases more aggressively. This is achieved by extending the cross-examination of witnesses extraterritorially across borders. The former IDA’s Blue Ribbon Task Force (2006) found that commissions were unable to successfully investigate and prosecute insider trading cases as the burden of proof rests with the prosecutor, not the accused, in proving the guilty state of the accused. These outcomes neglect to serve the public interest by failing to sufficiently punish perpetrators who inflict investor damages.  

[sam to jack] Q2. what are the risks of these settlements?

No-contest settlements in Canada would dilute the enforcement capability of commissions to bring perpetrators to justice. One of the principal conclusions of the Task Force to Modernize Canada’s Securities Legislation (2005) was that enforcement capability was weak among securities commissions. The most commonly cited reason among foreign investors to abstain from investing in Canadian issuers is the lack of will and power of Canadian securities commissions to enforce securities laws in high profile cases. This weakness is acknowledged as a source of foreigners attaching a trading discount to Canadian issuers, thereby raising the cost of capital for issuers and incenting to list elsewhere.
Furthermore, no-contest settlements that are negotiated with those who breach securities laws weaken securities enforcement effectiveness. This can increase the perceived risk of investing in Canada and reduce foreign investment in Canadian exchanges. This may raise the cost of capital for Canadian companies and cause issuers to exploit regulatory arbitrage by listing on other exchanges seen to have enforcement strength. This undermines the policy goal of market efficiency in regulation.

[Sam to Jack] Q3. How do these settlements preserve or hurt investor confidence and integrity in our capital markets?
The concept of no-contest settlements is based on the principle that a settlement offer requiring the defendant (respondent) to pay the regulator contains no agreed statement of facts or reasons for payment. This goes against the public interest concern under s. 127 of the Act which has broad scope and application. Achieving the objectives of the public policy interest of the SEC carries the following obligations outlined by Judge Jed Rakoff in his disapproval of no-contest settlements in SEC v. Citigroup Global Markets Inc. ("Citigroup").
No-contest settlements prevent regulators from engaging in a fact finding mission in search of the truth since they are designed to circumvent the enforcement investigation process. This includes the omission of discoveries, examination of witnesses, and other procedures that are part of a standard trial and administrative proceeding before a securities regulator. The absence of these administrative components undermines the OSC’s due diligence and due process enforcement requirements.
In addition, no-contest settlements further facilitate the contraction of private rights in supplementing public enforcement through lack of investigative effort by regulators. Fewer private enforcement mechanisms for securities breaches raise the importance of public enforcement in regulators investigating egregious misconduct. The decision in SEC v. Bank of America Corp. ("BofA") included a consent judgment with Bank of America required to pay a $33M fine while not admitting to any SEC allegations. Judge Rakoff’s refusal to approve the BofA settlement signalled that U.S. courts are not receptive to no-contest settlements. They are viewed as payments made to regulators at the expense of shareholders and dilute the fact finding investigative obligation of the SEC.
Finally, no-contest settlements weaken the perceived strength and credibility of the OSC enforcement regime. Settlements show the OSC lacks the will and power in enforcing its rules and regulations under the Act to oversee capital markets. As lead statutory regulator setting the bar for other provincial securities commissions, the OSC’s support of no-contest settlements is likely to become the standard across Canada.
[sam to jack] Q4. what is the court sentiment towards these settlements?
The decision in Citigroup showed that no-contest settlement agreements are private agreements that are not court enforceable if the defendant (respondent) fails to honor the settlement terms. The Citigroup decision illustrated the limitations of U.S. courts to impose injunctive relief where facts have neither been established nor agreed to. This is a major handicap for securities regulators in enforcing consent judgments on defendants while undermining the integrity of the settlement process. The U.S. experience with no-contest settlements suggests courts are not open to SEC settlements and fail to serve the public interest. OSC enforcement policy should follow suit.
Allowing no-contest settlements do not serve the public interest despite the low cost advantage and efficiency they provide for defendants and securities regulators. Defendants are reluctant to provide admissions of liability to regulators due to concerns over evidence that can be prejudicial in civil or class action proceedings. No-contest settlements fail to promote public trust and perpetuate the foreign perception of Canada having weak public enforcement will and power. This casts doubt over the integrity and strength of Canadian capital markets for issuers.
Segment IV: The Future and Trends of Securities Enforcement
[sam to jack] Q1. how will the future role of regulators change in the enforcement area?
[sam to jack] Q2. how will regulators manage the resource challenges of regulatory enforcement ?

[sam to jack] Q3. will we see regulators expand or narrow their scope of jurisdiction?
[Sam TO Jack] Q4: what lessons have we learned since the credit crisis of 2008 in implementing enforcement reforms?

Jack Bensimon thanks for speaking on our show and providing insights in reviewing and analyzing the various aspects of securities regulatory enforcement through comparing the Canadian versus the American approaches to enforcement. Jack Bensimon can be reached at 416-985-0757

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