The way the whistle blows

By Al and Mark Rosen | September 21, 2018 | Last updated on September 21, 2018
4 min read

In the last week of June, the OSC and SEC gave updates on their respective whistleblower programs, which provided further evidence that the two agencies seem to be moving in opposite directions.

The OSC, marking the two-year anniversary of its program, noted that it had generated 200 tips. Of those, 45 are under review and 68 either were, or are, in the process of being shared with another OSC operating branch or another regulator for further action. Nineteen tips were forwarded to the regulator’s enforcement division, and 15 of those are under active investigation.

Awards, if they occur, will only be paid to tipsters after the cases are finished and all appeals have been exhausted. The investigation, enforcement and appeals process could take years, and no awards have been made to date.

The SEC, in its update, reported that its program has resulted in enforcement actions ordering US$1.4 billion in financial remedies. This includes US$740 million in disgorgement of ill-gotten gains, the majority of which either has been or will be returned to investors. Whistleblowers, for their part, have been paid US$266 million in 50 award cases.

The SEC program is in its seventh year, and the commission issued a proposal in June to bolster its ability “to more appropriately and expeditiously reward those who provide critical information that leads to successful enforcement actions.”

The plan would provide potential awards in non-prosecution and deferred-prosecution situations, allow for financial awards in situations that don’t meet current thresholds, and increase the value of smaller monetary awards to further incentivize tipsters, among other changes.

We’ve explained before how the potential reward under the OSC program is lacking compared to the SEC program. The maximum available to a tipster under the OSC rules is just $5 million. This is reduced to only $1.5 million if the commission can’t collect its money, which it has a poor track record of doing (more on that below).

The rewards for whistleblowers are far more attractive under SEC rules. In fact, the average award to date (US$5.2 million) is greater than the maximum allowed by the OSC. The SEC has already paid out five awards of US$14 million or more.

The potential reward for an OSC whistleblower is pegged between 5% and 15% of the amount levied against the offender. The SEC aims for an award between 10% and 30%. Under its current proposal, it’s aiming for most awards to start at US$2 million to encourage more insiders to bring forth information on difficult-to-detect frauds.

Collectability crucial to credibility

If the OSC can’t collect sanctions, whistleblowers are capped out at just $1.5 million in potential reward money for taking significant career risks.

In fiscal years 2013 through 2016, the OSC’s collection rates on sanctions were 4%, 3%, 14% and 19%, respectively. Then, in 2017 and 2018, they climbed significantly to 50% and 47%. (The data don’t include whistleblower cases, for which no sanctions have yet been issued.) On the surface, things are looking up, but let’s dig deeper.

The OSC (and other Canadian securities regulators) have been routinely criticized over the years for their dismal performance as debt collectors. The defence (and reasonably so) was that you can’t get blood from a stone, especially in cases of fraud and misappropriated or hidden assets.

Unfortunately, the OSC’s improved collection track record over the past two years seems more a function of not issuing sanctions in situations where collection is unlikely, thereby improving the percentage of recovery even though the total dollar amounts have dwindled.

From 2013 to 2016, the OSC issued sanctions at an average annual total of $64 million. In 2017 and 2018, that dropped to just $14 million. In contested hearings, where collectability is in the low single digits historically, sanctions have dropped from an average of $41 million from 2013 to 2016 to $7 million in 2017 and 2018.

The concern is that the OSC seems less likely to issue high sanction amounts in situations where collectability is low, which would in turn lower potential whistleblower payouts. That would decrease the incentive for tipsters to come forward and impair the usefulness of a program that is already notably lagging in effectiveness compared to its American cousin.

Editor’s note:

The OSC didn’t comment by press time on why sanction amounts had declined. Its 2018-19 statement of priorities says the regulator is looking to improve enforcement efficiency through “strategic case selection” focused on disclosure, governance, conflicts of interest and market integrity.

Al and Mark Rosen run Accountability Research Corp., providing independent equity research to investment advisors across Canada. Dr. Al Rosen is FCA, FCMA, FCPA, CFE, CIP and Mark Rosen, is MBA, CFA, CFE.

Al and Mark Rosen

Al and Mark Rosen run Accountability Research Corp., providing independent equity research to investment advisors across Canada. Dr. Al Rosen is FCA, FCMA, FCPA, CFE, CIP, and Mark Rosen is MBA, CFA, CFE.