Are securities regulators in Canada finally pulling up their socks? Don’t count on it

We’ve been hearing rumblings lately from the media about whether Canadian securities regulators are taking a more serious approach to enforcement. While that would be nice, the more likely story is that regulators are running a stealth PR campaign to try to turn around their desultory reputation.

Securities regulation has been in the news thanks to Canadian-listed, Chinese-domiciled companies like Sino-Forest Corp. and Silvercorp Metals. But while noise is being made in the media, is there anything actually indicating a change in strategy by the regulators?

First off, investors should not get excited. They have been disappointed too much in the past to not be skeptical of so-called signs of improvement on the enforcement front. Looking back to 1999, the market thought a sea change was occurring due to some highly publicized speeches by the chairman of the Ontario Securities Commission (OSC).

He boldly stated that companies and auditors “stretch their interpretation of accounting standards beyond all reasonable limits” and that the Commission would develop “more effective screening procedures to detect sophisticated uses of performance enhancers in the form of creative accounting treatments.”

The uncharacteristic promises were made on the heels of two high-profile collapses the previous year. The first was Livent Corp., the live-theatre company headed by Garth Drabinsky and Myron Gottlieb, which imploded under accusations of accounting fraud.

The second was YBM Magnex International, incorporated in Canada, headquartered in the U.S., and listed on the Toronto Stock Exchange. It turned out to be a front for Russian-Ukrainian mafia head Semion Mogilevich, described by intelligence agencies at the time as “the most dangerous mobster in the world.” Mogilevich still holds a spot on the FBI’s Ten Most Wanted list as a direct result of the YBM Magnex scam.

Naturally, people starting asking where the regulators had been, and what their plan was to stop it from happening again. Cue bold speech-making. However, as time passed, the regulators went back to sleep, never implementing their promised solutions.

The following decade featured several high-profile chances to take action, including the Royal Group Technologies debacle, where company founder Vic De Zen and other executives privately purchased a land parcel north of Toronto, and flipped it the same day to the company’s shareholders for a $6.5 million profit. The transaction was not disclosed to investors.

There were also questions surrounding other deals. Regulators made a big media splash in 2005, when two dozen members of the new Integrated Market Enforcement Team (IMET) raided the Toronto offices of Scotiabank looking for paperwork related to the deals. De Zen and the other executives were acquitted of all charges in December 2010, with the judge ruling from the bench that no fraud had been shown.

That defeat is still fresh, and it’s probably dictating the recent actions taken by regulators to try to repair their reputations. Not helping is the ongoing fallout from the Nortel case, which is slowly winding its way through the courts.

Back in 2003, Nortel unexpectedly returned to profitability under CEO Frank Dunn and CFO Douglas Beatty. The surprise earnings triggered $19 million in performance bonuses to top executives and managers. Investigations eventually led to the executives being fired, and a multi-year probe resulted in repeated restatements of the company’s audited financial reports.

The RCMP and IMET announced charges against the former Nortel executives the same day that they accused De Zen and his partners of fraud. While a three-year delay in Nortel action is nothing compared to the dozen years that Livent dragged out, investors are still left wondering what takes Canadian regulators and prosecutors so long to act.

And Livent is still opening wounds. The appeal of Garth Drabinsky and Myron Gottlieb was recently turned down, but regulators and prosecutors suffered a blow when the judges reduced the fraud sentences by two years each. The appeal judges may have been uncomfortable with some aspects of the trial (the quality of the prosecution), or simply thought the punishment does not fit the crime. Either way, it’s not good news for investors.

Barring a successful appeal to the Supreme Court of Canada, Drabinsky and Gottlieb will have postponed their judgment by 13 years, and will only serve one-third of the five- and four-year respective sentences for orchestrating one of the most well-known financial frauds in Canadian history.

Those sentences are far from what was handed down in high-publicity U.S. frauds, such as Bernie Madoff (Ponzi scheme, 150 years), Jeff Skilling (Enron, 24 years), and Bernie Ebbers (WorldCom, 25 years). The record actually goes to Sholam Weiss, who is serving 845 years for the $450 million collapse of National Heritage Life Insurance (his current release date is listed as Nov. 23, 2754). The longest sentence for a white-collar criminal in Canada is still less than 10 years.

With American prosecutors and regulators repeatedly showing up their Canadian counterparts (by acting first on Livent, YBM, Nortel, and Hollinger, to name just a few), it’s no wonder our regulators have tried to follow suit with their own quick-strike approach. Unfortunately, even these efforts seem to backfire.

On August 26, the OSC made big news by halting the shares of Sino-Forest and barring its senior executives from serving as officers or directors of any public concern. It was mere hours before the OSC had to rescind the order. Apparently, someone informed the OSC that the executives were entitled to a hearing before effectively being sentenced.

Asked weeks later whether the Commission lost any credibility with the record-setting about-face, chairman Howard Wetston responded with an abrupt “No.”

Even the decision to halt the stock seems prejudiced given that the OSC allowed Nortel to continue trading long after the company admitted that years’ worth of financial statements were unreliable fiction. After all, Sino-Forest investors arguably have more information now than Nortel shareholders did after its financial statements were pulled by the auditors.
Have regulators learned anything from past missteps? They are continually overmatched on strategy, under-equipped on resources, and lack commitment to defend investors.

Part of the problem is the conflicted mandate to promote the markets while also keeping them safe. (In other words, to satisfy the wants of corporations while delivering on the needs of investors.) Unfortunately, promoting the markets often leads to public touting, which can give investors a false sense of security.

Given their long-term track record, it is no surprise that the securities commissions have retrenched. But why are they suddenly making a spectacle of themselves when it comes to the likes of Sino-Forest?

Perhaps the aggressive, albeit misplaced, approach in the Sino-Forest matter was just a blip. Wetston commented on the latest development in the 13-year-old Livent saga, saying, “It may have taken a long time, but it does seem that justice has been served.” Apparently he’s never heard the expression “justice delayed is justice denied.” If Wetston was truly charting a new course for the Commission, he would have said there was room for improvement in handling Livent.

So, other than the embarrassing public face-plant in the Sino-Forest matter, it seems like business as usual at the securities commissions. In other words, they remain as impotent as ever, and the only protection investors have is what due diligence they do for

DR. AL ROSEN, FCA, FCMA, CIP, CFE, CPA and MARK ROSEN, MBA, CFA run Accountability Research Corp., providing independent research to investment advisors across Canada.