A trio of executives at a company that misled shareholders about a possible transaction — resulting in many of its preferred share investors opting to convert their holdings into common shares and giving up certain entitlements — have been sanctioned by Ontario’s Capital Markets Tribunal.
Last December, the tribunal found that the company, TeknoScan Systems Inc., its CFO and treasurer Philip Kai-Hing Kung, chairman Soon Foo (Martin) Tam, and president and CEO H. Samuel Hyams, breached securities rules in connection with a notice that was sent to shareholders. The notice disclosed that the company was negotiating a potential transaction with a strategic investor that would see it sell 50% of its common shares to the investor at an attractive valuation.
However, the notice failed to disclose that the funding for the deal was uncertain, and relied on unconventional, non-arm’s length funding arrangements. The panel ruled that this information was essential for preferred shareholders to make a decision about whether to convert their holdings to common shares so that they could participate in the deal.
“By omitting this information, the notice conveyed the false impression that funding for the share purchase transaction, which would be transformative and lucrative for shareholders, was secure,” the panel said.
Relying on the notice, 92.3% of preferred shareholders opted to convert their holdings into common shares, “forfeiting redemption, dividend and royalty rights attached to their preferred shares,” it noted.
The deficient disclosure amounted to securities fraud, the panel found — and, it said that the executives were liable for the company’s breach.
However, it dismissed allegations that the executives made misleading statements to shareholders, and rejected allegations that Kung and Hyams made misleading statements to the Ontario Securities Commission (OSC) during its investigation.
Now, the tribunal has handed down sanctions in the case, ordering that TeknoScan, Kung and Tam are permanently banned. Hyams was banned from trading for 20 years, and all three were permanently banned from registration. It also imposed $1.2 million in penalties — $450,000 on Kung, $350,000 on Tam, and $250,000 on Hyams, along with $150,000 against the company. In addition, the panel ordered $400,000 in costs — $100,000 against the company, and $300,000 against the three executives.
While the tribunal ordered the trading and registration bans sought by the OSC, the monetary sanctions were less than the regulator requested in the case. It asked for a $1 million penalty against Kung, $900,000 against Tam, $600,000 for Hyams and $600,000 for the company. It also asked for $572,949 in costs.
The tribunal noted that it reduced the costs award based on the fact that several allegations weren’t proven. It also opted for lower penalties after rejecting some of the OSC’s arguments about the harm inflicted by the breaches.
Among other things, the panel found that the fraud involved a single instance of disclosure, it wasn’t a series of frauds. It also found that the executives didn’t personally benefit from the misconduct.
“We find the argument about the avoidance of a potential balance sheet liability to be too remote and hypothetical,” it said. “We are not satisfied that the commission established a causal link between the fraud and the salaries and bonuses received by the individual respondents,” it added.
The panel also noted that, while fraud is the most egregious violation of securities law, this fraud wasn’t the worst type of fraud. “This is not a case, for example, of misappropriating the life savings of unsophisticated investors,” it said.
“Their fraud consisted of sending shareholders a notice that failed to indicate that uncertainty and instead conveyed that the funding was not an issue. The fraud would be more severe if the [transaction] had been a complete sham,’ the tribunal said.
In deciding on less severe monetary sanctions than the OSC requested, the panel said, “We believe that these penalties, together with the market participation bans … achieve both specific and general deterrence. It is not necessary or in the public interest to impose administrative penalties at the high end of the spectrum.”