Backgrounder

Federal Strategy to Deter Serious Capital Market Fraud

Maintaining investor confidence in Canada's publicly traded companies and capital markets is a crucial element of sustained economic growth. Investor confidence in Canada's capital markets has suffered following corporate scandals in the United States, such as Enron and WorldCom in 2001-2002. Strengthening enforcement and legislation - ensuring individuals and companies that violate the public trust must face punishments consistent with the seriousness of the violation - is an important element of efforts to bolster confidence in Canada's capital markets.

In Canada, enforcement of laws governing corporate and securities activities is a shared responsibility, involving the federal government, provincial governments, and securities regulators. In this context, the federal government works closely with the provinces, market regulators, law enforcement and industry to ensure the integrity of Canada's financial markets. However, in the wake of recent corporate scandals in the U.S. and elsewhere, the federal government would like to ensure that this work not only continues, but is significantly strengthened.

Effective efforts to deter serious capital market fraud depend on four critical pillars, namely:

• Legal framework: A strong legal framework is required to provide appropriate sanctions for capital market fraud activity, and the necessary tools for investigators and prosecutors to take enforcement actions against such activity.
• Investigations: Enforcement actions relating to capital market fraud requires dedicated teams of highly qualified investigative personnel possessing specialized knowledge of financial markets and securities.
• Prosecutions: Prosecutors must have the appropriate resources to pursue cases in a timely manner. Cases potentially impacting investor confidence require immediate and sustained attention given the possible widespread economic impact.
• Sentencing: There must be appropriate sentencing of perpetrators of corporate fraud and market illegality, proportionate to the crime committed. The risk of significant legal sanctions can provide a real deterrent effect.

The federal government's proposed coordinated strategy to strengthen enforcement and legislation against serious capital markets fraud is based on strengthening these four pillars and enhancing the linkages among them by:

• Expanding the resources dedicated to investigating serious cases of capital market fraud. Integrated Market Enforcement Teams (IMETs) will be established in the key financial centres of Canada;
• Providing additional resources to support prosecutions of capital market fraud offences under the Criminal Code;
• Proposing legislative amendments to the Criminal Code that would create new offences and evidence-gathering tools, toughen sentencing, and establish concurrent jurisdiction with the provinces in the prosecution of serious cases of capital market fraud.

INTEGRATED MARKET ENFORCEMENT TEAMS (IMETs)

The Integrated Market Enforcement Teams initiative will strengthen the law enforcement community's ability to detect, investigate and deter capital markets fraud by focusing resources on the investigation and prosecution of the most serious corporate frauds and market illegalities. By sending the message that those who commit serious capital markets fraud offences will be brought to justice in an effective and timely fashion, this initiative will promote compliance with the law in the corporate community, and assure investors that Canada's markets are safe and secure.

The RCMP and federal partners will receive up to $30 million a year, over the next five years, to create up to nine integrated enforcement teams composed of police, lawyers and other investigative experts in Canada's four major financial centers: Toronto, Vancouver, Montreal and Calgary. The teams will be jointly managed by the Royal Canadian Mounted Police, Justice Canada and other partner departments and agencies, and will work closely with securities regulators and additional federal and provincial authorities - building on the RCMP's existing partnerships with these organizations.

Police officers chosen for IMET work will be highly qualified financial investigators. The RCMP will ensure that these investigators receive additional markets-related training, are kept abreast of the latest techniques and legal developments in their field, and are dedicated to the teams for specified periods of time. Investigators will receive ongoing advice from legal advisors from the Federal Prosecution Service.

Three teams, two in Toronto and one in Vancouver, will be established by March 31, 2004, with the creation of three additional teams in Toronto, Montreal and Calgary within the following year. All teams will have a presence in the key financial districts of these cities. The teams will incorporate a quick-start capability, allowing them to respond swiftly to major corporate frauds and market irregularities anywhere in Canada. Effective management and accountability mechanisms will be a key feature of the initiative.

LEGISLATIVE AMENDMENTS

Proposed reforms to the Criminal Code to strengthen enforcement and legislation addressing capital markets fraud respond to commitments made in the 2002 Speech from the Throne and the 2003 Budget.

How is the law being changed?

Current fraud provisions in the Criminal Code have been used effectively across a broad range of cases, including those involving capital markets fraud. But by introducing new offences, evidence-gathering techniques and sentencing provisions and by forging stronger partnerships with provincial counterparts, the Government of Canada is going further to deter criminal activity in Canada's capital markets.

New Offences

When employees of corporations and others use their access to privileged information that is not available to other investors in order to benefit themselves, investor confidence can be seriously undermined. The personal savings of individual investors can also be severely harmed. A new Criminal Code offence would be created to address this practice, commonly known as "insider trading," and would carry a maximum penalty of 10 years imprisonment. While improper insider trading is currently prohibited under provincial securities law and the Canada Business Corporations Act, the new Criminal Code offence would be used for cases that merit the more severe responses available through the criminal law.

Employees who inform or assist law enforcement officials in investigating cases of capital markets fraud also need protection from employment-related intimidation. Often these individuals play a pivotal role in exposing corporate scandals, but can face threats - including action taken against their employment or livelihood - designed to deter them from cooperating with the police. A new offence of employment-related threats or retaliation would encourage insiders to cooperate with law enforcement and punish those who retaliate against or threaten them. This offence would carry a maximum sentence of five years imprisonment.

Tougher Sentencing

To strengthen the penalties for cases of capital markets fraud and to help ensure that the punishment matches the seriousness of the crime, the proposed reforms would increase the maximum sentences for existing fraud offences and establish aggravating factors for courts to take into consideration at sentencing.

Maximum sentences would be raised from 10 years' to 14 years' imprisonment for current Criminal Code offences of fraud and fraud affecting the public market. The maximum prison term for fraudulent manipulation of stock exchange transactions would rise from five to 10 years.

The proposed reforms would also include adding a list of specific aggravating factors that would permit the court to impose harsher penalties for more serious offences. Factors, such as the extent of economic damage caused or negative effect on investor confidence or the stability of the market, could result in increased penalties. Moreover, a person's reputation and status in the community or workplace, which are traditionally used as mitigating factors to lower penalties, would be inapplicable in cases where those who commit serious capital markets fraud rely on these very factors to carry out their crimes.

Improved Evidence Gathering

Under the proposed reforms, production orders would be added to the Criminal Code, allowing investigators to obtain pertinent documents or data from third parties (those not under investigation) within a specified time period. These orders would be similar to search warrants but more efficient during investigations and less disruptive for the holder of the documents or data. Production orders, which already exist in some Canadian legislation, in particular the Competition Act, would:

• compel the custodian of data to produce information within a specified period of time in order to avoid lengthy delays in the investigation. Failure to comply could result in being charged with a summary conviction offence with a term not exceeding six months and/or a fine (maximum $250,000);
• ensure that information can be gathered when it is held outside the country but still under the control of a custodian of data in Canada, to address the increase in offshore data storage; and
• help to safeguard the privacy of those who hold the information, by allowing them to produce the information themselves rather than police, who might otherwise be forced to search through unrelated material.

When a production order is issued, rigorous safeguards would be in place - in particular, the right under the Canadian Charter of Rights and Freedoms not to be subject to unreasonable searches or seizures. Those who receive an order can also object, making an application to the court, to producing information on a number of grounds, including if the information is privileged or protected from disclosure, or because it is not in their possession or control.

A "general" production order would require a person, other than the individual under investigation, to produce information. In order to issue the order, a judge or justice must be satisfied that there are reasonable grounds to believe an offence has been committed, that the specific documents or data will produce relevant evidence, and that the recipient of the order has possession or control of these documents or data.

A "specific" production order would be issued in similar circumstances to a general production order but would be limited to specific types of information for which there is a lower expectation of privacy. For example, general details related to bank accounts, such as the name of an account holder or type and status of an account, could be obtained through a specific production order. This type of order, with a narrower scope, would only apply to financial institutions and other groups specified in the legislation.

While production orders would be of particular use when gathering evidence to prosecute serious cases of capital markets fraud, they could apply more generally to other Criminal Code offences. For example, the proposed legislation provides for a business to produce video surveillance tapes that may have recorded a criminal act, such as assault. Similarly, the production of shipping records from a port authority could help identify a drug smuggler.

Creating Strong Partnerships to Prosecute

Major cases of capital markets fraud have national and sometimes international impact on the economies of Canada and other countries. As a result, a strong enforcement approach is needed at the national level to strengthen the investigation and prosecution of serious capital market fraud cases. Under the proposed reforms, the Attorney General of Canada would exercise concurrent jurisdiction, with the provinces, to prosecute certain fraud-related offences in the Criminal Code, including the proposed insider-trading offence. Federal involvement would be limited to a narrow range of cases that threaten the national interest in the integrity of capital markets.

In order to help ensure proper coordination, the Government of Canada will work with the provinces to establish prosecution protocols that would ensure a coordinated and effective implementation of concurrent jurisdiction.

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June 2003