Carter Securities Inc. - Opportunity to be Heard
In the Matter of Staff’s Recommendation
to Suspend the Registration
of Carter Securities Inc.
Opportunity to be Heard by the Director
Section 31 of the Securities Act
|Dates of opportunity to be heard:||August 4 and 26, 2010|
|Date of decision:||September 22, 2010|
|Director:||Marrianne Bridge, FCA
Deputy Director, Compliance,
Ontario Securities Commission (OSC)
|Verbal arguments by:||Michael Denyszyn, Legal Counsel and Pamela Foy, Senior
Litigation Counsel for the staff of the OSC
Ellen Bessner of Cassels Brock & Blackwell, LLP on behalf
of Carter Securities Inc. (Carter)
1. My decision is that Carter is not suitable for registration, that Carter has failed to comply with Ontario securities law, and that Carter’s ongoing registration is objectionable.
Format of decision and reasons
2. Prior to the commencement of the opportunity to be heard (OTBH) on its merits, two motions were made by Carter’s counsel. The decision and reasons on the motions, together with the decision and reasons on the OTBH on its merits are included below.
3. For ease of reference only, the headings in this document are as follows:
- Motions to exclude Marrianne Bridge as Director
- Overview of the Motions
- Who should hear a motion on bias?
- Testimony of David Gilkes on the motions
- Reasonable apprehension of bias
- Production request
- Procedures in OTBHs
- Decision on the bias motions
- Nature of evidence at an OTBH
- Suspension of registration and meanings of suitable and objectionable
- Brief chronology of events
- Arguments from staff on suspension of Carter’s registration
- Outline of the arguments
- Ownership structure of Carter and its affiliated entities
- Financial position of NAFG
- NAFG’s marketing materials
- Where is the money coming from?
- Arguments from Carter’s counsel on suspension of Carter’s registration
- Outline of the arguments
- Testimony of David Gilkes on the suspension of Carter
- Decision on the suspension of Carter
Motions to exclude Marrianne Bridge as DirectorOverview of the bias motions
4. Two motions were made by Carter’s counsel – (1) that another Director hear the motion to exclude me as Director and (2) that another Director hear the OTBH on its merits.Who should hear a motion on bias?
5. Staff argued, referencing Macaulay and Sprague (Hearings Before Administrative Tribunals, 3rd ed. (Toronto: Carswell, 2007)), that in administrative proceedings any motion on bias should be brought to the person that is the subject of the bias claim. Carter’s counsel stated that Carter’s “preference would be at least to have this motion heard by another [D]irector and perhaps have the [OTBH] on the merits by another [D]irector”.Testimony of David Gilkes on the motions
6. David Gilkes, the former Manager of the Registrant Regulation team in the Compliance and Registrant Regulation Branch, testified as consultant and agent to Carter.
7. Mr. Gilkes testified regarding his views on what my role may have been on the decisions to:
- include Carter in a sweep of newly registered limited market dealers (the 2009 review)
- perform a subsequent more in-depth review of Carter’s operations (the 2010 review), and
- recommend that Carter’s registration as an exempt market dealer (EMD) be suspended.
8. Mr. Gilkes did not provide any evidence concerning communications between myself and senior staff on the Carter file. However, Mr. Gilkes testified that, in his experience, I would have been involved in all aspects of the file and that there would have been constant interaction between senior staff on the file and myself.
9. My involvement with respect to the 2009 review and the 2010 review of Carter was not as Mr. Gilkes described and was at all times in accordance with the Securities Act (Ontario) (Act). Specifically, as discussed below, the Director is entitled by the Act to be involved in all matters relating to the “life cycle” of registration – from initial registration to revocation of registration. And, as I said on the record at the start of the proceeding (in advance of the motions being made), I was not involved in staff’s recommendation to suspend Carter’s registration. In fact, as staff counsel advised at the OTBH, the recommendation to suspend Carter’s registration was made to another Director.Reasonable apprehension of bias
10. Carter’s counsel argued that bias is a state of mind. She also argued that I owed a duty of fairness to the registrant. I agree.
11. Carter’s counsel referred me to E.A. Manning Ltd. v. Ontario (Securities Commission) (1994), 18 O.R. (3d) 97 (Div. Ct., aff’d (1995), 23 O.R. (3d) 257 (C.A.), leave to appeal to S.C.C. refused, 125 D.L.R. (4th) vii (S.C.C.). Manning related to the eligibility of Commissioners to hear a matter in a situation where the OSC had previously issued a policy on “penny stock”. The test outlined in the case was whether there was prejudice to Manning. Staff argued that there was no evidence of my pre-judging this matter and thus the test set out in Manning was not relevant. I agree.
12. Staff argued that there was no reasonable apprehension of bias in the present case because the Director is permitted by the Act to be involved in all aspects of the registration process up to and including suspension. In support of this, staff referred me to various provisions of the Act authorizing the Director to be involved in all stages of the registration process (see sections 3.6(1), 20, 27, 28, and 31 of the Act).
13. Staff referred me to Brosseau v. Alta. Securities Comm.,  1 S.C.R. 301 and to W.D. Latimer Co. v. Bray (1974), 6 O.R. (2d) 129 (C.A.). Both Brosseau and Latimer deal with the various functions of securities commissions. Staff argued that these cases stand for the proposition that a reasonable apprehension of bias only arises if I acted in a manner that went beyond my statutory powers and duties. There is no evidence that this was the case here.
14. Staff also referred me to Norshield Asset Management (Canada) Ltd., Re (2009), 32 O.S.C.B. 1249, where the Commission adopted the test for apprehension of bias set out in Newfoundland Telephone Co. v. Newfoundland (Board of Commissioners of Public Utilities),  1 S.C.R. 623. As the Supreme Court of Canada stated:
“To ensure fairness the conduct of members of administrative tribunals has been measured against a standard of reasonable apprehension of bias. The test is whether a reasonably informed bystander could reasonably perceive bias on the part of adjudicator.”
15. Carter’s counsel argued that “full” disclosure in regard to correspondence relating to the matter had not been made and thus there was no current evidence of actual bias. She suggested that the disclosure requested, if provided, would provide evidence of actual bias.
16. Staff argued that the production request by Carter’s counsel was overly broad and irrelevant. Staff also argued that there was no evidence of actual bias and that Carter was not entitled to go on a “fishing expedition” to get that evidence. Lastly staff argued that there was no evidence to suggest that this matter had been pre-adjudicated or prejudged by me.
17. I agreed with the arguments of staff and denied the production request.Procedures in OTBHs
18. Staff referred me to section 8 of the Procedures for Opportunities to be Heard before Director’s Decisions on Registration Matters made under the Statutory Powers Procedure Act (Procedures). Part 8 of the Procedures states that:
“(a) An appearance before the Director will generally be an informal proceeding. The Ontario Securities Commission Rules of Practice and the Rules of Civil Procedure do not apply to such proceedings.
(b) At the appearance, the Director may ask any question and admit any evidence which he or she sees fit…”.
19. As the above quote makes clear, OTBHs are more informal than proceedings under section 127 of the Act.Decision on the bias motions
20. I agreed with staff’s submissions on the motion to exclude me as Director and determined that it was appropriate for me to hear the second motion that another Director hear the OTBH on its merits. In my view, it is clear from Macaulay and Sprague that in proceedings of this type, any motion on bias should be brought to the person that is the subject of the bias claim – in this case, me.
21. Despite the evidence of Mr. Gilkes, the overlapping of functions is authorized by the Act. Brosseau and Latimer confirmed that, to the extent overlapping functions are authorized by legislation, they will not generally be subject to the doctrine of reasonable apprehension of bias. Therefore, as long as the Director acts within the scope of his or her authority under the Act, there is no reasonable apprehension of bias. I did not and have not pre-adjudicated or prejudged the matter and there is no evidence that I went beyond my statutory powers and duties. As a result, there is no reasonable apprehension of bias.
22. I was also asked to consider the issue of fairness and whether my proceeding to act as Director in this matter was fair to Carter. There is no disagreement between the parties (or with me) that a duty of fairness is owed to Carter. Since there is no reasonable apprehension of bias, there is no issue of unfairness to Carter either. In my view, the duty of fairness will be satisfied if I act in accordance with my statutory authority and approach matters before me with an open mind.
23. As a result, my decision is that the motions are denied and that the OTBH on the merits will proceed before me as Director.
Nature of evidence at an OTBH
24. Both counsel made a number of submissions throughout the OTBH about the nature of required “evidence” at an OTBH.
25. I was specifically referred to sections 2(b) and 8 of the Procedures. Section 2(b) states that these “Procedures are intended to ensure that [OTBHs] by the Director are handled in a way that is not unnecessarily formal, while ensuring a fair hearing.” [emphasis added]. Part 8 of the Procedures is set out above.
26. Staff argued that there is no rule and no case law requiring staff to adduce evidence solely through viva voce evidence. The Director may admit any evidence into the proceeding and I, as Director, control the evidence and documents that form part of the record and evidence at the OTBH. Staff further argued that arguments on evidence should only go to the weight I place on the evidence, not the admissibility of the evidence itself.
27. Staff also referred me to Rex Diamond Mining Corp. v. Ontario (Securities Commission), 2010 ONSC 3926. The decision is an appeal of a decision pursuant to section 127 of the Act. The case provides, at para. 4, that “hearsay evidence is not, in law, necessarily less reliable than direct evidence”. As a result, staff argued that the two books of documents provided to me by staff in the OTBH are proper hearsay evidence.
28. Over the objection of Carter’s counsel, I entered the two books of staff documents as exhibits in the OTBH. Substantially all of the documents in the two books of staff documents are copies of, or extracts from, Carter’s or North American Financial Group’s (NAFG) books and records, or are documents or correspondence between staff and Carter or its registered representatives. As a result, I had no difficulty in accepting the two books of documents as evidence in the OTBH.
29. As well, many of the documents in the two books of documents were referred to by Mr. Gilkes, as consultant and agent for Carter, in his testimony. At no time did Mr. Gilkes suggest in any way that the veracity of any of these documents was an issue.
Suspension of registration and meanings of suitable and objectionable
30. The purposes of the Act, which are set out at section 1.1, are to provide protection to investors from unfair, improper or fraudulent practices, and to foster fair and efficient capital markets and confidence in capital markets.
31. Section 28 of the Act provides that the Director may suspend the registration of a company at any time during the period of its registration if it appears to the Director that (i) the company is not suitable for registration or has failed to comply with Ontario securities law, or (ii) the registration is otherwise objectionable.
32. A registrant is in a position to provide valuable services to the public. A registrant also has a corresponding capacity to do material harm to investors and to the public at large. Determining whether an applicant should be registered is thus an important component of the OSC’s public interest mandate. As well, as noted in numerous prior decisions, registration is a privilege, not a right.
33. The OSC has, over time, articulated three fundamental criteria for determining suitability for registration – integrity (which includes honesty and good faith, particularly in dealings with clients, and compliance with Ontario securities law), proficiency, and solvency. These three fundamental criteria have been codified in subsection 27(2) of the Act, which provides that in determining whether a person is suitable for registration, the Director shall consider whether the person has satisfied the requirements prescribed in the regulations relating to proficiency, solvency and integrity, and such other factors as the Director considers relevant. The criterion at issue here is integrity.
34. The determination of whether an applicant’s proposed registration may be otherwise objectionable goes beyond the three suitability criteria above. Prior OSC decisions have held that registration is “otherwise objectionable” if it is determined, with reference to the purposes of the Act, that it is not in the public interest for the person or company to be registered. For example, in Mithras Management Ltd., Re (1990), 13 O.S.C.B. 1600 the OSC held that:
“[T]he role of this Commission is to protect the public interest by removing from the capital markets… those whose conduct in the past leads us to conclude that their conduct in the future may well be detrimental to the integrity of those capital markets…”
Brief chronology of events
35. Carter was registered as a limited market dealer (LMD) in 2007. By operation of law, Carter became registered as an EMD in September 2009.
36. Staff performed two reviews of Carter’s operations – the 2009 review and the 2010 review. Staff identified concerns with respect to the suitability of Carter’s ongoing registration and, by letter dated June 23, 2010, staff advised Carter of its recommendation that Carter’s EMD registration be suspended. Pursuant to section 31 of the Act, Carter is entitled to an OTBH before a decision is made by the Director. The OTBH was held on August 4 and August 26, 2010 at the OSC’s offices.
37. My decision is based on submissions, arguments, evidence, and testimony provided at the OTBH.
Arguments from staff on suspension of Carter’s registrationOutline of the arguments
38. Staff argued that Carter has engaged in a pattern of conduct – through its individual registrants – that demonstrates that it lacks the integrity required of registered firms under the Act. The conduct identified included:
- Carter’s lack of disclosure to its clients purchasing NAFG securities of the severe financial difficulties being faced by NAFG – a violation of section 13.3 of National Instrument 31-103 Registration Requirements and Exemptions (NI 31-103) and of OSC Rule 31-505 Conditions of Registration (OSC Rule 31-505)
- NAFG’s marketing materials include statements that are misleading, unsupported or not accurate – a violation of subsection 44(2) of the Act
- Carter’s lack of disclosure to its clients of the Prestige Motors loan – a violation of section 2.1 of OSC Rule 31-505, and
- Carter’s lack of disclosure to its clients of the non-interest bearing related party loans (including the Prestige Motors loan) – a violation of subsection 13.4(3) of NI 31-103.
39. Carter is owned 50% by two brothers – Flavio Arconti and Gino Arconti. They also own the following affiliated companies – NAFG (50%, 50%), North American Capital Inc. (NAC) (50%, 50%), and 970910 Ontario Inc., operating as Prestige Motors (52%, 48%).
40. Flavio Arconti is the Chief Compliance Officer, Ultimate Designated Person, director and a dealing representative of Carter. Gino Arconti is a director and the other dealing representative of Carter.
41. Carter sells securities issued by NAFC and NAC to its clients using the accredited investor exemption under National Instrument 45-106 Prospectus and Registration Exemptions. Carter is subject to the know your client and know your product obligations with respect to investments sold to its clients.
42. Both NAFG and NAC are finance companies specializing in subprime car leasing. Prestige Motors is a car dealership. NAFG issues promissory notes at a 10% interest rate. NAC issues Class A preferred shares with a 10% dividend rate. Both NAFG and NAC have paid interest/dividends on a timely basis. Prestige Motors purportedly advertises guaranteed car loans regardless of past credit.Financial position of NAFG
43. Because NAFG and Carter are owned by the same two people, staff argued that the Arconti brothers (the individual registrants of Carter) had unlimited access to NAFG’s financial affairs and records. I agree.
44. NAFG’s balance sheet as at December 31, 2009 shows a loan to Prestige Motors for approximately $2 million. According to the correspondence of Carter with OSC staff during the course of the 2010 review, the “loan is used to finance the inventory of vehicles that is used to help originate loans and leases for [NAFG]” and “[n]o interest is charged on the loan and repayment is targeted within two years”.
45. The loan to Prestige Motors was not disclosed to Carter clients investing in NAFG. This was confirmed by Mr. Gilkes in his testimony. The impact of the loan is that a material part of investor proceeds raised by Carter for NAFG are used to loan monies to other Arconti companies with no interest income accruing to the public investors in NAFG. As a result, in staff’s view, Gino and Flavio Arconti put their own interests ahead of the interests of Carter investors. Staff also argued that the non-disclosure of the loan by Carter to its clients violates section 2.1 of OSC Rule 31-505 which requires registrants to deal with clients fairly, honestly and in good faith.
46. There are also two other relatively large related party loans on NAFG’s balance sheet – a loan to 1014177 Ontario Inc. ($177,625) and a loan from NAC in the amount of $200,000. 1014177, a corporation which operated under the trade name North American Coverage, offered in-house extended vehicle warranties to car lessors and buyers. It is now an inactive corporation.
47. Staff argued that the existence of the non-interest bearing related party loans creates undisclosed conflicts of interest. Subsection 13.4(3) of NI 31-103 provides that if a reasonable investor would expect to be informed of a material conflict of interest, the registered firm must disclose in a timely manner the nature and extent of the conflict of interest to the client whose interest conflicts with the interest identified. No evidence of disclosure of the conflicts of interest to Carter’s clients exists.
48. NAFG also shows almost $600,000 of accounts receivable on its balance sheet. A review of the aged accounts receivable of NAFG shows that over 83% of these receivables are over 91 days old. As per the correspondence of Carter with staff during the course of the 2010 review, virtually none of these very old receivables have been written off because Carter’s policy is to write off accounts receivable only if the client is bankrupt. Staff argued that this practice is not prudent because the purchasers of cars from Prestige Motors all have subprime loans. It is also not consistent with prudent accounting practices. Staff submitted that, because NAFG did not make an appropriate allowance for doubtful accounts, its financial position which staff submitted already reflects severe financial difficulties, is significantly overstated.
49. For the year ended December 31, 2009, NAFG’s income statements showed that on revenue of just over $500,000, the company sustained a net loss of over $300,000 (i.e. expenses exceeded $800,000). Total accumulated (net) losses to date total almost $1.2 million.
50. In staff’s view, NAFG’s financial difficulties bear directly on Carter’s integrity as an EMD. Carter did not disclose to its clients purchasing NAFG securities the severe financial difficulties being faced by NAFG. As a registrant, Carter is required under section 13.3 of NI 31-103 to take reasonable steps to ensure that, before it makes a recommendation to or accepts an instruction from a client to buy or sell a security, the purchase or sale is suitable for the client. In selling securities of NAFG to its clients, staff submitted that Carter was aware or should have been aware (because of the ownership structure of both NAFG and Carter) of the risks associated with NAFG’s financial position. However, Carter did not explain these risks to its clients, which staff submitted would have been material in making an appropriate investment decision. Staff also argued that the non-disclosure of the severe financial difficulties being faced by NAFG violates OSC Rule 31-505 which requires registrants to deal with clients fairly, honestly and in good faith.
51. Staff further submitted that Carter was not appropriately discharging its suitability obligations to its clients (under section 13.3 of NI 31-103) by not considering and explaining NAFG’s financial predicament, which staff submitted was not disclosed in its marketing materials and which was not properly reflected in its own financial statements.
52. Carter’s counsel argued that it is inappropriate for staff to raise issues related to the solvency of NAFG as a reason for concluding that Carter lacks integrity. I disagree. The issues related to NAFG’s solvency are directly related to Carter’s integrity. It is Carter and its registered representatives that are selling NAFG products to their clients without explaining the risks of these products to clients, without disclosing NAFG’s severe financial difficulties, and without disclosing NAFG’s non-interest bearing loan to Prestige Motors.NAFG’s marketing materials
53. Staff counsel walked me through NAFG’s marketing materials in detail. These materials are provided to all investors in NAFG (all of which are Carter clients). This fact was confirmed by Mr. Gilkes in his testimony. Staff argued that many of the statements made in the marketing materials are misleading, unsupported or not accurate. Examples include:
- No disclosure that a substantial percentage of NAFG’s investor funds are invested in non-interest bearing related party loans
- A lack of disclosure regarding NAFG’s poor financial condition
- NAFG has “grown to become a leader in the finance sector” and NAFG is “a leading non-bank finance lender”
- Comparisons of NAFG’s returns to those of low risk secured alternatives (Canada Savings Bonds and GICs)
- “Quantitative analysis, understanding and interviewing every borrower is the foundation of our lending”
- “Once a loan is advanced we continue to regularly monitor the borrower and the asset until the loan is repaid”, etc.
54. Staff claimed that NAFG’s marketing materials violate subsection 44(2) of the Act which provides that:
“No person or company shall make a statement about any matter that a reasonable investor would consider relevant in deciding whether to enter into or maintain a trading or advising relationship with the person or company if the statement is untrue or omits information necessary to prevent the statement from being false or misleading in the circumstances in which it is made.”
55. Staff argued that by inappropriately directing investor funds into unsecured, non-interest bearing related party loans, by not disclosing these loans or the conflicts of interest arising from them to investors, by failing to discharge its suitability obligations in light of NAFG’s serious financial difficulties, and by disseminating misleading and inaccurate marketing materials, Carter has engaged in a pattern of conduct that demonstrates that it lacks the integrity required of registered firms under the Act. Consequently, staff is of the view that Carter is not suitable for registration and should be suspended.
56. Staff also referred me to an advertisement by Carter from the business section of the Toronto Star. In staff’s view the advertisement is misleading because only the 10% return on investment in either NAFG or NAC is in print large enough for most people to read.Where is the money coming from?
57. Staff also argued that the Arconti companies are essentially a “house of cards”. Money is being paid out by Carter’s affiliated entities (NAFG and NAC) to investors. Yet the only source of money flowing into the group of Arconti companies discussed at the OTBH on a net basis is new capital from Carter investors. Staff supported this argument by arguing that NAFG is consistently losing money and that NAFG has a substantial non-interest bearing loan to Prestige Motors (approximately 40% of investor funds). Staff further argued that if Carter cannot provide me, as Director, with an explanation of where the money is coming from then Carter’s registration should be considered objectionable.
Arguments from Carter’s counsel on suspension of Carter’s registrationOutline of the arguments
58. Counsel for Carter made three main points in her submissions:
- The process followed by staff in recommending the suspension of Carter’s registration was not the normal process
- Staff’s concerns related mainly to the issuer (NAFG) and not Carter, as registrant, and that if staff had concerns about NAFG it should pursue them through another avenue. As an aside, counsel advised that proceedings have commenced against the “North American companies”, and
- Staff has no direct allegations against Carter and the allegations against NAFG as issuer are not relevant to staff’s case against Carter.
59. Mr. Gilkes testified that Carter meets its current registration requirements under NI 31-103.
60. He provided testimony on his views on the 2009 Compliance Team Annual Report. He referred to the summary of findings from the sweep of newly registered LMDs (now EMDs) and testified that the issues identified were similar to the ones identified during the 2009 review of Carter. He also testified that the issues from the 2009 review had been resolved by Carter.
61. Mr. Gilkes also testified at length about the chart on page 38 of the Annual Report which sets out possible outcomes from compliance reviews. He testified about the lack of a suspension outcome and that, in his view, the 2009 review fell into the lowest form of outcome from a compliance review (enhanced compliance). He later acknowledged in response to a question from me that suspension could not have been a possible outcome in the chart because the Director suspension power came into effect with NI 31-103 (after the period covered by the Annual Report).
62. The last correspondence from Carter to OSC staff on the 2009 review was dated mid November 2009. In early January 2010, staff notified Carter that it intended to do another review. Mr. Gilkes testified that the short period of time between the 2009 review and the 2010 review was “not common” in his experience.
63. The 2010 review took approximately 4 weeks. No deficiency report was issued by staff. Instead, staff recommended that Carter be suspended. Mr. Gilkes testified that this too was unusual – that there was always a field review report issued after an audit.
64. Mr. Gilkes testified that the issue here was integrity, not proficiency or financial solvency (since neither requirement comes into effect for EMDs until September 2010). He testified that the only issue raised by staff that is relevant to Carter is the disclosure to investors of the intercompany loans. He also testified that if there are solvency issues here, they are the issuer’s (NAFG), not Carter’s because the only revenues or expenses that Carter has are OSC registration fees.
65. On the issue of the NAFG loan to Prestige Motors, Mr. Gilkes testified that NAFG has now hired a lawyer to put documentation in place regarding the loan. They are also “having a general security agreement put against that loan so that any [NAFG] investors, should there be a problem with Prestige [Motors], will then be able to claim against the inventory based against that loan”. As an aside, I was informed on the second day of the OTBH that the general security agreement in favour of NAFG had been filed in respect of Prestige Motors’ inventory equipment accounts and other categories.
66. Mr. Gilkes also took me through a number of issues related to the suspension letter. He testified that the reference in the suspension letter to inappropriate use of investor proceeds by Carter was incorrect because Carter is only a conduit for the issuer (NAFG/NAC) and the investors (Carter’s clients), and that all investor cheques are payable to the issuer. He testified that NAFG “is the company that receives the money, it is the company that handles the money, it is the company that has the main operating business”. However, he also testified that all the Arconti companies (Prestige Motors, NAFG, NAC and Carter) are “all one organization. It is leasing cars. It is getting cars, leasing cars, and financing the leasing of those cars”.
67. Mr. Gilkes also testified regarding his views on the appropriateness of the suspension remedy for Carter’s conduct. In his view, terms and conditions were a more appropriate remedy, although he could not identify appropriate terms and conditions for these circumstances since his view was that staff’s concerns were more focused on NAFG than on Carter.
68. He also testified regarding his views on NAFG’s marketing materials, which are now in the process of being substantially revised (with his assistance). He testified that many of the problematic statements identified by staff above have been removed or amended. As well, the “original” marketing materials were removed in late July from NAFG’s website (more than a month after staff sent the suspension recommendation letter to Carter).
69. On cross examination, Mr. Gilkes confirmed that Carter’s suitability obligations as a registrant include both know your client and know your product. He also testified that the NAFG marketing materials were provided to Carter clients by Carter, NAFG or Prestige Motors. Mr. Gilkes stated that his view was that Carter clients were not being solicited to purchase NAFG securities via these marketing materials, but that the provision of the marketing materials to Carter clients could be considered to be an act in furtherance of a trade.
70. Also on cross examination, Mr. Gilkes was asked whether, in his view, the NAFG marketing materials constituted an offering memorandum (as that term is defined in the Act). Mr. Gilkes’ response was no. However, he later clarified that there are “no documents called offering documents, but there are documents that you must sign to invest [in NAFG and NAC]”.
Decision on the suspension of Carter
71. Although much was made of the fact that staff’s allegations and concerns focused on NAFG (as issuer) and not Carter (as registrant), my view is that the allegations and concerns relating to NAFG also equally relate to Carter. My view is based on the following factors:
- Carter and NAFG are both owned by the same two individuals – both of whom are registrants under the Act, and
- The significant intercompany relationships and business dealings between Carter, NAFG, NAC, and Prestige Motors. In my view, the businesses of these entities are inextricably linked.
72. As well, I was concerned about the following selected staff allegations, which in my view were proven during the OTBH:
- All of Carter’s clients receive NAFG marketing materials – from either NAFG, Carter or Prestige Motors - before investing in securities of NAFG
- Many of the statements made in the NAFG marketing materials were misleading, unsupported or not accurate
- The significant intercompany loan from NAFG to Prestige Motors, which was not disclosed to Carter clients investing in NAFG, and
- NAFG’s severe financial issues including the substantial percentage of over 90 day accounts receivables, all of which related to receivables on subprime loans. NAFG’s severe financial difficulties also were not disclosed to Carter clients investing in NAFG.
73. I find that Carter did not meet its registration obligations under section 13.3 of NI 31-103. Carter did not take reasonable steps to ensure that the purchase or sale of NAFG securities was suitable for its clients. As a result, I concluded that Carter did not meet its suitability obligations to its clients.
74. I concur with staff’s assertions that NAFG’s marketing materials violate subsection 44(2) of the Act. I also concur with staff’s assertions that both the non-disclosure by Carter to its clients of the Prestige Motors loan and the non-disclosure of the severe financial difficulties being faced by NAFG violate section 2.1 of OSC Rule 31-505 which requires registrants to deal with clients fairly, honestly and in good faith.
75. Carter did not provide me with an explanation of where, in staff’s words, “the money was coming from”. The only reasonable conclusion I was able to come to is that NAFG maintains its ongoing business operations through the infusion of new client monies from Carter clients. I was unable to determine how, absent new monies coming into NAFG from Carter clients, NAFG was able to continue to finance ongoing distributions to its promissory note holders. Certainly NAFG’s financial statements did not show sufficient income to be able to finance these payments.
76. Carter’s counsel also argued that the normal process was not followed by staff in recommending that Carter’s registration be suspended. I disagree. Following the completion of a compliance field review, staff has a number of “tools” available to it from including issuing a deficiency report (for identified issues that staff believes can be relatively easily remedied) up to and including the relatively new Director suspension power. In the majority of cases, a deficiency report is issued. However, faced with possible registrant misconduct, staff’s approach is to assess the possible misconduct and determine the appropriate tool to deal with the misconduct. In some cases, staff determines that terms and conditions on registration are the appropriate remedy. Other possible staff remedies are to refer the issue(s) to the OSC’s Enforcement Branch for further investigation and possible litigation, or to do as staff did in these circumstances and recommend suspension of registration.
77. Carter’s counsel referred me to Seal, Re (1996), 19 O.S.C.B. 1529. In Seal, the OSC sought to remove the registrant from the capital markets for misrepresenting certain facts to the OSC. She argued that “what is being sought by staff are extreme steps that could have been resolved with terms and conditions”. She further argued that, even in Seal where the registrant was criminally charged with fraud, the OSC did not impose terms and conditions (or recommend suspension). She argued that Seal is similar to the case before me in that this proceeding relates to the first allegations of impropriety against Carter or its principals. Since the OSC only reprimanded Seal, Carter’s counsel argued that a similar sanction (or perhaps terms and conditions) were appropriate in this case.
78. The Director decision in Jaynes, Re (2000), 23 O.S.C.B. 1543 states in part that “[w]hile terms and conditions restricting registration may be appropriate in a wide variety of circumstances, they should not be used to shore up a fundamentally objectionable registration”. In my view, the use of terms and conditions in this case would be shoring up a fundamentally objectionable registration.
79. I was asked to consider whether Carter’s recent steps to address the specific problems identified over the course of the OTBH (including the retention of Mr. Gilkes, the general security agreement in favour of NAFG, and the removal of the marketing materials from Carter’s website) were sufficient. I agreed with staff’s submissions that these “short term fixes” do not address the causes of staff’s underlying concerns – which are related to the failure of Gino and Flavio Arconti (as the individual registrants of Carter) to demonstrate the requisite integrity of securities professionals.
80. I was also asked to consider whether a higher level of evidence was required in this case since the impact of a decision to suspend Carter will seriously impact the livelihoods of Gino and Flavio Arconti. Carter’s counsel referred me to cases which generally related to conduct of an individual and where the impact of the decision could materially affect the ability of the individual to earn a livelihood. For example, in Law Society of Upper Canada v. Neinstein (2007), 85 O.R. (3d) 446 (Div. Ct.) (appealed to C.A. only in respect a finding of the hearing panel that was found to be inadequate, 2010 ONCA 193) the Court held that the “Bernstein test” (Re Bernstein and College of Physicians and Surgeons of Ontario (1977), 15 O.R. (2d) 447 (Div. Ct.)) applied. As set out in paragraph 54 of the Divisional Court decision:
“The standard of proof… was the civil standard of balance of probabilities. However, given the seriousness of the allegations of professional misconduct and the possible consequences for the respondent, the allegations had to be proven by clear, convincing and cogent evidence.” [emphasis added]
Carter’s counsel argued that this type of evidence did not exist in this case.
81. Staff counsel argued that the test in OTBH procedures is very clear in section 28 of the Act. Section 28 provides that the Director may suspend the registration of a company at any time during the period of its registration if it appears to the Director that (i) the company is not suitable for registration or has failed to comply with Ontario securities law or (ii) the registration is otherwise objectionable [emphasis added]. This is a different test than the standard of proof in civil cases.
82. Staff counsel referred me to a number of recent OTBH decisions which clearly set out the requirements in section 28 of the Act for OTBH procedures. Although none of the cases referred to by staff specifically addressed the issue of clear, cogent and convincing evidence, my view is that the Director in an OTBH has an obligation in coming to his or her decision to ensure that the evidence provided in the OTBH clearly supports the Director’s decision. In OTBHs, the Director may admit any evidence into the proceeding and I, as Director, control the evidence and documents that form part of the record and evidence at the OTBH.
83. Carter’s counsel also referred me to the 2010 Mutual Fund Dealers Association (MFDA) settlement agreement with Excel Financial Growth Inc., a mutual fund dealer and EMD. In Excel, MFDA staff performed two compliance examinations of Excel and identified what appeared to be serious issues related to failure to conduct suitability reviews and trade supervision, lack of evidence of trade supervision, suitability of exempt securities, etc. Carter’s counsel argued that, even after identifying these serious issues, the MFDA did not suspend Excel. Instead it chose to enter into a settlement agreement with Excel. Counsel argued that, if the same analysis were followed in this case, staff could have used the less extreme step of resolving its outstanding issues with Carter through the use of terms and conditions or other available tools. Staff argued that since the MFDA does not register its members under the Act, it does not have the ability to suspend registration and thus Excel is distinguishable from the present case. I agree.
84. Carter’s counsel also referred me to the May 12, 2010 Statement of Allegations against Nelson Financial Group Ltd. et al. In Nelson, staff alleges an illegal distribution of securities, misleading staff, misleading the OSC, and conduct abusive to the integrity of the capital markets. Carter’s counsel argued that, because the Nelson matter will proceed before an OSC Commissioners panel, there will be a higher level of evidence required, yet the consequence to the registrant is the same (i.e. the registrant may be suspended). She also argued that the allegations in this case are much less severe.
85. Staff counsel argued that Nelson is easily distinguishable from this one in that the enforcement proceeding involves the registrant, the issuer, and employees and former employees of the registrant. As well, other sanctions (including permanent cease trade orders, etc.) are being sought besides suspension. There is also a voluntary cease trade order in effect and there are CCAA proceedings underway. I agree with staff’s submissions on this case.
86. During the OTBH, staff referred to a power point slide which, although presented by staff at the OTBH, was not entered as an exhibit in the proceeding, nor was I provided with a hard copy of the slide. Carter’s counsel argued that the power point slide should not have been admitted as evidence in the OTBH. My decision in this matter was not based on any information contained in the power point slide which was not otherwise proven during the OTBH.
87. In conclusion, in my view the evidence in this case supports my decision that Carter’s registration should be suspended. I concur with staff’s assessment that Carter has engaged in a pattern of conduct – through its individual registrants – that demonstrates that it lacks the integrity required of registered firms under the Act. Many of the issues identified by staff are violations of securities legislation. If Carter possessed the requisite integrity for a registrant, it would not have engaged in the pattern of misconduct identified above. My decision is that Carter is not suitable for registration, that Carter has failed to comply with Ontario securities law, and that Carter’s ongoing registration is objectionable.
September 22, 2010
“Marrianne Bridge, FCA”
Deputy Director, Compliance
Ontario Securities Commission