If investors think they’re less likely to get bilked by investing in companies traded on Canada’s main stock exchange, they should think again.
A soon-to-be published study commissioned by the CFA Institute and conducted at York University’s Schulich School of Business has found that there were more litigated securities fraud cases involving TSX-listed companies than there were for companies listed on the TSX Venture Exchange between 2005 and 2011.
Douglas Cumming, one of the study’s authors, said he was surprised that there were fewer frauds detected on the junior exchange compared with the senior market.
“That was definitely not what we expected in Canada.”
The study is the first of its kind to break down the number of fraud cases by stock exchange. Cumming noted there’s no easy way for investors on any exchange in Canada, the U.S. or the U.K. to determine the number of frauds occurring on their respective exchanges.
In Canada, the Canadian Securities Administrators recently began listing fraud as a category within its 2012 annual enforcement report, but the organization doesn’t break out where the frauds originated. It took Cumming and his team of six MBA students an entire summer to collect and compile the data from the various regulators for their study.
“It was very time-consuming to gather this information. Nowhere can you find statistics that report fraud on an exchange-by-exchange basis. We think that’s quite useful information,” said Cumming. “Certainly, it would help people decide where to allocate their capital and the associated risks.”
On the TSX, the largest category of fraud was non-financial fraudulent misrepresentation and disclosure followed by financial fraud, illegal distribution and one litigated case of insider trading.
On the TSX Venture Exchange, illegal distribution of shares and financial fraud were the two largest fraud categories followed by fraudulent misrepresentation.
The U.K. followed the Canadian pattern with more cases involving companies listed on the country’s main board, the London Stock Exchange, than on the junior Alternative Investment Market.
By comparison, the number of litigated frauds in the U.S. was highest on the non-regulated Pink Sheets, followed by the Nasdaq and the New York Stock Exchange (NYSE).
Jim Allen, the CFA’s head of capital markets policy, said the study’s results confirmed their expectations that smaller companies would have more problems in the U.S. But he said it was surprising that was not the case in Canada or the U.K.
Cumming warned, however, that, given the relatively low number of litigated frauds in both countries, the results underestimate securities fraud in Canada and the U.K.
According to the study, there were 3,037 litigated frauds between 2005 and 2011 in the U.S. on the three exchanges analyzed in the study but only 48 in Canada and 49 in the U.K. in the same period of time.
“Having such a low rate of fraud in Canada could infer that Canadians are super-ethical,” Cumming said sardonically. “But more realistically, more needs to be done in Canada to detect fraud.”
Toronto-based independent forensic auditor Al Rosen of Rosen and Associates agreed.
“Ninety per cent aren’t reported,” he said. “There is this feeling in Canada that you are safe. You don’t have anything to worry about, and it’s not just so. A lot of our cases are foreign people who have come to Canada because they know we are stupid. They know we won’t prosecute; we won’t even investigate.”
He said the low number of litigated frauds is “a matter of where the bucks are” with lawyers having to consider if it’s worth pursing and if there is a strong enough chance of winning a favourable decision.
Rosen added that part of the problem is that investors must clear a host of high legal hurdles to try to get some of their money back. The primary way investors pursue fraudsters is through class-action lawsuits, which can take years, even decades to resolve.
Brent MacLean, a Vancouver associate counsel at Davis LLP, said there are also liability caps against issuers for claims of secondary market trading fraud of $1 million or 5% of a company’s market capitalization, whichever is greater.
“This is small potatoes compared [with] similar U.S. class-action claims.”
The BC Securities Commission (BCSC) launched its criminal investigations team in 2007. But its success rate has been equally low. According to the BCSC, provincial Crown counsel has laid charges in only 26 cases over the past seven years. Two dozen people have been formally charged and only 10 have been convicted.
Stuart Morrow, a Vancouver partner at Davis, noted that even if investors win a favourable decision, they might still not get any money because the perpetrators are bankrupt.
“Evaluating your potential for recovery is an essential precondition to initiating litigation.”
National securities regulator needed to protect investors
Cummins suggests having a national securities regulator would help simplify the process for cheated investors. Morrow noted that the CSA has done a good job in terms of preserving and protecting provincial interests and the maintenance of healthy capital markets. But “where effective action against securities perpetrators is concerned, one single national body would be more effective.”
Added MacLean, “The SEC [the U.S. Securities and Exchange Commission] has much more substantial powers to commence commercial litigation than our provincial securities commissions do by a long shot to protect investors.”
Morrow pointed out that increasing help for bilked investors requires far greater federal and provincial political will than exists today.
But Rosen said that before politicians do anything about Canada’s securities laws, investors have to “wake up.”
“We’ve got a system in Canada that is so backward, it’s beyond belief. And yet, Canadians are willing to believe they are protected. It’s exasperating. Canadians are too trusting of the system they have. There are people who think Canadians are easy prey. They just know Canadians are gullible.”
