A year after issuing its ruling on the merits, the Ontario Securities Commission has handed down its decision on punishments for the former management team of Sino-Forest Corporation. On July 9, 2018, the Commission announced millions of dollars in penalties against the former executives, together with various other penalties that include lifetime bans from participating in the Canadian capital markets. The long-awaited decision discloses some of the most severe penalties ever ordered by the Commission and highlights the severity of the securities laws breaches. But it does not quite bring the now seven year-old saga to an end – the respondents have appealed the Commission’s decision on the merits of the case to the Ontario Divisional Court.

The case

The Panel began its reasons by summarizing the key finding of the decision of the panel who presided over the merits hearing (the Merits Panel) and underscoring the devastating consequences the respondents’ conduct was found to have had on investors:

the Merits Panel found that during the Material Time the respondents perpetrated one of the largest corporate frauds in Canadian history. With deliberate planning and foresight, the respondents constructed an elaborate and complex organizational structure that misled investors and resulted in the cumulative loss of CA $6 billion in equity market capitalization, separate and apart from losses affecting Sino-Forest's outstanding debt.

Indeed, the Merits Panel found that the fraud was extensive. It held that approximately 70% of the total timber holdings by hectare that investors were led to believe Sino-Forest owned and approximately 70% of the revenue the company recognized between 2007 and 2010 cannot be verified. The Panel found that Allen Chan, the Company’s former Chairman and CEO, “lied to the Board of Directors, the Audit Committee and E&Y about critical information which led to Sino-Forest’s inaccurate disclosure, which put Investors’ pecuniary interests at risk.”

The accusations of fraud levelled in the Muddy Waters report issued June 2011 set in motion a catastrophic downward spiral for the company. Once the largest forestry concern listed on the TSX, Sino-Forest rapidly came to be regarded by investors as nothing more than a house of cards, which ultimately collapsed under the force of a plummeting market capitalization, regulatory and law enforcement investigations (including an OSC cease-trade order), and class actions in Canada and the U.S. The company filed for CCAA protection in 2012.

Earlier this year, an Ontario lawsuit resulted in a separate civil judgment against Chan in favour of Sino-Forest’s litigation trust, with damages totalling $2.63-billion.

The sanctions decision

The Ontario Securities Act provides the Commission with broad powers to sanction respondents using a mix of administrative penalties, disgorgement orders and various prohibitions from participating in the capital markets. Sanctions must be preventative and protective, with a view to preventing likely future harm to Ontario’s markets. They are not intended to be punitive.

Notwithstanding these guiding principles, the effect of the sanctions, if not the intention, is undoubtedly to punish the respondents in this case. The Panel ordered Chan to pay an administrative penalty of $5-million and to disgorge more than $60-million that he received through beneficially-owned companies connected with Sino-Forest and from salary and bonuses during the relevant period. The other respondents were ordered to pay lesser amounts in administrative penalties and disgorgement, though these amounts still totalled several million each. In addition, each of the respondents is permanently banned from participating in Canadian capital markets, including by trading securities or acting as directors or officers. Given that the respondents are all foreign nationals, whether the Commission ever actually collects any of these amounts remains a matter of considerable doubt.

The Commission noted in its sanctions decision that “[t]he duplicity demonstrated by these respondents in their actions resulting in the collapse of Sino-Forest is among the most serious misconduct engaged in by respondents in Commission proceedings.” The steep penalties issued in this case reflect that view, and serve as a warning to other participants in Canada’s capital markets.