In Hung et al v Ontario (Securities Commission), 2019 ONSC 3423, the Divisional Court dismissed an appeal brought by four senior officers of Sino-Forest Corporation (the Appellants) in one of Canada’s largest frauds in history. The Appellants sought to set aside the decision on the merits of a panel of the Ontario Securities Commission (OSC) dated July 13, 2017 (Merits Decision), and set aside or amend the decision of a second Panel on sanctions dated July 9, 2018 (Sanctions Decision). In the alternative, the Appellants sought to remit the matter back to the Commission for rehearing with respect to both decisions.
As discussed in our previous commentary, the OSC Panel found that the Appellants, among others, engaged in deceitful and dishonest conduct related to Sino-Forest’s standing timber assets and revenues knowing they constituted fraud, contrary to s. 126.1 of the Ontario Securities Act (the Act).
The Concept of Guanxi and the Intention to Commit Fraud
One of the Appellants’ primary arguments on appeal was that the Merits Panel failed to consider Chinese business and cultural practices in deciding that some or all of the Appellants had the intention, or mens rea, to deceive and defraud Sino-Forest investors.
Specifically, the Appellants argued that the Chinese practice of guanxi, which refers to implicit reciprocal obligations to respond to favours, precluded the need to cement business arrangements in writing until a later time. The Appellants stated that “Favours like assisting a business counterpart establish a new company, signing agreements on behalf of business counterparts and providing assistance in fundraising are common favours known to guanxi. […] Against the backdrop of guanxi, written contracts do not have the same prominence in China.” As such, the Appellants submitted that Sino-Forest would, among others, enter into handshake deals for standing timber volumes and complete the paperwork afterward and backdate the date of the contracts.
After a long hearing, the Merits Panel concluded on the basis of considerable evidence that the Appellants knew investors’ financial interests were put at risk by their acts, whether or not those acts were done in accordance with Chinese cultural or business practices:
Sino-Forest was listed on the TSX, was an Ontario reporting issuer, raised US $3 billion of capital from Investors, and was required to issue financial statements prepared in accordance with Canadian generally accepted accounting principles. For the purposes of our analysis, Ontario securities law is paramount and overrides any explanations for illegal conduct being excusable in the name of guanxi, however it is defined.
The Divisional Court found this conclusion to be reasonable. It held that although cultural practices can explain the Appellants’ behaviour, they cannot excuse illegal acts. As senior executives, the Appellants had a responsibility to ensure that Sino-Forest complied with Ontario securities law. As the Court stated, “This responsibility overrides any other explanation for illegal conduct.”
Sanctions Decision
The Appellants also appealed the Sanctions Decision on the basis that the sanctions were unprecedented and excessive. The Commission ordered, among others, that:
- The Appellants permanently cease trading or acquiring securities;
- The Appellants resign and be permanently prohibited from becoming or acting as a director or officer of any issuer, registrant or investment fund manager; and
- The Appellants Chan, IP, Hung and Ho pay administrative penalties in the amount of $5,000,000; $2,650,000; $2,000,000; and $2,000,000 respectively.
The Divisional Court found that the Sanctions Decision was reasonable. Since the Commission has wide discretion to impose sanctions to protect investors and foster confidence in capital markets, and given the enormity of the fraud which included the fact that approximately 70% of Sino-Forest’s total timber holdings and revenue claimed between 2007 and 2010 could not be realized, the Divisional Court held that there was no principled basis upon which the Court should interfere with the sanctions imposed by the Panel.
Takeaways
- Cultural practices may explain behaviour, but they do not excuse acts contrary to securities legislation.
- Securities regulators have wide discretion to impose sanctions provided there is a principled reason for doing so.
The author would like to thank Tiana Corovic, Summer Law Student, for her contribution to this article.