Written by Alan Gardner, Amanda McLachlan, Douglas Fenton and Maya Bretgoltz
In Ontario Securities Commission v. Tiffin, 2020 ONCA 217, the Court of Appeal for Ontario has adopted a broad approach to what constitutes a "security" within the meaning of the Securities Act, R.S.O. 1990 c. S. 5. In rejecting the application of the "family resemblance" test—which has been used in the United States and other jurisdictions to narrow the definition of a "security" under applicable securities laws —the Ontario Court of Appeal has affirmed that the intention of the Securities Act is to capture a broad range of financial instruments, including relatively informal "promissory notes" issued to family, friends and business associates. The Court of Appeal's decision also stands as a reminder of the potentially significant penalties that may be imposed for violations of the Securities Act.
Daniel Tiffin was a financial advisor. He sold insurance investment products through his company, Tiffin Financial Corporation (TFC). In 2009, the Ontario Securities Commission issued a cease-trade order (the Order) against Mr. Tiffin and TFC as a result of their involvement in a foreign exchange trading investment scheme. The Commission's Order prohibited Mr. Tiffin and TFC from trading in securities, and from relying on any exemptions under Ontario securities law, for a period of five years.
While the Order was still in effect, Mr. Tiffin borrowed $700,000 from friends and former clients, and issued promissory notes from TLC to evidence the loans. Before issuing the promissory notes, Mr. Tiffin told the noteholders about the Commission's prior proceedings against him, and that he was prohibited from trading in securities while the Order remained in effect.
When the Commission discovered the transactions, it charged Mr. Tiffin and TLC with three offences under section 122 of the Securities Act—namely, (1) trading in securities while prohibited under a cease trade order; (2) trading in securities without registration; and (3) distributing securities without filing a prospectus. The common basis for all three offences was that the promissory notes were "securities" within the meaning of the Securities Act.
Trial Decision: Ontario Securities Commission v. Tiffin, 2016 ONCJ 543
The only issue at trial in the Ontario Court of Justice was whether the promissory notes were "securities" within the meaning of the Securities Act.
The trial judge accepted that the intention of the Securities Act was to provide for a "catch and exclude" regime—intentionally designed to capture a broad range of transactions and then provide statutory exemptions to the requirement to register with the Commission before trading in securities in specific circumstances.
However, the trial judge held that to find that the promissory notes were "securities" within the meaning of the Securities Act would cast too wide a net. In reaching this conclusion, the trial judge adopted and applied the "family resemblance" test formulated by the Supreme Court of the United States in Reeves v. Ernst & Young (1990), 494 U.S. 56 to determine what constitutes a "security" under the United States Securities Exchange Act of 1934. In particular, the trial judge concluded that the promissory notes were not "securities" because they were similar to notes secured by a lien on a small business or its assets, which had been identified in Reeves as one "family" of recognized non-security notes.
As a result, the trial judge acquitted Mr. Tiffin and TLC of all three charges.
The Appeal to the Superior Court of Justice: Ontario Securities Commission v. Tiffin, 2018 ONSC 3047 & 2018 ONSC 5419
The Commission appealed to the Ontario Superior Court of Justice. On appeal, Justice Charney of the Superior Court held that the trial judge had erred by applying the "family resemblance" test to exclude the promissory notes from the ambit of the Act.
The court found that the term "security" had been defined in the Securities Act to capture a broad range of financial instruments. This reflected a deliberate policy choice by the legislature that should not be interfered with absent a constitutional challenge. The court also held that it was inappropriate to import the "family resemblance" test into Ontario securities law, because of the significant differences in the Ontario and United States' securities regulatory regimes.
The court ultimately found that the promissory notes were "securities" under the Securities Act. Remarkably, it then sentenced Mr. Tiffin to six months' imprisonment and directed him to make full restitution for the aggregate value of the promissory notes.
Ontario Court of Appeal's Decision
The Promissory Notes are Securities under the Securities Act
On appeal, the Court of Appeal affirmed (2020 ONCA 217) that the promissory notes were "securities" within the meaning of the Securities Act.
Writing for the Court, Harvison Young J.A. concluded that the promissory notes fit within the clause (e) of the definition of a security under the Securities Act—"a bond, debenture, note or other evidence of indebtedness". The Court declined to limit the definition of "security" using the "family resemblance" test set out in Reeves because in her view there were key structural differences between the securities regime in Ontario and the United States.
In this regard, the Court. affirmed that the Securities Act employs a "catch and exclude" regime: the Securities Act purposely defines certain key terms broadly to capture a wide range of instruments and activities, before providing exemptions carefully crafted to exclude more specific activates from the Securities Act's scope. In contrast, the Securities Exchange Act is drafted using exclusive language, intended to define a "security" in narrow and specific terms.
Moreover, the Court opined that the Securities Exchange Act is intended to regulate investments—not commercial instruments. For instance, short-term debt instruments are explicitly excluded from the definition of "security" under the Securities Exchange Act. As a result, the test in Reeves assists in only drawing a distinction between investments (which are subject to the regime) and commercial instruments (which are not).
According to the Court of Appeal, there is no indication that Ontario legislature intended to draw a similar distinction. Short-term debt instruments are captured within the definition of a "security" under the Securities Act. The Ontario securities regime provides for exemptions from the prohibition on issuing securities without a prospectus, in certain circumstances. This approach is generally indicative of the Securities Act's "catch and exclude" regime—narrow rules are enacted to exempt certain instruments from prospectus requirements.
The Court acknowledged that if it were not for the Order, Mr. Tiffin and TFC's conduct might have been exempted from the prospectus requirements in the Securities Act. However, the fact that an exemption was not available in these circumstances did not warrant narrowing the definition of "security" by importing a foreign test inconsistent with the scheme of the Securities Act.
The Court of Appeal, though it adopted the Superior Court's analysis, set aside Mr. Tiffin's six-month prison sentence, and instead directed that he serve a lengthy term of probation.
The Court clarified that while it may be appropriate to impose a term of imprisonment for regulatory offences in some circumstances (primarily to serve the goal of general deterrence), the sentence imposed must always be proportionate to the degree of responsibility of the offender and the gravity of the offence. However, the Court. did not go so far as to adopt Mr. Tiffin's submission that only "evasive and fraudulent" offences under the Securities Act warrant a term of imprisonment. The offender's intention in committing the violation of the Securities Act was only one of several relevant considerations in determining whether a term of imprisonment was appropriate in the circumstances.
In these circumstances, the Court. concluded that a six month prison sentence was demonstrably unfit because Mr. Tiffin had not attempted to deceive the noteholders. The absence of deceitful conduct was a unique mitigating factor that distinguished the case from precedent sentencing decisions in which a term of imprisonment was imposed. Mr. Tiffin had also acknowledged engaging in the conduct complained of, had effected restitution to the noteholders, and had expressed remorse for his conduct. This militated in favor of a reduced sentence.
The Court of Appeal's decision presents a number of important takeaways for capital market participants:
- The definition of "security" under the Securities Act is deliberately broad, and encompasses a wide range of instruments and transactions. Given the breadth of the definition, even sophisticated parties must pay close attention to whether a particular transaction would fall within the ambit of the Securities Act.
- In line with the "catch and exclude" scheme of the Act, a transaction may be exempt from the regulatory requirements of the Securities Act (i.e., to issue a prospectus prior to engaging in a distribution of securities or to register with the Commission before trading in securities) even if it is captured by the definition of a "security". A transaction may be exempt if it does not constitute a "trade", a "distribution" or otherwise falls within one of the prospectus exemptions provided under the applicable regulations.
- Contraventions of the Securities Act may lead to harsh penalties, including up to five years imprisonment. The Ontario Court of Appeal confirmed that it is not only evasive and fraudulent offences under the Securities Act that may warrant imprisonment, although market participants are cautioned to observe that Mr. Tiffin's avoided imprisonment because he did not deceive investors, acknowledged his conduct and effected restitution.
Given the breadth of the definition of a "security", it is important to seek legal advice before engaging in any transaction that might be subject to regulation under the Securities Act. If you or your business have any questions regarding a particular transaction or the requirements under the Securities Act, please contact a member of the Bennett Jones Securities Litigation group.