Top 5 securities litigation and enforcement issues to kick off 2020

With 2020 now underway, we outline the trends we anticipate in securities litigation and enforcement throughout the year.

1. Still no national securities regulator, but important national developments

2019 saw no meaningful movement on the attempt to achieve a national securities regulator. The status quo of each Canadian province and territory having their own securities regulator continues. As property (e.g., securities) and civil rights are within the constitutional jurisdiction of the provinces, the only way in which a national securities regulator can be achieved is through cooperation and opting in by each province. A number of provinces, including Ontario and British Columbia, have indicated a willingness to opt into a national regulator. They have gone so far as to create, with the help of the federal government, a “Cooperative Capital Markets Regulatory System” and staffed a “Capital Markets Authority Implementation Organization” to work towards a single operationally independent national regulator. Since the inception of the Organization in 2015, other provinces and one territory have opted in (NB, NS, PEI, SK and Yukon), but it remains in limbo, with no power to regulate. Two significant provinces (in terms of size of economy and volume of capital markets activity), Alberta and Québec, continue to vehemently oppose a national regulator. While hope springs eternal for those who wish for a national regulator, we don’t see any break in the gridlock of Alberta and Québec refusing to relinquish their intra-provincial control of securities regulation in 2020.

Though all the provincial securities regulators participate in the CSA (the Canadian Securities Administrators, which is a cooperative umbrella organization comprised of representatives from each provincial and territorial securities regulator) as an established resource to collaborate on regulatory initiatives and priorities, divergence on some important issues persists. This trend was illustrated over the past two years with the differing approaches by Ontario and British Columbia regarding the question of imposing a “best interest” standard on investment advisers. In the end, the CSA members reached a compromise in the form of amendments to National Instrument 31-103, Registration Requirements, Exemptions and Ongoing Registrant Obligations. The amendments seek to impose some new, higher securities registrant standards of conduct across Canada. While the reforms do not include a general “best interest” standard as was sought by Ontario, there are some discreet best interest requirements and other enhanced standards. Some of the reforms became effective on December 31, 2019 while others come into force on December 31 of this year. In the coming months, both Canadian securities self-regulatory organizations, IIROC and the MFDA, will be amending their rules to align with the CSA reforms. These changes will require securities dealers to refresh their internal policies and procedures, and it is foreseeable that investors suing for investment losses will try to rely upon these new standards before the courts.

There are other important national regulatory initiatives that will receive focus in the coming year, including potential changes to the compensation structures for mutual funds (with respect to deferred service charge fees and trailing commissions), and changes to the management of conflicts of interest between adviser and client. With the recent resignation of the Chair and CEO of the Ontario Securities Commission, there may be some delay to the implementation of new regulatory initiatives in Ontario while a new Chair is identified and new priorities are established.

Though development of a national securities regulator has stalled, 2019 saw the implementation of a more robust enforcement regime for the Federal Consumer Agency of Canada (you can read more about this issue in “Financial institutions should expect more enforcement”). FCAC has the mandate of consumer protection in the sale of consumer financial products by federally-regulated financial institutions, and has jurisdiction across Canada. The implementation of a new definition of “reportable compliance issues” in 2019 resulted in FCAC receiving more information about compliance issues. Amendments to the FCAC’s governing legislation, anticipated to come into effect in 2020, include an increase in permitted fine amounts. This change, coupled with a projected increase in FCAC enforcement staffing likely result in FCAC bringing more enforcement proceedings. We anticipate an increase in enforcement activity by this regulator in 2020.

2. Cannabis

After a year of frothy markets and high investor interest, recent compliance breaches at some Canadian cannabis issuers coupled with early supply management issues have led to increased investor caution and reduced interest in funding for issuers.

In 2019, class actions in Canada and in the U.S. were commenced against a number of Canadian cannabis issuers (as well as in some cases directors, officers, auditors and underwriters) for prospectus and secondary market misrepresentation. The pressure imposed by dried up funding opportunities and onerous litigation has many cannabis issuers to consider restructuring initiatives, with a number of companies seeking insolvency protection through the CCAA (Companies’ Creditors Arrangement Act—federal legislation which allows companies to re-structure their finances while avoiding bankruptcy). 

Regulators have been taking steps to enforce and enhance cannabis industry standards. Health Canada has been focused on ensuring compliance with the terms of licensing for cannabis producers and has been involved in a number of license infraction enforcement proceedings, including for unlicensed growing and storage facilities. As well, securities regulators have begun taking enforcement and other action in response to governance and disclosure concerns. In Q4 2019, the Canadian Securities Administrators released notice 51-359 which issued guidance aimed at improving governance and disclosure for cannabis companies. The Ontario and British Columbia Securities Commissions have announced several cannabis company-related investigations, and we expect to see more in 2020.

3. Securities regulatory enforcement remains active

IIROC, the MFDA and the Securities Commissions continue to strive towards increased enforcement activity to improve regulatory compliance through the deterrence that comes with the publicity of prosecutions and settlements. In 2020, we expect to see continued regulatory scrutiny regarding suitability as well as in areas of potential conflict of interest such as adviser compensation and fees paid by investment products (mutual funds and other investment funds).

We anticipate renewed focus by the OSC (and other Commissions) on enforcement activity that holds gatekeepers (e.g., auditors, underwriters) and directors and officers accountable for conduct that negatively impacts the capital markets.

Cryptocurrencies-related issues continue to be at the forefront of securities regulatory efforts, and we expect this trend to continue in 2020, with ongoing scrutiny of crypto issuers to assess whether they should register as capital markets participants, and whether they have met regulatory requirements for IPOs.

4. Securities class actions uptick

In 2019 the number of new securities class action filings increased from the prior year due in large part to mutual fund fee and cannabis issuer-related proceedings. Though the trend in the past four years has been a slowdown in new securities class action filings, likely due to general capital markets stability, we foresee a continued trend of increased new securities class action filings as the cannabis sector remains volatile and while the regulators continue to publicly focus on fund fee issues.

As with other types of class actions, securities class actions tend to resolve at or after certification, with few proceeding through the standard litigation process. A result of the high incidence of settlements is that few class action firms have deep trial experience. This, as well as a general judicial trend favoring certification, has caused some defendants to consider consent certification orders, with the strategy being to then push for summary judgment or a summary trial process. This strategic decision will be affected by the individual facts of each case, but we expect class action litigants to continue carefully weigh the strategic value of consent certifications in 2020.

5. Few individual investor loss claims

The sustained bull market has been a key contributor to the continued low volume of individual investor loss claims. Many securities dealers have implemented robust complaint-review processes that tend to detect and resolve client complaints at an earlier stage, leaving only the more difficult issues to proceed to dispute resolution. Non-traditional alternative dispute mechanisms, including OBSI (Ombudsman for Banking Services and Investments) investigations and recommendations, have also contributed to the reduction of these types of claims. As the markets continue to perform, we do not expect to see a significant increase overall in investor loss claims in 2020, though sector-specific claims (e.g., concentration in a volatile sector) may occur.

While individual investor loss lawsuits are on the wane, the principal regulator of full service retail brokers, IIROC, has been active in enforcement activity and general scrutiny of various investor protection-related issues. Predominant among those issues has been protection of vulnerable investors (including seniors) and conflicts of interest, and we see that focus, including related enforcement investigations and proceedings, continuing for 2020.