Chapter 15 - Regulatory Investigations.pdf

SECTION 5 REGULATORY INVESTIGATIONS AND REPORTING 15 Regulatory Investigations 16 Reporting Requirements © CANADIAN SECURITIES INSTITUTE  Regulatory Investigations...

SECTION 5 REGULATORY INVESTIGATIONS AND REPORTING 15 Regulatory Investigations 16 Reporting Requirements © CANADIAN SECURITIES INSTITUTE  Regulatory Investigations 15 CONTENT AREAS Internal Investigations External Investigations Handling External Investigations LEARNING OBJECTIVES 1 | Explain the requirements for conducting internal investigations. 2 | Discuss the various types of regulatory investigations and penalties. 3 | Explain how to handle external investigations. © CANADIAN SECURITIES INSTITUTE  CHAPTER 15      REGULATORY INVESTIGATIONS 15 3 INTRODUCTION In the previous section, we learned about the various areas at an investment dealer for which a chief compliance officer is responsible. In that context, we discussed the CCO’s day-to-day activities and specific duties related to account opening, recordkeeping, complaint management, registration, trade desk supervision and investment banking. In this chapter, we explore the CCO’s obligations to the board of directors and to entities outside the dealer member in regard to breaches of policy and procedure or the law. We begin this chapter with a discussion of investigations. Many situations occur in which CCOs must deal with client complaints, undertake reviews, respond to examinations and investigations, and conduct internal investigations. They may also be responsible for, or involved in, conducting or supervising internal investigations and reporting and keeping records of the investigation. Finally, they must make sure that appropriate action is taken and follow-up work is done, including employee disciplinary action, revision of policies and procedures, and staff training. Failure to comply with obligations under regulatory rules, securities, and other legislation, including civil and criminal law, results in time-consuming and costly consequences to a dealer member and its Registered Representatives. In addition, investors have a number of remedies available to resolve disputes or complaints alleging potential breaches of regulations and legislation. In this chapter, we discuss the types of situations that might require an internal investigation and explain the guidelines for conducting such an investigation. We also explain the various types of regulatory investigations, including the processes involved and the potential penalties imposed. Finally, we explain how a dealer member should handle an external investigation. INTERNAL INVESTIGATIONS 1 | Explain the requirements for conducting internal investigations. A dealer member conducts an internal investigation, review, or audit in response to a breach of its own policies and procedures, or the rules of a self-regulatory organization or other legislation. The requirement to conduct an investigation is in addition to any reporting requirements imposed by regulators. Consequences for breaches of firm policy should be set out and communicated to individual registrants, directors, officers, and employees. Penalties may include a reprimand, retraining, suspension of registration or employment, an internal fine, or termination of employment for cause. If certain triggers are met, the dealer member must carry out an internal investigation. The firm must also take steps to ensure that a full review is conducted, including all aspects necessary to resolve the matter, including discipline. The firm should consider applicable sanction guidelines when evaluating whether to impose internal discipline. Internal discipline should be applied when serious breaches of the dealer member’s policies and procedures have occurred. Sanctions may be imposed on the firm if it fails to conduct a proper investigation. Sanctions may apply for the following shortcomings: Failure to adequately conduct an internal investigation, review, or audit where required by legislation or by the dealer member’s policies and procedures. Failure to follow up with appropriate internal disciplinary action. Failure to keep adequate records regarding an investigation. © CANADIAN SECURITIES INSTITUTE 15 4 CHIEF COMPLIANCE OFFICERS QUALIFYING EXAMINATION      SECTION 5 CIRO expects that registrants and employees who are problematic or who have been under any form of enhanced supervision, either internal or external, are subject to continued heightened supervision. This measure is taken to ensure that the behaviour of such employees is properly monitored and subsequently reported to the SRO by the dealer member. Regulatory discipline and civil liability may result for a dealer member and its employees if such employees (particularly registrants) are not properly supervised. A dealer member must have adequate procedures to encourage and protect people within the firm who report suspected misconduct by the firm or by an employee. Such whistleblower protection must be addressed in the firm’s policy manual. Canada’s Criminal Code protects employees who inform or assist law enforcement in investigating cases of capital markets fraud by making employer-related intimidation an offence. Some dealer members provide dedicated communication channels to be used for such purposes, such as a dedicated telephone number answered by a compliance specialist. CIRO REQUIREMENTS FOR INTERNAL INVESTIGATIONS The requirements for internal investigations are set out in IDPC Rule 3700, Part B, Internal Investigations and Internal Discipline. A dealer member must conduct an internal investigation if the firm itself, a current registrant, or any former registrant while employed by the firm, appears to have violated legislation or CIRO rules in Canada or elsewhere. The CCO should have a policy in place that differentiates between matters that require an internal investigation and a formal filing with ComSet and regular queries with no such requirement. With such a policy in place (along with appropriate documentation), the dealer member can demonstrate to CIRO that it acted decisively and not negligently in a particular event. Activities that should prompt an investigation include the following violations: Theft Fraud Misappropriation of funds or securities Forgery Money laundering or terrorist financing Market manipulation Insider trading Misrepresentation Unauthorized or discretionary trading A dealer member must keep records of internal investigations that are detailed enough to show the cause, steps taken, and results of each investigation. It must maintain the records for a minimum of two years from the date of completion of the internal investigation. The records must be provided to CIRO upon request. A dealer member should conduct and maintain adequate records of all serious regulatory breaches, even if investigations are not mandated by regulation. Any apparent disregard of evidence of a serious violation may be considered a lack of supervision. UNIVERSAL MARKET INTEGRITY RULES REQUIREMENTS FOR INTERNAL INVESTIGATIONS UMIR Rule 10.16 requires that any Participants or Access Persons who note conduct that might involve a breach of SRO rules must immediately report the matter to their supervisor or compliance staff. A review in accordance with the dealer member’s trade desk policies and procedures must then be conducted. © CANADIAN SECURITIES INSTITUTE  CHAPTER 15      REGULATORY INVESTIGATIONS 15 5 If it appears that a potential violation has occurred, the person conducting the review must: Make a written record of the report and the review conducted. Diligently investigate the activity. Make a written record of the findings of the investigation. Report the findings of the investigation to CIRO no later than the 15th day of the month following the month in which the findings are made. A dealer member must retain records of all reports, reviews, and findings for at least seven years from the creation of the record. The firm must allow CIRO to inspect and make copies of the records at any time during normal business hours. If CIRO notes unusual trading activity involving a dealer member, it may request that the firm undertake an internal review of the conduct and report its findings to CIRO. An internal investigation may be necessary to respond fully to such a request. INTERNAL INVESTIGATION GUIDELINES In the daily conduct of compliance, the following issues are subject to enquiry during the normal course of business: Issues relating to the daily trading and monthly statement reviews Issues arising from correspondence and the media Issues identified by executive management Issues around the creation of new products and client complaints These issues are typically addressed by compliance staff members who gather information and report to management for action, as appropriate. In the event of serious allegations of wrongdoing, or when required by CIRO or UMIR, a more formal investigation is required. An internal investigation should be conducted whenever serious allegations of wrongdoing are made involving the following matters: Violations of policies and procedures Violations of industry rules and regulations Any matter that requires the dealer member’s intervention to protect its clients, assets, integrity, or reputation Internal investigations should be carried out discreetly and with sensitivity. In all instances, a process should be designed to ensure that the legal department is involved at a very early stage. At any stage of an investigation, it may be appropriate to alert regulatory authorities. The dealer member should preferably err on the side of caution by alerting regulators early in the investigation. Dealer members can usually conduct routine investigations internally, although a CCO should be prepared to use outside expertise if internal expertise is not available or if the matter is complicated. For example, an accounting fraud or misallocation of funds involving many clients over a long period might require outside expertise. Occasionally, consultants can also assist in internal investigations. PRESERVING SOLICITOR–CLIENT PRIVILEGE In preserving solicitor–client privilege in an internal investigation, it is most important to establish a sufficient connection between the investigation and the provision of legal advice. Privilege is preserved only if counsel conducts the investigation with the intention to provide legal advice to management. Counsel can direct that © CANADIAN SECURITIES INSTITUTE 15 6 CHIEF COMPLIANCE OFFICERS QUALIFYING EXAMINATION      SECTION 5 non-lawyers assist in the investigation, but it must be clear that their reports or memoranda are being produced to assist counsel in providing legal advice. These documents should be marked “Privileged and Confidential”. They should also include a clearly worded statement affirming that the documents were prepared by a lawyer, whose name is given, specifically to provide legal advice. The more widely circulated such reports are, the less likely that a court will find them to be privileged. Because solicitor–client privilege in an internal investigation is a complex matter, the CCO should seek legal advice to ensure that privilege is preserved. SELECTING THE INVESTIGATOR The person selected to conduct the investigation should have the following qualities: Knowledge of the issues relevant to the investigation Knowledge of the dealer member’s policies and procedures of and of industry regulations Credibility with interviewees and management Good interviewing skills Ability to produce accurate reports and draw appropriate conclusions Effectiveness as a potential witness in litigation or regulatory proceedings Most routine investigations can be conducted by trained compliance staff supervised by compliance management. In a large dealer member, where investigations tend to be more frequent, it may be helpful to provide training and establish guidelines regarding the conduct of investigations. The more serious the investigation, the more important it is to select an appropriate investigation team. Everyone involved in an investigation should understand their responsibilities and know who is in charge. EXAMPLE An advisor has suddenly resigned and departed from the dealer member where she was employed. Within days, the firm receives several written client complaints about large losses in their accounts, unauthorized discretionary trading, and off-book transactions. The CCO suspects that the problems associated with this advisor will be significant. The CCO contacts CIRO to advise them that a potential regulatory problem has been identified that is being reviewed on an expedited basis. He then assembles a team that includes the compliance manager, in-house counsel, and senior compliance officers. The compliance manager is identified as the most appropriate and qualified person to lead the investigation. Each team member is assigned specific tasks, such as assembling account documentation, client communications, meeting with clients, and interviewing employees. The dealer member’s outside auditors are engaged to help calculate client losses resulting from the impugned transactions and to conduct any additional forensic accounting that may be needed. With the help of the dealer member’s media advisor, the team develops a communication strategy to respond to enquiries from the media. The team then communicates the strategy to executive management. The CCO imposes timelines for the completion of various steps of the investigation, with the understanding that amendments may be necessary. With the advice of counsel, he takes steps to protect the legal privilege of the periodic reports prepared during the course of the investigation. © CANADIAN SECURITIES INSTITUTE  CHAPTER 15      REGULATORY INVESTIGATIONS 15 7 IDENTIFYING AND SECURING DOCUMENTATION It is crucial to the success of an investigation and to any subsequent litigation that documentation is identified and secured quickly. The compliance department should obtain original documents, which should not be marked in any way. It may be necessary to seek legal advice if issues of privacy and personal property arise. Depending on the subject of the investigation, documentation should include the following materials: All documentation and communications with the client or clients associated with the investigation, including account statements and trade confirmations The workspace and computer of the relevant employee Hard copy correspondence mail, as well as printed and secured email between the client and the advisor Internal communications, including emails and other correspondence, between the compliance department, management, and an advisor or a client that could affect subsequent litigation Any research material referred to or relied on with respect to investments in the client account In addition, formal instruction should be sent to all employees to caution against certain types of email communications, and to limit their communication with the legal department. CONDUCTING THE INVESTIGATION Interviews are conducted according to the six-step process outlined below. 1. Identify the subject of the interview. The investigation team identifies the employees who must be interviewed. Interviewees should include those people allegedly involved in the misconduct, those directly connected to the matter being investigated, witnesses, and any complainants. The list of interviewees may expand as the investigation progresses. Support employees are sometimes overlooked. However, these employees can often provide important details about the production and distribution of documents, or correspondence and prior meetings or discussions among key players. 2. Choose the setting. Employees are sometimes reluctant to answer questions about other employees, supervisors, and managers because of personal relationships and loyalties. Such dynamics should be taken into consideration, and the interview should be set up to make the interviewee comfortable. It should be private; for example, an office with a glass partition into an open area is inappropriate. Usually, no more than two investigating staff members should be present during the interview, and those present should not be involved in the matter being investigated. Similarly, no manager or supervisor of the interviewee should be present. Employees who are still reluctant to answer questions after these precautions are taken should be reminded of their responsibilities to the dealer member and its clients. 3. Conduct the interview. The investigation team should prepare a list of appropriate questions before the interview begins, while also allowing for unscripted questions to arise. The list helps ensure that all issues in the investigation have been considered and reduces the need for follow-up interviews. Any documents referred to during the interview should be made available. The person being interviewed should be advised of the purpose of the interview and of its serious nature. It should be presented as an opportunity to disclose their version of the matter and provide information to help the investigation. If the employee asks about job termination, the employee should be told that any such decision will be made after the investigation is complete. © CANADIAN SECURITIES INSTITUTE 15 8 CHIEF COMPLIANCE OFFICERS QUALIFYING EXAMINATION      SECTION 5 The interviewer should keep accurate and detailed notes of the interview. If the matter is very serious, the interview should be recorded; however, the interviewee may be less spontaneous if the interview is being recorded. Only one interviewee should be present during the interview, and enough time should be allotted for breaks and unforeseen circumstances. The interviewer should be accompanied by another member of the investigation team to reduce the possibility of misunderstandings and to help handle potential antagonism from the interviewee. Interviews of management team members should include a review of supervision or compliance issues regarding the apparent misconduct. Any compliance gaps will necessarily be a part of a complete investigation. Investigations can sometimes reveal problems with current exception reports or procedures that were either exploited or that prevented the detection of misconduct. In other cases, the review can reveal that, although policies and procedures were in place, they were not followed. Employees must cooperate with internal investigations and answer all questions relating to misconduct. It may be necessary to advise an employee that failure to answer questions fully and truthfully may result in disciplinary action or termination. Coercion, however, is not acceptable. The dealer member should allow the employee to have a representative present during the interview, if requested. 4. Present conclusions. After documents are compiled and interviews completed, the investigation team produces a report. The report includes a summary of the facts, the results of the review of materials and interviews, an analysis, and recommendations. The company policies and procedures or industry regulations being investigated should be referenced in the report. If similar situations have been investigated and resolved, these cases can be referenced, if appropriate. The recommendations can include employee disciplinary action, changes to policies or procedures, and steps to resolve any outstanding client complaints. 5. Disclose the findings to the employee. If it is determined that employee wrongdoing has occurred, the lead investigator and the employee’s supervisor, or someone with the authority to terminate the employee, should meet with the employee to present the findings of the investigation. The employee should have an opportunity to respond and may ask for time to do so. In most cases, this will not be necessary, because there will be little room for debating the conclusions of the investigation. If the likely outcome of this meeting is termination, counsel and human resources representatives should be consulted beforehand. If the employee introduces new information that might affect the conclusions of the investigation, it is reasonable to adjourn the meeting until this information can be considered. EXAMPLE An investigation team determines that an RR has engaged in unauthorized discretionary trading in more than one client account. At the meeting, where it is expected that the RR will be fired, she denies the allegations. She claims that her clients acted together to discredit her because of speculative trading losses in their accounts. Her evidence consists of notes maintained on her home computer regarding telephone calls she had with the clients. Her notes reveal that she discussed the losses with her clients and that they threatened retaliation. The RR claims she did not disclose this evidence during the investigation because she was embarrassed. The team decides to adjourn the meeting until the new information can be analyzed. 6. Impose discipline. Employee disciplinary measures resulting from an investigation should be documented and presented to the employee. The employee must acknowledge receipt of the memorandum. Copies of the document should be maintained by the compliance and human resources departments and the employee’s manager. © CANADIAN SECURITIES INSTITUTE  CHAPTER 15      REGULATORY INVESTIGATIONS 15 9 The actions taken, as a result of the production of the report, should also be recorded. For example, if it is determined that policies and procedures should be amended, this should be recorded and appended to the report. It may also be appropriate to make or revise a disclosure on the National Registration Database as an outcome of the investigation. At the conclusion of the investigation, appropriate filings should also be made on ComSet as required. EXTERNAL INVESTIGATIONS 2 | Discuss the various types of regulatory investigations and penalties. In addition to the requirement to conduct an internal investigation, violations by dealer members or registrants may result in external investigations by one or more regulators. The investigation and hearing processes followed by the different regulatory authorities in such cases are described below. INVESTIGATIONS BY THE SECURITIES REGULATORY AUTHORITIES The authority of the various securities regulatory organizations in Canada (such as the Ontario Securities Commission and the Autorité des marchés financiers in Quebec) is determined by statute. The securities administrators have the following powers, similar to those of a judicial court: The power to compel witnesses to attend interviews and hearings The power to take evidence under oath The power to seize documents for examination The power to freeze funds and other property The securities administrators also have the authority to gather documents and testimony, to determine whether breaches of securities legislation have occurred, and to assess whether regulatory or other proceedings are warranted. They can also lay charges under the Securities Act in a provincial court. However, they may not need to use these powers to conduct an investigation if they are able to obtain evidence voluntarily. THE INVESTIGATION PROCESS Securities administrators can initiate an investigation based on a public complaint, an issue arising from an audit, a referral from another agency, or an internal review. In terms of sanctions, administrators can seek to perform any of the following actions on an interim basis: Cancelling, suspending, or restricting the registration of any registrant Issuing a Notice of Hearing to order compliance and to assess potential sanctions against any person, including a dealer member, its registrants, or any director, officer, employee, or agent who authorized, permitted, or acquiesced in the conduct Appointing a receiver, a receiver–manager, or a trustee Freezing property Ordering a special audit or the appointment of an expert Halting trading of an issuer Demanding records and information from a third party Issuing an Order to Enter Premises of a registrant © CANADIAN SECURITIES INSTITUTE 15 10 CHIEF COMPLIANCE OFFICERS QUALIFYING EXAMINATION      SECTION 5 Obtaining an Order to Enter Premises from a superior court to enter the business premises of anyone in the province Applying to the superior court of the province to compel compliance with a commission’s order or for committal for contempt If administrators believe that ongoing conduct might be harmful to the public interest, they can issue a temporary order. This order takes effect immediately and remains in effect until the initial hearing is held, usually within 15 days. HEARING PROCESS The securities regulatory authorities’ hearing process is formal and has some of the hallmarks of a civil trial. The process has the following aspects: The administrator must fully disclose all relevant evidence to the respondent, including all materials that will be used at the hearing and especially all materials that may assist the respondent, even if the administrator does not propose to introduce the evidence. The respondent can have counsel, call and cross-examine witnesses, introduce evidence and expert testimony, and make legal arguments. The hearing panel has the powers of a civil court to compel witnesses and documents, to control its own process, and to issue interim orders. The administrator must prove the allegations to a civil standard of a balance of probabilities, although the standard of proof becomes higher depending on the seriousness of the charges and potential consequences to the respondent. The administrator’s decision may be appealed to a court of appeal with prior leave of the court. SANCTIONS A securities administrator has the authority to impose the following orders, restrictions, and sanctions: An order that a person cease contravening the Securities Act, an existing regulatory decision or order, or the rules of the SRO An order to cease all trading in a particular issuer A restriction stating that the exemptions under the Securities Act do not apply to a specified person An order that a person resign any position he or she holds as a director or officer of any issuer A sanction prohibiting a person from serving as a director or officer of any issuer A sanction prohibiting a person from engaging in investor relations activities An order that a registrant be reprimanded or that the person’s registration be suspended, cancelled, or restricted, or that conditions be imposed on the registration An order that a payment of an administrative penalty be made after a hearing An order that monies be obtained as a result of noncompliance if a person or company fails to comply with the Securities Act after a hearing An order that the costs of the hearing be paid An order that an existing regulatory order be varied or discharged © CANADIAN SECURITIES INSTITUTE  CHAPTER 15      REGULATORY INVESTIGATIONS 15 11 The maximum penalties for breaching Securities Act requirements that have been designated as offences vary among the provinces. In Ontario, the penalty is a fine of up to $5,000,000 or imprisonment for five years less a day, or both. Special penalties apply to offences such as insider trading, fraud, and market manipulation. Administrators may also pursue prosecution of Securities Act offences in criminal court, if the conduct constitutes an offence under the Criminal Code. It should be noted that imprisonment can result only from a conviction in provincial court, not from proceedings before a securities regulatory authority. An administrator’s ability to levy penalties directly also varies among the provinces. INVESTIGATIONS BY OTHER LEGAL AND REGULATORY AUTHORITIES The authority of CIRO to investigate its dealer members is found in the contract between CIRO and dealer members. CIRO rules allow it to investigate the conduct, business, or affairs of a dealer member and its employees when there have been potential breaches of CIRO rules or securities legislation. CIRO can also investigate the general conduct of a dealer member or registrant. Non-members cannot be subject to a CIRO investigation. An investigation can be initiated as a result of a complaint made by a client or the public or at the request of an administrator. It can also be initiated as a result of a violation uncovered during a CIRO business conduct or financial compliance review, or as a result of information received from a member on a Notice of Termination. The following transgressions are the most common violations of CIRO rules: Unsuitable recommendations Unauthorized trading Misrepresentation Conduct unbecoming a registrant Failure to comply with financial requirements, such as early warning violations or inadequate risk-adjusted capital It is a condition of membership that members and their employees agree to fully cooperate with a CIRO investigation. Failure to cooperate can result in the termination of membership for a dealer member or a registrant. During an investigation, CIRO can impose any of the following requirements on a dealer member or employee: Submitting a report in writing relating to any matter involved in an investigation Producing copies of any books, records and documents in its possession or control that might relate to an investigation Attending and giving evidence recorded under oath The dealer member and its employees are forbidden to withhold, destroy, or conceal information or documents reasonably required for an investigation. A CIRO panel does not have authority to make a finding that conduct is in contravention of securities laws. However, such conduct may lead to a finding of conduct unbecoming a registrant. Such general CIRO provisions are useful when behaviour is improper but not specified as a violation. For example, the failure of an RR to comply with provincial private placement requirements might result in such a finding. THE INVESTIGATION PROCESS CIRO begins an investigation by advising the dealer member or employee, in writing, about the matters being investigated. In the case of an employee, a copy is sent to the dealer member. The firm or the employee must respond with a written statement, produce documents relating to the investigation, and give a verbal statement, which may be recorded under oath. If an initial review suggests the need for a further investigation, the matter © CANADIAN SECURITIES INSTITUTE 15 12 CHIEF COMPLIANCE OFFICERS QUALIFYING EXAMINATION      SECTION 5 is referred to the investigation department. If there is evidence of a regulatory breach, it is referred to CIRO Enforcement Counsel for disciplinary action. This initial phase is sometimes referred to as case assessment. Following the completion of the work at the case assessment level, the matter may be referred to enforcement for further review and investigation. In the next stage of the investigation, all relevant parties are interviewed. Typically, these parties include the client- complainant, the registrant and other dealer member personnel such as sales assistants, compliance employees, or supervisory staff. These interviews are recorded and transcribed. The investigator also gathers documentary evidence. When the investigation is complete and all evidence assessed, a report is submitted with recommendations to the director of enforcement. Witnesses are entitled to have a lawyer present at their interview. Because a conflict of interest may arise if in-house counsel attends an interview with an employee, the investigator may bar or expel a representative whose presence could impede the interview. The investigator may also ask counsel to state whether he or she is representing the dealer member or the employee. Many dealer members advise that the employee, usually an RR, retain their own counsel. Often this will be at the firm’s expense, unless or until the interests of the employee and the firm diverge. A compliance officer may also attend an interview; however, this is only advisable if the compliance officer has significant experience in this area. If a compliance officer does attend, it is important that he or she does not impede the interview or attempt to answer questions for the interviewee. When an investigation reveals a minor or isolated contravention, the matter may be resolved by way of a warning letter to the dealer member, or to the employee with a copy sent to the dealer member. Warning letters are expressions of staff opinion only, not a formal finding. Therefore, they do not have to be disclosed on the NRD. A warning letter cannot be appealed, although CIRO will usually consider further evidence, if appropriate. Such a request should be made only in extreme circumstances. CIRO keeps warning letters on file and may consider them in any future investigation of the registrant. If disciplinary proceedings are necessary, the matter may be resolved by way of a settlement agreement. If the enforcement department confirms that a Notice of Hearing will be issued, an opportunity is usually given prior to this time for both CIRO and the registrant to engage in potential settlement discussions. Alternatively, and failing a settlement, the matter may proceed to a formal hearing. In a hearing, a panel decides whether the charges have been proven and, if so, what penalty is appropriate. In a settlement agreement, CIRO and the respondent agree on the allegations and a suitable penalty. The panel must review and approve the agreement before it is considered binding. SETTLEMENT AGREEMENT It is CIRO policy to attempt to reach a negotiated settlement of the allegations and penalties with the respondent before starting disciplinary proceedings. The settlement agreement is usually prepared by the enforcement counsel and sets out the required information specified in CIRO rules, including an admission of liability by the respondent. The hearing panel may accept or reject the agreement after it is signed, or it may amend the agreement by imposing terms that are less or more onerous. The hearing to consider and review a proposed settlement agreement is not public because, if the agreement is not accepted, the matter will proceed to a full disciplinary hearing. It would be prejudicial to have the matters contained in the agreement known to the hearing panel. A settlement agreement is final upon acceptance and contains a waiver of any right to appeal or review. Once accepted, it is a public document. CIRO publishes a notice summarizing the facts, the violations and the penalties agreed upon by the parties. © CANADIAN SECURITIES INSTITUTE  CHAPTER 15      REGULATORY INVESTIGATIONS 15 13 HEARING PROCESS Contested hearings are initiated by the issuance of a Notice of Hearing and statement of allegations by CIRO. Hearings are open to the public unless the hearing panel decides otherwise. The hearing panel is not bound to follow strict rules of evidence. It has discretion to admit any evidence it finds relevant and reliable. Respondents are entitled to have counsel, and the enforcement counsel acts on behalf of CIRO. The hearing runs much like a trial, with opening statements, the examination of witnesses, and final arguments. The onus is on CIRO to prove its case on the civil standard of the balance of probabilities. The hearing panel gives its final decision in writing, including its reasons for the ruling. Usually, CIRO can impose penalties and remedies only after a hearing has been held. However, if it is necessary for the protection of the public interest, CIRO can restrict, suspend, or revoke a respondent’s access to the marketplace without a hearing by issuing a temporary order before the hearing starts. Notice of the temporary order must be given to each person affected by it. The order expires after 15 days, except in the following circumstances: A hearing is commenced within that time to confirm or set aside the order. The respondent consents to an extension of the order until a hearing is held. Another securities regulatory authority directs that the order be rescinded or extended. SANCTIONS Various sanctions, as outlined in Table 15.1, may be imposed on Approved Persons and on dealer members for noncompliance. Table 15.1 | Impose Sanctions Approved Person A fine not exceeding $5 million per offence, or an amount equal to three times the pecuniary benefit that accrued as a result of committing the violation, whichever is greater Suspension of approval Revocation of approval Prohibition of approval of the person in any capacity Such conditions of approval or continued approval as may be considered appropriate Dealer member A fine not exceeding $5 million per offence or an amount equal to three times the pecuniary benefit that accrued as a result of committing the violation, whichever is greater Suspension of rights and privileges (including a requirement that the dealer member cease dealing with the public) Termination of any or all of the rights, privileges, and membership Expulsion from CIRO Such conditions of approval or continued approval as may be considered appropriate © CANADIAN SECURITIES INSTITUTE 15 14 CHIEF COMPLIANCE OFFICERS QUALIFYING EXAMINATION      SECTION 5 OTHER REMEDIES CIRO may also impose the following remedies: The respondent may be required to retain a qualified independent consultant to develop or implement procedures for improved compliance. The respondent may be ordered to disclose certain information including disciplinary history or sanctions to new and existing clients and to the public. The respondent may be required to implement heightened supervision of one or more persons or departments. The respondent may be required to write an exam to requalify. The respondent may be banned from acting in a compliance or supervisory position. CIRO may appoint a compliance monitor. A fine may be appropriate in cases requiring a general condemnation of misconduct. A temporary suspension is appropriate in the following cases: Many serious breaches have occurred. Potential exists for further misconduct. The respondent has a history of discipline. An element of criminal activity exists. Harm has been caused to the integrity of the industry. A permanent suspension is reserved for the most egregious cases where the public has been abused, the respondent is ungovernable, there is an element of criminal activity, or the respondent seems unable or unwilling to act honestly in his or her dealings with the public. CIRO considers any internal disciplinary action taken by the dealer member and any corrective measures taken by the respondent and the firm by way of mitigation. In cases where the dealer member has taken appropriate internal disciplinary action, CIRO may limit its sanctions to a public reprimand. CIRO WHISTLEBLOWER SERVICE CIRO’s whistleblower service is designed to protect people who report any suspicion or evidence of noncompliant activity. The service facilitates “prompt and effective action on reported first-hand knowledge or tangible evidence of potential systemic wrongdoing, potential securities frauds, or unethical behaviour by individuals or firms in the investment industry”. Whistleblowers have access to a toll-free number and an email address published on the CIRO website. A whistleblower team at CIRO assesses whistleblower tips and takes appropriate action. More information about the whistleblower program is available in CIRO Notice 09-0157. MARKET REGULATION INVESTIGATIONS BY CIRO CIRO electronically monitors all trading activity on Canadian marketplaces that have contracted with it, including the TSX, the CSE, and various alternative trading systems operated by CIRO dealer members. Marketplaces other than the exchanges must have a regulation services provider under the ATS Rule NI 23–101. If concerns arise during monitoring, such as unusual volume or price movements, a preliminary review is conducted to determine whether a violation has occurred. In the course of this review, CIRO collects trading information to determine various facts including which clients conducted specific trades. It can require dealer members to provide other information to determine details such as which person within a dealer member knew of pending deals and when the person knew the information. © CANADIAN SECURITIES INSTITUTE  CHAPTER 15      REGULATORY INVESTIGATIONS 15 15 Many of these reviews result in no finding of improper trading and are closed without notice to the dealer member. However, dealer members should make sure that the enquiries are monitored. Compliance or trading supervision staff should also ask about trading that appears questionable. Particularly, they should ask whether anyone at the firm had confidential information about an issuer, whether any clients are connected with an issuer, or whether the firm does a large percentage of the trading in the security. Because of jurisdictional issues, CIRO refers certain matters to other regulators. Matters related to corporate governance, director suitability, and listed company or manager misconduct are referred to the exchange on which the company is listed, as are repeated disclosure failures and breaches of exchange rules. Insider trading matters are referred to the appropriate provincial securities regulatory authority or criminal authorities. Cases involving Participant misconduct, by either the dealer member or a registrant, are referred to CIRO’s Investigation and Enforcement Division for further investigation and discipline. Investigations can also arise from a complaint, through an audit by CIRO, from conduct identified by CIRO market surveillance, or through a referral by another regulator. CIRO can also halt trading in the shares of a listed company to prevent further violations and to protect the public interest. A trading halt ensures that all investors have the same timely access to material information regarding the issuer. Halts are usually temporary and are meant to allow for the dissemination of announcements by issuers. If trading must be halted for a longer period, it is suspended. Dealer members are prohibited from trading in issuers that are halted, suspended, or cease traded, and penalties may result from continued trading. After an investigation is complete, CIRO’s enforcement counsel can close the matter, issue a warning letter, or proceed with disciplinary action. If the matter is minor or isolated, it may be resolved by sending a warning letter to the dealer member, or, in some cases, to the employee with a copy to the firm. Warning letters are kept on file and may be considered by CIRO in the event of future misconduct. If a matter proceeds to a disciplinary hearing, it can be resolved either through a settlement agreement or a hearing, as described above. In either event, a Notice of Hearing is issued. MONTREAL EXCHANGE/BOURSE DE MONTRÉAL Investigations by the Montreal Exchange relate to non-agricultural derivatives trading conducted on that exchange and are similar to those initiated by CIRO. Such investigations are confidential, and information regarding the investigation (even the fact that it is occurring) cannot be disclosed except by the exchange, if it is deemed to be in the public interest. INVESTIGATIONS BY POLICE FORCES The RCMP and other Canadian police forces conduct investigations that usually involve fraud and similar Criminal Code violations. A criminal investigation may involve interviews by police, as well as warrants that authorize the police to search and seize documentation. A dealer member that receives a search warrant should contact counsel immediately. Those people executing the warrant must comply with its limits, and a record should be kept of the documents that are seized. Employees should be instructed to cooperate; beyond that, they should be given no authority to discuss the matter with regulators unless they are required to do so. If any seized documents are thought to be privileged (and therefore not subject to a search), this fact should be stated and a request made that the documents be sealed. This will allow counsel to try to assert privilege and thus prevent the documents from being reviewed. © CANADIAN SECURITIES INSTITUTE 15 16 CHIEF COMPLIANCE OFFICERS QUALIFYING EXAMINATION      SECTION 5 FOREIGN REGULATORS Information required by foreign investigators is generally provided through a securities regulatory authority, in accordance with a memorandum of understanding, between the regulatory authority and the foreign investigator. Foreign investigators have in some cases approached dealer members directly to seek information. In such cases, the demand for information should be forwarded to CIRO, who then contacts the foreign investigator and may seek the required information on the foreign investigator’s behalf. HANDLING EXTERNAL INVESTIGATIONS 3 | Explain how to handle external investigations. Dealer members should handle external investigations according to the following four-step guideline: 1. Establish timelines When planning to provide information to an investigator, it is important to establish timelines with the investigator. A regulator often allows an extension of time when the request is reasonable. The investigator may also have a preferred way of receiving the information. 2. Secure information After receiving a request for information, immediate steps must be taken to locate and secure the sources of information. 3. Identify potential Compliance attention should be given to the supervision of an employee under compliance investigation. A broader internal investigation may have to be conducted than that problems being made by the investigator. 4. Obtain legal advice It is appropriate to ask for legal advice when an external investigation is occurring, especially if a dealer member has concerns about its rights or position. It is reasonable to cooperate with an investigation while still alerting counsel to ensure that existing rights are protected. EXAMPLE CIRO makes multiple requests from a dealer member for various documents relating to securities distribution at the firm. The requests all relate to the activities of a former employee. The dealer member asks for an extension to allow time to collect the documentation. The investigator agrees because of the large volume of information involved. For the same reason, he asks to have it sent in electronic format rather than a hard copy. After receiving the request for information, the dealer member acts immediately to locate everything CIRO has asked for. Because the case involves a former employee, that employee’s computer hard drive and office files are quickly secured. Throughout the investigation, the dealer member cooperates willingly but retains legal counsel to ensure that its rights are protected throughout the process. Independent of the CIRO investigation, the dealer member decides to conduct an internal review of its underwriting business to make sure that any potential misconduct is limited to the former employee, and that business is otherwise being conducted properly. © CANADIAN SECURITIES INSTITUTE  CHAPTER 15      REGULATORY INVESTIGATIONS 15 17 SUMMARY In this chapter, we discussed the types of situations that might require an internal or external investigation and explained the processes involved in the different types of investigations. We discussed that a dealer member conducts an internal investigation, review, or audit in response to a breach of its own policies and procedures, or of the rules of the SRO or other legislation. We also discussed that both the IDPC rules and UMIR have specific requirements regarding internal investigations. A point that is often overlooked is that compliance departments review numerous issues as they arise, but not all issues require an internal investigation. It is therefore important that the dealer member have a policy stating the types of issues that require an investigation. Otherwise, CIRO is likely to assume that the firm erred by omission when an investigation does not occur. In discussing internal investigation guidelines, we briefly touched on solicitor–client privilege. For a more in-depth explanation of this topic, you can revisit Chapter 11: Client Complaints. We also explained the process for conducting an employee interview during an internal investigation, which is to (a) identify the interview subjects, (b) choose the setting, (c) conduct the interview, (d) present the conclusions, (e) disclose the findings to the employee, and (f) impose discipline. Two important points to remember is that coercion is not acceptable and that the employee has the right to have a representative present during the interview. We also discussed that violations by dealer members or registrants may result in external investigations by one or more regulators, including the securities regulatory authorities, CIRO, the police, and foreign regulators. Police investigations usually involve fraud and similar Criminal Code violations. In discussing the different types of investigations, we covered the process for CIRO dealer member investigations and how it varies somewhat from its market regulation investigations. In many respects, however, they are similar, particularly in regard to the settlement agreement and hearing processes. Finally, we discussed the process for handling external investigations, which is to (a) establish timelines, (b) secure information, (c) identify potential compliance problems, and (d) obtain legal advice. In the next chapter – the final chapter in this course – we discuss the reporting obligations of both the dealer member generally and the CCO specifically. These requirements go hand-in-hand with investigations and are articulated clearly by CIRO and other regulatory bodies. © CANADIAN SECURITIES INSTITUTE