A settlement agreement between the Alberta Securities Commission and a former senior officer of Edmonton-based CV Technologies Inc., the maker of cold and flu remedy COLD-fX, highlights some of the pitfalls of the settlement process.

In a settlement, the details of which were released on June 11, Paul Norman Oliver admitted he sold 417,500 shares of CV’s stock from his own account in late 2006 while in possession of material information that had not been disclosed to the public.

At the time, the company was in the middle of an aggressive and expensive marketing campaign to distribute COLD-fX in the U.S. Former NHL star Mark Messier had been hired as the company’s U.S. pitchman. Hopes were high. CV’s share price peaked at $4.46 that autumn.

Oliver admitted that by Dec. 14, 2006, he was aware that U.S. sales were not meeting internal forecasts, that significant product returns were expected from U.S. retailers and that marketing expenses were higher than anticipated.

Although this critical information had not yet been disclosed publicly, Oliver sold 417,500 shares the following week. According to Oliver’s insider-trading reports, he sold at an average price of $2.75 a share, for gross proceeds of $1.1 million.

At the end of that week, he stopped selling due to a company-imposed blackout. According to the agreement, the “material undisclosed information” was not revealed to the public until Feb. 8, 2007. By selling when he did, the agreement states, Oliver saved himself $250,000.

As punishment, the ASC has suspended Oliver from the Alberta securities market for one year and ordered him to pay a $375,000 fine and $25,000 in costs.

This raises several questions. The first is that the punishment does not appear to fit the offence. Assuming Oliver saved $250,000 by selling when he did, the $400,000 in fines and costs amount to a net out-of-pocket cost of only $150,000.

In Oliver’s favour, the settlement notes he was suffering from stress and fatigue due to job demands and a neurological condition; his sales were part of a preplanned liquidation; the sales were promptly reported; and he stopped selling on Dec. 22, 2006, when the company imposed a trading blackout. “Oliver’s breach of the act was unintentional and not dishonest,” the agreement states.

But it is difficult to square this conclusion with Oliver’s admission that he dumped more than $1 million worth of stock after receiving material undisclosed information. Alberta clearly views illegal insider trading as a serious offence. Under the Alberta Securities Act, the maximum fine for illegal insider trading, if the ASC takes the matter to a hearing, is $5 million per contravention. If the ASC takes the case to court, the maximum penalty is five years in jail and fines of up to $5 million per contravention. So, relative to the sanctions that could have been imposed, Oliver’s punishment amounts to a slap on the wrist.

The second problem is there is no indication of how the ASC calculated the $250,000 loss Oliver is said to have avoided by selling when he did. After the Feb. 8, 2007, release, the share price dropped to $2.27. On that basis, Oliver saved only $200,000 by selling when he did. So, where did the $250,000 figure come from?

“We can’t comment on anything beyond the settlement agreement,” says the ASC’s director of communications and investor education, Tamera Van Brunt.

The third problem is the Feb. 8, 2007, release did not disclose the “material undisclosed information,” as stated in the settlement agreement. On the contrary, that release reported a “robust” 33% increase in sales. It gave no indication that sales were not meeting internal forecasts, or that U.S. retailers were likely to return a significant quantity of unsold product for refunds.

The first public indication U.S. sales were not going well came on March 26, 2007, when CV announced that U.S. retailers were likely to return a lot of product, which “could have a serious impact on the company’s cash position and working capital.” At that point, the share price fell by 48¢, or 20%, to $1.89. Using this as the date of full public disclosure, Oliver saved $357,000 by selling when he did. After paying his fine of $400,000, he was out of pocket by just $43,000.

But even this does not appear to be the appropriate date. On April 11, 2007, CV announced it would restate financial results for the fiscal year ended Sept. 30, 2006, and the first quarter of fiscal 2007 to account for U.S. returns. At this juncture, the share price declined by 6% to $1.38. Using this as the disclosure date, Oliver saved $570,000 by selling when he did, which means he actually made $170,000 (after paying his fines and costs) by selling illegally into the market.

@page_break@But even by this date, it was not clear what the restated figures would show. This was worrisome, not only to investors but also to regulators. On April 19, 2007, the British Columbia, Ontario and Alberta securities commissions imposed cease-trade orders. Clearly, regulators — including ASC enforcement staff — were not willing to let the stock continue trading until the damage had been fully quantified.

For the next thee months, the stock was in limbo. On June 14, 2007, the restated financials were released. The results were brutal. More than $8 million in earlier reported U.S. sales were reversed, wreaking havoc on CV’s bottom line.

Several days later, on June 22, 2007, the ASC lifted its cease-trade order; but trading did not resume until July 11, 2007. This was the first day that public shareholders could trade with full disclosure of all material information. The share price immediately dropped to $1.25. Using this as the end date, Oliver saved $624,000 by selling when he did. After subtracting his $400,000 penalty, he netted $224,000 from his insider-trading breaches.

Despite questions concerning the $250,000 savings, neither ASC enforcement director John Petch nor ASC chairman Bill Rice would discuss the matter, which highlights two problems with settlement agreements.

For one, the settlements are the product of secret, backroom negotiations, usually between lawyers. There is an understanding that nobody will deviate from — or elaborate on — the script. Even if the settlement is riddled with deficiencies and inconsistencies, no reporter or member of the public can get an explanation. This makes it crucial that regulators get it right.

However, the chance of getting it right is reduced by the fact that settlement agreements in Alberta are not reviewed or ratified by an ASC tribunal, as they are at the Ontario Securities Commission. This lack of accountability to a higher authority may contribute to illogical, erroneous and, ultimately, counterproductive settlements.

This case also highlights the problem of regulatory deferral of enforcement matters to what is commonly called the “lead jurisdiction.”

If a shareholder in B.C. complains to the B.C. Securities Commission about CV, the BCSC will refer that complaint to the ASC because the company is located in Alberta. But the ASC is responsible only to Alberta residents. This lack of accountability to residents in other provinces compromises the system of regulatory deferral — and provides another argument for national regulation. IE