As we close out 2021, we highlight some of the recent trends we have seen in securities litigation and enforcement which we anticipate will continue in the new year.
2021 saw an explosion of activity in the global crypto asset market, with crypto market capitalization doubling in 20211. Accompanying this increase in market activity has been heightened attention from Canadian regulators. The OSC, IIROC and CSA have all indicated that regulating crypto trading is among their priorities for the coming year.
Crypto asset trading platforms are now required to be registered in Ontario. In 2021, the OSC took a firm stance on the registration requirement and initiated enforcement actions against non-compliant firms. The OSC also brought proceedings against four international crypto-asset trading platforms, and settled with numerous firms, collecting over $10 million in settlements relating to crypto offerings or trading.
Registered platforms will need to be careful to follow evolving rules as regulators continue to refine their stances toward crypto trading; for example, guidance has been published about advertising and marketing expectations for platforms. To date, registered platforms in Ontario have been restricted as to the type of crypto currency they can offer.
2. Going “viral”: meme stocks and short selling practices
Several stocks saw their prices 🚀substantially in 2021 due to sudden internet popularity, leading to the moniker, “meme stocks”. Online campaigns that spurred the rise in popularity often highlighted short selling practices around these stocks. Some of the companies impacted saw over 60% of their outstanding shares sold short2.
Both the purchase and shorting of shares without an investment purpose trigger regulatory scrutiny. The OSC is looking into misleading, manipulative and self-interested statements made on social media. The British Columbia Securities Commission has proposed new rules related to the promotion of stocks on social media and video platforms. The meme stock phenomenon has also had the effect of bringing certain short selling practices—an area of regulation where Canada lags behind the United States and Europe—into the spotlight.
Two forms of short selling conduct that have been a concern are “short and distort” campaigns and naked short selling. Short and distort campaigns involve a short seller publishing false information publicly to try and get a stock price to decrease. Naked short selling is the practice of shorting a stock without borrowing the underlying security. Currently, short sellers are only required to have a reasonable expectation that they could borrow the security3.
We expect that regulators will increase enforcement as more attention is drawn to the issue of suspect short selling practices.
We expect rising focus in Canada on the regulation of short selling to emerge as a result of these trends. This year the Ontario Capital Markets Modernization Task Force made recommendations aimed at curtailing short and distort campaigns and naked short selling. The Task Force recommended creating a prohibition on misleading or untrue statements and requiring short sellers to confirm they can borrow the securities they are attempting to short.
Registrants engaging in short selling activities or, in the case of dealers, permitting their clients to sell short, should ensure compliance with the current requirements. We expect that regulators will increase enforcement as more attention is drawn to the issue of suspect short selling practices.
3. Client-focused reforms
The last of the CSA’s new client-focused reforms will be implemented at the end of 2021 after being delayed due to COVID-19. These reforms are significant for registrants.
On June 30, 2021, changes to the conflict of interest provisions came into effect. Now, firms and individual registrants must address material conflicts of interest in the “best interest” of the client and, where conflicts are material, simply ensuring these conflicts are disclosed will no longer be sufficient. The conflict of interest provisions are broad and seek to capture a range of conduct. Registrants should keep abreast of regulatory guidance on conflicts and be proactive in compliance.
On December 31, 20214, the remaining client-focused reforms will come into effect. These reforms expand registrant obligations, with a revised suitability threshold requiring registrants to put the clients’ interest first while recognizing that there is not always one best course of action. Other reforms include changes to know-your-product and know-your-client requirements. Relationship disclosure information may also have to be revised to reflect the new standard.
As these new standards are implemented, we expect to see enforcement action as regulators look to define and enforce the scope of these new rules. There is also a risk of class action liability for registrants found in violation of these rules. Plaintiffs may try to ground class action claims in the wake of these heightened requirements—and as conflict of interest claims were already emerging as the basis for novel securities class actions, we anticipate that plaintiffs will continue to assert them moving forward.
4. Civil cases rely heavily on regulatory obligations to assess liability
While individual investor loss lawsuits continue to occur with less frequency than in the 1990s and 2000s, the few civil cases that have been reported send important messages to registrants. Paramount among these messages is that the ever-increasing regulatory obligations and standards (as referenced in 3 above) will be used by courts to impose legal duties upon dealers when assessing liability for investment losses5. Importantly, case law from 2021 shows an inclination of judges to balance out the heavy onus on registrants by making clear that an advisor’s duty to her client is not independent or separate from the actions and decisions of the client, and that clients have important obligations in the advisor-client relationship that must be fulfilled if the client is to have a successful claim for investment losses6.
5. Financial Consumer Agency of Canada
After maximum penalties in the Financial Consumer Agency of Canada Act were increased for violations committed by financial institutions, the FCAC has made good on its intention to deploy these new maximum penalties as we continue to see large penalties imposed on financial institutions. We expect this trend to continue and that FCAC will be actively engaged in enforcement activities in the coming year.
Increased enforcement is always accompanied by an increased class action risk. Since the FCAC’s Supervision Framework requires remediation, to date, we have not seen a substantial increase in class actions. However, financial institutions should remain mindful of the potential for class action risk as they develop and evolve their remediation plans.
The new financial consumer protection framework is scheduled to come into force on June 30, 2022. This framework provides new consumer protection rules for federally regulated financial institutions (you can read more about the latest consumer protection rules here). The FCAC is currently seeking feedback on proposed guidelines for complaint-handling procedures and appropriate products and services, and intends to seek feedback on its proposed guidelines on whistleblowing. Financial institutions should monitor these guidelines as they are finalized to ensure they are compliance-ready on June 30.
Securities litigation takeaway trends for 2022:
Evolving regulations. Regulatory changes are on the horizon that will impact crypto trading, consumer protection rules and client-focused obligations. These changes may affect compliance requirements and lay the groundwork for new civil litigation for crypto trading platforms and other market participants.
Increased regulatory action. We anticipate enforcement action in new areas, as regulators focus on suspect short selling practices and newly-implemented client-focused regulatory reforms. We also anticipate that 2022 will bring continued enforcement action by the FCAC, with higher administrative monetary penalties.
Emerging litigation risks. Increased enforcement is routinely accompanied by increased class action risk. Areas of potential risk include litigation liability for registrants involving allegations of non-compliance with new regulatory obligations, and for financial institutions in breach of the Financial Consumer Agency of Canada Act.
Vingoe, Grant (OSC Chair & CEO), “Change: Accelerated” Canadian Club Toronto (May 19, 2021).
United States Securities and Exchange Commission, “Staff Report on Equity and Options Market Structure Conditions in Early 2021” (October 14, 2021).
UMIR 2.2 Part 2(h).
CSA Notice 31-357.
See for example, Miller, 2021 BCSC 1811; Fattal, 2021 QCCS 1471.
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This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
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