Mitigating the risks of litigation and enforcement action: strategies for financial institutions

We have seen an increasing focus on consumer protection in litigation and regulatory activity involving financial institutions.

The COVID-19 pandemic, and the economic volatility and uncertainty it has created, has heightened the attention placed by class action counsel and regulators on the relationship between financial institutions and their clients, and in particular the duties owed by financial institutions. Navigating this exposure will be assisted by keeping a careful eye on corporate conduct which runs the risk of disadvantaging consumers, whether due to conflicts of interest, business practices that do not put customer’s interests first or the trickle down impacts of financial services employee misconduct. These areas are a source of litigation and regulatory enforcement action. Proactive risk mitigation will prove essential in the coming months as we manage our way through the second wave of the pandemic.

Below are three areas of focus for financial institutions that relate to consumer protection and risk mitigation.

1. Consumer protection-based litigation and complaints on the rise

In the past few years, there has been an increase in class action and other litigation, and related customer complaints, with an emphasis on consumer protection concepts. Generally, these claims allege different forms of overpayment or improper payment by customers. Examples of such claims include alleged over-payment of investment fund fees, improper denial of insurance coverage associated with cancelled travel or non-delivery of services due to COVID-19, and investor claims for aborted M&A transactions which would have increased share value.

Common elements of these claims include arguments that financial institutions are in a conflict of interest, that they should not be able to rely on standard terms in consumer or client contracts, that those terms do not contemplate a pandemic or relieve companies from compensating clients and/or that fairness and individual hardship should trump the interests and relative financial wherewithal of large financial institutions.

Takeaway: To combat this exposure, financial institutions should consider reviewing and revising their standard form consumer contracts and disclosure documents to ensure clear and complete disclosure of fees, conflicts of interest and exclusions of liability for specific events. Financial institutions may also wish to consider dispute resolution out of court, though any arbitration or other dispute resolution clause will be carefully scrutinized to assess whether it is cost prohibitive, in light of recent Supreme Court jurisprudence¹.

2. FCAC enforcement is likely to increase and have a greater impact

The Financial Consumer Agency of Canada (FCAC) is a regulator with a consumer protection mandate regarding federally financial institutions. We believe that the FCAC’s enforcement activity is poised to increase, and that it will have a greater impact on regulated entities. This perspective is based on several factors.

First, for the past few years, the FCAC has been building its supervision and enforcement team. FCAC revealed in its 2019-20 Business Plan that it would continue to build its oversight and enforcement capacity and, in the 2020-21 Business Plan, FCAC indicated that a Secretariat in the Commissioner’s Office would be established to enhance FCAC’s regulatory effectiveness.

Financial institutions should be mindful of this expanded role of the FCAC and its enhanced powers to sanction by enhancing their compliance with financial consumer protection requirements.

Second, it is expected that the regulations necessary to complete the new financial consumer protection framework introduced in Bill C-86 will be released publicly later this fall or in early 2021. These Bank Act amendments expanded the scope of the FCAC’s oversight through the introduction of new market conduct obligations, including the requirements to establish policies and procedures to ensure that products or services the institution sells or offers take into consideration their customer’s circumstances, and that staff remuneration not impede the application of such policies and procedures. These new market conduct obligations could raise potential class action risks.

And finally, the Bill C-86 provisions amending the Financial Consumer Agency of Canada Act came into effect on April 30. Already, the increased maximum penalty amounts provided for in these amendments appear to have had an impact on FCAC’s approach to determining monetary penalty amounts. Although the new penalty maximum amounts were not applied in the three decisions released since the amendment², the penalties imposed in these decisions were, in general, higher than in previous FCAC decisions. In one of the decisions, FCAC imposed the highest penalties ever levied for individual violations ($450,000 and $400,000, respectively). Fines of this magnitude, and potentially even higher when the new provisions are applied, combined with the new mandatory naming provisions, significantly raise the stakes.

Takeaway: Financial institutions should be mindful of this expanded role of the FCAC and its enhanced powers to sanction by enhancing their compliance with financial consumer protection requirements, particularly the more onerous market conduct obligations that are forthcoming in the new framework.

3. With corporate misconduct on the rise, misconduct detection and liability mitigation is paramount

Corporate misconduct is the breach of a legal requirement (e.g., breach of statute, breach of regulation, breach of employment/internal business code) by employees, officers, directors, client or agents of financial institutions. This kind of misconduct gives rise to liability, including employment discipline, regulatory sanctions, criminal prosecution and class actions or other civil litigation. The ripple effects of misconduct can be pronounced, including not only litigation and regulatory action, but also reputational damage associated with public disclosure of the misconduct.

Past economic downturns and crises have led to an increase in corporate misconduct³. Financial crises put multiple internal and external pressures on companies and their personnel. Languishing financials and share price can lead to improper adjustments to financial reporting, improper sales practices or public disclosure that glosses over poor results. Pressured employees rationalize self-serving misconduct as being short-term and necessary. Employees who are experiencing personal financial strain may have an increased propensity to put their own financial self-interest ahead of client or stakeholder interests, which can lead to misappropriation of corporate opportunities and other personal misconduct. Finally, stressed business partners and clients may breach legal requirements or standards for the same reasons.

Each of these forms of misconduct can have trickle-down adverse impacts on consumers and investors, in the form of investment losses as well as excessive cost of goods and services. As increased regulatory interest in investigating and prosecuting white-collar crime followed the 2008 financial crisis, regulators are currently on heightened watch for the same issues⁴.

Takeaway: Financial institutions can stem the tide of corporate misconduct and its pernicious impacts through a number of means. It is particularly important to maintain a strong compliance culture in times of economic stress. Officers and directors should understand if and how a company’s culture is creating or reducing risk. Exemplary “tone from the top” is even more important than usual, especially given many regulators have made it a priority to hold officers and directors personally accountable for corporate wrongdoing. Internal controls and lines of defence should not be reduced or cut at this time, despite pressure to do so—regulators expect this and our experience is that most corporate misconduct and fraud is attributable to weak controls. Internal reporting (including whistleblower programs), as opposed to external audits, are responsible for the vast majority of corporate misconduct detection, and therefore financial institutions should ensure that such policies are not only in place but are properly staffed and operationalized.

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¹ Uber Technologies Inc. v Heller, 2020 SCC 16

² FCAC did not apply the mandatory naming provision and the increased penalty maximum amounts because the violations in these decisions occurred before April 30, 2020.

³ Association of Certified Fraud Examiners (ACFE), April 2009

⁴ See for example the current focus of U.S. and Canadian securities regulators on COVID-19-related investment fraud and misrepresentation.