GETTING READY TO REGULATE – THE FEDS TAKE ON THE PROVINCES IN A BATTLE OVER SECURITIES REGULATION

In May 2010, the federal government released a draft version of the Canadian Securities Act, which outlines its proposed national securities regulatory body.  The federal government contends that a national regulator will create a national voice for Canada in the global market.  Canada will be able to better respond to global events that may pose a systemic risk to its financial markets.  The feds also argue that a national regulator will be both effective and proactive in dealing with securities-related crime. It will be better able to protect investors from securities fraud, since it will have stronger enforcement powers, greater expertise and more resources.

There are a number of hurdles that the federal government must overcome to create a national regulator, starting with the strong opposition of the provincial governments in Alberta and Quebec.  The provinces’ position is that a national regulator is an unwanted intrusion by the federal government into an area that is provincially regulated, and doing so very well. The idea of a national regulator strikes fear into the heart of many provincial governments who believe that centralized regulation will result in significant economic and job losses in the provinces.  Several provinces argue that the “passport system” which allows registrants (dealer members and investment advisors) a single point of access to the capital markets regulated by those provinces that have signed on is working fine, so why fix something that isn’t broken. 

While the passport system does work well, the system does not deal with matters related to securities enforcement, such as regulating securities exchanges, self-regulatory organizations (the MFDA and IIROC) or clearing agencies, all of which are currently regulated at the provincial level and are fundamental elements of an efficient regulatory system.

The jurisdictional battle lines between the federal government and the provinces of Alberta and Quebec have been drawn.  The federal government has referred the proposed Canadian Securities Act to the Supreme Court of Canada on the question of whether the Act is within the legislative authority of the Government of Canada.  The constitutional reference is expected to be heard by April 2011.  The provinces have also brought reference cases to the courts.

Whatever the merits of creating a national regulatory system, it is clear that it must be an all encompassing system.  Since the federal government has already provided an “opt out” provision in its proposed national scheme, which will almost surely leave one or two provinces out, it has "shot itself in the foot".  The proposed system will be fragmented, and will likely leave many of the inefficiencies it was aiming to cure. Still, the situation is not fully settled, and perhaps a sensible solution will be found. 

We will keep you abreast of the process as the federal government continues its journey down the road to a national securities regulator

IIROC Members will now face an increase arbitration award limit to $500,000 under the IIROC Arbitration Program (the “Program”)

There are a number of options available to investors to resolve disputes with dealer members, including the Program.  Up until recently, the award limit under the program was $100,000 which in many instances, did not provide sufficient recovery for investors, who would then turn to the courts as a means of obtaining compensation from the dealer member.  With the increase award limit, the Program just became more attractive to investors.  Coupled with the increase award limit, arbitration is a faster process and more cost-effective than suing in court.  Many might say that with the higher limits, the Program is a real choice for investors to use as a recourse to resolve disputes with the dealer members.

In increasing the award, IIROC has also implemented a change to the rules of procedure under the Program to permit a claimant at the commencement of the arbitration proceeding to opt to eliminate the arbitrator’s discretion to award costs against a party, unless the arbitrator finds that the party has acted in a manner that may be characterized as unfair, vexatious, improper, in bad faith or has unnecessarily and unreasonably prolonged proceedings.  The opt-out relates to cost awards, which includes legal fees and expert fees.  Some argue that placing the authority in the hands of the investor to unilaterally decide to eliminate cost awards is unfair.  IIROC takes the position that there still remains discretion in the hands of the arbitrator to award costs in certain circumstances.

Overall, in my view, the move to increase the award limit is a good one.  The Program becomes a viable option for investors, and in turn helps reduce defence costs for dealer members who would otherwise find themselves in the throes of civil litigation. 

Mutual Fund Dealers in Canada will soon be required to disclose fees and charges to clients.

Earlier last year, the MFDA published proposed rules to require a Dealer Member to inform clients of any fees or charges to be deducted, while also requiring the Member to maintain evidence that the client was so informed. The comment period expired in September and we now await confirmation, which is expected early this year.

Types of Fees Covered by the Proposed Rule

The proposed rules will capture direct transaction charges but not indirect charges, such as trailing commissions. 

What does this mean?

By meeting these requirements, Dealer Members will be in a better position to defend alleged disgorgement of fees, churning and in some cases alleged unauthorized trading allegations.  The key will be the effective implementation of controls to ensure compliance with the rules. 

We are a “victim” of Computer Fraud – Do we have coverage?

Back from the Fidelity conference in NY just in time to answer the question - why are there only nine cases on computer fraud coverage in the US?

When the presenter at the Fidelity and Surety conference in New York began her presentation on computer fraud coverage by saying there were only nine cases in the US dealing with computer fraud coverage, I must admit I was shocked.  I would have thought that since computers are now being used more frequently in the commission of crimes,  we would see a lot more computer fraud coverage cases coming out of the courts.

After listening to the presentation, it dawned on me, all the reasons given by the presenter make sense, but for me, the primary reason, although not the primary reason given by the presenter, is simply reputation.  The reputational risk to the financial institution or the organization in having to acknowledge that someone hacked into their secure network and stole data or transferred money, is a business killer.  The public wants to feel secure in knowing that their money or precious belongings are being stored in a safe place and this trust can be easily destroyed with the admission that “our computer system was hacked”.

Does it matter whether it’s an outside job or carried out by someone on the inside?  From where I stand, as a member of the “public”, no.  But it does matter for the definition of what a computer fraud is under most insuring agreements in the US. 

Of the reported cases in the US on computer fraud coverage, there are some general principles that can be drawn that explain why there are so few cases.  The primary reason given by the presenter was the fact that the definition used in many insuring agreements as to what constitutes a computer fraud is very narrow, thereby making it difficult for an insured to fall within the covered definition of computer fraud.  In particular, most coverage forms require the fraud to be perpetrated by a third-party who has unauthorized access to the system, the “hacker” and, the property being stolen must be “tangible”.  Since most of the what is stolen is information, an intangible asset, the insured would likely not have coverage.  Even if the insured, could get past the first two hurdles, there still remains the requirement that the loss must result directly from the computer fraud.  Just because a computer was involved in the fraud, does not satisfy this requirement.  Most courts in the US are of the opinion that direct means direct.  There is a recent US case, Owens, Schine & Nicola, P.C. v. Travelers Casualty and Surety Company of America, No. CV95024601, 2010 WL 4226958, where the court veered away from the “direct loss” requirement and instead said the insured only had to show that the computer was the proximate cause of the loss.  However, this case stands alone on this point, and only time will tell whether the courts in other “direct loss” jurisdictions can be swayed to this side of the fence.

Although this article is by no means a complete picture of the computer fraud coverage issues in the US, it does provide a flavour for the issues that an insured must turn their minds to if they are indeed going to try and claim a loss under the computer fraud form of their policy, if they have one.  In the interim, we will continue to watch as the law on computer fraud coverage evolves in the US as a sign of what is to come in Canada on this topic.  As we continue to rely on computers to manage many facets of our lives, one would expect to see computer crime continue to rise and it will be interesting to see how the courts interpret what constitutes a computer crime.