Ontario Court of Justice

Date: August 31, 2016

Between:

ONTARIO SECURITIES COMMISSION

— AND —

DANIEL TIFFIN and TIFFIN FINANCIAL CORPORATION

JUDGMENT

Before: Justice Joseph F. Kenkel

Delivered: August 31st, 2016

Counsel:

• Mr. Jonathan Feasby, for the Ontario Securities Commission
• Mr. Glen Jennings and Mr. Alex Zavaglia, for the defendants

KENKEL J.:

Introduction

[1] Mr. Tiffin and his company Tiffin Financial Corporation (TFC) issued 14 interest bearing promissory notes to investment clients to a total value of $700,000. They are now charged with three breaches of the Securities Act RSO 1990 c S.5:

1. Trading in securities without being registered s.122(1)(c)
2. Trading in securities without filing a prospectus s.122(1)(c)
3. Trading in securities while prohibited s.122(1)(c)

[2] Mr. Tiffin and TFC admit that they were not registered to trade in securities, did not file a prospectus in relation to these transactions and at the material time were prohibited from trading in securities by order of the Ontario Securities Commission.

[3] The sole issue at trial – were these promissory notes simple private loan agreements not subject to the Securities Act or were they securities as defined by that statute?

Background

[4] Mr. Tiffin is a financial advisor licensed to sell insurance and insurance-based investments through TFC. Tiffin is the sole officer, director and owner of TFC. He had been registered with the Ontario Securities Commission (OSC) to trade in securities from 1983 to 1999 but at the time these promissory notes were issued he was subject to a "Cease Trade Order" (CTO) issued by the Commission.

[5] A temporary Cease Trade Order was issued on December 22, 2009 in relation to promissory notes issued in relation to the Rezwealth Financial Services Inc. (Rezwealth) investment scheme which purported to engage in foreign exchange (FX) trading. The promissory notes were traded by TFC and Tiffin.

[6] On July 8, 2014 the OSC issued its final decision and order in the Rezwealth proceedings. The sanctions against Tiffin and TFC for issuing and trading in Rezwealth included five year prohibitions on trading in securities or relying on exemptions in Ontario securities law. In addition, the Rezwealth Final Order imposed an administrative penalty of $25,000 and disgorgement of $517,000 in proceeds. Funds are "disgorged" to the OSC by order of the Commission but are then typically redistributed to the investors. The final order prohibited Tiffin and TFC from trading in securities or relying upon any exemption in Ontario securities law.

[7] Following those financial penalties Mr. Tiffin solicited funds from his insurance investment clients for personal use and to keep his business operating. He told them about the OSC investigation and order and the impact on his finances. Six clients agreed to loan funds to TFC on terms set out in promissory notes. The notes were signed by Tiffin on behalf of TFC.

[8] All funds received for the promissory notes were deposited into TFC's corporate account. Funds from that account were disbursed "for general business purposes" and to cover Mr. Tiffin's personal expenses.

The TFC Promissory Notes

[9] Six clients agreed to advance funds to TFC on terms set out in fourteen promissory notes. The notes were signed by Tiffin on behalf of TFC. The total value of funds obtained was $700,000.

[10] Twelve of the fourteen notes require that TFC pay principal and a single interest payment on a given maturity date. The interest on the notes ranges from 10% to 25% on the one year term.

[11] The notes state:

9. Lender and Borrower intend that the relationship created an [sic] evidenced by this note shall be solely that of debtor and creditor. Nothing in this Note shall be construed as creating a joint venture, partnership, tenancy in common, or joint tenancy between Lender and Borrower.

[12] The notes all refer to the Securities Act: "This note shall utilize the accredited investor exemption available in Ontario has [sic] modified from time to time by the Ontario Securities Commission."

[13] All funds received for the promissory notes were deposited into TFC's corporate account. Funds from that account were disbursed "for general business purposes" and to cover Mr. Tiffin's personal expenses.

The Position of the OSC

[14] The Commission submits that the Securities Act uses a "catch then exclude" system of regulation where the term "security" is defined broadly so as to capture most transactions. Statutory exemptions are then crafted to remove transactions that policy does not justify regulating and the Commission has the authority to grant further discretionary exemptions upon application. The Commission points to the broad definition of "security" in s.1(1) of the Act as consistent with this view.

[15] The OSC submits that promissory notes meet four or more statutory definitions of security including:

• 1(1)(a) any document known as a security
• 1(1)(e) a bond … note or other evidence of indebtedness …
• 1(1)(n) any investment contract

[16] The OSC submits that the broad definition in s.1(1)(e) including "…note or other evidence of indebtedness …" captures virtually all forms of debt instruments. Promissory notes have been found to be securities under this act and similar provisions of other provincial securities acts by the Supreme Court, and by trial courts in this province.

[17] While the Act captures all commercial debt transactions, the legislature has set out statutory exemptions that limit the application of securities law in keeping with the goals set out in the Act. In that context the Commission submits the question is not whether a particular transaction is a security, but whether it is an exempt security. The Commission submits that these TFC notes do not fall under any statutory exemption and that reference to American securities cases is unnecessary given Ontario's statutory framework. In the alternative, even under the US test the TFC notes meet the definition of security.

The Position of the Defendant

[18] The defence submits that the scope of the Securities Act is necessarily limited by the twin purposes set out in s.1.1. Neither of those goals would be advanced if securities law were to be applied to this private debt transaction. The defence submits that the "catch then exclude" theory of the Commission is overbroad.

[19] Courts have developed numerous tests over the years to determine whether a particular instrument that meets one of the broad statutory definitions of security is in fact a security. The common thread in all of these cases is the notion of the instrument as an investment. This is consistent with the statutory mandate to protect "investors" and "capital markets". Securities law was not meant to displace other legal regimes that govern commercial transactions including contract and tort law.

[20] The evidence at trial shows that the TFC promissory notes were understood by the parties to be loans to the accused through his business. They were secured against assets of the business and carried no expectation of gain or loss based on the fortune of the business. To apply securities law in this context is contrary to the purposes of the Act.

Burden of Proof

[21] Securities offences are strict liability offences. The prosecution must prove the accused committed the prohibited act alleged beyond a reasonable doubt. Where the prosecution proves the prohibited act to that standard the defence may raise a defence of due diligence. The accused may be relieved of liability if he or she shows on the balance of probabilities that they took all reasonable care to avoid committing the prohibited act or operated under a mistake of fact.

Are Promissory Notes Securities?

[22] A purposive reading of the Securities Act begins with the twin goals of the Act set out in s.1.1:

a) to provide protection to investors from unfair, improper or fraudulent practices; and

b) to foster fair and efficient capital markets and confidence in capital markets

[23] The Securities Act is remedial legislation that should be given a broad construction, read in the context of the economic realities to which it is addressed.

[24] Section 1(1) of the Securities Act sets out a very broad definition of "security". In Ontario Securities Commission v. Pacific Coast Coin Exchange Ltd., [1977] SCJ No. 117 the Supreme Court of Canada commented on the scope of that definition:

If any doubt could be entertained about the intention of the legislature … that doubt should be dispelled by the very wide terms employed in defining the word "security". The fourteen subdivisions of the definition encompass practically all types of transactions to such an extent that this definition had to be narrowed down by a long list of exceptions.

[25] The present Securities Act sets out 16 branches to the definition of "security" in s.1(1).

[26] The defence concedes and I agree that promissory notes can be securities under one or more of the headings cited by the Commission. The reference to "note or other evidence of indebtedness" effectively includes all forms of debt instruments issued by any issuer.

[27] Both parties agree that the Securities Act was not meant to regulate all promissory notes. The OSC submits that the legislature has crafted exemptions in the Act and by adopting National Instruments as rules under the Act that provide exemptions for promissory notes in particular circumstances. The OSC submits that the statutory scheme is complete. Promissory notes meet the wide definition of securities and if they're not specifically excluded by the Act or regulation then they are "securities" within the meaning of the Act.

[28] The defence submits that the Commission's approach casts too wide a net and is inconsistent with the purposes of the Act. The defence submits that this court should adopt the "Family Resemblance Test" established by the US Supreme Court in Reves v. Ernst & Young, 494 US 56 (1990).

Are the TFC Promissory Notes Securities?

[29] The US Securities Act of 1933 and the Securities Exchange Act of 1934 both contain broad definitions of "security" in similar terms to Ontario's Securities Act. US courts have developed numerous tests to determine whether ever-changing commercial transactions fit those broad statutory definitions. For example, in SEC v. Howey, 328 US 293 (1946) the Supreme Court considered the term, "investment contract" and held that the term required proof of: 1) an investment of money, 2) in a common enterprise, 3) with an expectation of profit, 4) where profits come solely from the efforts of others. The court disregarded the form of the instrument in question and looked instead to the substance of the transaction. The Howey test was adopted and cited by the Supreme Court of Canada in the Pacific Coast case.

[30] Notes are part of the definition of "security" in the US Acts, but given the wide non-investment commercial use of notes courts there have not found all notes to be securities. Consideration of many different types of promissory notes in this context gave rise to multiple legal tests to the point where, "the status of note instruments under the Securities Acts …perplexed Federal Courts." The issue was settled in Reves v. Ernst & Young where the US Supreme Court applied the "Family Resemblance Test" to determine whether a note was an investment that should come under the regulation of the Act. Under that test a note is presumed to be a security unless it bears a strong resemblance, determined by examining four specified factors, to one of a judicially crafted list of categories of instrument that are not securities. The court explained that the phrase, "any note" could not be given a literal interpretation considering the wide variety of notes used in the commercial context, but must be read against the backdrop of what Congress intended to accomplish in the Securities Acts. Included in the family of non-securities are notes secured against an asset of a small business.

[31] Reves was adopted and applied by the British Columbia Court of Appeal in BCSC v. Gill, 2003 BCCA 169. In that case the court applied the Family Resemblance Test to the phrase, "other evidence of indebtedness" in the definition of security in the BC Securities Act. (The phrase "other evidence of indebtedness" is also part of the same definition section (e) as "note" in the Ontario Act – "… not or other evidence of indebtedness"). The court found that loans which the parties called "personal loans" were actually intended as investments and therefore met the statutory definition of security. The court looked at the substance of the transaction not just the stated form.

[32] The OSC submits that while courts have developed tests to determine whether an instrument meets a general statutory definition such as, "investment contract", no such test is required in this case. Promissory notes plainly meet one or more of the statutory definitions of security. While the definitions are very broad, further restriction by a court-created test is not necessary given the exemptions in the Act and regulations.

[33] The fact of exemptions isn't necessarily sufficient to distinguish the US cases as there are similar exemptions in the US legislation and regulatory scheme. The point does appear to apply to the BC Act although BC provides exemptions through National Instruments and elsewhere in the regulatory scheme.

[34] The Commission submits the fact that US courts have not applied the literal interpretation of broad terms such as "note" may result from unique wording used in the introduction to their statutory definitions which states, "When used in this Chapter, unless the context otherwise requires." The US Supreme Court did not rely on that wording though when they rejected strict literal interpretation in Reves. Instead they were concerned with overreach, that deeming all notes "securities" would be unjustified.

Unlike "stock," "note" may now be viewed as a relatively broad term that encompasses instruments with widely varying characteristics, depending on whether issued in a consumer context, as commercial paper, or in some other investment context. While common stock is the quintessence of a security, and investors therefore justifiably assume that a sale of stock is covered by the Securities Acts, the same simply cannot be said of notes, which are used in a variety of settings, not all of which involve investments. Thus, the phrase "any note" should not be interpreted to mean literally "any note," but must be understood against the backdrop of what Congress was attempting to accomplish in enacting the Securities Acts.

[35] The BC Court of Appeal adopted that reasoning in Gill.

[36] In Pacific Coast Chief Justice Laskin started his dissent by noting that it was otherwise agreed in that case that the term, "investment contract" could not be given a literal meaning, "because to do so would bring within the scope of the Securities Act innumerable transactions which have no public aspect." He also warned:

It is easy, in a case like the present one, when faced with a widely-approved regulatory statute embodying a policy of protection of the investing public against fraudulent or beguilingly misleading investment schemes, attractively packaged, to give broad undefined terms a broad meaning so as to bring doubtful schemes within the regulatory authority. Yet if the Legislature, in an area as managed and controlled as security trading has deliberately chosen not to define a term which, admittedly, embraces different kinds of transactions, of which some are innocent, and prefers to rest on generality, I see no reason of policy why Courts should be oversolicitous in resolving doubt in enlargement of the scope of the statutory control.

[37] I agree with the Commission that the ordinary meaning of the statutory definitions in s.2 of the Act is presumed to be the meaning intended by the legislature. However, the terms must also be read in context. In particular, the interpretation of such broad terms must be consistent with the twin goals of the Act in s.1.1. The literal interpretation of "note" or other s.1 terms in this case conflicts with the s.1.1 goals of the Act which do not seek to regulate all such commercial or private transactions but rather seek to provide protection to investors from unfair, improper or fraudulent practices; and to foster fair and efficient capital markets and confidence in capital markets.

[38] Literal interpretation focuses on the form with no inquiry into the substance of the agreement. That's contrary to the approach in Pacific Coin where the majority of the Supreme Court held that, "Substance, not form, is the governing factor" in interpreting Ontario's Securities Act. It's contrary to the approach taken by the BC Court of Appeal in Gill. Substance over form has been a consistent theme in securities law.

[39] I agree with both parties that the definition of "security" in s.1 of the Act is necessarily broad as the legislature cannot anticipate all of the potential transactions that may be crafted over time that might reasonably meet the s.1.1 criteria for securities regulation. However, applying the same reasoning to exemptions, it's likewise not possible for the legislature to anticipate all of the potential transactions that would not meet the s.1.1 criteria.

[40] The Commission submits that any overreach flowing from a literal interpretation is corrected by statutory exemptions such that the regime as a whole meets the goals of s.1.1. As the defence notes, the exemptions in sections 25, 34, 35, 73, 74 of the Securities Act and National Instrument 45-106 are far from comprehensive and still capture transactions such as this one which are private loans unrelated to capital markets or consumer protection.

[41] I agree with the OSC that the legislative scheme is fairly characterized as "catch and exclude" but I disagree that exclusions are found only in the statute or regulations. Courts have looked at the broad terms defining security and they've looked at the substance of the particular transaction at issue to determine whether applying the statutory term in that context is in keeping with the purposes of the Act. The non-literal approach applied to the interpretation of "investment contract" has been applied to other broad terms such as "note or evidence of indebtedness."

[42] In the past our courts have often referred to the extensive experience of the US courts in the area of securities law. The US Federal Courts have spent many years analyzing the difficult issue of promissory notes in this context within a similar legislative scheme. The highest level Canadian court to have considered this issue applied the Reves approach and I find it appropriate to do so here.

[43] The US statutes define "security" as including "any note" just like the Ontario Act. The Reves test begins with that presumption – that every note is a security. That presumption is consistent with the legislative approach in section 1 of our Securities Act.

[44] That presumption can be rebutted by reference to a general list of notes, referred to in the decision as a "family" of notes, that have been held not to be securities. Aside from the listed notes, other notes can be evaluated as to whether they resemble securities or exempt notes based on the following list of factors:

1. Whether the borrower's motivation is to raise money for general business use and whether the lender's motivation is to make a profit.

2. Whether the borrower's plan of distribution of the note resembles "common trading for speculation or investment".

3. Whether the investing public reasonably expects that the note is a security.

4. Whether there is a regulatory scheme that protects the investor other than securities laws.

[45] The exempt family of notes in Reves includes notes secured by a lien on a small business or some of its assets. The TFC notes for that small business are secured by property of the business as collateral.

[46] The Reves court mentioned "correcting for the seller's cash-flow difficulties" as a circumstance where a note is less likely to be security. While the borrower TFC was seeking money for general business use and the lenders were expecting profit in the form of interest, there was no sense of investment or interest in the TFC business beyond the limited terms of the loan. The TFC notes contain some elements of a security on this criteria.

[47] The loans were secured from existing customers, most of whom considered Mr. Tiffin a friend. In contrast with many of the cases cited by the Commission where promissory notes were found to be securities, there was no general public solicitation of funds or wider distribution. The fact that there were a small number of loans from existing friends without any wider distribution tends to show that the TFC notes were not securities.

[48] The evidence of the lenders at trial showed that all of them viewed the transaction as a loan and not an investment. There's no allegation that Mr. Tiffin made any misrepresentations that induced the lenders to misunderstand the nature of the transactions. Some lenders even appeared to resent state interference in what they viewed as a personal matter. While the views of the parties are not necessarily determinative, this branch of the test supports the view that the TFC notes are not securities.

[49] Contract and tort law apply should TFC and Mr. Tiffin fail to repay the loans. The loan contracts are enforceable like any other commercial contact. The lenders have the added protection of collateral for the loan. The absence of collateral was an important factor in Reves indicating that the transaction was an investment related to the fortunes of the company and not a loan. Collateral is a "risk reducing factor" not typical of securities investments. The defence further submits that the security interest in property in the TFC notes could be registered under the PPSA. The fact of collateral as a risk reducing factor which also gives rise to effective enforcement of the loan agreements without resort to securities regulation also favours the defence position that the TFC notes are not securities.

[50] Beyond the Reves factors, I've considered further circumstances particular to these notes. Even though the parties to the notes described them as personal loans, the notes were made payable to TFC Financial Corporation. Daniel Tiffin is the sole shareholder and director of TFC and appears to operate his financial affairs through that company for tax reasons. He stated in his voluntary interview that he had no personal bank account at the time and he appears to have used the TFC accounts for all purposes. TFC owned the toy soldier collection that was the collateral for the loan. I find the fact that TFC issued the notes in these circumstances is not inconsistent with the defence assertion and the evidence from the parties that they were not meant to be securities.

[51] Paragraph 11 of the TFC notes makes reference to "accredited investor" which is a direct reference to securities law. On its face that would appear to be a strong indication that the notes were meant to subject to securities regulation. Although the TFC notes were drafted by a lawyer, this provision seems to be similar in part to the Rezwealth promissory notes which were held to be securities. However, there was much more to the Rezwealth notes, they were 18 pages long. The TFC promissory notes are 3 pages long and the accredited investor reference appears completely out of context. The evidence shows no party to the loans relied upon that exception and Mr. Tiffin's lawyer knew he was not able to engage that exception. I agree with the defence that the references to "accredited investor" don't make sense in context and appear to have been the result along with other examples of reckless drafting and editing by Mr. Tiffin's solicitor.

Conclusion

[52] I find that the TFC notes are presumptively securities under the Securities Act, but the defence has shown that these notes do not meet the overall statutory definition of "security". An examination of the four Reves factors shows that the TFC notes are similar to notes secured by a lien on a small business or its assets, one of the "family" of recognized non-security notes in Reves. Neither the statutory goals in s.1.1 of the Act nor the circumstances of the particular transactions require that these promissory note loan agreements be regulated as securities.

[53] The charges are dismissed.

[54] I wish to thank Mr. Feasby and Mr. Jennings for their help throughout. Their very thorough written submissions were of great assistance as was their patient and detailed response to the court's request for further written submissions. This was advocacy at its best and most effective. I ask both counsel to convey my thanks as well to those assisting them for all the work that was done to present such a focused securities case.

Delivered at Newmarket August 31st, 2016

Justice Joseph F. Kenkel