In the recent case of North American Financial Group Inc. v Ontario Securities Commission, 2018 ONSC 136, the Ontario Divisional Court dismissed an appeal by North American Financial Group Inc. and a number of related individuals charged with securities fraud. In its ruling, the Court upheld the significant monetary penalties levied by the OSC, despite the Appellants’ contentions of not having "pocketed" the amounts they had raised as a result of their fraudulent activities.

Background

The Appellants, North American Financial Group Inc. and North American Capital Inc. founded by brothers Alexander and Luigino Arconti were all named as defendants by the OSC in a securities fraud action. In a December 2013 decision, the OSC found that the Appellants had committed securities fraud on the basis of misrepresentation and failure to disclose.

Specifically, the Appellants made intentional misrepresentations to investors regarding the financial health of their companies, releasing a number of marketing brochures implying that their businesses were profitable, when in fact they were not. The appellants also were found to have failed to disclose to their investors that their funds would be used either in whole or in part to pay interest, dividends or principal to other investors – where in effect "new" investor money was used to pay "old" investors. This conduct, according to the OSC, amounted to acts of “deceit, falsehood or […] other fraudulent means”. In total, the Appellants were found to have raised almost $4 million from investors throughout the course of the fraud. Some of this amount went toward repaying the ‘old’ investors as well as to loans to North American Financial Group, which eventually became insolvent.

Following the finding of fraud, the OSC released a subsequent decision on sanctions, imposing lifetime trading bans, $3 million in disgorgement, and a further $2 million in penalties and costs. In the ruling, the Commissioner stated that it was his view that such sanctions were proportionate with respect to the conduct and circumstances of the Appellants. He went on to express that such penalties would deter the Appellants and other likeminded individuals from engaging in similar misconduct in the future.

Divisional Court upholds the sanctions imposed

In their appeal, the Appellants submitted that the penalties imposed were too harsh given the nature of their conduct. In particular, the Appellants contended that the disgorgement awarded should be based on the funds that went into their own “pockets”, as opposed to the amount that was lost by investors. In the OSC sanction decision, the Commission noted that under section 127(1) of the Securities Act, the Commission has the power to order disgorgement of amounts “obtained” as a result of the non-compliance with securities law, and the question is not, therefore, what profit was earned, but what amount was obtained from investors. The Commission therefore ordered disgorgement of the net amount obtained from investors (as noted above, some investors received distributions from funds contributed by other investors; this was a Ponzi scheme). The Appellants’ submission that the profit they made from the investors was far less than the amount obtained from investors, was found not to be pertinent.

The Divisional Court upheld the Commission’s decision. On the issue of disgorgement, the Court emphasised that the goal of sanctions is, among other things, to foster confidence in the capital markets. The proper “lens” is therefore the effect of the conduct on market participants, in particular innocent investors, rather than on the profit derived from the wrongdoing:

If the aim is to preserve confidence in the capital markets by ensuring that fraudulent behaviour does not occur as opposed to punishing those who commit fraud, there is less reason to focus on whether the fraudsters pocketed the money for themselves. What they did with the money does not lessen the seriousness of the effect of the behaviour when looked at through the framework of restoring confidence in the market. (at paragraph 218)

This case serves as a reminder that raising money through the capital markets through means that do not comply with Ontario securities law can have significant consequences. Since disgorgement is based on the harm caused to investors, rather than the benefit accruing to the wrongdoer, the wrongdoer may end up having to “disgorge” funds that did not in fact find their way into his pocket. Both the Commission and the Divisional Court were unsympathetic to the argument that this was disproportionate saying, in effect, that if you raise money through illicit means, you do so at your peril.