It is most often the case that retail clients purchasing “exempt” securities are required to sign a subscription agreement in which they make certain promises (representations and warranties, in legalese) regarding their financial status. In most such agreements clients assert that they are “accredited investors,” as defined in the applicable national instrument.
As a general rule, the law provides (in the absence of unconscionable or illegal terms, very unusual circumstances or specific legal requirements), that a person’s signature or click on an “I accept” icon on a contract or other document is sufficient to bind the person to the agreement, regardless of whether the person read the document or understood it.
The necessity of such an approach is obvious. We simply do not have the time to read every contract or document we sign. Rightly or wrongly, we choose to believe that the contract is fair, especially where there is no opportunity or ability to negotiate a change to a standard form contract. Absent this willingness to sign blind, the lineups of customers reading every word and trying to negotiate minor or major changes to agreements would bring the economy to a halt.
As in life, there are many exceptions to this general rule, many of which are intended to protect the public from particularly egregious actions. One of these exceptions, of considerable importance to dealers and their representatives, is discussed below.
In a criminal prosecution of Maitland Capital Ltd. in 2010 relating to the alleged breach of a variety of provisions of the Securities Act (Ontario), an Ontario court made it abundantly clear that a signature alone on a subscription form for an exempt product in which a subscriber (purchaser) of securities makes representations and warranties as to his, her or its status (in this case, meeting the requirements to be considered an accredited investor) is not sufficient to be relied upon by a dealer, absent evidence of satisfactory due diligence being completed.
The decision states that it has been long established that the defendant dealer “must establish that he or she took all reasonable steps and made all reasonable inquiries to find out the correct information” [emphasis added].
Generally, in a criminal proceeding, it must be proven that the defendant committed the illegal act and had the intention to commit the act, to be convicted. In the Maitland case, there was no need to prove any intent to commit an illegal act; it was only necessary to prove that the illegal act took place — that Maitland had not obtained registration or a prospectus was not filed and receipted or exemptions from registration and prospectus requirements were improperly relied upon.
Maitland argued that a prospectus was not required, as all the purchasers had signed a subscription agreement in which each purchaser gave a representation that they met the requirements of being an “accredited investor.”
But the court held that the signature on the subscription was not enough to establish a defence of reasonable reliance on the accredited investor exemption; this defence was only available if the dealer could establish that reasonable due diligence had been undertaken with regard to the claim of purchasers that they were accredited investors.
Unfortunately, the court did not provide comprehensive guidance as to the steps necessary to meet the required standard of due diligence, as what is “reasonable” is likely to differ significantly depending on the specific circumstances.
However, the court made it clear that at least the following is required:
1. The subscription form must be signed by the purchaser before the transaction is entered into or consummated, regardless of any right to cancel the purchase with or without penalty.
2. A dealer/rep must make inquiries, and record the result of such inquiries, to establish that the representations and warranties given by an investor are supported by facts.
3. Wilful blindness or a failure to make a factual inquiry will kill any hope of raising the defence of “due diligence.”
4. One signature at the end of a lengthy document that includes the representations and warranties offers little or no protection to a dealer or representative who is the subject of a prosecution. If anything, it heightens the need to bring the representations and warranties to the specific attention of the investor.
One would think the court is effectively stating that the longer a document, the less likely it is that any portion — let alone the entire document — will be read, much less understood.
Dealers need to establish policies and procedures to ensure that a “reasonable” amount of due diligence is undertaken and the results are recorded when selling exempt securities or face the prospect of criminal conviction — with its attendant jail time and fines. IE
Richard Austin is Counsel to the Toronto office of Borden Ladner Gervais LLP. His practice focuses on the financial services industry, including dealer compliance.