Behind the Crimes

Canada’s outdated financial regulation is incapable of dealing with today’s cyber-crime. Lawyers in the field are calling for an overhaul.
ANY COMPANY THAT HAS ever suffered embezzlement at the hands of an employee has run smack into Canada’s arcane maze of financial regulation, whether they know it or not. At Teva Canada Ltd., one of Canada’s largest generic pharmaceutical companies, they know it. Over three years, a former finance manager at Teva had systematically been defrauding the company by drafting false purchase orders using six entities for which he had set up five separate bank accounts.

They were either former, existing or fictitious customers with names very similar to real Teva customers. He sent the paperwork to accounts payable and, once they were authorized and mechanically signed, the cheques were sent back to him for distribution. Instead, he deposited them or cashed them using the accounts he had set up as sole proprietorships. The total amount of the fraud, according to court documents, was around $8 million and involved 63 cheques. When the fraud was discovered, he was fired.

Banks give customers a set amount of time to report forged or suspicious cheques, usually 30 or 60 days. The question is, who bears the loss on forged endorsements? Is it the company on whose account the cheques were fraudulently issued, or is it the bank where the fraudulent account was set up and that collected the cheques?

This winter, the Supreme Court of Canada is going to be tackling exactly that issue. Teva sued the banks for “conversion,” or the misappropriation of its property, as the employee and his accomplices were not entitled to the cheques. The banks counter-sued, arguing that the cheques were made out to payees who were non-existent or fictitious, as defined under the Bills of Exchange Act, which allows them to treat the cheque as though it were payable to bearer. The Ontario Superior Court sided with Teva, the Ontario Court of Appeal with the banks. The Supreme Court is hearing the case in February.

It’s a perfect illustration of how arcane and out of step some of Canada’s financial regulations are, says Martin Sclisizzi, a banking litigator at Borden Ladner Gervais LLP. The Canadian Bills of Exchange Act is modelled “almost word for word” on the 1882 British act of the same name. The only difference between them, he says, is “the English have actually updated it from time to time. Our legislation has not been even tinkered with in 150 years and it is completely out of touch with the reality of cheque clearing.”

Where that really comes into play is cheque fraud, says Sclisizzi (who is acting in Teva for Bank of Nova Scotia). “There’s been a massive increase in cheque fraud. Why anybody would ever want to rob a bank with a gun these days is beyond me because it’s so easy to do it with a pen.” Academics and banking lawyers believe the legislation needs to be brought into the 21st century, but Sclisizzi says, “This is for legislators, for Parliament to fix, which will probably never happen. Parliament’s not interested in that kind of stuff.”

FEW PEOPLE ARE INTERESTED in wading into the labyrinth of financial regulation unless something goes terribly wrong. There are huge numbers of regulations, and a “whole slew” of regulatory instruments, governing the nitty gritty of bank regulation with respect to particular products, says Mahmud Jamal, a litigator at Osler, Hoskin & Harcourt LLP. To list them would not only cause eyestrain, but eye glaze. The important thing to know is they all fall under the federal Bank Act, and are policed by the Financial Consumer Agency of Canada.

What Parliament is interested in wading into, however, is where banking hits Canadian retail customers. Very interested, in fact. The thing is, the provinces also have their own consumer protection acts, and Ottawa and the provinces already bump heads over whose rules apply and when. Sometimes it’s both. Jamal says there’s “an extraordinary amount of regulation” around consumer protection, particularly as it relates to banks and payment or credit cards. “There’s also an extraordinary amount of litigation,” he adds, affecting consumers across the country.

As it stands, much of the consumer litigation — especially the class actions — against the banks is filed under provincial statutes. Jamal, for example, is currently involved in a class action in BC over whether bank-issued, pre-loaded payment cards are subject to provincial consumer-protection legislation as well as the Bank Act. There are consequences, he says, for the obligations in disclosure and “the remedies and the fees that can be charged.” The case was denied certification, but is on appeal. In Quebec, meanwhile, a class action was started alleging several big banks, and some other large companies, breached the Québec Consumer Protection Act’s negative-billing provision by marketing credit cards that would waive the annual fee for the first year.

So here’s where it gets really interesting: Ottawa is getting ready to rumble. The last two budgets have talked about beefing up federal powers to fill in the gaps in federal regulations with regard to retail customers. The 2016 budget document, the Liberal’s first, reiterated that amendments to the Bank Act will be proposed “to modernize the financial consumer protection framework by clarifying and enhancing consumer protection through a new chapter in the Act.” The budget stated the amendments will “reaffirm the government’s intent to have a system of exclusive rules” to ensure an efficient national banking system from coast to coast to coast.

If Ottawa enacts the amendments it’s describing (and it’s working on this in conjunction with the provinces), Jamal says the end result — consumer protection in banking — will be exclusively federal terrain. “What they’re saying is, ‘We’re going to work with the provinces, but this patchwork that exists currently, whereby some provincial laws apply and some federal laws apply — we’re not having that. We’re going to change it to an exclusively federal system.’”

Will the provinces hand off their right to regulate how the banks treat retail clients in their home jurisdiction without a fight? While Ottawa might have paramountcy on its side — which says in any federal-provincial conflict of law, federal law trumps — Jamal believes the federal government won’t take over consumer protection, even in banking, without a substantial Constitutional battle. “If the government’s saying it’s going in to occupy a space currently occupied by the provinces, I expect there will be litigation.”

In the meantime, he says, the issue is being watched closely by both the plaintiffs’ and defendants’ Bar. “The plaintiffs because they may see it as creating new opportunities for litigation, and the defence Bar because it may give them additional grounds for defence in some of these consumer-protection class actions.”

THE BANK ACT, COMPREHENSIVE as it is, can run up against equally powerful federal statutes such as the Competition Act that affect financial institutions. In a reported case, Paul Morrison, a senior partner in the litigation group at McCarthy Tétrault LLP, defended Bank of Nova Scotia before the Competition Tribunal, the specialty court for competition challenges, in an abuse-of-dominance case. An entrepreneur wanted to start something like a small PayPal but with a twist: he designed a system for people “who wanted to hide the payment.”

He needed a banking facility in order to run his business, though. Normally, if someone applies for a payment facility and the bank has those facilities, it is obliged by regulation to provide them. The man claimed that the bank was abusing its market position by denying him. The bank argued that he had designed a system to provide secret payment, “especially in the online gambling world,” which risked putting it offside its anti-money laundering obligations.

So the obligation to provide payment facilities ran smack into its “really serious obligations” in the money-laundering area, says Morrison, who has acted for all the big banks. “That’s really where the tension was in the case.”

But there can be tension in any case brought against a bank, he says, because defence litigators sometimes have to fight with one hand tied behind their back. Take the “open-market defence” under which a regular business can argue it’s just doing what is permitted to compete in a free market if it decides to raise or lower prices or flood the market with a certain product.

Morrison says that is very possibly off limits when defending a bank because the regulators might say, “Wait a minute, it’s not an entirely open market. We regulate you, and you’re subject to this restriction and that restriction, and don’t tell me you’re entitled to do this because I, your regulator, say you’re not entitled.” So Canada’s banks are very much restricted in their ability to put that forward as a defence because of the regulatory structure.

He says even the business-judgment rule available to most listed companies — the presumption that the directors acted on an informed basis, in good faith and the action taken was in the best interests of the company — an apple-pie defence for publicly traded corporations, is subject to regulatory restrictions and may be out of bounds for the banking litigators in some cases.

Canada’s big banks are also very much affected by privacy and securities regulations and anti-money-laundering provisions, says Duncan Boswell, a banking and commercial litigator at Gowling WLG International Ltd. Privacy is a huge concern because of the potential for class-action litigation. Boswell points to Evans v. Bank of Nova Scotia, the first class action arising out of a privacy breach to be certified in Ontario. The case started when a bank employee provided clients’ private information to his girlfriend. The concern was that it was being used for identity theft. Scotia responded “fantastically,” got out in front of it, notified all the people who were affected and provided them with assistance. They also provided the appropriate remedies for people whose identities had actually been stolen. They helped them get things back to where they should be and paid for it all.

Those people should have been outside the class, says Boswell, who wonders whether there should still be a certified class of people who were affected but unharmed? The court said, “Well done, bank, but we’re still going to certify it because we don’t know if there will be any damages from the invasion of privacy going forward.”

Banks, by virtue of being large listed corporations with very deep pockets, and bound by masses of regulation, are just going to keep attracting more and more imaginative litigation, Boswell and others say.

While embezzlement is no doubt as old as business itself, in the fast-paced digital age, issues involving hacking, privacy and cybersecurity are going to keep coming at financial institutions faster and faster. While some of the regulations circumscribing the lawyers who defend financial institutions are arcane, some are contemporary and others just developing. One thing is for sure: banking litigators will be looking to the courts and to Parliament to see if they can keep up.