Where’s the harm?: OSC proposes new rules to use disgorged funds to compensate harmed investors

Investors who suffer direct financial harm resulting from the contravention of Ontario securities or commodity futures laws may soon be able to receive compensation directly from the Ontario Securities Commission (OSC) as a result of two new proposed rules (the Proposed Rules) the OSC published for comment last month. If they come into force, the Proposed Rules would require the OSC to initiate a claims process and distribute funds obtained in satisfaction of disgorgement orders directly to eligible harmed investors, subject to certain exceptions and conditions.

What you need to know

• New investor compensation mechanism: If adopted, the Proposed Rules would allow the OSC to join the British Columbia and Quebec securities regulators as the only Canadian securities regulatory authorities statutorily empowered to distribute funds obtained through disgorgement orders directly to harmed investors.
• Only direct financial harms are compensable: Harmed investors would be required to provide sufficient evidence to prove quantifiable financial losses as a direct result of the misconduct that led to the disgorgement order. Lost opportunity to invest funds in another investment would not be considered a compensable harm.
• Methods of distribution: Depending on the number of eligible applicants and the complexity of any issues that may arise, the OSC could seek a court-appointed administrator to conduct the distribution or conduct the distribution itself.
• Exceptions: Under the Proposed Rules, the OSC would not distribute disgorged funds derived from contraventions of Ontario’s insider trading or tipping prohibitions, or where the amount of funds available would not justify the costs of distribution.
• Impact on class actions: The Proposed Rules can be expected to affect class action risk for the party found not to have complied with securities law.

The Proposed Rules

On July 11, 2024, the Ontario Securities Commission (OSC) published for comment two new OSC rules¹ and respective companion policies² (the Proposed Rules) that would, if adopted, establish a new framework by which money received by the OSC in satisfaction of disgorgement orders would be distributed to harmed investors.

Although there is no current statutory requirement or prescribed process through which the OSC must distribute funds directly to harmed investors, the OSC can, if practicable in the circumstances, distribute funds to investors who were directly harmed as a result of misconduct. This can occur through a claims-based process under the Ontario Securities Act (OSA) or Commodity Futures Act (CFA), via a receivership or with the assistance of the Ontario Ministry of the Attorney General through the civil forfeiture and claims adjudication process under the Civil Remedies Act, 2001. In rare instances where harmed investors and their losses are readily identifiable, the OSC can also directly distribute funds itself.

The Proposed Rules would provide a new mechanism that would require money received in satisfaction of a disgorgement order to be distributed to persons or companies who (i) incurred direct financial losses as a result of the contravention, giving rise to the disgorged funds and (ii) otherwise satisfy the conditions, restrictions and requirements set out in the Proposed Rules. Investors must have direct financial losses that can be quantified (not estimated) and must be able to provide sufficient proof of those losses. Lost opportunity damages are not eligible for inclusion in the amount of an investor’s harm. If an investor qualifies as an eligible applicant under the Proposed Rules, they will be entitled to a pro-rata share of any disgorged funds, subject to the amount ultimately received under the disgorgement order, their direct financial loss and the direct financial losses of other eligible investors, and other information which the Commission may consider appropriate in the circumstances.

Exceptions to the Proposed Rules

While all money received from disgorgement orders must be subject to a claims process in all cases, the Proposed Rules do provide two exceptions where distribution to harmed investors would not be required.

First, where the disgorged funds relate to a contravention of Ontario’s insider trading and tipping prohibitions, distribution would not be required. This type of misconduct generally leads to diffuse losses, making it challenging to assess direct financial harm or to quantify specific losses for individual investors. As a result, any disgorged amounts received in relation to insider trading and tipping cases will continue to be dealt with under existing mechanisms of the OSA. Notably, this exception is unique to the framework proposed by the OSC and is not found in any of the comparable frameworks from jurisdictions outside of Ontario. 

In line with the distribution framework established by the Quebec securities regulator (the AMF), the Proposed Rules also carve out an exception where distribution is not required if the amount received through disgorgement is too small to justify the costs of administering the distribution. This can occur when there are minimal or inaccessible assets against which to enforce an order, or as is often the case with OSC collection efforts³, where collection of amounts occurs incrementally over time⁴. To account for these realities, the Proposed Rules set a de minimis (although undefined) threshold for distribution and allow the OSC to collect and hold amounts for three years or until sufficient funds are collected to warrant a distribution.

The framework of the Proposed Rules

The OSC opted for the hybrid method of distributing disgorged funds used by the United States Securities and Exchange Commission (SEC), allowing the OSC to have an administrator appointed by the court to conduct the distribution while also preserving the OSC’s ability to conduct the distribution itself where appropriate. The OSC would reserve distributing the funds in instances where there are few applicants who are readily identifiable with easily quantifiable financial losses. Where there are a high number of claims or claims that require the resolution of complex issues, it is likely the OSC would defer to a court-appointed administrator to handle the distribution process.

In arriving at the Proposed Rules, the OSC drew on comparable investor compensation regimes adopted by financial regulators in other jurisdictions including those used by the British Columbia Securities Commission and AMF in Canada, the SEC’s framework in the United States, and the similar 2023 Proposal⁵ from the Canadian Investment Regulatory Organization (CIRO).

The Proposed Rules are yet another development of the 2021 Capital Markets Modernization Taskforce Final Report, which recommended the creation of a new statutory framework to allow the distribution of disgorged funds received by the OSC to be paid directly to harmed investors. In furtherance of this recommendation, the Ontario Government introduced amendments to both the OSA and CFA in 2023 as part of Bill 146, Building a Stronger Ontario Together Act (Budget Measures). Following any amendments to the Proposed Rules that may result from comments received by the OSC, it is anticipated that the Proposed Rules will come into force at the same time the legislative amendments to the OSA and CFA are proclaimed into force by the Lieutenant Governor.

Impact on class actions

To the extent that class actions follow securities regulatory proceedings, the Proposed Rules governing the distribution of amounts disgorged pursuant to a sanction (as opposed to findings of liability or admissions of wrongdoing which are the predicate for the disgorgement sanction) should not increase the risk of class proceedings being commenced.

If implemented, the Proposed Rules will provide a means for harmed investors to recover a portion of their direct financial losses. However, the Proposed Rules will not completely eliminate losses suffered by investors because of the distinction between disgorgement, which is intended to deprive an alleged wrongdoer of amounts obtained in breach of their duties, and tort or other common law damages suffered by an investor, which are measured by their investment losses. As a consequence, the Proposed Rules may reduce the likelihood of class proceedings being commenced against an entity alleged to have breached securities laws because the class of harmed investors will have received some recovery. However, depending on the delta between amounts recovered through a disgorgement order and damages suffered by a proposed class, some risk of a class proceeding in these circumstances will remain.