A rarely used enforcement tool that helped recover US$6-million in losses from an online trading company offers a glimpse into the future of investor restitution, says the head of enforcement of Canada’s newly merged investment regulator.
Currently, the Canadian Investment Regulatory Organization, or CIRO, does not have the power to return funds directly to harmed investors, even when the regulator orders a company to give up profits it earned because of wrongful conduct. Rather, the self-regulatory organization directs all monetary fines and repayment of ill-gotten profits – known as disgorgement – into a restricted fund. The money in the fund can only be used for a handful of reasons listed in CIRO’s rules, such as investor education and research projects.
But in a recent disciplinary hearing, Vancouver-based Fortrade Canada Ltd. accepted a settlement agreement with CIRO in which, among other remedial measures, the online trading company agreed to establish a US$6-million compensation fund to directly return money to harmed investors.
CIRO alleged the online brokerage broke regulatory rules by making investment recommendations to clients, including soliciting clients for market “opportunities” over the phone and providing predictions on a particular company. CIRO also alleged Fortrade failed to establish and maintain a supervisory system, and failed to retain adequate records to demonstrate compliance, as required by CIRO rules.
Fortrade was the first company to set up a compensation fund as part of a CIRO settlement agreement. A compensation fund must be agreed upon by both parties in order for CIRO to include one in its remedial measures.
CIRO hopes to progress its enforcement powers even further, says Elsa Renzella, CIRO’s senior vice-president of enforcement and registration. The organization is currently reviewing its rule book to amend how it can distribute disgorged funds, including reimbursing harmed investors.
Disgorged funds are typically money that investment companies or individuals received through unethical or illegal business transactions. Right now, those amounts are collected in a restricted fund, along with other amounts collected from enforcement proceedings, such as fines or settlements. The restricted fund currently does not permit payouts to harmed investors.
“Fortrade is just the preamble to what we hope will be a much stronger investor protection framework where we will not have to rely on companies to be the ones exchanging money,” Ms. Renzella said in an interview.
The investigation into Fortrade began in September, 2021, after CIRO received several client complaints about stock recommendations.
Under CIRO rules, discount brokers – referred to as order-execution-only firms – are prohibited from providing advice to clients.
However, CIRO found that from December, 2020, to July, 2022, Fortrade agents made recommendations in e-mails and telephone calls. CIRO says the agents also engaged in other “improper communication” with clients, including “encouraging or persuading” clients to deposit funds into their trading accounts to complete trades based on the recommendations the agents provided.
The majority of Fortrade’s clients hold accounts to trade “contracts for differences,” or CFDs, which are a complex, high-risk product that allows an investor to speculate on whether the price of the underlying asset will increase or decrease, without owning the underlying asset.
According to CIRO, the majority of Fortrade’s clients were unsophisticated investors with annual incomes of less than $50,000 who had limited trading knowledge.
In November, 2022, after listening to recorded calls between Fortrade agents and clients, CIRO placed a temporary order on the company halting it from opening any new client accounts or adding any new deposits into existing client accounts.
“That was a big accomplishment for us, to be able to use this temporary order, which gave us some breathing room to investigate but at the same time be pro-active and stop the harm at least on its face as we saw it,” Ms. Renzella said.
It was the first time CIRO has used the temporary order – which had been incorporated as a rule in 2016 – as well as the first case in which a compensation fund formed part of the sanction terms in a settlement.
In addition to the US$6-million compensation fund, Fortrade agreed to pay a $2-million fine and another US$703,478 to clients who had outstanding unresolved complaints as of July, 2023.
“The compensation fund was something we hadn’t done in the past, but I think the circumstances that presented itself through a joint discussion with the company made for a good case to take those monies the company had clearly benefited from and redirect it to the harmed investor,” Ms. Renzella said.
In February, 2023, CIRO published a proposal for public comment that would permit disgorged funds collected by the regulator to be paid out directly to harmed investors. CIRO would require approval from its board’s governance committee and the Canadian Securities Administrators in order to implement such a program.
If approved, the measure will provide CIRO with more power in investor restitution. CIRO is still reviewing the proposal, along with the public comment letters it received last summer.
“The goal is to find the right solutions and the appropriate cases so that we can effectively get money into the hands of clients, recognizing that the approach may differ with each case,” Ms. Renzella added.
Clare O’Hara